CRE Construction Recovery May Gain Steam After Slow Start

Increases In Bank Lending, CMBS Expected To Boost Development Activity In 2014

August 28, 2013

A new report by Fitch Ratings predicts that the pace of new U.S. nonresidential construction will likely pick up headed into 2014, bolstering forecasts by CoStar Group economists during midyear economic reviews who expect modest rises in new supply for some commercial property segments. 

Another leading indicator for construction, the Architecture Billings Index (ABI), also shows that the building sector should see solid -- if still not exactly red-hot -- activity over the next 12 months. The ABI, compiled monthly by the American Institute of Architects (AIA), jumped more than a full point in July to 52.7, up from June’s 51.6 mark. 

In addition, AIA's new projects inquiry index was 66.7, up a dramatic 6.6% from the reading of 62.6 the previous month; any score above 50 indicates an increase in billings. 

Much of the new present and future construction activity in the commercial sector is largely the result of activity in a single sector -- the full pipeline of apartment and condominium projects in many markets. 

Overall in its report, Fitch is projecting private non-residential construction will grow just 2% in 2013, partly due to wet weather early in the year. Activity is slated to pick up in the second half and rise a stronger 5% in 2014 if weather permits. 

Financing and credit standards, while still constrained, are loosening up to a point, with some institutions beginning to lend with more frequency. Commercial mortgage-based securities (CMBS) issuance has also picked up, though the pace of originations is far below the record levels of 2007. 

"Institutions will continue to be selective in their lending activities in the near term, which will likely moderate growth in the commercial construction," said Fitch Ratings Director Robert Rulla. 

Public construction spending will remain flat this year and advance a modest 3% in 2014, with last year's passage of a new highway bill providing state and local governments with the certainty to plan projects, Fitch forecasts. However, "it will take some time to start larger, longer-term projects, so the benefits of the new highway bill will be more evident next year," said Rulla. 

Because of varying levels of demand across construction markets, building materials companies will see varying financial performance, with companies bearing exposure to the public infrastructure segment continuing to be challenged with still-weak construction spending trends. 

AIA Chief Economist Kermit Baker termed the upward trend in the billings index and other data "encouraging signs that the design and construction industry continues to improve. 

"But we also hear a wide mix of business conditions all over the country, ranging from outstanding and booming to slowly improving to flat," Baker said. "In fact, plenty of architecture firms are reporting very weak business conditions as well, so it is premature to declare the entire sector has entered an expansion phase." 

The rebound in construction employment is also spotty, with 201 of the 339 metro areas posting gains in July from last year, according to an analysis of labor data by the Associated General Contractors of America released Aug. 23. Job growth remained flat in 48 other metros and declined in 90 metros over the past year with 28 areas losing at least half of the employees they had at their peak, AGC chief economist Ken Simonson said. 

The Houston-Sugar Land-Baytown, TX metro area added 13,000 jobs, the largest number of construction jobs by a wide margin and a 7% increase over last year. Boston-Cambridge-Quincy, MA, saw and annual increase of 8,400 jobs or 15%; and Phoenix-Mesa-Glendale, AZ, rose 9%, adding 8,400 jobs. 

That said, the Phoenix market remains down 86,500 jobs and 47% from its July 2006 peak, and Las Vegas has lost 73,900 jobs lost since that month, a 67% plunge. Year-over-year, Riverside-San Bernardino-Ontario, CA, saw the largest decline, shedding 6,000 jobs in July for a 9% decrease.

By Randyl Drummer