Last year's ELECTRICAL CONTRACTOR's Construction Forecast went halfway out on a limb to prognosticate that 2005 "may be a big year all around." It's easy-and wise-to be tentative in predicting this year's economy, and some industry gurus have done just that, sticking with "maybe."
A group of these gurus assembled at the Reed Construction Data's North American Construction Forecast conference and the McGraw-Hill Outlook 2005 Executive Conference in Washington, D.C., last fall. At Reed, the consensus was the current economic downturn is temporary, but the experts there were cautiously optimistic. They felt a recovery would begin this year and gain momentum through 2007 in the face of higher interest rates and slow job growth. Several industry sectors, such as industrial with 14 percent growth and public works with 2 percent, will have a good two-year run.
With the Federal Reserve expected to raise the federal fund rates above 3 percent in the last half of 2005 and worries over oil and building-supply prices, the McGraw-Hill group thinks the economy's expansion will idle down to 3.5 percent, down one-half percent from 2004. They also spotted some general trends:
o Moderate job growth will fuel demand for offices and multifamily housing, though residential building may scale back from 2004's record pace because of higher interest rates
o Looser lending standards will offset higher interest rates and free up construction funding
o An improved economy will ease the states' fiscal woes and pump up the institutional building sector
o Bridge and highway construction will rise while electric utilities will decline 8 percent. In the latter area, a loss in plant construction will be partly balanced by transmission-line work
The big picture
So how does this translate into cold, hard cash? Robert Murray, vice president of economic affairs at McGraw-Hill, said the contract value of total U.S. construction should reach $585.5 billion in 2005, a 2 percent jump over last year's figure, but a rather disappointing number considering construction spending rose 9 percent between 2003 and 2004. (See chart on page 41.)
Murray noted this "all hinges on single-family housing" and said that sector should drop 3 percent in 2005 after achieving double-digit dollar growth the previous three years. McGraw-Hill's estimate reflects construction starts and varies significantly from Reed's figure for 2005's estimated U.S. total construction spending (or put-in-place construction), which tops the trillion mark, a 4 percent jump from 2004. But, again, the growth rate weakened when compared to 2004's estimated 7 percent increase. Reed also includes renovation construction, which isn't listed in McGraw-Hill's estimate. Here's the breakdown from Reed:
o $384 billion in new residential spending; down 4 percent from 2004
o $138 billion in residential improvements; up 7 -percent
o $317 billion in nonresidential; a 13 percent hike
o $181 billion in nonbuilding a 7 percent jump
In general, the economy may "decelerate significantly in 2005" according to Merrill Lynch chief North American economist David Rosenberg. He sees a growth rate of just 2.5 percent in the first quarter of next year. And according to Peter Morici, a University of Maryland business professor:
o Gross domestic product, the value of all goods and services produced, will grow at a 3.5 percent annual rate, down 3/10 to ½ percent from 2004
o The economy will create 144,000 jobs per month and the unemployment rate will fall only modestly
o Inflation, influenced by international commodity markets, will register at 2.4 percent in 2005, down 1 percent from 2004.
However, Morici projects the consumer price index will "settle down" as gas prices continue to fall.
"That pulls a lot of prices with it," he said.
Single- and multifamily housing
David Seiders, the National Association of Home Builders' chief economist, also called housing volume a key to the economy and thinks, as Murray does, housing starts will recede. Still, single-family starts will remain positive-though unable to match the phenomenal growth of the past two years-and multifamily will keep a steady pace. The national homeownership rate will continue to grow-albeit more slowly than in the recent past-and will hit a remarkable 70 percent by the decade's end, Seiders said.
New and existing home prices, according McGraw-Hill's Murray, should increase by 11 percent, and he envisions burgeoning specialty markets for single-family housing, including home theater, Internet alcoves and separate male/female offices. Reed forecasters expect mortgage rates to climb a bit from a 5.94 percent annual average in 2004 for 30-year fixed rates to 6.43 percent in 2005.
In raw numbers, 1,425,000 new single-family starts are expected this year, according to McGraw-Hill, down from 1,530,000 in 2004, which translates into a 7 percent loss. Multifamily will have 445,000 starts, a 2 percent gain from 2004's estimate of 435,000. The contract value of single-family will drop to $267.6 billion, a 3 percent loss from 2004's total of $276.6 billion, while the 2005 multifamily number is $48.8 billion, a 7 percent gain over 2004's $45.4 billion figure. (See charts page 42.)
McGraw-Hill expects the Midwest to be up 1 percent in single-family starts, the only region with an increase. The South Atlantic and West will be big losers at minus 5 percent. The Northeast at minus 7 percent is the only region facing a decline in multifamily starts, while the Midwest and West should see double-digit expansion. In fact, western states can expect a whopping 19 percent growth rate spurred by building in cities such as Las Vegas.
"The metro markets will be amazing," said Murray.
The commercial side
McGraw-Hill lumps stores, offices, lodging, manufacturing, educational and healthcare into nonresidential and sees $176.3 billion spent in those areas, an 8 percent jump from last year. All of these building sectors will have an increase, led by hotels and motels at $6.9 billion (a 15 percent gain), manufacturing at $8 billion (14 percent) and office buildings at $23 billion (12 percent).
Nonbuilding or public works, will find a modest 1 percent uptick in 2005. Bridges and highways ($43 billion) are the big gainers with a 5 percent increase; however, electric utilities will total $5.5 billion, an 8 percent drop from last year.
But why does nonresidential fare so well and residential seem so ho-hum? Murray said the lodging sector, especially, is "getting primed for expansion." This could be a direct result of the tourist industry shaking off the slump after the Sept. 11 terrorist attacks, coupled with a quick end to hostilities Iraq, a somewhat dubious explanation. McGraw-Hill found occupancy and room rates had gone up and noted several large projects, including the $297 million Caesar's Palace Hotel South Tower and the $154 million South Coast Hotel/Casino in Las Vegas, are driving this sector.
Jim Haughey, director for economics for Reed Business Research Group-writing about the 2004 spring growth spurt for nonresidential, a period in which building projects "jumped at a 21 percent annualized pace" after three quarters of decline-said 2004's spring showing was a harbinger of more good things to come. Expect several years of double-digit growth, Haughey wrote. With some caveats. Market activity declined slightly in the summer of 2004, and he expected little, if any, inflation-adjusted growth in fourth-quarter 2004. He blamed poor weather, concrete and steel shortages, work delays caused by material-pricing sticker shock, anxiety over reports of economic weakness, and Fed actions to raise credit costs. But he thinks 2005 will show a rebound.
"Expect growth to resume in the fall and extend through 2005 because most of the key market drivers are improving," Haughey wrote. "In the leasing market, vacancy rates for leased buildings, while still high, are declining. Overall rents are now stable or slightly rising. This increase in cash flow for building owners is prompting more construction."
He outlined some other signs for nonresidential expansion:
o Hotels reacting to rising room and occupancy rates
o Retailers adding space after a 7 percent annual-sales jump
o Office expansion due to higher employment levels
Retail, industrial and real estate
At Reed, Glenn Mueller, Johns Hopkins University professor and Legg Mason Inc. real investment strategist, noted a "physical" real estate cycle reflects supply and demand for space and drives occupancy and vacancy. That sets rents and stimulates construction. In the "financial" cycle, changes in real estate capital affect buildings prices. In these cycles, sluggish expansion is followed by precipitous decline.
"We bottomed out in 1990, then peaked in 2000. But it only took three years to go back to the bottom. We'll now start climbing back up. This is a typical cycle," he said.
Rental growth, he said, is slow nearly everywhere except Southern California and Florida, but should start moving up by 2006. Mueller believes the nation's industrial sector will grow in 2005, and as the job market improves, so will the multifamily and real estate. His colleague at the conference, Edward J. Sullivan, the Portland Cement Association's (PCA) chief economist, has even higher hopes. He sees industrial climbing strong and steady, reaching $35 billion by 2008, up from 2004's level of just over $10 billion. It's a height industrial hasn't reached since 1998.
"It's optimistic," Sullivan said. "But I don't know if many will agree with that."
The chart on this page, "Industrial Construction Outlook," shows this dramatic upswing, with separate projections for spring and summer of 2003-2008. In an e-mail, Sullivan explained: "I make three forecasts per year. The spring forecast refers to my projections made in the spring and the summer [forecast], my forecasts made in the summer. The intent was to show what, if any, changes I have made regarding my outlook for each of the sectors."
Despite good vital signs, Mueller thinks hotel occupancy won't pass the 65 percent "average" until 2007. Retail is the strongest, most recession-proof market, and low interest rates and home refinancing have given consumers a lot of spending cash. The average retail occupancy-86 percent-will begin to grow in 2005.
Warehouses and RFID
In 2000, warehouse construction hit 304 million feet but dropped to 184 million in 2003, a stunning 40 percent loss. What happened? In the 1990s, a strong retail sector and Internet sellers looking for storage space boosted construction. But the fabled dot-com bust and lukewarm retail activity put speculative warehouse projects on hold indefinitely and slowed build-to-suit projects.
But vacancy rates, which peaked at 11.7 percent in third-quarter 2003 and fell to 11.2 percent a year later, are turning around. Successful retailers are planning distribution centers, and McGraw-Hill says this sector, after 5 percent growth in 2004 (193 million square feet) will leap 14 percent in 2005 to 220 million.
With warehouse construction, the McGraw-Hill report noted the rapidly developing use of radio frequency identification (RFID) tags in tracking inventory. As Thomas E. Glavinich wrote in ELECTRICAL CONTRACTOR in April 2004: "Wal-Mart is requiring its top 100 suppliers to put RFID tags on their pallets and cases by Jan. 1, 2005. Similarly, the Department of Defense (DOD) is requiring suppliers to put RFID tags on its shipments by 2005."
For electrical contractors, RFID technology could mean limited opportunity in Cat 5 hard-wiring for stationary scanning systems and unlimited opportunities in wireless network installations. But the technology is evolving and its potential is as yet untapped.
"To what extent the use of RFIDs will affect warehouse demand is uncertain," the report stated, "but at the least it will increase our need for new warehouse designs to be able to accommodate new technology."
The institutional sector
Normally a steady performer, institutional building has stumbled since 2002 and recorded its third straight decline in 2004 with minus 4 percent. McGraw-Hill blames state and local governments' poor health and their taxing structure, which is, in turn, tied to the economy. The states' fiscal fortunes are irregular, but, in general, conditions are improving, the bad times having peaked. The report said: "This should set the stage for an improved performance by institutional building in 2005," and the "broader forces affecting the pattern of institutional building are generally positive."
These forces are the following:
o Rising student enrollments
o A growing elderly population
o The population shift to the Sunbelt
o A large number of bond issues passed recently
o The residential sector's strength in 2001-2004 will introduce need for institutional facilities
In short, the report stated institutional will have a 3 percent gain to 518 million square feet with slight improvement in schools, healthcare facilities and transportation terminals. Public buildings, such as courthouses and churches, will suffer a decline.
Building in education
In response to escalating student enrollments and heavy state and local funding, education construction hit a peak with 273 million square feet in 2001. But in two years, it slid 12 percent to 241 million square feet with the biggest losers being Midwestern and Northeastern states. California was the exception to the trend, racking up an increase of 3.2 million square feet in 2001-2003.
In 2004, the pattern continued. University-related construction fell 19 percent, triggering an 11 percent drop in high school construction, a 13 percent decline in elementary schools and a 14 percent skid in junior high school construction. Community colleges had a slight increase, but museums, libraries and labs were down. At the time of the report, educational construction was a facing a possible 10 percent across-the-board drop to 217 million square feet, the skimpiest total since 1998's 203 million.
McGraw-Hill predicts that though in retreat, this sector will bounce back. Growing enrollments in 2005 will continue through 2013. The bulk of this activity will happen in the West, with an 11 percent gain, and in the South, with a 5 percent increase.
Healthcare and other institutional
Healthcare construction in 2003 took a step backward, dropping 5 percent to 92 million square feet, according to the McGraw-Hill report, and dropped 1 percent in 2004 to 91 million. Though this sector has seen declines recently, it has grown considerably in the past seven years. In 1997 through 2003, new construction averaged 93 million square feet, up 28 percent from 1990-1997's 73 million-square-feet average.
Several factors will help this area grow an estimated 3 percent to finish 2005 with 94 million square feet in new construction:
o Medicare reform and corresponding bigger reimbursements
o Hospitals are investing in new technology and replacing older facilities in the face of competition from specialty outpatient -clinics
o Bigger demand for healthcare exists as baby boomers grow older
The fiscal woes of governments have squeezed financing of prisons, police stations, courthouses, and post offices. Steady at 44 million square feet in 2000-2001, this building type took a cut to 35 million in 2003 but was expected to rebound 10 percent to 38 million square feet in 2004, before dipping to 36 million in 2005. Other points for these institutional areas:
o In 2002, religious building reached 52 million square feet, a high not seen since the early 1960s. It dropped to 43 million in 2004
o Amusement-related building-convention centers, sports arenas, theaters-was at 94 million square feet during 1995-2000 but fell sharply in recent years, landing at 65 million in 2003. It's expected to make a minor comeback to 73 million square feet in 2005.
For several long years in the recent past, manufacturing was a wasteland, hitting the skids at 67 million square feet in 2002. There are reasons for the fall-a strong dollar in the late 1990s that made U.S. exports more expensive and manufacturers who moved production overseas-but whatever the case, this depressing decline has been a sore point for many electrical contractors.
But remember the good old days? In 1997, this sector was at 191 million square feet. A small part of that was regained in 2003 with a hike to 71 million square feet, and 2004 saw another small increase to 73 million, spurred in part by auto plant construction in Oklahoma, Texas and Mississippi; the $600-million conversion of an Arizona Intel semiconductor plant; and a $300-million expansion to a California biotech manufacturer. These projects, and others like them, will help manufacturing reach 80 million square feet in 2005, a 10 percent jump, according to McGraw-Hill.
Public works, electric utilities
Moribund government spending affected this sector, too, as public works money began drying up in 2003 after several years of growth. But in 2004, prompted by the need for water and sewer works, these project types jumped 4 percent to reach $85.9 billion.
A 2004 bill by Congress set forth these spending levels:
o Highways up 4 percent (from 2003 levels) to $33.6 billion
o Mass transit increased 1 percent to $7.3 billion
o Airport grants didn't budge, remaining at $3.4 billion
o Army Corps of Engineers construction funding cut 3 percent
o EPA water infrastructure grants raised 3 percent
o The EPA Superfund account received an 8 percent bump upward
But in 2005, President Bush set a 0.5 percent limit on discretionary funding and things look tight, except for the Transportation Security Administration-homeland security was exempt from the limit-which received a 20 percent increase, including $250 million slated for airport upgrades. At the time of the report, 2005 levels were not set by Congress, but they look similar except for a 13 percent EPA cut and a 7 percent raise for the Corps.
Closing the books
Sullivan, who delivered the U.S. construction overview at Reed, noted many signs of a brighter economy. After a 2001-2003 drought, investment spending has made a strong return and will no doubt help replenish funding for manufacturing construction and other sectors that have fallen on hard times. Job growth looks good. The fiscal crisis in most states, he said, is fading. Still, the signs portend only a modest recovery in most sectors and slight declines in some others. And oil prices are the most frightening bugbear, the biggest wild card for many an economic pundit. Not a real boom year, yet certainly not a bust. Just a time to be cautiously optimistic. EC
FULMER, editor of ELECTRICAL CONTRACTOR and SECURITY + LIFE SAFETY SYSTEMS, can be reached at 301.215.4516 or firstname.lastname@example.org.