A step in the right direction

Following a stagnant 2001 and a decidedly down 2002, total construction spending (not including single-family housing) should be up on the order of 3.8% or so during the year ahead — not anything to make your pulse quicken, but a step in the right direction.

Such a growth rate for both privately and publicly funded work would be well below the annual average for the past decade. But after two devastating years of losses in the commercial and industrial subsectors of the construction market, half a loaf is better than none.

From a larger perspective, national and international political and economic conditions — not least the situation in Iraq — make the prospect for a construction boom in the next 12 months unlikely. Certain sectors — notably office, retail, hotel, and manufacturing construction — will continue to be flat or worse, while a select few — schools, hospitals, R&D, specialty projects — offer reasonable cause for optimism.

Let's take a look at the underlying trends and what they tell us about the year ahead.

The value of nonresidential construction spending declined by an estimated 7.3% from 2001 to 2002. This was the first loss recorded for the sector since 1992.

In fact, total nonresidential growth had already come to a standstill during 2001, since the value of construction work completed on commercial, industrial, and institutional buildings rose by a scant 0.4% from its 2000 level.

Still, the nonresidential sector as a whole kept growing during 2001, thanks largely to impressive gains in publicly financed projects. Spending for private nonresidential construction work fell by 3.4% during 2001 and by a breathtaking 15.9% last year, making 2002 the worst year for private work since the 18.8% plunge recorded from 1990 to 1991.

At the same time, publicly funded building grew by 9.5% in 2001 and by 10.3% over 2002. As a result, the private-sector share of total nonresidential construction activity shrunk from 67.4% in 2001 to just 61.2% during 2002.

In the seven-year period between 1994 and 2000, overall nonresidential construction spending grew at an average annual rate of 9.6%. The gap between privately funded (+9.9%) and publicly funded (+10.4%) gains during this period was negligible.

We're not likely to see growth approach the 1994-2000 average during 2003 — or during 2004 either. But the projected 3.8% increase in total nonresidential construction is at least a hopeful sign.

Over the past two years, the most hard-hit sectors have been the commercial and industrial markets. Overall office, retail, and hotel construction spending declined by 4.2% during 2001, after recording growth that averaged 12.1% a year between 1993 and 2000. Then last year, spending fell off the table, with an estimated full-year loss of 17.2%. Spending in both the office and hotel sub-sectors declined 25-30% between 2001 and 2002, while spending for retail buildings was down a relatively modest 7%.

We're looking for total commercial spending to inch ahead over the second half of this year, but the projected full-year increase of 3.4% will still pale in comparison to the glory days of the mid- and late-1990s.

The industrial sector has been a basket case for some time now, owing largely to gross overbuilding of manufacturing and warehouse space worldwide. With U.S. capacity utilization rates extremely low for most manufacturing industries, and with vacancy rates for warehouse and manufacturing space at the highest level in almost a decade, there's little prospect for any strong gains in industrial construction spending until mid-decade.

On the bright side, we believe that the industrial subsector should begin to stabilize during the next six months and be able to record a modest gain in spending of about 6% for the year as a whole.

The institutional sector, on the other hand, is likely to see the factors that have propelled growth during the past several years diminish in the year ahead. This won't be enough to stop total construction spending in the institutional sector from continuing to grow during 2003, as it did during every single year in the 1990s. However, the projected gain of just under 4% will be the lowest for this submarket since 1994.

All in all, 2003 is shaping up to be a year of transition, certainly when compared to the go-go days of the 1990s, but not so bad when measured against a disappointing 2001 and a dismal 2002. Underlying this comparative optimism for a second-half recovery in most nonresidential market subsectors is the bold assumption that the U.S. economy will gather strength as we move through the year, following a positive resolution of the "Iraqi problem."

In sum, our best estimate is that the nation's Building Teams will be enjoying somewhat brighter days by the time we reach the closing weeks of 2003 than were experienced during the closing days of 2002.