Nonresidential Construction Growth Continues In ’07

Construction will experience a supportive economic environment again in 2007, with the nonresidential construction sector sustaining its boom, although its growth rate will slow gradually over the year.

Spending on nonresidential construction expanded at a 16% annual rate during the year ending September, but growth has currently slowed to 11-12% and will slow further to 8% by the end of 2007. The slowdown results from the plunge in residential building last year, as well as the slowdown in overall economic growth from 3.5-4% to 2.5-3%. Cautious consumer spending accounts for the slower gains in GDP.

The investment market will continue to expand strongly as it typically does at the mature end of an economic expansion, which means that commercial developers will continue to see rising rents and falling vacancy rates. The funding sources for institutional facility managers will also improve. Public budget balances are high, with rapidly rising tax receipts likely to yield budget surpluses again for most state and municipal budgets in the 2007 fiscal year. The investment returns and gifts that fund nonprofit projects are also increasing.

Credit costs will be steady at the current level thanks to slower growth in consumer spending and a decline in residential construction. Although mortgage approval standards have tightened in the residential market, it’s unlikely to happen in the nonresidential market. Owners and developers have better financial reports to show lenders than they did just one year ago. The generous supply of credit will force lenders to aggressively pursue available borrowers.

The GDP slowdown will also reduce general inflation pressures, although there will be little inflation relief for materials used primarily in nonresidential construction, or for cement, metal, and plastic materials priced in world markets.

The overall unemployment rate will stay in the 4.5-5% range. Nonresidential contractors should expect to have no availability problems with low-skilled construction workers; however, bigger wage gains and more frequent availability problems are anticipated for skilled workers. Note that heavy contractors have replaced homebuilders as the main competition for labor and materials. Expect continued weak pricing and probably further price declines for lumber, plywood, gypsum, and other materials used heavily in residential construction.

The value of year-to-date nonresidential starts is up 11% through October compared to the same period last year. The gain is 19% for commercial projects and 7% for institutional projects. Starts are forecast by Reed Construction Data to increase 7% in 2007.

The condo market plunged more than the single-family market, although overall multifamily starts are being buoyed by additional apartment starts. The steepest declines are for entry-level condos where buyers are now less able to get a mortgage and for high-end investment condos where investors no longer anticipate a large, quick resale capital gain. These restraints will persist through 2007, and are strong enough to cause some condos to be turned back into apartments. The weakest condo markets will be in the overbuilt Florida, Washington, D.C., and Southwestern markets, as well as in the still depressed auto centers of the Great Lakes states.

Shopping center expansion continues. Construction spending for shopping centers, malls, and large discount stores is nearly 50% higher now than at this time last year, but spending is up only 8% for standalone stores—barely ahead of inflation. New shopping centers are being built to serve new residential developments while older, “Main Street” stores are being abandoned. And regional malls are being built again after several years of minimal activity. Total retail starts increased 12% in 2006, with a similar gain expected in 2007. Starts, after inflation, are expected to be steady in 2008.

Office construction spending surged last summer, up 11% from spring levels after lagging behind other commercial sectors for several years. Office rents and vacancy rates have been improving for more than a year but remain well below 2001 peak rates. Most of the office expansion in this building cycle is still to come. The initial expansion has been primarily in the Washington, D.C., Los Angeles, and New York markets, where vacancy rates are well below the national average. The continued expansion will encompass most major markets, although few new projects are expected in the economically depressed Midwest, with the exception of Chicago and Minneapolis. The office-based finance and business services industries will continue to expand employment rapidly, which will improve rental and vacancy rates.

Manufacturing construction spending jumped 20% in 2006, but construction volume, after inflation, is still one-third lower than its 1998 peak. The industry is still sick even though nominal spending doubled in the last three years during an economy-wide investment boom. The expansion over the last year was 62% in the chemical industry and 21% in the electronics industry. Spending declined 37% in the transportation equipment industries. Consumer products industries generally kept construction spending steady at a depressed level compared to the late 1990s. Reed Construction Data reports that the value of manufacturing starts is down 42% year-to-date through October compared to 2005, so job site spending is likely peaking now. Factory production activity is concentrated in the Rust Belt from Boston to Chicago, in the Gulf chemical centers, and in the Los Angeles area to serve expanding trade with Asia.

Hotel construction soared 52% in 2006, nearly doubling in 12 months. The value of project starts increased 86% in the first 10 months of 2006 compared to the same period last year. The abrupt building surge was the result of sharply higher room and occupancy rates in a rapidly expanding economy. Both rose at a 4% annual rate for nearly two years. Post-Katrina housing and the loss of New Orleans hotel rooms also contributed to room demand. Hotel room supply has only been increasing for a few months because post-9/11 construction was so low and because some hotels were converted to condos. However, the hotel boom is now slowing. Starts are expected to fall 20% in 2007, but job site construction spending will still increase more than 20% as recent starts are completed. Las Vegas and other resort areas have an unusually large share of recent starts. The expansion has been and will continue to be much stronger for airport and luxury hotels than for less expensive facilities along highways.

Education construction spending increased 6.5% in 2006, with all gains coming toward the end of the year. Projects were slowed or postponed earlier in the year because of sharply higher project costs, which led to scaled-back plans or additional funding requests. Growth will rise 10% in 2007 as state and local government finances continue to improve. The value of project starts increased 12% year-to-date through October compared to the previous year, according to Reed Construction Data.

Recent construction increases have been primarily for middle schools, high schools, and colleges. The demographic enrollment bulge is now in the ninth grade, so spending is declining for K-8 schools. Projects in the Northeast and Midwest are primarily focused on renovations or replacements, since enrollment is stable or declining. Projects in the South and West are primarily focused on adding classroom space.

Healthcare construction spending growth doubled to 15% in 2006 and is expected to stay at this pace through 2008. In October, spending was up 47% from the same period last year for nursing homes and other special care facilities. Spending was also up 18% for hospitals. However, spending was down 17% for nonclinical, nonresidential healthcare buildings. Recent Reed Construction Data starts totals suggest that these divergent trends will persist through 2007. Extra money for healthcare construction is coming from an 8% annual rise in healthcare insurance premiums, a nearly 10% annual gain in both Medicare and Medicaid budgets, and from the healthcare premiums for nearly two million new jobs added in the last 12 months. Regionally, the growth in healthcare construction is spread across the country, even in depressed areas, unlike the concentration of new commercial projects in a small number of rapidly growing metro areas.

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RSMeans costs comparisons: Auditoriums, fire stations, gymnasiums, libraries