Count it out

Education will lead softening building market

January 01, 2001 |

Spending for the construction of new educational buildings, and for the expansion or renovation of existing structures, continues to grow at an extremely healthy pace and looks to be the leading building market for 2001. Commercial, industrial and institutional building sectors such as office, industrial, institutional, multifamily residential and health care will see the pace of their growth slow while retail and hotel sector spending declines.

For these and all of the other building sectors reviewed in this report, the spending numbers discussed are those expressed in current (i.e., not inflation-adjusted) dollars. Likewise, all of the government's spending estimates incorporate dollars spent both for new, from-the-ground-up construction and for the wide variety of capital expenditures related to remodeling, renovation, rehabilitation and retrofit work.

About 80 percent of all educational construction is publicly funded, and President-elect George W. Bush last year made it clear that education would be a high priority of the new administration. This should mean a steady stream of funding for new school construction and renovation for at least the next four years.

As states and local communities throughout the country struggle to address the challenges of rising enrollments, large class sizes and the technological demands of an increasingly information-technology-focused world, they'll need to spend more money to build new schools and extensively renovate existing ones that have often fallen into serious disrepair after years of deferred maintenance.

Through the first 10 months of 2000, overall educational construction spending was increasing at an extraordinary 17.9 percent annual rate, better than twice the 7.8 percent increase recorded between 1998 and 1999. Although more difficult credit market conditions for private educational construction are likely to prevail during 2001, publicly funded work should once again grow at a double-digit rate.

The office sector was the healthiest commercial construction market for the third consecutive year during 2000. By the time the final Commerce Department spending numbers are compiled for last year, we expect to find that about 13 percent more office construction work was completed in 2000 than during 1999. Growth again is expected this year of about 7 percent-the smallest gain in the past six years, but a trend still solidly positive at a time when the rest of the commercial sector takes a small step back.

While all construction sectors have benefited to some degree from the long-strong U.S. economy, the office market has benefited disproportionately because of the continued expansion in professional, technical and sales jobs. The third-quarter 2000 national office-vacancy rate stood at less than 9 percent, a sure sign that in many U.S. markets supply hasn't yet caught up with overall demand for office space.

However, it is inevitable that closures and layoffs at dot-com firms will dampen demand for new office space in many markets during the year ahead. Office construction spending growth is expected to continue-albeit at a much slower rate-during 2001, but the national vacancy rate will likely rise to about 10 percent to 12 percent. But there is still no indication that the sector is headed for the kind of "bust" conditions experienced by the office market during the late 1980s and early 1990s.

Industrial slows, remains positive

After fading badly during 1999 when construction spending for the year was almost 14 percent lower than it was in 1998, construction of new manufacturing facilities and industrial warehouses surged during 2000. The market's recovery began slowly in the winter and spring, but by mid-year industrial construction spending was growing at a double-digit annual rate. Through the first 10 months of 2000, the value of all industrial construction work completed was running at 13.9 percent ahead of its year-earlier level.

Many sectors of manufacturing (e.g., chemicals, autos, steel) continue to be overbuilt globally, but the U.S. industrial construction market was still able to grow at a strong rate last year. This was because of the need for additional warehouse space and a surprisingly large number of expansion projects initiated among durable goods manufacturers-particularly producers of high-tech communications equipment and semiconductors.

Gains will almost surely be smaller this year, as slower overall economic growth and tightening credit markets constrain demand and limit the ability of United States manufacturing businesses to add or renovate space. But the market is unlikely to slip backward into negative territory over the next few years-unless the economic slowdown unexpectedly turns into a full-blown recession.

Institutional to march more slowly

The very large "other institutional" category grew at a faster rate last year than in either 1998 or 1999. "Other institutional" includes religious buildings, public administrative buildings, prisons, courthouses, police, fire, airport facilities and miscellaneous other private and public nonresidential construction not explicitly included in other building categories. Most of the relative weakness in this area in recent years had been concentrated in the public buildings subsector, where government entities had become more reluctant about appropriating money for new prisons, courthouses and other building categories that had grown at double-digit annual rates throughout much of the past decade. That changed during 2000.

Through the first 10 months of last year, spending on public buildings (other than educational and health-care facilities) was growing 7.5 percent annually-almost three times as fast as during 1999. Spending for new construction in the private institutional groups also expanded during 2000, but at a slower rate than during the previous two years. Spending for new religious building grew by about 6 percent-not bad, but less than half the rate of gain registered during 1999. And spending on miscellaneous other private institutional buildings-movie theaters, casinos and health clubs-eked out about a 2 percent increase during 2000 after growing by almost 9 percent the year before.

Overall growth will continue in this building category during 2001, but the gain is likely to be a bit below the average annual increase recorded during the past decade.

Multifamily to outpace singles

Construction spending for the multifamily residential (primarily apartments and condominiums) sector was little changed during 2000 from its solid 1999 level, following four consecutive years of strong gain. The housing sector as a whole will take a breather this year, and vacancy rates for multifamily space have begun to rise in some large metropolitan areas. Consequently, spending on the new construction or renovation of multifamily buildings will grow slowly during 2001.

But the short-term outlook is actually somewhat better for multifamily residential construction than for single-family residential construction. Slower economic growth next year will mean smaller employment and income gains, and serve to dampen household formation growth as more single people choose to live at home or in the company of roommates.

The longer-term outlook for the multifamily subsector is not bad either. More people are being born as the Baby Boomers move into retirement years and the parents of the Baby Boomers continue to age. Those changes in demographics will support solid gains in multifamily housing throughout the first half of this decade. During the entire decade, more dollars will be spent on every unit built, with more construction of condominiums, luxury apartments and assisted-living centers.

Health of health care to stabilize

Prior to 1998, the construction of hospitals and other health-care facilities had grown for six consecutive years. But then the combination of an accelerated pace of consolidation in the industry and general health-system-wide cost containment initiatives led to small declines in health-care construction spending over the final two years of the 1990s. Growth returned in a big way last year.

Privately funded construction (about 78 percent of the health-care sector total) fared a bit better than publicly funded work last year, but all subsectors of health-care facility construction work enjoyed their healthiest market conditions in three years during 2000. Long-term demographic trends remain unambiguously and increasingly positive for the industry sector, so it is unlikely that the market will see two consecutive years of "negative growth" for the sector-as in 1998 and 1999-at any time during this decade.

Still, until cost-cutting pressures ease and the United States sorts out its options on long-term Medicare funding and elderly care priorities, including home health care and prescription drug coverage, only moderate annual growth is expected in health-care facilities construction work-with an occasional double-digit "bounce-back" year like 2000.

Retail to sag but not slump

Despite the understandable degree of special attention being paid to the strong growth rate-albeit from a very small base-recorded by e-commerce sales, the fact remains that most Americans are still making the vast majority of their purchases the old-fashioned way. Consequently, construction of new "bricks-and-mortar" stores and shopping malls has continued at a surprisingly high level, and spending in the sector has been further supplemented by new retail warehouses being constructed by new economy online retailers who are under increasing pressure to more efficiently fulfill and distribute customers' orders.

Through the first 10 months of 2000, retail construction spending expanded 9.4 percent annually, half-again as strong as the spending increase recorded between 1998 and 1999. After a period of weakness from April through July, retail construction spending growth accelerated as the year moved into its final two months.

Vacancy rates for choice downtown retail space remain very low (and rents very high), but there is an abundance of surplus and outdated space in many local strip shopping centers and mid-sized regional malls. The bet is that the impact of "virtual" shopping trends will soon catch on with this sector, although probably not in a dramatic way.

Spending should decline during 2001 for the first time since the early 1990s. But burgeoning e-commerce won't severely depress construction in the sector; rather it will dampen it appreciably from the heady double-digit growth days of 1992 to 1996.

More vacancies on hotel horizons

Construction of new hotel/motel space was little changed between 1999 and 2000, making this the weakest subsector of the commercial market. Last year's near-stagnation followed a five-year period of extraordinary annual growth. During the past couple of years, however, the lodging sector has begun to show unmistakable signs of being overbuilt in an increasing number of geographic areas and property classes.

Occupancy rates peaked during 1998, and have slowly fallen throughout most of the past two years for all property types despite the continued strong economy and the healthy pace of business and leisure travel. Nevertheless, after a very weak beginning in 2000-when construction spending in the sector was running about 4 percent below the year-earlier pace-hotel spending growth unexpectedly returned during the summer and fall. Still, weak demand fundamentals for the industry suggest that this rebound will be short-lived, and that less new hotel space will be added this year than last. The spending decline in 2001-and likely in 2002-won't begin to rival the plunge experienced during the late 1980s and early 1990s. And after a couple of years of dealing with a moderate supply-demand imbalance, the hotel construction industry will probably again go on a binge of sharply accelerated new building.

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