Academic journal article Economic Review - Federal Reserve Bank of Kansas City

Tenth District Construction: Smoother Sailing Ahead?

Academic journal article Economic Review - Federal Reserve Bank of Kansas City

Tenth District Construction: Smoother Sailing Ahead?

Article excerpt

Activity in the Tenth District's construction sector underwent wide swings in the 1980s. During the national recessions of the early 1980s, construction in the district slowed from its torrid pace of the late 1970s. Then, just as building activity began to recover in the mid-1980s, two events shook the district's construction industry. Federal tax reform removed strong incentives for investment in commercial construction. And the collapse of the energy industry ended much of the demand for office space and housing in the district's major cities. As the decade drew to a close, building activity in most parts of the district stood still.

Will the district's construction sector enjoy smoother sailing in the 1990s? This article examines the growth of construction in the 1980s and explores the outlook for district construction in the decade to come. The first section of the article documents the nation's construction cycle in the 1980s and highlights the factors responsible for the cycle. The second section explains how the district's construction cycle varied from that of the nation and how construction activity varied across the district's major real estate markets. The third section concludes that growth in the district's construction sector in the 1990s will be slower than in the 1980s but less erratic.

THE NATION'S CONSTRUCTION CYCLE IN THE 1980s

Understanding the wide turns in the district's construction sector requires a closer look at the nation's construction cycle. In the 1980s, both cycles were driven by a wave of commercial property development--that is, by multifamily residential construction and nonresidential construction, such as office, industrial, and retail structures. The wave in commercial property development was caused by three forces: new tax laws regarding real estate investments, changes in the lending behavior of financial institutions, and the boom and bust of the energy industry.

Other types of construction were less sensitive to these forces. Single-family residential construction responded primarily to other factors such as demographic trends and real mortgage interest rates (Miller; Peach; and Garner).(1) And nonbuilding construction such as roads, bridges, and dams responded to state and local budget outlays for public infrastructure. As a result, these types of construction took a back seat to multifamily residential and nonresidential construction in shaping the construction cycles in the nation and the district during the 1980s. Therefore, this article focuses on construction of commercial property.(2)

After the nation's construction activity dropped sharply in the early part of the decade, commercial property development fueled a rapid and dramatic recovery in building activity. More favorable tax laws, readily available financing, and the energy boom boosted commercial property development. Construction jobs, a good measure of overall construction activity, fell during the 1980 and 1981-82 recessions, turned around in 1983, and climbed sharply in the middle years of the decade (Chart 1).(3) (Chart 1 omitted) The nation continued to add construction jobs moderately until 1990, when the number of construction workers peaked at over 5 billion. In 1991, building activity faltered and construction jobs fell again sharply, a key element in the economy's recent sluggishness.

Not all of the forces that shaped the nation's construction cycle in the 1980s had the same impact everywhere. Changes in the tax treatment of real estate investments sharply altered the incentives faced by real estate developers nationwide. And financial institutions stepped up their lending to real estate developers across the country. But the energy boom and bust jolted real estate markets only in the energy-producing regions of the country.

TAX TREATMENT OF REAL ESTATE INVESTMENTS

The U.S. Tax Code was revised numerous times during the 1980s, but two revisions stand out as milestones for the construction industry. …

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