Time to Send in the Reinforcements?

Some experts say the construction market has bottomed out and that work will soon begin to pick up. Others aren’t as optimistic.

By Myra Pinkham, Contributing Editor

Crushed by the credit crunch, the nonresidential construction market has been gasping for air for months. Is the pressure beginning to ease or will the market squeeze continue? There is no consensus view.

Some observers fear that the small number of new projects being added to the construction pipeline is a harbinger of continued weakness. Others say that a recent pickup in inquiries offers at least a glimmer of hope that the bottom is near.

Will Housing Soon Turn the Corner?

There are growing indications that the housing market is about to turn the corner, but suppliers of metals and other building materials are not likely to feel any benefit for a while—probably not for another year or two, say many experts.

“There are several good signs on the horizon,” said Jerry Howard, president and chief executive officer of the Washington, D.C-based National Association of Home Builders during the NAHB’s teleconference on the state of the housing market in mid-May. “I think it is fair to say that we are closing in on the bottom [of the market], but we still have a long road ahead.”

Among the positive signs cited by Howard are stabilizing sales of new and existing homes, as well as housing starts, plus a slow but steady decline in the inventory of unsold houses. In addition, housing affordability is now at its highest level in 18 years.

According to the recent NAHB/Wells Fargo Housing Opportunity Index, a family with a median income could afford 72.5 percent of the homes sold in the first quarter, which is a 10 percent increase from the fourth quarter of 2008. David Crowe, an NAHB chief economist, attributes this rise—the greatest quarterly increase in the index’s history—to historically low mortgage rates and housing prices that have reverted to levels last seen in 2003.

Crowe also notes that the NAHB/Wells Fargo Housing Market Index, which measures builder confidence in the newly built single-family home market, improved for the second consecutive month in May. That index reached 16 points—its highest level since September 2008 and significantly better than the single-digit levels registered from October to March. Builders showed increased confidence in both current sales and expectations for future sales.

NAHB also reports that, according to U.S. Commerce Department statistics, single-family housing starts rose for a second consecutive month in April, up 2.8 percent compared with March. Total housing starts, however, fell 12.8 percent for the month to a record low seasonally adjusted annual level of 458,000 units due to a 46 percent decline in the multifamily housing sector. Multifamily construction consumes far more steel (largely concrete reinforcing bar) and other metals than single-family homes.

Bernard Markstein, vice president and a chief economist for NAHB, says that the multifamily market will be “flat at best” through the rest of this year and will not rebound until 2010, after the single-family sector has already begun to pick up.

“While these market indicators provide more indication that the housing market is at, or very near, the bottom, there are still a number of headwinds out there,” particularly access to credit for both the borrower and the builder, says Crowe. He observes that while mortgage rates are at historic lows, underwriting standards have been tightened and buyers are often asked to come up with larger down payments. At the same time, homebuilders are also finding it extremely difficult to get new credit to build homes, with “financial organizations [such as banks and thrifts] shying away from most forms of real estate lending, even in recovering marketplaces.”

“While we are seeing the market reaching a bottom in sales, we are not ready for a significant increase in building any time in the very near future,” says Howard.

Because of this, Crowe predicts that even with an anticipated pickup at the end of the year, the single-family housing market will still be 50 percent below the 2008 level. “Then we will begin to return to some kind of normal market in 2010 and 2011.”

“While we are not ready to pop the champagne cork and sing ‘Happy Days Are Here Again,’ there is light at the end of the tunnel,” adds Howard.

Markstein says there will probably be at least a three to six month lag before any upswing in construction will improve demand for materials, especially since many builders are currently holding high inventories of surplus products.

Other markets connected to the housing market, including the metals-intensive appliance market, are also experiencing weakness. According to the Association of Home Appliance Manufacturers, domestic shipments of washers, dryers, dishwashers, refrigerators, freezers, ranges and ovens fell 15.5 percent year-to-date through April compared with the first four months of 2008.

Currently, the construction market is “dismal at best,” says Michael Busse, sales and marketing manager for Fort Wayne, Ind.-based Steel Dynamics Inc.’s Structural and Rail Division.

Of like mind is Ken Simonson, chief economist for the Associated General Contractors of America, Arlington, Va., who says demand for most types of construction work has gotten worse in the last few months.

The magnitude of the decline has been masked by different methods of statistical reporting. The U.S. Department of Commerce’s “put in place” construction spending numbers were still showing slight growth as recently as the first quarter of 2009 due to the completion of certain projects that were begun several years ago. “But in the real world, as it relates to steel and other building materials, the market has gone off the cliff,” says one executive who asked to remain anonymous. He believes the building construction market “will continue to be in a wipeout at least through 2011,” and that it might not see a noticeable turnaround until late 2012 or early 2013.

Others see the market very differently. Jim Kirkvliet, vice president of sales and marketing for Gerdau Ameristeel, Tampa, Fla., says that while steel sales to the nonresidential construction market this year will be down compared with 2008, he believes the decline has already reached bottom.

Lourenço Gonçalves, chairman, president and chief executive officer of Metals USA Inc. in Houston also reports signs of improvement. “It isn’t anything huge yet, but it is starting to pick up,” he says.

Even though there has been an uptick in quoting activity, it hasn’t necessarily translated to increased orders yet. “More times than not, new projects are waiting for funding,” says Burt Tenenbaum, president of Chatham Steel, Savannah, Ga.

“While certain projects that are already in the pipeline continue to go ahead, nonresidential construction starts are currently the lowest they have been since our association started tracking them in 1970,” says John Cross, vice president of the American Institute of Steel Construction in Chicago.

Several other well-watched indices have shown similar findings. Reed Construction Data reported that institutional building starts plummeted by 47 percent, while commercial building starts fell by 45 percent, year-to-date through April. Even the heavy infrastructure projects that were propping up the market saw starts that were off by 16 percent.

The same basic scenario was reported by the American Institute of Architects in Washington, D.C., whose billings index saw a year-to-date decline of 26.1 percent in new construction billings. For full-year 2009, the group expects billings to fall by 33.7 percent and to continue to decline, albeit by a less steep 6.7 percent, next year (see chart on page 14 of the print version of Metal Center News).

“The nonresidential market seems to have fallen more rapidly than had been expected,” says John Anton, manager of the steel service of IHS Global Insight, Washington, D.C. “It will continue to fall all this year and part of next year.”

This is especially true of private nonresidential construction, which Anton estimates will decline about 21.4 percent this year after rising 11.2 percent last year. He forecasts it will decline another 13 percent in 2010 before rising 5.3 percent in 2011. “It won’t get back to the 2008 peak level until 2014-15,” he says.

Public works construction is expected to fare somewhat better. It could start to turn up late this year, partly because of the federal government’s economic stimulus program, says Christopher Plummer, managing director of Metal Strategies Inc., West Chester, Pa. While he believes the American Recovery and Reinvestment Act will not even indirectly affect private nonresidential construction, about $150 billion will go toward certain public works projects, as well as municipal construction such as schools and government buildings.

“In general the reports of a $787 billion stimulus bill are greatly exaggerated,” maintains Bill Jones, vice chairman of O’Neal Industries, Birmingham, Ala. “The amount that will go to actual infrastructure spending is much less than had been expected, and a lot of that is not slated to be released until sometime in the future.”

To make matters worse, he says, the federal budget contains a number of proposals “that reverse the effectiveness of what is in the stimulus program through increased taxes and regulation. All of this gives many investors a lot of pause.”

People who counted on the stimulus program to ignite the market are most likely disappointed, Gonçalves agrees, “but in the long run it should help.”

Simonson at AGCA says that some contractors started seeing stimulus money in April or May, which should start translating into orders for steel soon.

“We hope to begin seeing the effects of the stimulus plan on infrastructure spending sometime in the second half of this year and continuing into 2010,” says Kirkvliet. “In addition, we believe that the ‘Build America Bonds’ program within the act has the potential to spur additional infrastructure spending by state and local governments,” as it will give them access to lower yield debt in the tax-exempt market.

Right now the nonresidential construction market is “pretty dead,” says SDI’s Busse, with few new projects and an increasing number of companies—as many as 15 to 20, according to Cross—scrambling to bid on each newly announced job.

Jones says most of the current activity is limited to big industrial projects, largely in the energy sector. “Also, ThyssenKrupp is still building its new carbon and stainless steel mill in Alabama, although even that project might be delayed.”

Bill Brown, SDI’s long products sales manager, maintains that the true underlying demand in the market is not all that bad, but is being held back by funding issues. “Projects that have been able to get funded are going forward, but those that weren’t able to get funding are waiting in the wings.”

The natural construction cycle was already at a peak and starting to wane before the financial crisis and the resulting credit crunch accelerated the decline, says the unnamed executive. “So what we are seeing now is an added negative effect on what was already a negative cycle. That is why it is so unusually bad.”

“Just when we would have gained momentum again, we fell off of the ski slope because of the credit crunch,” Cross agrees.

Busse estimates the tight credit situation has caused the cancellation or delay of up to 30 percent of the potential projects since October.

According to an AISC survey, over 50 percent of fabricators saw more projects put on hold during the first quarter than during the previous quarter, continuing what has become a very troubling trend, Cross adds.

Some observers point to early signs of a slight loosening of credit constraints, but builders are still having a hard time getting funds for many of their projects. Part of the problem is a belief by many banks that the financial crisis could actually get worse mid-year when a number of commercial and industrial loans come due. Thus there could be a second wave of loan delinquencies even worse than the first. Because of this, they are holding onto their money.

“There has to be more credit available for there to be any semblance of a normal market,” says Chatham’s Tenenbaum, echoing the prevailing sentiment.

“Even if the banks were more accommodative with their credit lines, I’m not sure that many people are confident enough about the future to borrow money anyway,” Jones says. “With consumers not spending, there isn’t a need to build commercial and retail space. The same is true in the industrial sector, where demand for most products is down significantly.”

“The economy will eventually revive, but today a lot of projects are just not needed,” concurs Anton. “Just like housing, the nonresidential construction market was overbuilt causing an over-inventory of buildings. Even if there was no credit crunch, there would have been a decline.”

While all nonresidential sectors are weak, they are down to varying degrees, says Cross, with schools and other municipal projects probably faring the best. Industrial construction is doing better than the commercial sector.

Construction of power plants and other energy-related structures, while down from last year, are still holding up fairly well, and could see some positive growth as early as late this year thanks to the Obama administration’s push for energy independence, say some executives.

“As the construction market goes, we go,” says SDI’s Brown, referring to producers of structurals, rebar and other construction-related steel. “We can only supply material to the construction market if someone is building something.”

Kirkvliet agrees, noting, “As our customers have reduced their purchases of steel, we have had to reduce production and employment levels. The de-stocking that occurred in the fourth quarter of 2008 and the first quarter of 2009 has led our mills to run at capacity utilization rates of below 50 percent.”

Plummer says total apparent consumption of steel used in nonresidential construction was down 45.4 percent year-to-date through February, including a 52.8 percent decline for structural steel, a 54.6 percent decline for pilings, a 50.5 percent decline for reinforcing bar and a 39.6 decline for plate mill plate. Many facilities in these product lines are currently running at 35 to 50 percent of capacity. “If the market continues to be weak, it has to result in more idling of capacity, but I’m hopeful that won’t have to happen,” he adds.

Brown believes it is possible that the construction rebound has already begun, but we just don’t know it yet. “It might be like the recession where we didn’t see it until we were already in it,” he says.

The recovery, however, will likely be very different than the downturn, Simonson says. “While the whole construction market, and the whole economy, contracted at the same time, I think the recovery will be in several stages,” he explains. “First, we will see home sales improve, which is already starting to occur. Next will be improvement in single-family home construction at the end of the fourth quarter, followed by retail construction in the first half of 2010.” Most private commercial, industrial or state-funded construction won’t pick up until late 2010 or beyond, he predicts.

The market could bounce along a slow, flat bottom for some time until people work through their credit issues, Cross adds. He does not believe it will take the nonresidential construction market as long to dig itself out of the hole as it has taken the housing market, however. “One reason is that before single-family construction went down, it had been severely overbuilt. Nonresidential construction wasn’t nearly as overbuilt and doesn’t have as much of a need to work down inventories before the market could improve.”

Nevertheless, most industry observers expect a painfully slow, gradual recovery in construction activity and demand for metal products. “The market didn’t just get a cold, it got a serious disease,” says Gonçalves. “Its recovery will be slow, but it will recover.”

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