During the 1990s, retail construction (here defined as the furniture-friendly segments of privately-owned stores and restaurants) moved in the same general direction as housing starts, and the two were considered to have a close relationship since retail was typically the "second tier" of construction following the start of a new housing development. In the new millennium, however, the relationship between housing and retail construction has become more ambiguous.

From 2000-2005, the housing market climbed 32 percent thanks to a precipitous decline in interest rates (the Fed's effort to stave off a recession) and the strong rise in home prices (which lower rates engendered). Housing starts reached the all-time high of 2.068 million units in 2005. We now recognize that this peak was caused by an investor-driven bubble that quickly began to deflate in 2006. From the 2005 peak through 2007, housing starts fell 35 percent wiping out the previous gains and bringing starts down to their lowest level since 1995.

Table 1: The link between retail and housing

Effects of recession

By contrast, the recession at the start of the new millennium caused the dollar value of retail construction to dip 7 percent from 2001-2002 and then to remain at that level in 2003 when the start of the Iraq war froze business confidence and investment spending. Retail construction spending, however, then soared 42 percent through 2005, when the housing market peaked (retail construction includes the effects of inflation, so the two measures are not comparable). However, rather than ebbing with the downturn in the housing market, retail construction continued to soar in 2006 and 2007, bringing the value of construction to $38.2 billion fully 98 percent higher than at 2002's low point. Essentially, retail construction spending has yet to see any effect of the housing downturn.

Given their tight historic relationship, however, the current disconnect between stores and housing is unlikely to continue for much longer. In fact, this year's generally weaker economic conditions and tighter financing conditions that the housing downturn has created are very likely to bring an end to the gains in retail construction. Because of the very sharp gains the retail construction market has experienced over the past four years, it is very likely to experience a pointed and extended downturn as well.

Retailers begin to feel the sting

While construction has yet to turn downward, the nation's malls and shopping centers have certainly begun to feel the sting of tighter credit and the slowing economy. The UBS-International Council of Shopping Centers (ICSC) reported that their sales tally for 43 major retailers rose just 0.5 percent in January 2008 following an anemic 0.7 percent gain in December 2007. According to the ICSC chief economist, this is the weakest same-store performance in the history of their statistics, which date back to 1970.

The Commerce Department's measure of retail sales was a bit more optimistic in January, when sales rose by an unexpected 0.3 percent after a very disappointing 0.4 percent decline in December. Despite the January gain, the market remains weak the year-over-year increase in core sales (excluding auto sales) was the weakest in almost five years. And, the number of retail segments posting year-over-year declines is growing as consumers pull back on all but the most essential purchases.

Store closings

The news media is also full of reports about how retailers are girding for a rough 2008. The ICSC predicted that 5,770 retail stores will close this year, 25 percent more than in 2007. Store closings have surged and include well-known names such as Ann Taylor (closing 117 stores), Talbot's (100 stores), Sprint-Nextel (125 stores), Pacsun (173 demo stores), Movie Gallery (400 stores) and Charming Shoppes (150 stores). Retail jobs are also on the line: Macy's announced the elimination of 2,300 jobs and Home Depot is cutting 500 jobs at its Atlanta headquarters.

With retailers shuttering stores, it can't be long before plans for new construction are shelved as well. Forewarned is forearmed.