Nonresidential construction spending set to decline alongside residential spending

Yesterday, the Census Bureau released its August construction spending report, and as you may have heard, it was not a strong report. The overall growth rate, 0.0%, beat the consensus forecast, -0.5%, but July’s construction spending was revised sharply downward from a -0.6% contraction to -1.4%.

On the residential side: mixed signals

On the bright side, residential construction rebounded by 0.3% in August, following sixteen consecutive months of decline. Residential investment has been dragging down GDP growth (negative contribution to growth) since the first quarter of 2006, and any revival in construction spending would be good news for the growth outlook. However, the rebound was driven by a surge in spending on home additions, 9.8%, rather than actual construction of new single-family residential homes, which fell -4.2%. Like the old saying goes: beggars can’t be choosers; those additions are still spending, and that bodes well for GDP.

On to the nonresidential side: taking a turn for the worse

Calculated Risk does a great job of reporting economic statistics; here is an excerpt from CR’s report, but the whole report is worth reading:

“It now appears that private non-residential construction has peaked, and I expect non-residential investment will decline sharply over the next year.”

I agree, non-residential construction – which is the sum of private and public construction spending – has peaked, and a closer look at its spending categories tells a pretty compelling story. Non-residential construction can be propped up, in net, by either public or private spending, but it looks like they have both peaked and are set to decline. Aggregate profits are tanking, pushing back firm expansion and the demand for new structures. Further, tax receipts, especially at the state and local level, are suffering, and the public sector is forced to cut back on future projects.

The chart illustrates nonresidential construction growth broken down by its categories in July. Private non-residential spending fell 1.1%, with manufacturing very negative, -4.2%, and communication spending declining for the third consecutive month, -2.2%. Public spending grew 1.1%, with strong growth in conservation and development, 4.6%, sewage and waste, 4.5%, and public safety, 5.5%.

The chart illustrates non-residential construction growth by its categories in August. The graph shows a strong downward trend from July. Private spending declined another-0.8%, while public spending decelerated to 0.8%. The rate of public spending growth will likely continue to decline and may turn negative for the rest of 2008. The few increases in spending were dominated by highway and street construction, 3.8%, and office space, 1.0% (saw growth in private and public spending), but most of the categories posted declines.

Going forward, the risk to investment – which includes both residential and nonresidential construction - has risen. There was a large downward-revision to July, and non-residential construction may be deteriorating in both the private and public sectors. There have been surprising revisions to several statistics, including this one, suggesting that U.S. growth will be much weaker in the third quarter than previously expected.

Rebecca Wilder