Outlook 2008: non-residential markets should hold up well

By John Rainone

One hates to dwell on the negative at the beginning of a new year, but lately we've been reading and hearing the words "housing bust" and "recession" in the news more and more. This doesn't bode well for 2008, and the fallout from the subprime mortgage crisis will continue to hurt the residential sector this year. But there is also room for some optimism in non-residential development and construction.

First, the bad news.

According to the American Institute of Architects' "Home Design Trends" survey of 500 residential architectural firms conducted in the fall, there is widespread weakening demand for townhouses, condominium apartments and vacation homes. "Even more negative were [respondents] market observations and forecasts for move-up homes and affordable homes for first-time buyers," wrote Roger K. Lewis, an architect and a professor emeritus of architecture at the University of Maryland, in a December Washington Post column. "These signals clearly reflect the foreclosure and credit problems with which middle-class home buyers and production home builders are struggling."

The federal government has moved to blunt the subprime mortgage meltdown by making it easier for some borrowers to refinance and avoid foreclosure, but these measures will only reduce the damage. Many of the problems in the mortgage market are systemic and will take considerable time to correct-and many investors are going to lose a bundle.

"[Mortgage] investors are spread out all over the world," explained Treasury Secretary Henry Paulson on CNBC recently. The bailout process "approximates the way the market would work under normal circumstances," Paulson said. "Our biggest focus is on making this work, and it's not going to be easy to make this work."

The AIA's survey did contain some good news, however. Neighborhoods and communities designed to include greater access to public transportation, recreation, commercial and entertainment options are becoming more popular, and there is rising demand for infill housing, "where smaller land parcels closer to urban centers are targeted for development."

"These positive trends are not surprising given the escalating energy and transportation costs, worsening traffic congestion, and long commuting times experienced by millions of suburbanites," Lewis wrote.

Architects still optimistic

In another positive sign, the AIA's November Architecture Billings Index rose to 55.3 in November from 53.2 the previous month. The index measures architects' billings and is a gauge for future construction. A reading above 50 indicates expansion. Construction activity usually lags architectural work by nine to twelve months.

When broken down by sector, commercial and industrial projects registered a 58.7, mixed practice projects registered a 57.0, and institutional projects a 55.8. Multi-family residential projects lagged sharply with a reading of 44.2.

The outlook from a contractors group is not so encouraging, though. In a December Associated General Contractors survey, 46% of member respondents said demand for commercial projects would decline in 2008; 32% said spending on commercial projects would increase; and 22% said spending might decline depending on the economy. By a large margin, AGC members said the South would be the top regional market this year, followed by the West Coast.

For developers, the big question is how much of an impact tightening capital markets stemming from the mortgage meltdown will have on their access to capital. According to a recent report in the New York Times, commercial real estate executives believe Wall Street firms will have to work out at least $40 billion in troubled residential loans before they resume investing in commercial properties.

Bank of America's $4 billion deal in January to buy Countrywide Financial, the nation's largest lender, is an encouraging sign that the mortgage mess is beginning to sort itself out. The transaction may result in more help for people who can't afford their Countrywide loans, as Bank of America immediately signaled it would expand efforts to help troubled borrowers through counseling and loan modifications.

Some strength in non-residential

According to FMI, management consultants and investment bankers to the construction industry, nonresidential construction will remain strong in 2008, increasing 9 percent. Four nonresidential segments will see double-digit growth: office, healthcare, public safety and transportation, according to FMI. One key factor impacting this optimistic forecast will be the health of the overall economy.

While industrial facilities are reportedly close to capacity in many areas, pointing to increased development, an economic slowdown could dampen prospects. The hospitality and retail sectors, which have been strong in recent years, may well be heading for a slowdown, particularly as the threat of a recession looms.

Although the overall commercial real estate market is likely to soften, some urban areas will fare well, according to respondents to the 2008 Emerging Trends in Real Estate report by PricewaterhouseCoopers and the Urban Land Institute. The so-called global gateway cities like New York, Washington, San Francisco, Los Angeles, and Boston have become magnets for employers, residents and investors and will continue to thrive, according to the report

"Uncertainty and challenges characterize 2008, with greater downside risk than real estate markets have faced in close to two decades," concluded the report.

That sentiment sums up the outlook for developers and contractors in 2008.

What do you think? Are you optimistic or pessimistic about 2008? Let us know.

John Rainone is Project Operations Manager for MorganSullivan. He can be reached at jrainone@morgansullivan.com.

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