A Gloomy Construction Picture

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:

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 more 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.

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.)

Comments

[PastTense:]

There is one area of construction not mentioned which Obama strongly supports: infrastructure. Things like highways, mass transit, electrical transmission facilities, alternative energy generation facilities. So this should go up.

May 12 03:25 AM

[HardwoodFlo...:]

Well, it looks like a bottom anyway. It's back to the future on this whole thing. Remodel is taking hold in a big way right now. People are choosing not to sell and to stay and remodel. They have cash to do it, they can't get a home equity, and the M2 money supply is through the roof. In the future, it will look like the past, where homes are built to design by "mom and pop" builders. That sounds great to me.

May 12 11:37 AM

[billp37:]

PNM forecaster Steve Martin alerted us about new construction as the principal factor in increased electric load. See FOIL 1.


“If you can reduce rather than produce, you’re better off. And DR helps us reduce. We’re in the same position as a lot of utilities—we’re at capacity, gas prices are high, and the price of energy on the wholesale market is also high. So we have to look at cost-effective alternatives.“ — Carlos Lucero, senior energy efficiency engineer

"If you take participants in both programs, we expect they could save up to 50 megawatts this summer on high-demand days," Brown said. "A megawatt is typically enough power to supply 700 homes."

home.comcast.net/~bpayne37/pnmelectric...

We're wondering when and if future shortages of electricity, natural gas, and water may limit new construction.

May 12 05:17 PM

[Fred Voetsch:]

Excellent article and sound reasoning. It's so rare I really appreciate it when I see it.

May 12 05:23 PM