Crisis Changes Demand Side of Costs
 Cosmopolitan Resort & Casino Banks forced foreclosure on $9.3-billion Las Vegas casino in midconstruction. |
Record high oil and steel prices during the first half of the year were just starting to work their way into construction industry cost indexes when the financial meltdown on Wall Street threatened to drastically reduce the demand side of the cost equation. Commodity prices had already started to slip from their second-quarter peaks, but that slip could turn into a major step back as commercial construction gets sucked into the subprime-mortgage debacle.
“Our forecast was already looking for a decline in nonresidential building work this year,” says Robert Murray, chief economist for McGraw-Hill Construction, of which ENR is a unit. “Recent economic events will make a tough situation more difficult and more extended.” Murray was predicting a 13% decline this year in square footage of new nonresidential buildings, followed by another 7% decline in 2009. “That forecast will be lowered as a result of the freezing up of the financial markets,” he says.
Related Links: The financial meltdown also will cut deeply into overall economic growth, says John Mothersole, an economist with Global Insight, Washington, D.C. “We were predicting a very weak 1% growth in GDP in 2009, and now we are chopping that in half,” he says. “Embedded in those numbers are expected mild declines of 0.2% in the fourth quarter of this year and 0.1% in the first quarter of next year. That fits the textbook definition of a recession.”
New construction had already faced an uphill battle, as underwriting dealt with increasingly tighter lending markets before last week’s events rocked Wall Street (see chart, p. 30). The shuddering collapse of investment bank Lehman Bros. and global insurer American International Group led to at least $172 billion in U.S. government bailouts in addition to $200 billion in prior federal aid to mortgage backers Freddie Mac and Fannie Mae.
On Sept. 19, the U.S. Treasury proposed a longer-term solution aimed at restoring investor confidence and averting a national economic meltdown: The U.S. government would purchase a record $700 billion worth of bad mortgages from various banks and lenders, raising the national debt to $11.3 trillion. The end result would likely mean tougher underwriting criteria for new construction, which would produce fewer realized projects.
Setting the Stage
The scenario was preceded by slumping property prices, greased by tremendous numbers of home-loan defaults. Lenders responded by reevaluating loans secured by real estate, including those in the commercial sector. Many financial institutions adjusted loan-to-value ratios accordingly, requesting more hard-money commitments from borrowers, which has since led to project foreclosures, cancellations and delays.
In Las Vegas, developer Ian Bruce Eichner in January defaulted on $930 million in loans for the $3.9-billion Cosmopolitan Resort & Casino. Deutsche Bank AG wanted him to increase his equity stake in the project. Eichner acquired financing with 8.5 acres of prime Strip property purchased for $90 million in 2004, with half of the money coming from Hyatt Corp., which will manage the Cosmo. But loan defaults triggered a foreclosure process that squeezed out Eichner.
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Deutsche Bank, unable to find a new buyer, purchased the project itself earlier this month for $1 billion. It had previously reached a payment agreement with contractor Perini Building Co. to ensure continued construction progress.
Las Vegas is hardly alone in feeling the pain from an economic crisis. The majority of contractors are “bracing for more competition and tighter financing,” according to a third-quarter nonresidential construction survey conducted by FMI Corp., Raleigh, N.C. Project delays and cancellations are running 2.2 to 2.5 times the normal rate, the survey reports.
Chicago-based General Growth Properties, for instance, is deferring $500 million in development plans over the next 18 months due to the souring economy, slow pre-leasing activity and waning consumer confidence. The company's stock has fallen nearly 50% from a year ago because of investors’ concerns over a weakening retail market.
“Planned projects that looked like a given are now being questioned, and [those projects} are being delayed 12 to 14 months,” says Jay Bowman, FMI’s manager for research services. “People are in the holding-their-breath phase.”
Architecture billings also paint a gloomy picture for the nonresidential construction market, reports the American Institute of Architects, Washington D.C. There is a 12-month to 18-month lag time between architecture billings and construction spending, AIA notes.
“These numbers are a continuation of weak conditions in the nonresidential construction sector,” says AIA chief economist Kermit Baker. “Given that inquiries for new project work have not seen much improvement, it’s likely we are several months away from a turnaround.”
Yet AIA still reports continued demand for schools, hospitals and government...