Gloom Then Boom?

December 1, 2001

Construction industry analysts and economic forecasters at a recent conference provided both bad and good news about the outlook for the next few years. While some said much of 2002 will see declines in construction activity and the economy in general, most also predicted quick recovery by 2003.

Among the forecasters at CMD’s 6th annual North American Construction Forecast in Washington, D.C., was Bill Toal, chief economist for the Portland Cement Association in Skokie, Ill. According to Toal, the U.S. construction industry can expect an overall decline of 6.3 percent in activity next year due to the economic downturn. Still, "by historical contrast this would put construction spending back to slightly above 1998 levels, which were record levels of activity," he said.

"We expect a 10 percent decline in private, nonresidential construction spending next year after a 5.4 percent drop this year," Toal said.

Toal said it won’t take long for the construction industry to recover. He predicts the construction industry overall will see a 4.2 percent increase by 2003. Toal attributed the decline in construction activity in part to a "hole in the economy. The economy was already weakening significantly before the events of September 11." Forecasts have been revised down further because of those events. He revised his overall economic growth rate predictions for 2002 to 1.8 percent, down from his prior forecast of 2.7 percent. In contrast to the declines in residential and nonresidential construction, public construction was predicted to grow slightly, albeit at a much slower rate than it has for the past two years.

Retail/Industrial/Commercial Outlook

Glenn Mueller, a professor with the John Hopkins University Real Estate Institute and managing director for Real Estate Investment Strategy with Legg Mason, Inc., said there are two ways to look at how construction is faring: the physical realities of demand and supply and the financial realities of where capital is flowing and how it affects pricing.

For example, Mueller said the demand and supply cycle in the office sector has reached some equilibrium after several decades of dramatic swings in what was available and who wanted it, he said. Those levels will remain somewhat balanced though both sides will be lower for the next year or so, he said.

The demand and supply cycle is local in nature, Mueller said, and different cities in the United States are at different points in their cycles. For example, in the office market cycle analyses, Washington, D.C., San Diego, Los Angeles, and parts of New York, as well as a host of other metropolitan areas, are in the hyper supply stage of their cycle-they are experiencing increasing vacancies, but new construction is still occurring. Dallas, Jacksonville, Tampa and Salt Lake City, however, have bottomed out-they have low or negative demand growth and construction starts have greatly slowed, but completions are still occurring. They have actually entered a recession stage in their office market cycle, according to Mueller.

In the industrial market, none of the nation’s major cities had yet entered the recession stage at the end of the second quarter. But in the hotel market, most are moving toward that stage and some markets like Charlotte, Cleveland, Indianapolis, Philadelphia, Phoenix and Portland, have already entered it.

On the supply side, construction labor had been the hardest to find in 2000, Mueller said, but that situation is easing rapidly this year. Meanwhile, materials costs are increasing and the nation’s infrastructures have not been expanded, which restricts new approvals and thus new construction.

Mueller had said demand growth will be stable but slower, and once supply growth slows to match it, equilibrium will return. For most of the construction industry, Mueller said a growth phase should begin in either late 2002 or early 2003.

Mixed Signals North of the Border

While the Canadian overall economy is following the United States in a downturn made worse by the events of September 11, there are some bright spots ahead, according to Alex Carrick, chief economist for CanaData. One of those bright spots is the institutional building market, where several segments of have hit seven-year building level highs.

The segments include hospitals, which climbed this year to more than $4.4 billion in commitments to new projects for 2001; schools, which had more than $2.3 billion allocated for education-related projects in 2001; and senior homes, which hit a high of $1.35 million and hold promise for further growth.

Unfortunately, Carrick said other sectors of the construction industry don’t look as bright. The biggest drop in construction starts in Canada occurred in the industrial market, which fell almost 50 percent this year from 23.5 million square feet in 2000 to 12 million square feet in 2001. A large part of the decrease was due to events in the automobile industry, where a 10-year boom just ended and an anticipated three- or four-year decline began.

Other aspects of construction in Canada are tracking closely to what is occurring in the United States, and some of these areas will most likely feel the effects of decreased consumer and business confidence that was exacerbated by the terrorist attacks.

Commercial construction starts for 2001 are expected to be 45.5 million square feet, slightly less than the 47.9 million of 2000. Carrick predicts starts will continue falling to 42.5 million square feet in 2002, but rebound to 44.5 million by 2003. The probable effects on commercial construction of the terrorist attacks include more office building in the suburbs rather than downtown skyscrapers; lowered retail construction activity because of consumer anxiety; and negative impacts on the hotel industry. Conversely, the entertainment industry, including casinos and entertainment complexes, may flourish as people seek escape from their worries.

Engineering investment, including infrastructure projects as well as energy projects, continued an upward trend from $41.4 million spent in 2000 to $46.7 in 2001 and is expected to be over $49 million in 2002. "The question here is whether funds diverted into military spending will be taken away from infrastructure projects," Carrick said.

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