5 Nov

Construction spending falls again, a negative for the economy

WRITTEN BY Brent Nyitray, CFA, MBA

Construction spending decreased 0.4% month-over-month in September

Construction spending decreased to a seasonally adjusted annual rate of $950.9 billion in September from an upwnward-revised $955.2 billion in August. Spending is up 2.9% year-over-year. Private construction fell 0.1%, while public construction decreased 1.3% month-over-month.

Recently, public construction has been coming back. Private construction is up 3.4% year-over-year. Residential construction rose 0.4% month-over-month and is up 0.7% year-over-year. Nonresidential construction is up 4.2% year-over-year.

Construction spending falls again, a negative for the economy

Outlook

Construction spending is just off its post-recession high, but it’s still depressed. Current levels equate to mid-2003 spending levels. Construction spending peaked at $1.2 trillion in March 2006. It bottomed in February 2011 at $746 billion.

Single-family residences, which accounted for 52% of private residential construction, have been inching up over the past year. The multi-family residence segment, which accounted for 12%, has been increasing its share as well. Home improvement comprised the balance, and it has been falling as a percentage. This is important to investors in home improvement retailers such as Home Depot (HD).

Multi-family construction is notoriously volatile, but it has been rising steadily. As the supply of rental properties increases, rents should fall relative to house prices. This will negatively affect new home pricing at the margin.

Homebuilders such as Lennar (LEN), Pulte Homes (PHM), Toll Brothers (TOL), and D.R. Horton (DHI) will feel the impact of an increasing rental property supply. However, the current low inventory level will offset this effect. Investors can participate through the Standard and Poors depositary receipt (or SPDR) Homebuilder exchange-traded fund (or ETF) (XHB).

Renting versus buying

Right now, the difference between renting and buying is heavily skewed in favor of buying. When you consider the difference between median house prices and median rents, purchasing is cheaper. Rock-bottom interest rates and low prices for starter homes are making home ownership very affordable.

As the job market improves for younger adults, those who are currently renting will contemplate home ownership. The Obama administration has been pushing banks to lend more and to use Federal Housing Administration (or FHA) loans for first-time homebuyers. FHA loans require only a 3.5% down payment, so they’re perfect for the first-time homebuyer. Mel Watt has floated the idea of a 3% down conforming loan targeted to the first-time homebuyer. Homebuilders such as Pulte Homes (PHM) and D.R. Horton (DHI) have the highest exposure to the entry-level homebuyer.

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