by Calculated Risk on 2/25/2008 03:53:00 PM

We've been debating in the comments whether the Commercial Real Estate (CRE) bust would be similar to the Residential Real Estate bust.

Richard Berner at Morgan Stanley writes that the "contraction in [CRE construction] outlays will be shallow", see: Recession Claims Its Next Victim: Commercial Construction

Recession is about to claim its next victim: Commercial construction. A downturn in such activity would represent a significant turnaround from last year’s boom: Although nonresidential or structures investment accounted for only 3.4% of (nominal) GDP, the 16% jump in real outlays contributed half a point to overall real GDP growth over the four quarters of 2007. Such a gain — the sharpest 4-quarter rise since 1984 — is unsustainable, and we think this economic asset is about to turn into a liability. Tighter financial conditions, uncertain tenancy, rents, and property values all will contribute to a downturn in office, retail and warehouse activity. Soaring construction costs are also a negative. Weakness is already showing: Nonresidential construction starts tumbled 13% from a year ago in January, according to Reed Construction Data.

Despite these hurdles, we think that the contraction in outlays will be shallow by historical comparison. The key factor limiting the downturn in traditional commercial construction is that the overall growth in supply for much of this expansion has been modest by historical standards. The “capital discipline” theme that governed corporate spending in this expansion partly extended to construction as well. For example, commercial construction excluding healthcare facilities rose by only 3.9% annualized over the past five years.

But discipline seems to have faded over the past year, when construction accelerated in virtually all categories, and with the slowdown in business activity, vacancy rates have begun to rise. There are clear pockets of excess in financial services office building and in retail and lodging. A slowdown in office employment and shakeouts in retail and wholesale activity may pressure rents just as lenders and investors tighten credit availability and raise its price. However, mining, power, and healthcare construction may buck the trend.

This is similar to my view that the CRE bust is here, but that it will not be as bad as the residential bust - simply because CRE wasn't as overbuilt as residential.