Route to Recovery

The imminent demise of recessionary tendencies in the overall economy encourages one to surmise about an impending turnaround in commercial construction. But the route to recovery appears to be tenuous and tardy given the current circumstances. Beyond the customary lag between a revival of the economy and that of commercial construction, there are several other factors that are likely to impede any rapid recovery for this market in 2010.

Currently, the core concern for the commercial construction industry seems to be the estimated $1 trillion plus in commercial real estate mortgage debt that will mature in the 2009-2013 time period. Delinquency rates in this market have been rising steadily through 2009 and recent estimates suggest that a majority of these loans could be ineligible for refinancing. The sustained freeze in the Commercial Mortgage-Backed Securities (CMBS) market further complicates the financing and refinancing scenario.

And as mentioned in my previous blog, neither the American Recovery and Reinvestment Act (ARRA) nor the Term Asset-Backed Securities Loan Facility (TALF) program has been able to resolve the financing conundrum in commercial real estate. 

A cursory glance at the construction drivers for the major building segments within the commercial sector further accentuates the gloomy outlook for 2010. Although the economic recession appears to have receded, employment figures are expected to remain lackluster well into 2010. Consequently, office vacancy rates are forecasted to rise until 2011 and compel building owners to reduce rents and increase incentives. Supply of new office space in this environment will likely be improbable as companies adopt a cautious approach to any new construction.

Residential construction, a leading indicator for the retail building segment, continues to recover from its protracted slump but consumer discretionary spending is still quite modest as individuals pause to repair their balance sheets.  A persistently high unemployment rate will also adversely impact consumer spending going forward. On a more positive note, it seems that some discount and food retailers have expansion plans to meet the demands of an increasing number of price sensitive customers.

Relative to the office and the retail segments, the primary institutional building categories (education and healthcare facilities) had a superior growth in 2009. However, the gradual erosion of tax receipts due to rising unemployment is straining state and local finances, the principal drivers of institutional construction. Additional factors, like decline in endowment fund values and uncertainty over healthcare reform, will restrain spending in higher education and healthcare facilities respectively. But over the long-term construction in the education and healthcare segments will be driven by broad socio-economic trends like rising school enrollment and increasing demand for medical care by aging baby boomers.

So, the commercial construction market is not in recovery mode yet and it looks like the market will get worse before we see any signs of a sustained recovery.

Regards,
Andy Nag