Two years ago, home builders couldn't construct houses fast enough to meet demand. They transformed huge tracts of lands into millions of new single-family homes, emboldened by rapidly appreciating home prices. Meanwhile, in cities across the country skylines were dotted with construction cranes as new multifamily towers rose. Moreover, developers transformed older hotels and office buildings into condos.
To suggest that there was overbuilding then would have gotten you laughed out of any room. But that building boom came with a price — and not just because it contributed to the downfall of the housing market. The boom sent prices of construction materials skyrocketing. Some materials costs grew at double-digit percentage point paces. This, in turn, had a profound effect on retail construction. For one, new retail follows residential, so new construction created opportunities for retail builders. But there was another impact. Developers — if they wanted to build at all — had to act fast or else risk seeing project costs skyrocket in a matter of weeks or months based on how quickly materials prices changed.
But now — with the residential market thrust into chaos — a different picture has emerged. New housing starts declined 27 percent in the first six months of 2007 compared to the same period in 2006, according to Reed Construction Data. Single-family starts dropped 28.5 percent and multifamily starts fell 18.5 percent.
With only 1.49 million units starting construction since October 2006, the country's housing market is in its worst shape since 1997, Reed researchers estimate.
On the downside, a slowdown in housing usually does not bode well for retail. The appetite for new development dissipates. Moreover, faced with a housing crunch, consumer spending remains a concern. This time, however, there is a silver lining. Suddenly materials prices have taken an about-face. On many items, such as gypsum, plastics and ceramic tile, prices have dropped. On cement and precast concrete, prices are still rising, but not nearly as fast as before. And there aren't as many shortages occurring.
Retail developers can now enjoy stabilized construction pricing. As of July, prices for commodity construction materials were up only 0.5 percent from a year ago, and down 0.4 percent from June, according to Reed. In the second quarter of 2007, the price for construction of shopping centers remained flat, says Brian Smith, chief investment officer with Regency Centers, a Jacksonville, Fla.-based REIT with $1.3 billion of new space currently under construction.
By more generous estimates, however, the cost of commercial construction may have gone down as much as 10 percent compared to 2006, says Scott Loventhal, director of development with Garden Commercial Properties, a Short Hills, N.J.-based real estate owner with more than 25 million square feet of commercial space in its portfolio. Garden Commercial is a subsidiary of Garden Homes, a residential developer, and based on the slowdown in the firm's residential business, Loventhal doesn't expect to see an improvement in the housing market at least until the spring of 2009.
The drop in the price of gypsum products, which are used in both residential and commercial construction and which came down in value 17.3 percent compared to a year ago, is one of the most notable changes so far, according to Reed data. Also going down are prices for engineered wood products, which have decreased 9.4 percent from last year; plastics, which posted a 2 percent price decrease; and softwood lumber, which posted a decrease of 5.3 percent.
When it comes to other commercial construction materials, however, such as concrete, there hasn't been much of a change, though price increases have moderated compared to the previous three years, says Jim Haughey, chief economist with Reed. Precast concrete is up 4.9 percent compared to last year, cement is up 4.7 percent and sheet metal is up 2.3 percent. However, those increases are modest compared to the jumps experienced in the recent past. In 2005, for example, prices of concrete products rose 17 percent.
Looking forward, over the next 12 months construction prices will increase an average of 3 percent to 5 percent, estimates Kenneth Simonson, chief economist with the Associated General Contractors of America (AGC), compared to annual increases of 6 percent to 9 percent experienced over the past three years.
Still, the volatility in the oil markets can cause a spike in the price of plastics, paints, rubber and steel at any point, in addition to driving up the cost of site work that relies on fuel-guzzling road machinery, such as excavation trucks. As of July, the price of diesel fuel used for construction work was up 1.7 percent year-over-year, according to AGC, but on Sept. 13, crude oil prices rose more than 2 percent in one day, to $79.91 a barrel, and analysts worry that they will continue to climb higher because of the increased demand for energy in China and India.
Plus, “some of the decreases [in construction materials prices] are offset by higher wage rates for labor for nonresidential building contractors,” Haughey says. “Wages have gone up for nonresidential subcontractors because their skills are different” than those of residential builders.
As of August, average hourly earnings for construction work were up 4.5 percent compared to the same period last year, while earnings for all private production workers were up only 3.9 percent, according to the Data DIGest published by AGC. The wage rate for subcontractor labor went up 4.2 percent compared to last year, estimates Haughey. This suggests that contractors are still bidding up wages, Simonson writes, even though the contractors lost approximately 96,000 jobs since September 2006.
The slowdown in the residential sector has freed up those subcontractors who can be used for site work — in AGC's estimates, up to 400,000 residential workers switched to commercial projects this year. But laborers who specialize in retail development are still hard to come by, according to Walter Bagley, director of construction with Edens & Avant, a Columbia, S.C.-based retail developer with a $1 billion construction pipeline.
Retail developers worry about more than just the labor prices, however. As a rule, retail follows rooftops, and a decrease in the number of new residents in certain areas means a slowdown in new retail construction and, possibly, scrapped projects. This year, overall spending on retail job sites is going to rise 13 percent compared to 2006, according to Reed, but in 2008, that figure is expected to drop to 5 percent, with $37.8 billion in new projects. “That is just a little more than the construction cost increases,” says Haughey, who expects the pace of new retail development to slow down.
Still, that's ahead of the figure for commercial building overall, which is forecast to increase 3.8 percent from 2007 to 2008, with $103 billion in new projects.
A big factor in how things play out could be retail sales. Retail sales have averaged growth of 2.4 percent in 2007 on a same-store basis, down from 3.6 percent last year. They could fall further depending on housing. But even if retail sales plunge, the fallout won't be felt equally. While the slowdown in the residential sector is likely to affect developers of neighborhood and community shopping centers in up-and-coming markets, those whose pipeline is concentrated in primary areas with established populations should emerge unscathed, says Smith.
“As home building slows down, it will slow down retail,” says Steven Rivers, senior vice president with Hardin Construction Co. “But the Southeast is still pretty active, and out West, places like Arizona and Nevada still have a large influx of population, so I think they will keep up. Where we are, in Orlando, we had such a large inventory of new homes come in that the retail is still catching up to the new rooftops.”