Speakers at this fall’s McGraw-Hill Outlook 2006 and Reed Construction Data Building Team Summit 2005 conferences in Washington, D.C., in fall 2005 were less dramatic as they pondered the post-Katrina economic landscape, but nonetheless they made last-minute adjustments to deal with the storm’s sudden, overwhelming effect.
Jim Haughey, Reed’s director of economics, released a report subtitled: “Katrina Will Have a Wide-ranging Impact on the U.S. Economy.” The report predicts the hurricane will cut U.S. economic growth by 0.5 percent from a projected 4 percent increase in 2005, a drop that will be offset by a 0.5 percent pickup in the first half of 2006 that will bump growth back up to 4 percent.
But that message seems confusing. Is a half-percent loss followed by a half-percent gain a “wide-ranging impact?” Robert Murray, McGraw-Hill’s vice president of Economic Affairs, somewhat agrees. His figures match Haughey’s, but Murray said this “discernible slowing” won’t “tip the economy into recession.”
Is this good news, bad news or merely a safe bet? Murray, like his counterparts, believes economic growth will remain at 3 to 3½ percent for 2006, about the same as McGraw-Hill projected in 2005. It was as if Katrina put economists in a headlock. But how does one gauge the effect—just weeks after it struck—of what has been called accurately or inaccurately America’s greatest natural disaster?
In the beginning of his McGraw-Hill presentation, David Wyss, chief economist for Standard & Poor’s, said in mid-2005 the picture looked pretty clear: The economy was supposed to slow down gradually because of high interest rates and end up with a 3 to 3½ percent growth rate with 2 percent inflation and 5 percent unemployment.
“You know,” Wyss joked, “I’d take 10 more years like that right now.”
Then along came Katrina and suddenly the world changed, said Wyss, though his analysis seemed to contradict that notion. Wyss talked about oil price spikes, how a major city was lost and how 300,000 to 400,000 new homes will have to be built in the Gulf states. However, Wyss said, “We’re still looking at 3 to 3½ percent growth, inflation holding at 2 percent and the unemployment rate staying at about 5 percent.”
Does energy matter?
The temporary loss of New Orleans’ port hurt Midwest grain shipments, Wyss said, and we’ve relied too heavily on Gulf-area oil refining. Despite that, he said the country hasn’t been affected much because energy isn’t that important to the economy anymore. With the higher gas prices, the average household this winter was expected to spend about 6 percent of income on energy, Wyss said, assuming gasoline stood at $2.75 a gallon and natural gas increased 50 percent.
“Now that’s up from about 4 percent back in 2002,” Wyss said. “So we’ve lost basically 2 percent of purchasing power, but Americans have managed to offset that through the simple method of refusing to save any money. Last quarter, we finally attained the American dream: We actually spent more than we earned.”
We have seen gasoline prices fall below $2 a gallon in some states, so what will Katrina’s impact be? Haughey predicts demand for spot materials—mainly lumber—will increase for several years and that equipment rental rates and availability in the Gulf region will be negatively affected. The brief oil price hike made transporting most construction materials more expensive.
Post-Katrina efforts by President Bush and congressional Republicans to temporarily suspend the Davis-Bacon Act failed, and Haughey believes wage premiums will be needed to lure construction workers to the Gulf states.
The U.S. Bureau of Labor Statistics said the construction industry will need to add 100,000 jobs a year every year until 2012, on top of filling positions for 90,000 workers who are retiring annually. Whether our already-thin labor force will be stretched further by hurricane-recovery efforts is still to be determined. In fact, the economy’s future seems to be an open-ended question.
“There won’t be as many roofers in Nashville and Atlanta,” Haughey said. “All the bulldozers will have moved to New Orleans.”
Name No. 2
After Katrina, the second most-frequently heard name was Greenspan. Economists deal every day with an inanimate force that seems to take on a personality: the stock exchange is described in zoomorphic terms as a bull or bear market, and business writers often call the economy “sluggish” or “overheated,” as if it were beast that needed to be jolted with a cattle prod or tamed with a whip. In any case, Federal Reserve Chairman Alan Greenspan was the economy’s supreme ringmaster, and the end of his 18-year reign was marked by incremental increases to the target federal funds rate, a traditional method used to slow the economy, hold back inflation and raise mortgage rates, which have an enormous effect since residential construction is largely responsible for growth in all sectors.
In addition to higher mortgage rates, the gap between sellers’ asking prices and buyers’ offers has been narrowing in some areas of the country and more homes have been put up for sale. The nation’s largest luxury homebuilder Toll Brothers, Horsham, Pa., revised its 2006 forecast and now expects to build about 500 fewer homes. A Nov. 8, 2005, corporate announcement blamed Katrina and her influence on gas prices, saying prospective homebuyers had lost consumer confidence and were taking longer to make purchasing decisions. But this news has made economists only mildly anxious because the market is sending out mixed signals.
For instance, Toll Brothers said that the revised 2006 number—now set at 9,500 and 10,200 homes—would exceed its 2005 figure of 8,769 homes built. D.R. Horton, the Fort Worth, Texas, builder of mid-range homes, said it had raised expectations for demand just 19 days later. Horton, one of the nation’s largest homebuilders—it closed more than 50,000 homes last year, an industry first—notched a 61 percent increase in 2005 fourth-quarter profits.
The construction conference gurus weren’t sanguine about the residential market, but were hardly bleak. Murray sees only a 1 percent drop in the dollar value of single-family home starts and a 2 percent drop in multifamily, and Haughey sees some growth in residential construction put-in-place.
In 2005, the forecast for put-in-place stood at $625 billion and is expected to reach $636 billion in 2006. But that $11 billion difference appears paltry when compared to the gain between 2003 and 2004 ($98 billion) and 2004 and 2005 ($55 billion). It should be rosier in 2007 when put-in-place hits $661 billion.
Greenspan’s departure was treated with optimism. His chosen successor, Ben Bernanke, chairman of the White House council of economic advisers, should leave the Fed in able hands. (Note: Bernanke won’t be officially confirmed until after this goes to press, but it is considered a lock.)
With a 1 percent interest rate, Wyss, in a metaphorical mood, said the Fed had a lead foot, which is not the best way to drive a car. The Fed’s rate increases were more to a point Greenspan would consider neutral, which is around 4 percent.
“That gives room to slow down or speed up,” Wyss said. “So Bernanke doesn’t have to do anything until he gains footing, gets the market’s confidence and has ability to move rates in either direction, should something happen.”
But Greenspan has famously granted there is “froth” on home prices, and Irwin M. Stelzer, writing in The Weekly Standard, is less generous concerning Bernanke’s freedom of movement. He thinks the new Fed chairman will have no choice but to continue raising rates.
Stelzer sees a connection between higher home prices—which help consumers fall deeper in debt as they tap into home—equity loans at the rate of $600 billion a year, higher mortgage rates, housing starts that fell 5.6 percent in October 2005, increased hesitance in new home purchases and a core inflation rate that is creeping beyond Bernanke’s “comfort range” of 1 percent to 2 percent.
“Inflation expectations would soar were he to call a halt to rate increases. In short, Bernanke might have to keep raising rates as the housing industry, the most interest-sensitive sector of the economy, goes from boom to bust, perhaps dragging the economy down with it,” Stelzer said.
President Bush promised the world’s biggest construction project in New Orleans and the Gulf. Is that possible as the country faces record trade deficits and billions for the Iraq war?
Wyss said the long-term problem Americans face is the national debt as we have become too reliant with foreign investors—especially Japanese investors—gobbling up Treasury securities with relatively high interest rates because their central banks have kept bond rates low.
Wyss said that has capped U.S. bond yields, but lack of faith in the dollar or higher foreign yields could change the picture. This affects housing construction because the 10-year U.S. bond yield plus 1½ percent is the formula for mortgage rates.
“We are borrowing 6 percent of GDP from someone else, and we’re willing to take it from anyone who has a spare yen to give us,” Wyss said.
As noted earlier, new homes, which make up more than half of all U.S. construction, are a catalyst. Stores, schools, business, hospitals and new roads spring up after new subdivisions are built and, despite some bad news on residential—Murray thinks 2005 is the year single-family hits the wall—Haughey said nonresidential construction should expand at a 10 percent clip through 2007 and be led by a charge in office, retail, lodging and other “leased” construction.
Murray said industry growth looks healthy for 2005 with an anticipated 8 percent gain in new construction starts. Despite the aforementioned potential problems with Katrina and mortgage rates, next year’s GDP, growing at 3 percent, “implies decent job growth,” which will help support demand for offices, multifamily housing, institutional building and public works. Let’s talk a look at some individual sectors.
After steep declines in 2001 and 2002, construction starts in retail, warehouses, offices, multifamily and lodging made a partial recovery in 2003 and rose 9 percent in 2004. Last year saw better hotel occupancy rates, easing of bank lending standards and improved employment figures. However, Murray expects this sector to increase by 3 percent in 2005 and 2006 as the positive factors have been offset by rising material prices.
“These increases have brought uncertainty into the project-financing picture causing owners and developers to remain cautious about undertaking new construction,” he said.
Reed’s Haughey predicted 2005’s insignificant loss in lodging put-in-place in 2005 would be followed by a gain of nearly $2 billion in 2006 and a big gain of $4.2 billion in 2007 to end at $18 billion. He thinks office construction put-in-place will rise dramatically from 2004’s $45.1 billion to $66.3 billion in 2007, and retail will have a slower, steadier climb in those years from $66.6 billion to $76.7 billion.
Schools and healthcare construction dominate this sector, which also includes public construction projects such as police and fire station, post offices, courts, detention centers, military bases and churches. A handful of Rust Belt states—Ohio, Michigan, Illinois and Pennsylvania—get good news and land in the top 10 for healthcare construction in 2005; however, the U.S. population shift means more school construction in the West and Southwest.
As school enrollments rise and our aging population requires more access to healthcare, Murray sees a slow upswing in institutional with 1 percent growth in 2005 and 4 percent in 2006. School-related construction, which fell precipitously beginning in 2001, will inch upward 1 percent to 212 million square feet. In 2004, community college construction saw a phenomenal growth rate of 95 percent over 2001’s figure.
According to Murray, public-sector construction in general will drop 2 percent in 2005 and 3 percent in 2006, and church building sank terribly in 2005, falling 18 percent. Healthcare construction is going strong with an anticipated 12 percent jump to a record 105 million square feet. This includes 41 hospital projects at $50 million or more.
Haughey also likes healthcare—he thinks put-in-place construction there will jump $12.5 billion from 2004 to 2007—and has a sunnier outlook on school construction, predicting that put-in-place construction in that category will zoom from $72.3 billion in 2004 to $97.9 in 2007.
He thinks church-related construction put-in-place, after dropping in 2004 and 2005, should exceed 2003’s $8.6 billion figure in 2007 and hit $9.1 billion. Amusement and recreation construction dipped slightly from 2004 to 2005, ending at $19 billion, but Haughey thinks put-in-place figures should increase in that category to $23.4 billion by 2007.
This sector, once so important to contractors, has taken a beating as manufacturing jobs have fled overseas. After a recent high of $40.5 billion in put-in-place construction in 1998, this sector tumbled to a woeful $21.5 billion in 2003, according to Reed’s statistics. Things will look brighter, Haughey said, as a steady increase, beginning with 2004’s $23.7 billion figure, taking manufacturing to $33.9 billion in 2007.
Murray is also upbeat. McGraw-Hill based its predictions on square footage and said this sector climbed 11 percent in 2003 and 2004 after five straight years on the slide. Murray sees some positive signs, including the decreasing value of U.S. currency in relation to that of major trading partners—which should increase the value of U.S. goods overseas—and industrial production—which is beginning to show more vitality.
But there is bad news as manufacturing began to lose steam last year. Murray lays the blame on more efficient production methods, including technical innovations, and owners who are too leery of conditions in this sector and fearful of expanding capacity. General Motors Corp.’s predicament—lousy bond ratings, their partner Delphi’s possible bankruptcy, layoffs and plant closings—is just part of an industrywide slump that cut automotive-related projects by 53 percent in the first three quarters of 2005.
But Murray noted some significant 2005 groundbreakings, led by a $900 million Intel plant in Arizona and another semiconductor plant in Texas valued at $325 million, and he thinks manufacturing will rebound after an awful 2005. In addition, President Bush wants to lift the unofficial moratorium on oil-refinery construction that has gone on since the 1970s, the last decade a plant of that type was built in the United States.
“New construction starts for manufacturing buildings in 2005 will drop 10 percent to 75 million feet,” Murray said, calling it a temporary halt to a growth trend that began in 2003. “This structure type should see renewed expansion in 2006, and contracting is expected to rise 9 percent to 82 million square feet.”
Still, a peek at the recent past reveals a disheartening picture. In 1997, this sector was at 200 million square feet.
Public works and electric utilities
“Public works will increase 8 percent in 2005, the largest increase in six years,” said Murray, noting that water and sewer projects and the new energy bill, the Energy Policy Act of 2005 (EPAct 2005), would provide the boost. “For 2006, public works is expected to see another large gain, rising 7 percent as the momentum shifts to the transportation sector.”
Katrina figures in again, of course, and Bush’s Gulf Coast reconstruction commitment will be put to the test. Some members of Congress, pushing for hurricane-recovery funds, wanted to siphon money from the new transportation bill, which has the unwieldy acronym, SAFETEA-LU and will increase aid for federal projects by 38 percent.
Any major public works related to Katrina—namely levee reconstruction or flood control—would probably have a limited effect on electrical contractors; however, EPAct 2005 is another matter altogether.
“New construction starts for electric utilities continues to slip,” Murray said, “but recent evidence suggests that the extended retreat is near an end. Last year’s 19 percent decline brought contracting down to $7.2 billion, well below 2001’s all-time high of $24.1 billion. In 2005, the decline is expected to be only 4 percent.”
Transmission line work should also be an opportunity zone for contractors. Utilities have undergone huge changes since 2000 when moving electricity across state lines and through different regions became more commonplace. EPAct 2005, among other things, will make transmitting electricity across federal lands easier.
Reed predicts transportation construction put-in-place for 2005 will make a tiny increase ($100 million) to $30 billion. It goes up to $30.3 billion in 2006 then leaps to $35.4 billion in 2007. Sewer and water construction, in Reed’s view, makes steady progress upward from $29.9 billion in 2005 to $37.6 billion in 2007, while electric power figures take a similar track, going from $36 billion to $47.4 in the same period.
By late November, just weeks after McGraw-Hill and Reed, economic indicators signaled the country had begun recuperating from Katrina. The Commerce Department reported that orders for big-ticket, durable goods were up 3.4 percent, and The Conference Board said rapidly falling gas prices and improving employment figures were the one-two punch that drove its Consumer Confidence Index for November to 98.9, up 13.7 points from October and 6.3 points higher than November 2004. Conference Board Director Lynn Franco just had to mention Katrina, too.
“While the index remains below its pre-Katrina levels, the shock of the hurricanes and subsequent leap in gas prices has begun wearing off just in time for the holiday season,” Franco said on the board’s Web site.
Perhaps more important, The National Association of Home Builders (NAHB) said single-family home sales soared 13 percent to a record 1.42 million units, the largest one-month increase in 12 years and a sales pace that rose 9 percent above October 2004’s figure.
A wire report in The Baltimore Sun said the news had “confounded analysts” who had expected higher mortgage rates to tamp down sales, and NAHB Chief Economist David Seiders, who called the report “surprising,” thought escalating rates “may have pushed a lot of fence-sitters into a buying mode” and induced builders to add sales incentives.
“But it’s also likely that today’s report overstates the true pace of home sales because of well-known statistical deficiencies,” Seiders added. “More data will be required to assess the true condition of the housing market as we move ahead.”
More data to counter well-known deficient statistics? This expert sounded confounded. Let’s go back to the beginning. As Wyss, Murray and Haughey all said, look for 3½ to 4 percent growth in GDP. As for the 2006 housing market, keep your fingers crossed, hope the bubble doesn’t burst and pray the only froth you see is on a Starbucks cappuccino. EC
FULMER is a freelance writer based in Joppa, Md., and former editor of ELECTRICAL CONTRACTOR. He can be reached at email@example.com.