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Housing Starts May Be Up But Don't Expect A Construction Recovery Just Yet

This article is more than 10 years old.

Builders are beginning to amp up plans for new homes. The number of building permits jumped to the highest level in nearly four years, according to figures released this week by the U.S. Department of Commerce. Permits, which are a proxy for future construction of single-family and multifamily homes, rose to a seasonally adjusted rate of 780,000 in May, representing 25% more activity than a year ago. It's the highest rate seen since October 2008. What's more, housing starts, which track actual work begun on new permits, are up 28.5% from a year ago -- despite slowing down nearly 5% from April. And the National Association of Home Builders also says builder sentiment rose this month, now enjoying its highest level in five years.

Sounds promising, right? It is. But that doesn't mean construction is enjoying a recovery just yet. Construction activity hinges in large part on the growth experienced in the rest of the economy-- and growth remains weak.

Many economists note that in times of economic recession and consequent recovery, construction, which encompasses both residential and nonresidential building, is usually the last sector to rebound. Historically, construction levels begin bouncing back 12 to 18 months after the growth rate of  Gross Domestic Product turns positive following a recession.  That hasn't happened in this downturn. Economic growth turned positive in the third quarter of 2009 and, nearly three years later, construction still activity remains markedly below its pre-recession levels.

Take single-family home starts. Starts fell about 80% from the 2006 peak to the 2009 trough. With 516,000 starts projected for 2012, starts are currently up 3.2% from April to May. While that's hopeful news, the number is still down 70% from the peak, according to the National Association of Home Builders. Even before the housing bubble fully inflated, the average annual number of starts from 1995 to 2003 was 1,256,000.

Then there's home builder confidence. It may be at five year highs, but in historical context, the number remains well below what would be considered healthy: NAHB's confidence index clocked a 29 this month but a reading of more than 50 is necessary to show that a majority of builders view construction conditions as "good."

David Crowe, NAHB chief economist, says there are several reasons home building is recovering so slowly: home prices have not bottomed in some markets; another 8.5 months' worth of distressed inventory hasn't hit the market yet; and financing remains too tight. (NAHB reports that folks with FICO of scores as high as 730-- well above the minimum requirement -- are being denied loans still.)

The biggest issue, however, is jobs. A mere 69,000 jobs were netted in May, less than half of what economists has projected. It marked three consecutive months' worth of declines in jobs added. Last month the sector that shed the most positions was construction, with 28,000 jobs lost. In fact, construction has hemorrhaged nearly five million jobs since December 2007 -- more than any other sector in the past five years. Weak jobs data translates into weak economic growth on a macro level; it also shows how weak building continues to be.

“I’m not buying into the proposition that the nation’s construction industry will recover in 2013,” says Anirban Basu, chief economist of Associated Builders and Contractors (ABC), a Washington, D.C.-based association representing construction industry firms. “What we have right now is an utter lack of confidence in the economy, and confidence represents a centrally important requirement for construction spending growth."

ABC predominantly focuses on nonresidential construction and Basu notes that a recovery in this kind of space (which includes office, healthcare, infrastructure, retail, lodging) should have kicked in about two years ago according to history. It hasn't.

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"We have capital and profitability in the broader economy, and there is money sitting in the banks," says Basu. "But many decision-makers have adopted a wait-and-see attitude until the sea of uncertainty that faces us recedes. This uncertainty includes confusion regarding the future path of federal spending, tax rates, the financial chaos in Europe and our own 2012 elections."

The American Institute of Architects (AIA) carries a foreboding message in its new Architecture Billings Index as well. Released today, it shows design activity (which serves as an early indicator of new upcoming construction) at two year low. It's down 2.6 points to a reading of 45.8. A reading of 50 or higher indicates growth in design activity. It has been trending down for six straight months. Since architects' billings typically predate construction starts by 9 to 12 months, there's a likelihood that construction is doomed for further sluggishness.

"For the second year in a row, we’re seeing declines in springtime design activity after a healthy first quarter. Given the ongoing uncertainly in the economic outlook, particularly the weak job growth numbers in recent months, this should be an alarm bell going off for the design and construction industry," says Kermit Baker, chief economist at the D.C.-based  AIA. "The commercial/industrial sector is the only one recording gains in design activity at present, and even this sector has slowed significantly.

"Construction forecasters will have to reassess what conditions will look like moving forward," he adds.

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