Down but not out

America's longest-ever period of economic prosperity ended during the third quarter of 2001 after 10 years of uninterrupted economic growth. The hope now is that the nation is in the middle, not the beginning, of the recession.

The indeterminate economic impact and political uncertainty created in the aftermath of Sept. 11 renders standard forecasting models essentially useless. Nevertheless, the most likely scenario is that the U.S. economy will grow very little during 2002. Following gross domestic product (GDP) growth of 4.1 percent during both 1999 and 2000, the economy will be lucky to expand by 1.1 percent during 2001.

On the bright side, the nation is likely to experience low interest rates and low inflation during 2002. Weak worldwide demand will keep commodity and materials prices low, while at the same time dampening labor market inflationary pressures. Furthermore, the Bush administration and Congress have committed to an economic stimulus package worth between $70 billion and $120 billion.

Despite the current unnerving state of affairs, however, comfort can be taken in that the U.S. economy is in reasonably good shape to weather the storm. There are very few imbalances in the economy. Unlike the last recession 10 years ago, neither housing nor commercial construction markets are overbuilt. The huge inventory of speculative space that burdened the market and financial institutions during the early 1990s is absent. Manufacturers, wholesalers and retailers have spent the last year paring inventories. These factors will cushion the current blow, and position the economy to realize solid gains in activity once the recovery materializes. The short-term outlook may appear bleak, but the medium- and long-term outlook remains decidedly positive.

The strongest sectors for 2002 should include education; health care; apartment buildings; retail buildings focused on consumer basics, such as grocery-store-anchored strip malls and discount department stores; backup capacity for critical functions; and security-enhancing renovation projects for all existing private and public buildings.

Sectors expected to be the weakest during 2002 in terms of declines in the actual dollar value of construction work completed include hotels; retail buildings, especially malls, department stores and clothing specialty retailers; office buildings; industrial buildings; airport terminal construction and renovation projects; public projects requiring substantial state or local matching funding; and convention centers, sports stadiums, movie theaters, theme parks and other recreational facilities.

Although more difficult credit market conditions for private educational construction are likely to prevail during 2002, publicly funded work should once again grow at a near-double-digit rate. It is likely that educational construction spending growth during 2002 will be lower than its long-term annual average. This is because of declining tax revenues and competing priorities at the state and local level such as public health and security. Therefore, some tentatively planned projects will be postponed or put on a slow track until fiscal health improves.

Overall health-care construction activity will grow by about 7 percent this year. Some public funds will inevitably be diverted away from health care and other longer-term priorities to fund defense, internal security and other more immediate priorities. But relatively low interest rates will continue to support modest gains in the dominant privately funded side of the market. Continued public health concerns about biological, chemical and nuclear terrorism will ensure a modest increase in dollars flowing to public health-care facilities.

Spending for new multifamily construction should hold up reasonably well in the year ahead. Slow economic growth will dampen household formation growth as more single people choose to live at home or with roommates. Multifamily residential construction should continue to skew more upscale throughout the first half of the decade, with more condominiums, luxury apartments and assisted-living centers being built. Although the total number of units started during this year will probably be slightly below the 2001 level, spending should continue to rise.

Overall market gains were evaporating in the closing months of last year and demand for new retail space will probably weaken further before it gets stronger again during the latter half of 2002. Consumer-targeted grocery-store-anchored strip malls and discount department stores should remain strong, but developers will be more selective with spending. Thus, retail construction spending is expected to decline 6 percent to 7 percent this year, following last year's estimated 2 percent loss.

The very large "other institutional" category grew at a faster rate last year than during the previous three years, thanks almost entirely to strong gains in publicly funded work. But much of this largesse was tied to surpluses in government budgets. The fiscal position of most state and local government authorities deteriorated during the second half of 2001, and revenues are likely to decline further through at least the first half of 2002. This will cause many projects to be put on hold, although outright cancellation of needed infrastructure improvements should be rare.

About 30 percent of total dollars represented by this "other institutional" building sector comes from private sources. Spending on churches, synagogues and other religious buildings grew by about 2 percent last year, but will probably decline by about the same amount during 2002 as cash-strapped parishioners have less money to give.

Money spent on other private institutional work such as airline terminals, sports stadiums, amusement parks and conventions centers declined by about 8 percent during 2001 and is likely to decline by about the same amount this year.

Because overall manufacturing capacity utilization rates are at their lowest levels in 30 years, the majority of dollars spent on industrial buildings during the year ahead will be for enhancing productivity and improving process technology. However, increasing dollars have gone towards expanding or renovating production facilities. This trend will continue, softening a blow that would otherwise result in a double-digit decline in overall spending.

Given the rapidly deteriorating condition of the market, office construction spending will likely be down by about 8 percent this year. It is important to recognize, however, that the market enters this down part of the cycle at a time when there is little evidence of significant overbuilding, in marked contrast to the market's condition entering the last recession. According to Boston-based Property & Portfolio Research Inc., national vacancy rates for class A and B offices should peak at 14 percent late this year or in early 2003 — a rate well below the 20 percent-plus level that existed in the early 1990s.

Current opinion is that full-service and resort-community-lodging construction will face a very difficult year in 2002. Business travel will be slow to recover from Sept. 11 and the overall recession, and vacationers will stay closer to home. Development activity should increase for properties within reasonable driving distance of major population centers, and for limited-service lodging facilities.

However, the bellwether measure of industry profitability — average revenue per available room — will increase only slightly during 2002, and therefore overall construction spending in the sector is likely to decline by more than 10 percent for the second consecutive year.