Concrete Construction's Editor in Chief, Bill Palmer, interviewed PCA's Chief Economist, Ed Sullivan, on the state of our economy in terms of residential and commercial construction.
Bill Palmer: Why is the west so much worse?
Ed Sullivan: One of the big things is, residential, those that participated in the housing boom. In terms of demographics, it's a great place to live, but they were seduced by exotic mortgages, so there is a huge foreclosure issue. In many of these states, construction is a huge component of the economy, and residential is a huge component of that. That helped to undercut some of the economic footing, which cascades into a drop in job growth, higher vacancy rates on nonresidential, and the emergence of these huge deficits. If you look at the middle part of the US, they still suffered, but not nearly as much because they weren't seduced by the exotic mortgages and home prices weren't exaggerated. Look at the composition of the economies: in the central portion of the country they have energy and some agriculture and those are both doing pretty well, so the recovery in terms of employment returns there first instead of in more diverse or retail sales economies.
BP: Does residential have to come back before commercial can gain strength?
ES: No. They are totally independent, although there are some of the same forces. In residential, a builder isn't going to build unless he can get a return on his money. Home prices are still falling because of foreclosures, so a builder is only going to make money when there are stable prices and there's not a long carrying period for inventory. Neither one of these is going away until the foreclosure issue goes away and that's at least early 2012. Nationally you are looking at late 2012 early 2013 before we see a substantial recovery in housing.
For commercial, again, you only build if you can get a return on your investment, and that's when vacancy rates decline. The vacancy rates went so high that now building owners are competing on leasing rates. That determines net operating income asset value. You don't get a reversal on the nonresidential side until net operating income comes around. We think the threshold on occupancy rates is about 14% when you start seeing softness in leasing rates and that should happen by the end of this year.
We think public construction is bottomed out and that's tied to employment. You lay off a worker, you lay off a taxpayer. So state deficits is the issue now. The private economy is doing OK, but it's what's happening with federal and state governments that brought the GDP down. They have cut public construction so severely that we think it's at the low threshold. As you get job growth, the budgets start to look better and we expect surpluses in 2013. But just because I don't have the money and don't repave the road, once the employment picture comes back the road still isn't fixed. So there will be pent-up demand and that's going to be released when employment comes back. So the issue becomes the highway bill and we don't think that will get addressed by Congress until 2013.
So, bottom line, we're going to run along the bottom for the rest of this year and next year-it won't be until 2013 until things start really coming back. The western part of the country will be among the laggards, although Florida and Georgia are pretty bad too. The budget deficit in California has a big impact on all of this and that can change the long-term outlook.