Author Archives: Lee R. McPheters

About Lee R. McPheters

Lee R. McPheters is a professor of economics and senior associate dean of the W. P. Carey School of Business at Arizona State University. He is also director of the JP Morgan Chase Economic Outlook Center.

nonresidential building outlook

Non-Residential Building Feeling Effects Of Recession

Although non-residential building held up longer than residential activity in the current recession, the non-residential downturn now has started and is expected to continue into 2010.

Non-residential building began to increase strongly at the beginning of 2006, just as residential activity started to sag. Double-digit growth continued in seven of the next 10 quarters, propping up the economy and partially offsetting the drag on GDP created by the residential downturn. But non-residential building hit the skids in the fourth quarter of 2008, with an annualized decrease of 9 percent. However, that was a minor dip compared to the latest GDP figures. In the first quarter of 2009, spending on non-residential building was down a whopping 44 percent. Double-digit quarterly decreases in non-residential building outlays are expected through 2009. If forecasts from Arizona State University’s W. P. Carey School of Business prove to be correct, spending on non-residential structures won’t move back into the positive range until the third quarter of 2010, after nearly two years of decline.

Just as residential building has been hit by a weak economy, non-residential construction is now feeling the effects of reduced demand for office space and facilities of all types.

Moreover, tighter credit standards, originally linked to residential mortgage problems, are now affecting non-residential financing, while commercial real estate borrowing is plummeting. According to surveys of bank loan officers by the Federal Reserve Board of Governors, non-residential construction loan credit standards have grown tighter in each of the past 12 consecutive months. Meanwhile, bank loan demand by builders of commercial real estate declined in each of these months.

A collapse in non-residential building will have a sharp impact on an already weak construction industry in metropolitan Phoenix. In 2005, at the peak of the housing boom, residential permits accounted for approximately two-thirds of the $14 billion total value of building permits for the year, while non-residential made up the remaining third. By 2008, the relative importance of residential and non-residential activity switched, as non-residential permits of $6.6 billion accounted for two-thirds of the total, and residential permits fell from $9 billion in 2005 to less than $3 billion in 2008.

Observers expect the value of non-residential permits will fall by as much as one half this year, offsetting any meager gains if residential housing shows signs of life.

New retail, office and industrial space actually put in place is expected to be less than 10 million square feet this year, down two-thirds from more than 30 million square feet in 2007. And 2010 will be even weaker. The consensus among real estate analysts is that new retail, office and industrial space added next year will not reach 4 million square feet.

Non-residential building has posted many instances of sustained downturns, the most recent being the six consecutive quarters beginning with the fourth quarter of 2001, after the attacks of Sept. 11.

As long as labor markets are weak, financial markets are tight and securitization barely exists, it is unlikely that non-residential building will show strong signs of life nationally or in the Phoenix metro area.

Dark Days: Recession in Arizona

The Recession In Arizona And The Nation Could Drag On For Another Year

Winters in Arizona may be sunnier than other places, but the economy in the Grand Canyon State has cooled faster than almost every state. Analysts expect 2009 to bring even more bad economic news, and it is likely that the monthly reports on job growth and unemployment will be downright chilling for some time to come.

As in all downturns in the past 50 years, Arizona’s economy will track the national business cycle. There are no forces inherent in the makeup of the state’s economy that would propel Arizona into an independent turnaround. Arizona will recover at approximately the same time as the country as a whole.

And, entering 2009, a rebound for the national economy is nowhere in sight. The National Bureau of Economic Research recently decreed that we have been in recession since the end of 2007. Now that a start date has been identified, it is only natural to wonder how long recessions typically last. The answer is that the average post-World War II recession has been 10 months from peak to trough. This information is perhaps useful for trivia buffs, but in the current environment, the 10-month average is not much of a guideline. This recession has already persisted past 10 months, and may be well on its way to setting a post-war record for length. The recession will certainly be 18 months at a minimum, and could persist for as long as 24 months. Or more.

The list of economic problems facing the country and Arizona continues to grow. Until recently, exports and non-residential building were actually expanding at a double-digit pace, keeping the Gross Domestic Product growth figures in the positive region. As the global economy slows, exports will decrease, probably early in 2009. Arizona has important manufacturing exports, especially in high technology, that will be affected.

Non-residential building (commercial, office, and warehousing) will grind to a halt in 2009 as current projects are completed. When the economy is losing jobs and sales are falling, there is no need for additional offices, retail space or warehouses.

During the first half of 2008, consumers in Arizona and the nation continued to spend, and that bolstered growth. New unemployment claims were mounting during this period, but conditions would have been worse if consumers were not contributing to the economy. The credit crunch hit in the second half of 2008. Combined with a chaotic stock market and continually falling home values, consumer willingness — and ability — to spend hit the breaking point. Arizona retail sales were down sharply in 2008, with auto sales and restaurant and bar sales both off by 25 percent. Consumer spending is expected to fall more during the early months of 2009.

Compared to other states, Arizona’s labor markets are in the deep freeze. Employment in the state is down by more than 75,000 jobs compared to last year at this time. Arizona is just one of 37 states now losing jobs, but conditions are worse here. Arizona ranks 49th among all states in job growth. Only Rhode Island is losing jobs more rapidly. Unemployment rates nationally and in Arizona are destined to increase into the 7 percent or possibly 8 percent range before recovery begins.

And recovery will come, as it always does in business cycles, although this one will be deeper and longer than has been seen since the 1930s. Housing inventory will eventually be worked off, and foreclosures will begin to slow. Home prices will stabilize. The nation adds three million new residents per year, and the pent-up demand created by family formation and population growth will start to translate into new sales.

Arizona benefits from high levels of domestic migration. Even if migration slows temporarily in the down period, the basic attractions of Arizona remain powerful in the longer term.

One of these attractions for many decades has been affordable housing. During the housing boom, home prices in Phoenix increased faster than in many peer metropolitan areas, and Phoenix became less competitive to relocators. Although falling values have caused dismay to Arizona home owners, the resulting new lower prices actually create an environment for ultimate growth.

The table shows housing affordability as measured by the National Association of Homebuilders. Higher numbers indicate housing is more affordable. At the end of the previous recession (third quarter of 2001) Phoenix had an affordability value of 70, which means 70 percent of homes were affordable to families at the median Phoenix income. Phoenix housing was more affordable than the nation and the peer metro areas shown. Two years later, at the peak of the boom, Phoenix was less affordable than Denver, Riverside, Calif., and the nation as a whole. But the most recent values, for third quarter 2008, show Phoenix affordability up by 75 percent over the 2005 figure, and more affordable than the other metro areasandthe nation. The Phoenix housing advantage has been restored.

There is one final optimistic observation to be made, one which is familiar to Arizona economy-watchers. When recovery does begin, Arizona invariably rebounds much stronger than the nation, and more vigorously than most other states. What analysts are still debating is whether this rebound will come in 2009 or is delayed until early in 2010.