The economic downturn seems to be taking its toll on the non-residential sector, which despite a strong year in 2007 and gains as recently as last month could be treading water for a while.

Last week, McGraw-Hill Construction estimated that non-residential building during the five months ended in May had increased 13 percent to $102.3 billion, based on its assessment of projects that were started during that period. However, a closer look at those numbers reveals some reasons for concern about this sector's health. For one thing, the projects being started are smaller: An analysis conducted by Zelman & Associates found that the square footage for non-residential building was off by 9 percent in May and by 23 percent for 90 days ended that month. While construction of healthcare, lodging, and educational builders rose, on a square footage basis, commercial construction (e.g., retail stores) was off 39 percent and office building was down 34 percent.

Zelman also found that the cost per square foot for non-residential building had "skyrocketed" by 34 percent over the previous six months. The housing analyst judges new-order trends as "disappointing."

One of the more reliable barometers of future non-residential activity—the Architecture Billings Index, which the American Institute of Architects calculates—stood at 43.4 in May. That's better than the 39.7 index in March, but is below the threshold of 50 that indicates a decline in billings. Some markets are also seeing non-residential projects running into financial difficulties. The Jacksonville Business Journal reported recently that nonperforming commercial and industrial loans had increased $2.3 million in the first quarter.

"It's all about the credit market," explains Lee Smither, a managing director with FMI Consulting, a Raleigh, N.C.-based firm that provides consulting advice to companies in the residential and non-residential sectors. With credit tightening "all over the place," consumers aren't buying new homes or moving, which means that investment in commercial and other non-residential construction becomes less attractive. "Eventually, non-res will catch up [with the residential sector] and feel the pain," especially if the availability of credit gets worse, he says.

FMI still finds strength in some areas such as public infrastructure, schools, healthcare, and institutional construction. But Smither points out that the money for many of these projects had been appropriated years ago, before the downturn in the general economy became apparent. Consequently, following a 17 percent increase in 2007, non-residential building is projected to grow by a modest 1.8 percent to $465.7 billion in 2008, which FMI expects to level off over the following two years, and then increase again by 7 percent each year in 2011 and 2012 to $536.1 billion.

In 2008, FMI foresees the biggest percentage gains in non-residential construction coming from public safety and transportation (8 percent up each), and the biggest falloffs in the construction of religious buildings (10 percent off). Other "bright spots,"says Smither, might be found in construction related to homeland security and prisons, as the inmate population in the U.S. is expanding at a faster rate than the population in general.

While some home builders have ventured into non-residential construction, Smither observes that these have been few and far between, primarily because the non-res sector requires a significantly higher degree of skill sets than new-home construction in terms of project management, financial control, and so forth. Commercial builders typically use different subcontractors than home builders. And the risks and potential liabilities related to non-residential construction are considerably higher.

"It's like going from the minor leagues to the major leagues," says Smither, comparing home building to non-residential construction.

Learn more about markets featured in this article: Raleigh, NC, Jacksonville, FL.