Monday, November 27, 2006

WaPo on Non-Residential Construction

by Bill McBride on 11/27/2006 12:25:00 AM

From the WaPo: Commercial Boom Softens Housing Bust

To understand why the housing slump hasn't dragged the economy into a recession, it helps to visit the Smoketown Plaza in Woodbridge, where the thumping of hammers signals the healthy pulse of a building boom that's still going strong.
[These commercial projects have boosted] non-residential construction enough over the past year to more than offset the decline in home construction. That boom is helping to cushion the impact of the housing slump on the economy.
The main reasons the housing bust hasn't dragged the economy into a recession yet, are: 1) there have been few layoffs in residential construction (they are coming), and 2) mortgage equity withdrawal (MEW) has still been strong (MEW will slow soon). The boom in non-residential construction has helped, but if the bust follows the typical pattern, the non-residential boom will end soon (or is already ending).
The money spent on private non-residential construction nationally rose a sizzling 19.2 percent over the 12 months that ended in September, according to Census data. In addition, state and local governments are building roads, schools and other public buildings. Public construction rose a robust 11.6 percent in the year ended in September.

Add it all up and the increase in non-residential work more than offset the 6.7 percent decline in home building over the same period, so the value of all construction rose a net 2.9 percent.
These YoY numbers are correct, but the picture is different if you look at the last 6 months. Total nominal private construction spending peaked in May, and has declined since then. Total construction spending, including public spending, peaked in June.
Builders of non-residential projects say they are simply playing catch-up. So many new neighborhoods filled up during the housing boom that they're still building the stores, offices, restaurants, bank branches, hotels and hospitals needed to serve the influx of residents.

In Prince William County, for example, the population surged by 23 percent in the past five years, during the peak of the home-building boom, to 374,678 people. Now, many residents complain they have to drive too far, often to Fairfax County, for basic business services.

The companies that provide those services "don't build until they see the rooftops" over new customers, said Bill Fairchild, president of R.W. Murray Co., a construction contractor in Manassas that's overseeing the Arby's on Minnieville Road and a dozen other non-residential projects in Northern Virginia. "People have got to get groceries. They've got to get their hair cut. They need to go to the cleaners."
From a previous post, but worth repeating: YoY Residential Investment typically leads YoY Non-residential investment by 3 to 5 quarters.

Click on graph for larger image.
This graph shows the YoY change in residential investment vs. nonresidential investment. As I noted in August: In general, residential investment leads nonresidential investment. There are periods when this observation doesn't hold - like '95 when residential investment fell and the growth of nonresidential investment remained strong.

Another interesting period was 2001 when nonresidential investment fell significantly more than residential investment. Obviously the fall in nonresidential investment was related to the bursting of the stock market bubble. But typically changes in residential investment lead changes in nonresidential investment, and GDP, by three to five quarters.

As the article noted, companies don't build non-residential projects "until they see the rooftops" - and that is why there has been a non-residential boom - about 3 to 5 quarters behind the final residential boom. But the analysis in the article didn't take the next step - what happens to non-residential construction 3 to 5 quarters after the residential construction bust? The graph above provides the likely answer.