Using a skiing analogy, Standard & Poor’s chief economist, David Wyss, explained the current economic situation: “The economy is still heading downhill but on a lesser slope,” he said in the April 23, 2009, S&P Market Views report on BusinessWeek.com. “We’re off the black diamond. We’re onto the blue slope. We’re a little more confident that somewhere ahead there’s a chairlift.”
During the same report, Wyss cautioned that the recent market plateau does not indicate a turnaround.
“It just means the pace of decline has lessened,” he said.
But in this economy, any modicum of good news springs hope for those long suffering from this lengthy downturn.
The Federal Reserve Board of Governors confirmed what the economic experts have suggested in an official statement: “Weak sales and difficulties in obtaining credit have led businesses to cut back on inventories, fixed investment, and staffing. Although the economic outlook has improved modestly […], partly reflecting some easing of financial market conditions, economic activity is likely to remain weak for a time.”
Electrical contractors, an integral part of the construction markets, are hurting, too. Those entrenched in the residential market are the hardest hit.
Residential inventory woes
So what is the main problem? What is preventing the flattening of the market before a turnaround? In the residential market, the an-swer boils down to simple math in the housing sector: there is too much inventory of available homes and not enough demand. Throw in an increase in foreclosures and a decline in home values, and you have a long way down before climbing again. The market is ripe for first-time buyers but not for those trying to sell a home to get into a larger, more expensive one.
According to the latest statistics, homes are very affordable right now, mortgage rates are favorable at 4.84 percent, existing home af-fordability is at 65.1 percent, and new home affordability ratio went to 59.5 percent. Unfortunately, existing home sales, existing home in-ventory, employment growth, the unemployment rate, real gross domestic product (GDP) growth, and a host of other leading indicators, remain dreary at least for the next couple of quarters.
“We will see the bottoming out of the residential housing market, as far as the pace of decline,” said Keith Leggett, American Bankers Association (ABA) senior economist. He, like S&P’s Wyss, cautioned against thinking a rebound is on the immediate horizon. “The excess inventory of housing will continue to be a drag on the market, but we have reached an inflection point.”
Leggett also warned that “foreclosures and ‘shadow inventory’ are preventing the residential housing market from increasing.” He defined “shadow inventory” as homeowners who wanted to put their homes up for sale but pulled them off the market in hopes of a more favorable market. When the economy turns in favor of selling a home again, those people could put their houses up for sale again, thus adding to the housing inventory.
In his April 20 Hutchinson Lecture in Newark, Del., Donald L. Kohn, Federal Reserve Board of Governors vice chairman, said the declines in sales and construction of single-family homes have “abated in the last couple of months—in part, perhaps, because of the low levels of mortgage interest rates and greater affordability of housing.” As demand solidifies and when inventories are brought into line with sales, he said, economic activity should begin to stabilize.
“At some point, however, house prices will begin to flatten out, and fears about buying into a falling market will start to wane,” Kohn said. “At the same time, the improved affordability of homeownership resulting from reduced house prices, low mortgage interest rates, and government programs (including incentives for first-time homebuyers) should boost demand. Because inventories of unsold homes are still very high relative to sales, it may take awhile for any pickup in demand to translate into higher production.”
Pending U.S. home sales rose more than predicted in March, as indicated by a National Association of Realtors (NAR) statement. The Pending Home Sales Index, a predictor of home sales activity based on contracts signed in March, indicates a 3.2 percent increase over February numbers. It also marks a 1.1 percent hike from March 2008.
NAR Chief Economist Lawrence Yun said it will take some time for the market to gain any type of momentum, but the news is good.
“This increase could be the leading edge of first-time buyers responding to very favorable affordability conditions and an $8,000 tax credit, which increases buying power even more in areas where special programs allow buyers to use it as a down payment,” he said. “We need several months of sustained growth to demonstrate a recovery in housing, which is necessary for the overall economy to turn around.”
Nonresidential markets surprise economists
In March, after five straight months of decline, overall construction spending increased modestly by 0.3 percent, the Commerce De-partment reported. Nonresidential and government construction offset declines in the still-dreary housing sector. This 0.3 percent hike in construction, while modest, represents a departure from the 1.5 percent decline many economists expected for the period.
Spending on private residential projects fell by 4.2 percent, as nonresidential spending rose by 2.7 percent—the biggest jump in nine months. Government construction rose by 1.1 percent in March, according to the Commerce Department. A 1.3 percent increase in state and local government spending offset a decline of 1.7 percent at the federal level.
ABA’s Leggett was among the economists surprised by the March construction data. He, like many of his peers, expected a weak nonresidential construction market through the end of 2009. Vacancy rates had been on the rise, and there was a lot of idle store space.
“With job losses and the economy, more office space will become vacant,” Leggett said.
He didn’t expect any significant increase in construction in this area for quite some time.
Another problem with commercial real estate is the new supply of available space that came on the market in 2007 and early 2008.
“That will inhibit new construction,” Leggett said.
Perhaps this slight uptick in nonresidential construction is a blip on the screen, but it could be an indicator that a turnaround in that sector is upon us. The next set of data will answer that question, so stay tuned for the next few months.
Yes, there are some positive indicators that provide glimpses of hope, but the recession still grips the market. Seasonally adjusted March construction spending rests at $969.7 billion, which is solid when compared to recent months but remains more than 11 percent off the pace of a year ago. That said, let’s approach these figures with cautious optimism instead of overwhelming glee. This is a slow trip out of a nasty valley.
Labor and production
“Labor market and production data continued to deteriorate through the first quarter,” said the Federal Reserve’s Kohn. “Businesses shed more than 650,000 jobs in March, the fifth consecutive month of job losses in the neighborhood of 600,000 or more, and the un-employment rate jumped to 8½ percent.”
Unemployment claims rose again in April as well. That equates to too many empty job sites and a lot of electrical and systems workers sitting on the bench waiting for a payday. It means temporary layoffs and tight times. The U.S. government is willing to help, but the best bet might be to seek greener pastures.
Stimulus plans and going green
The recent $787 billion government stimulus package, according to the Congressional Budget Office, will increase the real GDP by be-tween 1 and 3 percent by the end of 2010. Until then, expect slow, incremental growth.
The Federal Reserve has committed billions of dollars to extend credit to households and businesses to stimulate the economy through liquidity programs, but it will take time to trickle down to the construction markets. The government has taken other steps re-cently, including the Making Homes Affordable program, which aims to reduce the number of foreclosures. By doing that, it slows the pace of decline and keeps the inventory of available homes on a steady descent.
The American Bankers Association’s Leggett said a lot of the stimulus money will go toward already-on-the-books infrastructure projects, such as bridges, roads and highways. He said the other main thrust of the stimulus will be “green collar” jobs and green pro-jects.
“Not now, but in 2010 and 2011, there will be a huge increase in green construction—wind and solar,” Leggett said.
There will be plenty of opportunities for electrical contractors installing wind turbines and solar panels, but how about retrofits on government buildings?
“There will be a movement to take government buildings and retrofit them to make them more environmentally friendly,” Leg-gett said. “This will add green collar jobs especially with a new push toward LEED [Leadership in Energy and Environmental De-sign] certification.”
That movement also is expected to be prevalent at the state and local level, Leggett said. Developed by the U.S. Green Building Council (USGBC), LEED is an internationally recognized certification system that measures how well a building or community performs across various environmental metrics. LEED provides building owners and operators a concise framework for identify-ing and implementing practical and measurable green building design, construction, operations and maintenance solutions.
Beyond green projects, other areas of growth include healthcare and school construction.
There may be a lot of electrical grid work on the horizon as well. The aging grid will require a lot of work, which requires the skills of qualified electrical contractors, but the federal budget allocated a mere fraction of what is necessary to repair the outdated system. The grid is more of a long-term, major undertaking from which electrical contractors will benefit for many years.
Tight credit loosening up
Another economic variable that has squeezed the work from electrical contractors is available credit and favorable terms. The days of easy credit terms such as those in 2005, 2006 and early 2007 are long gone and unlikely to return. Banks are much more risk-based in their lending practices because of the mistakes that spurred this economic crisis.
“Instead, lenders will be examining contractors’ books to ensure they are not a high risk to lend to,” ABA’s Leggett said. “There will be more analysis of balance sheets. Just as banks are being stress-tested, banks will be stress-testing contractors.”
The electrical construction market has no doubt contracted during this economic crisis, as smaller, less-sophisticated operators crumbled under the economic heaviness this crisis brought. Credit terms tightened as the work dried up. It was a perfect scenario for failure. However, the solid, well-funded operators that survived and are surviving will find strength when the economy turns around.
“The good operators shouldn’t have a problem,” Leggett said. “They will be fine.”
How does your balance sheet look? What kind of terms are you getting from your bank? What types of projects are you banking on? The answers to these questions will determine how strong your business is when the residential market rebounds and the economy recovers. How you position your company now will forge your path to success.
Federal Reserve Chairman Ben Bernanke announced during his semiannual testimony before the Senate Banking Committee on May 5, 2009, that he expects the U.S. economy to continue to contract through the first six months of 2009, but that a turnaround could start before the year is over.
“If actions taken by the administration, the Congress and the Federal Reserve are successful in restoring some measure of finan-cial stability—and only if that is the case, in my view—there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery,” Bernanke said.
Bernanke, like economists Wyss, Leggett and Yun, is approaching the second half of 2009 with cautious optimism, knowing that many things have to fall in place for a turnaround to come to fruition.
Is that chairlift approaching, or are we stuck on the blue slopes for a while? The economy, like many construction businesses, could use that lift—and soon.
KELLY, former editor of ELECTRICAL CONTRACTOR, is a Baltimore-based freelance writer. Reach him at email@example.com.