A step in the right direction
Nonresidential construction took a hit in 2002, but the coming year offers hope for recovery
By Daryl Delano, Reed Business Information Economist
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 &M>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 &M>not least the situation in Iraq &M>make the prospect for a construction boom in the next 12 months unlikely. Certain sectors &M>notably office, retail, hotel, and manufacturing construction &M>will continue to be flat or worse, while a select few &M>schools, hospitals, R&D, specialty projects&M> 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 (a Commerce Department survey estimate, which is inclusive of both new construction and remodeling, renovation, retrofit, and reconstruction work) 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 virtual 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 &M>or during 2004 either. But the projected 3.8% increase in total nonresidential construction is at least a hopeful sign.
Commercial on road to recovery
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.
Industrial market begins to settle
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, following declines during five of the past six years (including a heart-stopping drop of 40% during 2002), the industrial subsector should begin to stabilize (at an abysmally low level of total construction activity) during the next six months and be able to record a modest gain in spending of about 6% for the year as a whole.
Institutional sector in transition
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 sub-sectors 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.
SIDEBAR FROM RS MEANS:
Materials prices on even keel for 2003
Though the economic forecast for 2003 may not present a clear direction for the economy, materials prices should remain stable, with only small price increases projected for some CSI divisions. Annual construction price research conducted at RS Means reflects current economic conditions for 2003. Here is a look at what 2003 has in store for materials prices in some of the major CSI divisions.
Division 2: Site work
Due to tight state and federal budgets, publicly-funded projects are anticipated to decline during 2003. Costs for most site work materials have remained stable or slightly declined over the past year. It is anticipated that this trend will continue in 2003.
Division 3: Concrete
In 2002, cement continued a trend of small increases, which were up about 1% from 2001. Concrete showed a larger increase of 2%. There were no perceptible changes for reinforcing steel. These trends should remain the same for 2003.
Division 4: Masonry
Concrete masonry units and brick costs were up 2 to 3% from 2001. Cement and lime increased 1 to 2 % in cost. Cost increases for 2003 should be about the same.
Division 5: Metals
The U.S. national average material price for fabricated steel products delivered to a job site has remained fairly constant over the last two years due to several factors, including pricing pressure from imported steel on mini-mills, global economic conditions, and excess inventories. With most of these challenges overcome, and the demand for fabricated structural steel anticipated to increase in 2003, the price of fabricated steel projects should increase 4% in 2003 from $1,225 per ton to $1,275 per ton for a 100-ton project. The cost of cold-formed load-bearing metal studs and joists will be subject to an average increase of 30% in 2003 due to relaxed pricing pressure felt by domestic mills that produce steel coil stock. This relief came in the form of tariffs on foreign imported steel coil stock.
Division 6: Wood and Plastics
Dimension lumber is down from a year ago. In 2002, RS Means’ 30 city average cost for two-by-fours was $534 per thousand feet of board. In 2003, the price will be $482. Standard 1/2-in.-thick CDX plywood per thousand square feet will remain at 2002 prices, which was $490 per sq. ft.Milled lumber in 2003 will increase 2 to 5%.
Division 7: Thermal and Moisture Protection
Petroleum based products saw modest increases, anywhere from 3 to 5% in 2002. Insulation and wood-based siding products remained flat. Metal roofing, siding, and flashing increased from 3 to 5%. These trends will continue in 2003.
Division 8: Doors and Windows
Most material items for doors, windows, and hardware increased slightly in 2002, and should once again in 2003.
Division 9: Finishes
Metal stud prices increased from 25 to 35% in 2002. Steel coil mills, which produce the coil stock from which non-load bearing metal studs are made, are not subject to the same government regulation as domestic structural steel mills. The steel coil mills lobbied hard and won Presidential tariffs on foreign imported coil stock, resulting in an impact of dramatically raised prices of domestic coil stock that stud manufacturers have to purchase from the mills. Prices should continue to rise in 2003. Drywall, ceramic tile, paint, and wall coverings remained in line with 2001 prices, and flooring showed modest increases. These trends should continue in 2003.
Division 10: Specialties
Stable prices are forecasted for 2003. Costs of access flooring have increased slightly and are under the 5% increase range, which is considered within a normal range for such annual price increases.
Division 11: Equipment
No significant changes in price are forecasted for 2003.
Division 12: Furnishings
With tremendous pressure by discount office suppliers and a general slowdown in office space construction and renovation, its no surprise that there were significant declines in the cost of moderate to low-end office furniture in 2002. Prices in 2003 are expected to remain at the 2002 level.
Division 14: Conveying Systems
Elevators and escalators prices in 2003 will remain at 2002 prices. However, there will be minor price increases in conveyors, material handling equipment, and bridge cranes.
Division 15: Mechanical
Copper products have trended downward since spring 2002 and have recently stabilized. No major price or supply problems are anticipated in 2003. Plastics used in pipes and fittings have been remarkably stable for the past several months with only a small price increase. As plastics tend to fluctuate with the price of petroleum, the threat of war in Iraq could have some impact in the months to come. Mechanical equipment prices also are stable with spot increases for some items as manufacturers try to maintain or increase their market share while watching the bottom line.
Division 16: Electrical
Overall, the electrical division experienced a 2 to 3% increase in material costs from 2002. The cost of copper building wire is down 10 to 15%, lowering demand for future expansion within the commercial market. Lighting fixture prices are flat. There are no changes in non-metallic conduit and fittings, such as schedule 40 and 80. Due to the unstable political environment in the Middle East, PVC conduit prices are quoted by application. In 2003, motor prices will be flat due to hefty increases in 2002. There are no perceptible market changes in panel boards. Aluminum fitting prices are increasing annually at 5 to 7%. Safety switches and control device prices are up 2 to 5% and should continue to increase.
Source: Reed Construction Data &F>RS Means, Kingston, Mass. With the largest professional research staff in this specialized area, RS Means cost engineers and cost researchers conduct and publish pricing reports that assess material and labor rates for all aspects of construction. For more information visit www.rsmeans.com .
Making the right moves
The outlook for the construction industry as a whole during 2003 depends, as always, to a large extent upon the timing and strength of the overall economic recovery. In general, the fluidity and unpredictability of the year ahead means that the direction of the global economy is more important than ever. The combination of plunging business and consumer confidence, higher unemployment, and slow/no growth in household income can’t help but have negative implications for construction end-markets.
Nonetheless, the major positive force &M>the stimulative impact of low interest rates &M>will continue to provide significant support for the industry during the year ahead. Although office and industrial vacancy rates have risen steadily over the last two years, they are still reasonably low by historical standards.
The likelihood of a bust of the kind that hit in the late 1980s and early ’90s is negligable, since space has been added with much more restraint and less speculation over the past decade. Without an overbuilding boom, we should avoid any real danger of bust in this period of diminished demand.
So we can take some comfort in the fact that the construction industry entered the 2001 recession in reasonably good shape &M>certainly much better than the manufacturing sector. While the rest of the U.S. economy struggled to keep its head above water throughout 2001 and much of 2002, the construction sector held its own, as measured by total dollars spent.
Accessing market strength
In sum, we believe that the weakest sectors during 2003 &M>in terms of absolute declines or paltry growth in the actual dollar value of construction work completed &M>are likely to be:
·Hotels (except those anchored by casinos or other specialty attractions)
·Office and retail buildings
·Airport terminal construction and renovation projects (except for security purposes)
·Public projects requiring substantial state or local funding
·Convention centers, sports stadiums, movie theaters, theme parks, and other recreational facilities (possible exception: gaming facilities)
The relatively strongest sectors for 2003 are likely to be:
·Institutional (i.e., non-commercial, non-industrial) buildings, especially educational and health-related
·Multifamily apartment buildings
·Retail buildings that are focused on consumer basics (e.g., strip malls anchored by grocery stores; drugstores; discount department stores)
·Off-site back-up capacity facilities (new-built, as well as renovation/retrofit) for critical functions, such as financial and operation record keeping, in commercial, financial, transportation, and industrial sectors
·Security-enhancing redesign/renovation projects for existing buildings (including security enhancements for the nation’s more than 400 airports)
·Research facilities, especially in the biotech and pharmaceutical sectors.
What to Bank on in 2003
Strongest sectors for the coming year, according to Reed Business Information economist Daryl Delano:
·Hospitals and other health-related institutional projects
·Education facilities, from kindergarten to university level
·Multifamily apartment buildings
·Basic consumer retail buildings, such as drugstores, discount department stores, and strip malls anchored by grocery stores
·Back-up capacity) for critical functions in commercial, financial, transportation, and industrial sectors (new-built or renovation/retrofit)
·Security-enhancing redesign or renovation for existing buildings (including 400-plus airports)
·Research facilities, especially in the biotech and pharmaceutical sectors.
The Big Picture
Economic growth will improve during 2003
Make no mistake: The U.S. and global economies face continued challenges in the year ahead. On balance, however, it’s reasonable to assume that if at least some things go right, overall economic growth rates during 2003 will be at least a bit stronger than during either 2001 or 2002.
Not that there isn’t plenty that can still go wrong. Uncertainty stifles growth, and these are nothing if not uncertain times. Nonetheless, it is possible to make a reasonably well-informed guess about our economic fortunes between now and the end of 2003.
How well the building design and construction sector will fare during the next year is, as always, critically dependent upon the course and vigor of overall economic growth, which, in turn, is almost wholly dependent upon consumer and business confidence.
For the year ahead, everything has to be viewed against the backdrop of an economy still struggling to deal with the excesses that grew out of the so-called “bubble economy” of the late 1990s.
Consumer spending a vital cog
During the first three years of this decade, consumer spending was remarkably resilient. Growth slowed a bit from the late-1990s surge, but remained positive even during the darkest days of the 2001 recession. Americans continued to spend not because they were euphoric about the short-term prospects for the U.S. economy, but simply because they still had the money to do so. Interest rates were at their lowest levels in almost 40 years, pushing up house prices and homeowner equity.
At the same time, wages continued to rise at a surprisingly healthy clip &M>for those who still had jobs &M>and inflation for most products and services was all but nonexistent. So the aggregate purchasing power of American consumers continued to expand during 2000-2002.
This proved to be something of a stabilizing force for the private sector and for the economy as a whole, because from mid-2000 until late 2002, capital spending directed toward new equipment and buildings fell during every single month.
Consequently, even a marginally positive outlook for economic growth during 2003 depends critically both upon consumers continuing to increase purchases of good and services and on businesses ratcheting up their spending on equipment, buildings, and people.
Business investment needs boost
Without a significant rebound in business investment during 2003, there is simply no way that the U.S. economy can achieve anything near a 4% annual increase in the GDP.
But how do we get there, given the current state of anxiety about the future?
For almost the past three years, manufacturers and service-sector companies alike have shown reluctance to invest in their future. There’s been a pervasive wait-and-see attitude that has made the private sector squeamish about investing in anything beyond absolutely critical immediate needs for keeping the doors open.
This pattern is quite different from that of past recessions. In a classic recession, higher interest rates combined with credit restrictions choke off business investment. That’s not the case in the current capital-spending drought.
Instead, the stock market plunge and the related depressing impact on corporate profits have combined to give most businesses almost no cash with which to invest in new buildings, equipment, new employees, travel budgets, office systems, or anything else &M>even when it was the logical thing to do.
All this all comes at a time when, for the vast majority of industrial sectors, there’s a well-documented global surplus of most manufactured goods and even some service-sector products. This state of affairs won’t last forever, but one of its inevitable effects will be a much less robust increase in capital spending during the early and middle stages of any economic recovery. The past economic recession was hardly a textbook case, and the recovery will be similarly unconventional.
The resulting high degree of risk aversion has virtually paralyzed investment and, by extension, economic growth. Cost-cutting through layoffs, tighter inventory control, travel cutbacks, etc., has kept most companies marginally profitable and lessened the anxiety of shareholders. But these actions have done nothing to enhance the growth prospects for these companies in the future.
Without forward-looking investment in skilled people and productivity-enhancing equipment, these companies will be hard-pressed to maintain even their current market share &M>much less grow their businesses &M>in a world economy that becomes more competitive each passing day.
The single most important question that the U.S. faces as we enter is our situation vis à vis Iraq. The immediate concern focuses on the impact that such a war would have on energy prices, inflation, and interest rates. Add to this the uneasiness related to possible further acts of domestic terrorism, and you have quite a mess.
In the year ahead, therefore, American businesses will have to summon up all the resources at their disposal to fight through the dark forces of uncertainty that could paralyze them. Moreover, this must be done at a time when positive action is most called for, to ensure their continued success and profitability.
Institutional construction: The saving grace of 2002
At an estimated $220.2 billion, the value of nonresidential building construction spending (for both new and remodeling/retrofit/reconstruction work) during the first nine months of 2002 was 8.1% less than during the same period of 2001. Spending on commercial buildings was down steeply across the board, while construction activity on industrial buildings plunged.
There is just no way to sugarcoat what’s been happening in these privately funded categories of nonresidential work &M>the market stinks.
The bright spot in the nonresidential building universe continues to be the institutional sector, about 70% of which is publicly funded.
Let’s take a look at last year &M>and try to forget it as quickly as possible.
Construction of offices, retail establishments, and hotels saw total spending decline by 18.3% through September 2002 year compared to the first three-quarters of 2001. Retail construction spending through the first nine months of 2002 was a comparatively modest 7.4% below the January-September 2001 total, but hotel/motel spending was off 27.8%, while spending on office buildings was 28.1% lower than during the first nine months of 2001.
Spending on manufacturing plants and warehouses had declined even more precipitously during the past twelve months ending last September. Through nine months of 2002, construction work on these kinds of buildings was worth a breathtaking 45.1% less than the total for January-September 2001. The seasonally adjusted annualized rate of spending during September 2002 was still running 50.1% below the September 2001 level, so there’s as yet no real sign of recovery in this market segment.
The growth rate for the construction of nonresidential buildings outside the commercial and industrial sectors descended from its lofty double-digit rate for the first four months of 2002 to a “mere” 9.3% over the entire first three-quarters of last year. This was in dramatic &M>and heartening &M>contrast to what was happening throughout the commercial and industrial market sectors.
Through the first nine months of 2002, the institutional sector continued to defy most of the negative forces impacting the income-producing-property segments of the nonresidential construction market. January-September construction spending for the sector as a whole totaled $115.6 billion.
In sum, “institutional” remains the Energizer bunny of the construction market: 2002’s 9%-plus growth rate represented an acceleration from the strong 7.2% gain recorded during 2001.
Health facilitiesconstruction gained a stellar 14.0% annual growth through September 2002, after this sub-sector recorded only modest growth of 3.2% between 2000 and 2001.
Educationconstruction spending gains accelerated as well during the first three-quarters of 2002. After growing by 11.8% during 2001, the value of work completed on public and private educational buildings through September 2002 was running 14.1% ahead of the January-September 2001 pace. In California, the passage of a state referendum on school funding in last November’s election alone could account for billions in K-12 construction over the next decade.
“Other” public buildings &M>correctional facilities, government administrative buildings, courthouses, public housing, etc. &M>have served as a more accurate barometer of the impact that deepening fiscal problems at the federal, state, and municipal levels are likely to have on all aspects of publicly funded construction work as we move into 2003. During January-September 2002, total “other public buildings” construction spending was up a modest 4.4% from the nine-month-2001 level of $27.4 billion.
Healthcare climbs high on growth curve
Oakland’s East Bay region tops industrial and retail markets, while Cincinnati leads office in 2003
By Jim Crockett
The forecast of Glenn Mueller, Ph.D., a professor at John Hopkins University’s Real Estate Institute, proves useful in helping M/E/P firms develop plans for struggling free of this economic morass.
The 2003 model
Throughout this Reed Construction Data forecast recap are a series of graphs depicting a skewed bell curve. The curve is a model, developed by Mueller, based on a 30-year economic cycle and is fairly reflective of the nation’s economic ups and downturns. It is comprised of 16 points that indicate various stages of economic growth and decline on a time versus building type occupancy curve. On the charts, “1” indicates the absolute bottom, with the country in full recovery with no new construction and declining vacancies. On the other hand, stage 6 indicates the start of growth and stage 11 represents the peak of the economic cycle. Stages 12 through 14 represent continued construction, but increasing vacancy, with 14 and beyond indicating decline and movement toward the bottom of the cycle.
Mueller’s model forecasts where the major construction market sectors &M>industrial, office, retail, and hotel construction &M>will lie come the second quarter of next year, as well as where the nation’s major cities will stand in respect to these markets. To gain an accurate feel for when such growth spurs might begin &M>around position 8 on the curve &M>one has to be aware of where these markets are in the cycle.
What’s to come?
Mueller estimates that in the second quarter of 2003, hotels, suburban offices, senior housing, and outlet-oriented retail will be at stage 2. R&D and industrial will fare slightly better at stage 3, as will power center retail and downtown offices, at stages 4 and 5 respectively. But all will still be below any real growth phases. Warehouses, first-tier regional malls and multi-family housing, however, should begin to see the light of day. Healthcare should remain the strongest market and continue to wax. On the wane, however, will be second-tier malls, according to the economist.
In further analyzing the cycle, Mueller makes some significant points: On the demand side, there’s a projected U.S. population growth rate of 2.4 million per year for the next 10 years, due primarily to two factors: immigration and the “echo boom.” At this rate, he says, a city the size of Denver would need to be built every year.
‘Boomers’ drive demand
The college-age echo boomers will soon be entering the workforce, meaning a need for new apartment space. On the other hand, their parents &M>the baby boomers &M>are at their highest income earning years, meaning there may be a wave of second-home purchases, according to Mueller, especially with favorable mortgage rates and uncertainty about the stock market. Toward the end of this decade, Mueller adds, baby boomers will start to hit retirement age, possibly creating another new market for more sophisticated senior living facilities.
On the supply side, Mueller notes things appear to be in a constrained mode. Capital for construction will be economically driven, which means a low amount of speculative building; there are more research watchdogs on the lookout for bad investments; and construction labor is increasingly becoming hard to find. Combined with increasing material cost and infrastructure problems constraining growth &M>roads in the east and power and water in the west &M>not much in a building boom can be expected, hypothesizes the real estate tracker.
Jim Crockett is editor of BD&C’s sister publication, Consulting-Specifying Engineer. Glenn Mueller’s forecast was presented last fall at the Reed Construction Data 2003 Construction Forecast in Washington, D.C. For more information, visit www.reedconstructiondata.com