Implications of Hurricane Katrina for U.S. Construction Industry

November 1, 2005

By size and scope, Hurricane Katrina ranks as the costliest natural disaster in U.S. history. The total cost of the devastation is expected to be $125 billion or more, substantially greater than the damage caused by 1992’s Hurricane Andrew, estimated to be $37 billion (adjusted to 2005 dollars).

With regard to construction, some perspective is gained by looking at the size of the impacted area relative to the United States. During 2004, total construction in the impacted area was reported at $7.1 billion, or 1.2 percent of last year’s national total of $589.2 billion. Of this 49-county region, the heaviest damage was experienced in five counties: Orleans Parish, St. Bernard Parish, and Jefferson Parish in Louisiana; as well as Harrison and Hancock counties in Mississippi. In 2004, these five counties reported $1.7 billion in new construction starts, or 0.3 percent of the national total. The necessity for cleanup work over the next few months means that most new construction in the nonresidential and residential sectors will be deferred for the time being. This will be a negative to the overall level of U.S. construction starts, but only to a very modest degree.

Most of the flooding occurred in primarily residential areas. On the nonresidential side, the damage is less intense, with the downtown/ tourist areas of Orleans Parish having missed most of the major flooding. Some downtown attractions will undergo major renovation work. Estimates for an overhaul of the Superdome are at $400 million, while the $250 million planned expansion of the Ernest Morial Convention Center has been shelved for now. On the plus side, reports suggest that most of the area?s hotels have been relatively spared, with damage mostly to windows and ground floor levels.

As for Harrison and Hancock counties in Mississippi, there’s concern about Katrina’s impact to that state’s gambling sector. The storm may have put at least eight of the casinos out of business permanently and caused millions of dollars in damage to the other four.

The Impact on Building Materials

As rebuilding efforts get underway, construction should increase in the local Gulf area, with activity well above pre-Katrina forecast scenarios. The fear, however, is that this very concentration of activity could raise prices and diminish availability of construction materials and skilled labor, and not only in the affected area, but across the entire United States. The reason for this fear is that many construction materials and many types of skilled construction labor are currently in short supply, due in part to the robust expansion for housing that is now reaching its peak.

On the positive side, wholesale prices (as measured by the Bureau of Labor Statistics’ (BLS) producer price index) rose more moderately than expected in August, gaining 0.6 percent for the month after a 1.0 percent increase in July. The index of construction materials actually peaked in February then declined 2.8 percent through August. And while many complain that the BLS statistics do not capture “spot” prices or the true price paid by the construction industry, these spot prices are much more volatile and will likely return to more “normal” levels once panic buying subsides. Thus, a look at longer-term wholesale prices might be more telling about what to expect in the months to come.

Some wholesale prices, such as those for steel mill products, peaked in February and declined 13.2 percent through August. Steel product prices shocked the construction industry with their 2004 increases, but have shown much more restraint since the beginning of 2005. Unfortunately, the Gulf of Mexico is a major port of entry for steel imports, and thus the still-reduced capacity of the port may have a negative impact on steel prices over the next few months. Even if steel prices do rise once again in the near term, it’?s expected that the upward movement will be temporary.

The prices of several other construction materials, by contrast, have continued to rise steadily in 2005. The price of gypsum, for example, has climbed 9.9 percent since February, cement is up 5.6 percent, and construction machinery prices are up a more modest 3.5 percent. Over the year (August through August), price gains were slightly higher: gypsum up 12.4 percent, cement up 12.7 percent, and machinery up 7.0 percent.

According to the Portland Cement Association, cement remained in short supply in 32 states and the District of Columbia, even before the advent of Katrina. The disruption to transportation systems and loss of power to cement plants in the Gulf region further cut into supplies, while the need to rebuild roads, buildings and other infrastructure will increase demand. That adds up to continued increases in cement prices during 2005 and 2006, unless, as urged by the Associated General Contractors of America, the Commerce Department and the Southern Tier Cement Committee reach an agreement to allow Mexican cement into the Gulf states without the 55 percent duty which is now in place.

Overall, a greater risk to lumber prices may reside less with the impact of Katrina than with NAFTA negotiations between the United States and Canada over softwood lumber tariffs. A NAFTA panel determined that the United States should remove tariffs on imports from Canada, but the Bush Administration has ignored that ruling. In response, Canada has threatened to discontinue its U.S. exports, although that position is likely to soften over time given how important the U.S. market is to Canadian lumber.

Moreover, the very real issue of skilled labor shortages could dwarf concerns over materials prices. A rule of thumb holds that construction labor is virtually half of the total cost of a building. That share could rise unless labor shortages can be ameliorated. Because subcontractors are quick to relocate to where the demand is greatest, some analysts fear that if labor converges on the Gulf region, shortages of skilled workers will develop in other areas of the United States.

The Broad Impact on Construction Starts

The heightened demand for materials and skilled labor arising from rebuilding efforts in the Gulf region means reduced availability, which will be a constraint on further growth for construction activity.

The post-Katrina environment has both positives and negatives for U.S. construction activity. The major positive is that the U.S. economy appears capable of absorbing the shock from Katrina, without slipping into recession. Continued employment growth will help the market fundamentals for such income property types as offices, hotels and multifamily housing over the long-term. Total construction starts for the U.S. are still expected to rise 6 percent to 7 percent in 2005, even with the loss of new construction start activity in the Gulf region.

A major plus for next year will relate to reconstruction efforts, and the near term estimates for infrastructure work are substantial. Furthermore, there is now added emphasis that the cleanup and reconstruction process will be efficiently
carried out. Reconstruction involving nonresidential structures will take longer than housing as patterns of development are debated by local and state groups. The major uncertainty for the entire U.S. construction industry in the post-Katrina environment remains the price and availability of building materials, meaning that the industry as a whole will continue to adjust to a higher cost structure.