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  • Construction Outlook Dismal

Economy

11 May 2009

Construction Outlook Dismal

  • By Bill Conerly
  • In Economy
  • 1 comment

A loyal reader asked about the outlook for construction.  Not good, unfortunately.  Residential activity will be limited by the current oversupply of housing.  That oversupply gets eliminated in a year or less–if you think of normal demand.  However, demand is not normal at this time.  People are taking roommates or living with their parents more than normal.  So we need to both work off the fundamental excess supply, then get demand back to normal.  And even then, financing will be difficult for developers, both because of lender nervousness and lack of equity on the part of developers.  Here's the picture:

Res

Non-residential real estate was not fundamentally overbuilt coming into the recession, but the recession certainly clobbered demand for office space, retail stores, industrial space, etc.  The demand for space will recover in pace with the overall economy, but construction will be slower to react due to financing constraints.  A great deal of permanent financing for non-residential real estate projects were from CMBS: commercial mortgage-backed securities.  That market has dried up as part of the investor reaction against securitization.  The other large source of funding is insurance companies, which are now able to cherry-pick applications, selecting on the highest returns and lowest risks.  The insurers are not able to ramp up their volume to generate all the funding necessary.  Banks can get in the "permanent" financing game with five year bullet loans.  (They cannot extend maturities longer for fear of interest rate risk.)  However, the banks are now stuck with plenty of bullet loans that cannot be rolled over, because of tighter loan-to-value standards now than five years ago.  More on that subject here.)  I think it will be a couple of years before the banks will loosen up on long-term commercial real estate loans.

Banks may be willing to make the short-term construction loans, but only if they can see the permanent financing in place.  And that's a real problem for commercial real estate.  So I take a gloomy attitude toward non-residential construction.

Nonres
Here's some room for optimism:  landlords will be in the catbird seat in two years.  Very little new supply coming on line, but a rising economy pushing occupancy up, then rents up.  This applies to both commercial and residential properties.  (On the residential side, the biggest imbalance will probably be traditional apartments, rather than urban condos or single family properties.)

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    Comments

  1. City Steel Buildings
    May 12, 2009

    The Economic Downturn has effected greatly and especially the construction business. Your observations are really insightful and useful.
    The effect on Residential Construction seems inevitable. Let’s hope the future years are more amiable.
    Regards,
    Kirk J. Steel
    http://www.citysteelbuildings.com/

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