The near term outlook for construction spending weakened again in the last month. The largest month-to-month decline in single-family construction spending in the ongoing housing recession dropped total construction spending 0.8% in October 2007, after several small monthly gains.

Several more small housing-driven declines in total spending now appear likely to finish out the year. Activity is now clearly slowing outside of new home construction. This results both from financing restraints that have spilled over from the subprime mortgage market and slimmer demand growth as the economy enters a two- to three-quarter period of GDP growth at about half of the average pace. Construction spending is projected to decline 2.3% this year, rise 4.2% next year and 9.2% in 2009.

Residential — Will Remain Below Underlying Demographic Demand
New residential construction spending is now forecast to drop 23.1% this year and a further 8.1% in 2008, although the monthly spending total will be growing slowly beginning early in the year. Spending for new rental apartments is increasing. The decline is dominated by single-family homes and condos. A 12.3% rise in spending is expected in 2009 but this will recoup less than 40% of the 2006 to 2008 decline. Residential construction will remain below the underlying demographic demand of 1.85 to 1.90 million units at least into 2010.

The virtual shutdown of the subprime mortgage and speculative housing markets set off the housing collapse and accounted for most of the decline in housing starts and residential construction spending from early 2006 until well into 2007. Last spring and summer, the continuing decline was dominated by tighter credit approval standards and by plunging home values, which restrained existing homeowners from trading up (or down). That negative impact continues and has now been joined by two new problems.

Homebuilders have cut the size of new homes and reduced the number of features included, such as granite countertops and flooring and landscape allowances. Construction spending is now declining faster than housing starts. Several months of declines in material and labor costs for homebuilders also contribute, although this is expected to persist for only a few more months. At the same time, housing demand is shrinking as consumers become increasingly concerned about income and job security in a period of slow economic growth.

At this late stage of the housing collapse, the housing recession is beginning to look more like the demand-collapse housing recessions in the 1970s, 1980s and 1990s. This means that the apparent Federal Reserve Board strategy of further cuts in interest costs will have a measurable positive impact on housing demand by mid-2008.

Non-residential Construction — A further 19% Gain Expected
Non-residential construction spending is up 56% since January 2004, with a further 19% gain expected by the end of 2009. However, the pace of growth is clearly slowing.

Growth peaked at an 18% annual rate from spring, 2006 through spring, 2007. It has now slipped to 15% in the second half of 2007 and will fall to 6% by the end of next year. Recent new project starts reported by Reed Construction Data confirm that the development pace is easing. The American Institute of Architects reports that design work at the pre-start phase is now expanding only slowly. Both financing difficulties and increased concerns about demand for buildings, when completed, are behind the turn to slower growth. Falling asset values in the commercial real estate market are also contributing.

The growth in construction spending for institutional buildings, as always, is peaking and then slowing one or two quarters later than for commercial buildings. The growth of tax receipts has slowed from the very high 2004 to 2005 pace and public budget reserves fell 15% in the last fiscal year, with a similar decline expected in the current fiscal year.

Short-term trends over a long business cycle are always hard to predict. However, it is increasingly likely that growth in non-residential starts and construction spending could weaken in the next six months and then, at least partially, recover when the impact of the late 2007 interest rate cuts hits by mid-2008.

Heavy/Engineering Construction — Expanding at 12% Annual Pace
Spending for heavy/engineering construction projects will continue expanding at about a 12% annual pace through 2009. Month-to-month changes, as always, will be erratic.

Water and sewer project starts were more than 20% above the 2004 high point in September, with this surge to gradually work into the monthly spending data over the next year. Offsetting this, highway project starts fell by more than a third in the last two months, but the impact has not yet hit the monthly spending totals.

Highway work is being held up by the delayed federal budget and the flat sales of fuel, measured by gallons not dollars, which is keeping the growth in highway trust funds well below the rise in project costs.

For more information, please see U.S. Construction Forecast Tables — Issued December 2007.

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