Improving economic conditions, unseasonably warm weather last winter, and increased government spending helped bolster the construction industry in the first six months of 2002. But these results may not represent changes in the underlying factors that determine the direction of the construction market and may have little bearing on the amount of construction built this summer and into the fall. Most underlying factors point to a renewed construction expansion beginning later, in 2003.

Most Americans believe that the economy bottomed out over the winter and was improving in the spring. Commercial builders, unlike residential builders, currently face a weak market and would welcome a strong, rapid recovery that will increase owners’ revenues and profits, resulting in greater demand for commercial and industrial construction. Public-sector contractors continued to enjoy a period of expanding government infrastructure spending. The federal government’s monetary, fiscal and regulatory policies during the past six months have been well-received, and the public sector remains a growing market for nonresidential contractors despite reduced state budgets.

Pleasant Surprise

The U.S. construction economy has been a pleasant surprise to many because it has proven to be resilient to rising layoffs and wavering consumer confidence levels during the past year. Unfortunately, underlying drivers such as home affordability, office vacancy rates and industrial capacity-utilization rates aren’t likely to be as favorable for the remainder of the year. But look for a healthy rebound in many building sectors in 2003.

U.S. construction spending fell 0.9 percent in March due to a large drop in public building as construction retreated from high levels seen over the mild winter. The value of new construction in the United States dropped to a seasonally adjusted annual rate of $874 billion in March from an upwardly revised level of $881.5 billion in February.

Nonresidential building construction was at a rate of $181.9 billion in March, nearly the same as the revised February estimate of $182.5 billion. The rise in available commercial space has been exacerbated by active sublease markets and additional construction in some areas. Office rents have declined moderately compared with a year earlier. Consequently, commercial construction activity has slowed in most parts of the country.

It will likely be several years before we see rates of commercial investment like those found in the late 1990s. Commercial construction had benefited from large influxes of investment spending in previous years but seemed to be headed for a downturn as capital investment funds decreased in 2001. Surprisingly, however, commercial construction held up well in many areas over the winter despite recessionary conditions and rapidly rising vacancy rates and subleasing activity. Last winter’s construction, while welcome, probably was the result of excellent weather conditions in many areas that enabled projects to start earlier in the year than they normally would. A summer drop-off in commercial construction was expected to follow this period of unseasonable building conditions. Unlike commercial and industrial construction, public sector construction would continue to grow with the expanding role of federal government.

U.S. businesses invested a record $1.172 trillion in capital investment in 2000, a 12 percent increase from $1.047 trillion in 1999, according to a report released by the Census Bureau. In hindsight, this spending appears to be a classic overinvestment boom. Like all booms, it was driven by excessive optimism about the “New Economy,” as evidenced by massive capital investments into the telecommunications, computer and utilities industries. Then, as the economy began to slow in the second half of 2000, firms reevaluated their assumptions and abruptly revised down capital investment plans.

Industrial

Even though the manufacturing sector appears to finally be recovering from its deep two-year recession, overinvestment during the 1990s and current low factory utilization rates will prevent much new construction until 2003. Manufacturing activity rose in March 2002 to its highest level since February 2000 to meet the strongest demand for goods in more than eight years, according to the Institute for Supply Management’s (ISM) closely watched purchasing manager’s index. Also favorable are the recent results of a National Association of Manufacturers survey of its members regarding their capital investment plans. The survey results suggest that overall capital spending will rise by about 5 percent during this year. However, the structural component of capital spending appears to be less robust.

While about half of ISM’s survey respondents expect investments in structures to rise up to 5 percent next year, almost 40 percent expect investment to be negative. Data from the Commerce Department confirms that better times for manufacturers may not equal new capital expenditures because so much was invested in the 1990s, especially in the high tech sector. Overall, manufacturers spent $215 billion on capital goods in 2000, up 9 percent from 1999. The information sector spent $164 billion on capital expenditures-up nearly 34 percent, following a 1999 increase of 27 percent. The semiconductor industry alone posted a 60 percent increase over 1999.

Spending on new manufacturing facilities plunged in 2001, helping to limit the overhang felt in 2002. According to the real estate firm Cushman and Wakefield, the year-end industrial vacancy rate was 8.1 percent, up from 6 percent a year earlier. Most of what was built was warehousing/distribution space, with very little new manufacturing space added in 2001.

Hospitals and Health Care

For 2002, FMI forecasts slightly lower health care construction activity. The reason is that approximately three-quarters of health care construction is private and will experience growth limitations similar to other commercial structure types.

However, FMI forecasts a growing need for health care construction as the population grows and ages. According to the American Hospital Association, “With an aging population and the ‘Baby Boomers’ entering years of higher incidence disease, the demand for health care services and the need [to] provide care are increasing significantly.” In 1950, 12 percent of Americans were over age 60. The Labor Department projects that number to increase to 25 percent of Americans by 2030. As a result of this steady increase in older Americans, the Labor Department projects that an additional 3.1 million new health workers will be needed by 2010. Of course, more rooms will be needed to accommodate these increased numbers of health care professionals. In addition, concerns over biological or chemical attacks will result in increased public funding in this area.

It would seem to follow that a growing market in the assisted living sector would stem from the graying of the population. In the short term, however, the improved health and relative great wealth of the retiring Baby Boomers and “Greatest” generations are minimizing this effect, and there is currently an oversupply of assisted living centers. In the immediate term, assisted-living construction will grow greatly in response to subsequent poorer generations that were unable to reap bonanzas from home sales and didn’t adequately save for retirement.

Public Construction

Public construction was expected to remain a strong market for contractors this summer because federal spending appears to be flowing quite freely. But lower projected state and local revenues will put a little downward pressure on construction spending on highways and schools. In March, the estimated seasonally adjusted annual rate of public construction put in place was $208.5 billion, 6 percent below the revised February estimate of $220.8 billion.

Highway construction funding now appears to be heading back in line with 2003 TEA-21 funding targets-even though President Bush’s budget initially proposed an $8.6 billion drop from 2002 federal funding levels. After state governors and congressmen applied considerable pressure on the administration regarding highway funding and its impact on recession-hit states, $4.4 billion will likely be added back to the 2003 highway budget.

A relatively new strong market-water and sewer construction-is receiving welcome attention from Congress. Although most observers believe that water and sewer infrastructure will not receive the doubling of appropriated funds in 2003 proposed by the Senate Environment and Public Works Committee, it’s likely that this sector will grow markedly from the remainder of 2002 through 2005. Some water and sewer treatment infrastructure spending will be for homeland security to protect against waterborne chemical or biological attacks. However, large investments are needed because of the average age of U.S. systems.

Expansion Likely

It’s likely that the U.S. economy stands at the beginning of a new period of expansion, but the construction industry may come a little late to the party. Defying many forecasters, the U.S. economy successfully navigated a perilous period after Sept. 11 and waded through a very shallow recession.

Surprisingly, residential construction performed very well while nonresidential construction performed as one would expect during a period of shrinking corporate profits.

Commercial construction growth will come after the massive 1990s investment overhang is cleared and after corporate profits improve later in 2002. Public construction will be a strong market for the foreseeable future due to expansionary federal policies. After the short-term economic stimulus dries up, infrastructure funding will be replaced in 2003 by state and local coffers refilled by declining unemployment rolls and growing business revenues.