Construction Spending Dips in January

By Dirk van Dijk

In January, total construction spending declined by 0.6% to a seasonally adjusted annual rate of 884.1 billion. That is 9.3% below the 974.3 billion rate of a year ago. However, residential construction spending actually rose by 1.1% on the month to an annual rate of $269.2 billion, although it is still 6.0% below the 286.4 pace of a year ago.

Just to make very clear, a year ago was not exactly boom times for the housing industry, which is where the vast bulk of residential construction spending goes. Thus, while it is nice to see a 1.1% increase on the month, things are still extremely depressed, and with the weak recent data on new home sales and housing starts, we could easily relapse into declines in the coming months.

However, things have been down so far for so long that it is more likely that we bump along at the bottom for awhile rather than face another major down leg in residential construction spending. Non-residential construction spending is a much bigger concern right now. In total it dropped to $615.0 billion annual rate in January, a 1.4% decline from December and 10.6% below a year ago.

Even that does not tell the full story, since construction spending is done both by the private sector and by the government. Almost all (but not all) of the government's construction spending is on the non-residential side. Private non-residential construction is just in the early stages of a collapse, with a 2.1% decline from December and down 19.9% year over year. Government spending on things like schools and highways has held up much better, with a 0.7% decline in January relative to December but up 2.1% from a year ago.

All major forms of commercial real estate are facing very high vacancy rates. However the lead times on commercial construction of things like hotels, office buildings and strip malls tend to be fairly long. Thus there are still projects that were started before the credit crunch hit that are still coming on line and adding to the excess supply of space.

Check the Architects

A great leading indicator of commercial construction is the amount of work that architects are getting. Generally there is about a year delay (or slightly less, depending on the size of the project) between when an architect gets the work and when money is actually spent on construction.

The architects index, which is shown in the first graph below, is one of those indexes where any reading above 50 indicates expansion, and anything below means contraction. It has been consistently been below 50 since the recession started way back in December of 2007. But if you look at the second graph (both graphs are from Calculated Risk), you can see that the downturn in private non-residential construction really did not start until the fall of 2008, and has picked up steam ever since. By contrast, the decline in residential investment spending started way back in early 2006.

Also note that the current situation where private non-residential construction spending is greater than private residential construction spending is very unusual, and will probably not last. We will probably see a stabilization of residential spending at around current levels, or perhaps even a slight rebound later in the year. Given the current very low levels, it would not take very heroic absolute levels to generate decent percentage gains in residential construction.

We will probably see residential construction back above non-residential construction by the end of the year. However, it will be because of the rapid decline in non-residential spending rather than because of an impressive increase in residential construction.

I think it is probably still a bit early to be investing in the home builders like D.R. Horton (DHI). The over-building on the residential side early in the decade was truly epic, but the decline in spending has been going on for a very long time now.

The numbers in the second graph are not adjusted for inflation. For a full year now, residential construction spending has been running below $300 billion a year, which is where it was in the late 1990’s. Eventually that low level of investment will cause a good case of pent up demand The homebuilders are closer to the end of their downturn than are the more commercial-oriented construction firms like Fluor (FLR) and Foster Wheeler (FWLT). It is also not good news for firms like United Technologies (UTX), at least not for the elevator (Otis) and Air Conditioning units (Carrier) of the firm.

The report was largely in line with expectations, so it should not have a major impact on the market. However it does remind us that the recovery is going to be long, slow affair. (Click charts to enlarge)