The Wall Street Journal-20080213-Commercial Building Boom Peters Out- Spending Ebbs as Troubles On Residential Side Spread- Retail Sector Is Hit Hard

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Commercial Building Boom Peters Out; Spending Ebbs as Troubles On Residential Side Spread; Retail Sector Is Hit Hard

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For the past several years, as residential construction nearly collapsed, commercial construction continued to grow, helping to keep contractors busy and regional economies growing. Now, nonresidential construction spending may be headed for a decline.

A recent report by the Census Bureau showed that spending on commercial construction projects -- hotels, office buildings, hospitals and other nonresidential construction -- was running at a seasonally adjusted annual rate of $671 billion in December. That was essentially flat with November and brings to an end 14 consecutive months of growth in spending on commercial construction.

Economists say the latest numbers reinforce concerns that the commercial building boom, exemplified by lines of construction cranes clogging cities all across the U.S., is coming to an end. "Even if we avoid a recession, nonresidential construction will go negative this year," says Edward Sullivan, chief economist of the Portland Cement Association, a North American trade group. "If there's a recession, it will go even more negative."

Already, a handful of projects have been stalled or canceled. In October, Chicago-based mall developer General Growth Properties dropped plans for a one-million-square-foot regional shopping center in Oconomowoc, Wis., a Milwaukee suburb. In Detroit, General Growth has pushed back the construction of the Shoppes at Gateway Park, a 330,000-square-foot open-air mall.

For construction firms, the change means greater competition for work and lower profit margins. Ken Simonson, chief economist for the Associated General Contractors of America, said the contractors are starting to see increased bidding on projects from new rivals. "These are general contractors or subcontractors who until a year ago were busy on the nonresidential side," he said.

Competition for work is expected to be especially intense on government projects, which aren't likely to be scaled back as much as private projects. The U.S. Army Corps of Engineers throughout the year ending Sept. 30 is expected to award $1 billion in construction grants for 12 to 15 projects to transform military installations.

Private educational spending is expected to continue strong growth, largely because schools have committed funding through capital campaigns. "Any firm that is involved in school construction is going to have a good year," says Robert A. Murray, vice president for economic affairs at McGraw-Hill Construction. While public educational spending pulled overall spending for the sector down last month, bond measures in several states, including California and North Carolina, should provide reliable funding as the construction downturn hits other sectors.

One of the hardest-hit areas is expected to be retail, where companies such as Starbucks Corp. and AnnTaylor Stores Corp. have scaled back new store openings or announced plans to close existing stores. Retail stores averaged an annual 300 million square feet in construction starts in the past three years, and those numbers should fall by 12% to 15% this year, according to McGraw-Hill Construction.

Construction firms also are bracing for fewer office developments. "Although we have many projects that are in the budgeting phase . . . I think there is a question mark as to whether some of that is going to go forward," says William Calhoun, executive vice president of Clark Construction Group Inc. in Bethesda, Md.

Still, some large construction firms see a silver lining in a possible slowdown. The rapid construction growth that has occurred since the 2002 recession generated intense competition for materials, labor and management. "A small decline in the market would be a little bit of a relief for the industry," says Nicholas T. Makes, senior vice president for portfolio development at Turner Construction Co. in New York, which has $11 billion of projects in its pipeline.

But even firms with a steady supply of institutional construction projects express concern about filling their pipeline beyond 2009. "We are all very, very aware of what's going on in the marketplace and very concerned about where it will go in the future," says Greg Nook, executive vice president at J.E. Dunn Construction Co. in Kansas City, Mo.