2006 forecast: Construction market volatile

Construction analysts mark their 2006 forecasts with caveats. They worry endlessly about higher energy prices, material costs and wages, federal debt, the trade deficit and labor shortages. However, when it’s time to study the bottom line, they come up smiling. U.S. construction will grow by 3 percent in 2006, says Robert A. Murray, vice president of economic affairs for McGraw-Hill Construction, New York City; and construction spending will grow by 6 percent, predicts James W. Haughey, director of economics, Reed Construction Data, Norcross, Ga. Both see the U.S. economy growing 3-to-4 percent during the same period. Murray spoke at McGraw-Hill’s Outlook conference Oct. 20 in Washington, D.C., and Haughey at Reed analysts’ meeting on Oct. 28, also in Washington, D.C. 

This, “despite the devastating effects of the year’s hurricanes,” said Norbert W. Young Jr., McGraw-Hill president, at the Oct. 20 conference. Speakers at both gatherings highlighted the following issues relevant to flat-glass executives nationwide.

Energy. The hurricanes hit and the world changed, said David A. Wyss, chief economist for Standard & Poor’s of New York City. Economic growth slowed and oil prices hit new highs. At the same time, the destruction created a demand for rebuilding that will be good for the nation in the long run, he opined.

Wyss warned that the loss of natural gas production from Gulf Coast facilities might slow growth of the nation’s gross domestic product, particularly if winter weather proves severe. In fact, natural gas prices went up 50-to-60 percent in recent months and will not go back to previous levels long term, Haughey emphasized. Higher prices for natural gas, a necessity for flat-glass manufacturing, could ultimately be reflected in the prices of glass products.

Inflation. Wyss agrees that energy prices will stay up long term and the Federal Reserve will continue to raise interest rates to keep the economy on an even keel. Today, inflation remains mild worldwide, he noted. Yet Ken Simonson, chief economist for the Associated General Contractors in Arlington, Va., is so concerned about “construction materials inflation” that he launched an e-newsletter Oct. 29 to track it. Major construction materials showed price spikes in 2004-05, he wrote in the first issue. And in his forecast on p. 54, Bob Leyland, vice president of sales for Kawneer North America in Norcross Ga., described such inflation by relating how the price of energy directly affects the price of aluminum products that contract glaziers use in most commercial buildings.

“Material availability and pricing top architects’ concerns for 2006,” said Kermit Baker, chief economist, American Institute of Architects, Washington, D.C., and senior research fellow for the Joint Center for Housing Studies at Harvard University in Cambridge, Mass.
“What is the impact of the rise in building price materials?” Murray asked. “You will see a curl but not derailment [in construction spending]. I see a reasonably positive picture for 2006; I’m a little more concerned for 2007. Are we going to be seeing construction shortages as the Gulf Coast gets rebuilt?” 

Prices of gypsum and steel remain most critical, Murray said. Iron and steel prices rose 6-to-10 percent in 2005 and might rise an additional 2 percent in 2006. He explained how architects change their designs and construction gets delayed as a result of these price hikes; one architect replaced a steel foundation with concrete to control costs. “Looking at the broad picture, material price increases may cause deferral of projects rather than derailment,” he concluded. “Market fundamentals are still strong.”

Inflation will add about 2-to-3 percent to overall construction costs, predicted Haughey, writing in Reeds’ U.S. Construction Outlook 2006-07. “The nominal value of construction spending will expand quickly as material prices resume rising. The price increases will come from three sources:
•  The progression of inventory cycles in steel and lumber
•  A general rise in inflation as credit, oil and natural gas price increases spill over into all products
•  Impact of the two Gulf hurricanes on material demand.”

Labor availability and wages. Gregory L. Sizemore, executive vice president of the Construction Users Roundtable of Cincinnati, a group of building owners, said his members voice concern regarding labor, labor cost and material supply. “We have a workforce problem now and we don’t know what to do about it yet. A Louisiana building owner recently told me that his labor costs had increased by 60 percent following the hurricane. This industry has moved into a crisis mode with workforce issues,” he said. He called for industrywide collaboration to seek solutions.

Labor costs will skyrocket during the next five years, further fueling inflation, currently rising 4.7 percent year over year, warned Bret R. Wilkerson, chief executive officer of Property & Portfolio Research in Boston. He cited two ways to fix inflation: slim down profits or drive prices up.

Echoing these sentiments, Robert Fry, senior associate economist for DuPont in Huntington, W.Va., asked, “Can [the economy] continue to grow like this? No.” He was speaking before attendees at GlassBuild America in a September forecast. “A lot of people are out of work, lots of businesses destroyed. The short-term impact is decidedly negative. Price increases associated with supply disruptions are more harmful than those associated with strong demand.” Furthermore, “the labor market remains a lot tighter than political pundits admit. It’s hard to find good people and Katrina didn’t help any. Any able-bodied person who can swing a hammer is going to be swinging a hammer,” he said.

The forecasts
“The mix of construction spending is changing,” Haughey said. Nonresidential construction spending will rise at least 10 percent over 2005, but remain below the 2001 peak. Expansion in this category that began in 2005 will continue through 2008. However, “while spending pickups in the much smaller nonresidential and heavy [construction] markets will be substantial, the decline in residential spending will be larger, as homebuilders build fewer homes,” he explained.

Reed’s forecasts for total construction put in place: an 8.1 percent hike for 2005, a whopping 6 percent for 2006 and 7.4 percent for 2007. The data include residential, residential improvement, nonresidential and heavy construction.

Meanwhile, housing starts will drop slightly in 2006 as homebuilders finish current projects. Residential construction has peaked, but will continue to report high numbers of new starts until late 2007 (see story on p. 60). “Defacto legalization” of foreign immigrants, who can now obtain home mortgages, slow the rate of decline in new starts.

Murray and other analysts say global exchange rates encourage the flow of foreign dollars into the United States, improving the outlook for nonresidential construction. The improving fiscal condition of state and local governments fosters long-postponed construction of schools, health-care facilities and public buildings.

Baker said that the association’s tracking of architects’ billings and inquiries for new work also show steady levels of growth through 2006 in all regions of the country. Architects nationwide predict revenue growth of around 4 percent for 2006, he said. The residential market now accounts for more than 56 percent of total U.S. construction activity, twice the size of the commercial market and much larger than public works. He called the flourishing construction of condominiums nationwide the “balance wheel of the housing market: volatile, strong and probably headed for a downturn.”

Some of the short-term effects of the 2005 hurricanes have already come and gone, Haughey said. “Some prices are higher, some supplies tighter. Spot shortages of equipment will stay with us a little longer.” The main impact was on supplies of cement, diesel fuel, asphalt, petrochemicals and plastics; and “there are some instances where we will have availability problems later on.” Reed’s most recent price index of construction materials, dated October 2005, showed a year-over-year price increase of only 2.9 percent for flat glass, whereas ready-mix concrete increased 12.3 percent, softwood plywood, 23 percent, plastic construction products, 12 percent, and gravel, 10.2 percent.

Construction sectors
“The first half of the decade turned out as a golden period for residential construction,” Murray said. However, “some fear we might be dealing with a housing price bubble.” Single-family housing starts again set an all-time record in 2005, with housing starts rising 3 percent to 1.6 million units, with correspondingly high investment in new single-family homes and single-family improvements and repairs. Implications of the Federal Reserve Board’s monetary policy will weigh in for next year, with higher home mortgage rates. “Our picture for single-family housing for 2006 is down 5 percent,” he said. “For 2007, we might see a steeper decline.”

Construction of multifamily housing units rose 2 percent in 2005, with recent strength coming from condominium development. Murray terms the sector “still relatively attractive as an investment target,” although he voices some concern about overbuilding of condos. Such developments have been helped by downtown redevelopment projects and demand from empty nesters, Wilkerson said. “One area where development is completely out of control is the condo market,” he said. “A bubble. We also have rondos, the conversion of rental units to condos as their value increases. We’ve done that with 177,000 units [nationwide], 1.4 percent of entire stock.” New starts among such multifamily projects “could turn cold relatively quickly,” he warned.

The nonresidential market grows quickly, Haughey said. Contractors will see a substantial pickup in spending on commercial and institutional projects through 2007, fostered by retail construction, rising hotel occupancy and better office rental rates.

A major role in the prosperity of the retail construction segment will be played by the expansion plans of Wal-Mart, Lowe’s, Home Depot, Target and Kohl’s. Elsewhere in the retail sector “there may be a pull-back due to department-store mergers. There will be store consolidation and some vacant space in the U.S. market,” Murray predicted. Traditional shopping malls continue to lose traffic in favor of open-air village centers.

Wilkerson predicts new retail and warehouse construction during the next five years as shopping facilities follow new home construction. Long term, however, retailers grow increasingly concerned about consumers’ behavior, he said. “People are spending more at the gas pump, not at the mall. They’re spending more at discounters, a long-term trend. Traditional mall anchors will die. It takes a long time, but they will die.”

Officials at PricewaterhouseCoopers have documented the growing profitability of the hospitality sector, Murray reported. The conversion of hotels to condos should spur more construction.

With lower occupancy rates, construction of office buildings started to pick up, but some projects have been reassessed because of higher material costs. Murray expects a 9-to-10 percent year-to-year increase in the amount of office space built in 2006 (see table, p. 57).

“Planned projects rise across the country for all property types, with capital driving the investments,” Wilkerson said. Office and retail developments abound, and “speculative office construction will take place.”

Heath-care construction flourishes as a result of higher insurance premiums that providers instituted in the last couple of years, Haughey said.

As both introduction and conclusion to his remarks, Murray celebrated the idea that the U.S. construction economy’s performance in recent years belies the traditional concept of the industry as a volatile one. “The industry has become stable and resilient,” he maintained, with the dollar value of construction put in place having grown by 11 percent in 2004 and 9 percent in 2005, far exceeding the forecasted growth rate of 5 percent. The value of new construction starts rose that year by 8 percent to $637 billion, an upward revision from earlier estimates, he reported. Contractors and suppliers must draw on that resilience as they battle the combined inflationary forces of energy, materials and potential wage price hikes and labor shortages.