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Miss, Boom, Blah: The Outlook for the Economy and Construction

September 26, 2002
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The economy and the construction industry sound like an out-of-step marching band these days. Homebuilding continues to lead the parade; the boom of its drum is reverberating through other kinds of construction. Consumers skipped the recession but are stepping more cautiously now and have a case of the blahs, while the rest of the economy has missed its cue for a strong entrance and is acting as if might start marching backwards. Each of these trends has implications for different types of construction.

Blah

There are two key indicators of construction industry health: employment and value put in place. At the moment both are suggesting relative stagnation in construction. The Bureau of Labor Statistics reported that seasonally adjusted construction employment nationwide in August was little changed since April and down almost 2% from August 2001. The Census Bureau reported that nationwide construction put in place for the first seven months of 2002 was virtually unchanged from the same period of 2001, and the seasonally adjusted figures for July nearly matched the total for June.

However, a lot of churning is going on beneath that calm surface. Let's start with the best news.

Boom

Nationally, single-family new-home sales set a record in July, topping 1 million at a seasonally adjusted annual rate for the first time. Existing-home sales also were close to record heights.

August building permits, the best indicator of future home construction activity, fell by 2.5% from the near-record levels of June and July but remained 4% above August 2001. Cumulatively, the number of permits issued in the first eight months of this year is 3.5% higher than in the same span of 2001.

The hot housing market helps several categories of construction. New subdivisions create business for site-clearing, grading, utilities and paving contractors. The fixing up of houses before and after sale provides work for a variety of subcontractors and helps pump up retail sales for home furnishing, hardware and housewares, and landscaping businesses, which in turn generates more construction orders. And the strong level of home values, coupled with low mortgage rates, means many homeowners will refinance or at least have confidence that their wealth is rising enough to support higher spending despite a weak stock market.

In addition to housing-related purchases, consumers have continued to lay out money at car dealers. Dealers in turn have spent some of their money on new construction. New detailed information from the Census Bureau on value of construction put in place shows that automotive construction rose 9% from July 2001 to July 2002. But retail sales have slowed alarmingly.

These trends appear likely to continue for several more months. Foreign travelers will remain scarce, depressing construction and the economies of areas like Orlando, Las Vegas, and major national parks, but having little effect on "drive-to" destinations like Cape Cod. Shopping centers, where construction fell 16% from July to July, compared to a 3% slide in general-merchandise store construction, will continue to lose ground. Auto dealerships will be vulnerable to any bouts of consumer caution. And both consumer and business spending will be set back if oil prices remain elevated. Gasoline prices have been unusually stable for the past five months. But crude oil prices are up sharply, as are diesel prices, which have risen 14 cents per gallon in the past three months, and gasoline prices are likely to spike soon.

Misses

Turning to the business sector and business-related construction, it is apparent that there is a lot more nervousness about the future than there was a few months ago. Manufacturing activity dropped by a seasonally adjusted 0.1% in August, according the Federal Reserve's industrial production release on Tuesday, following increases of 0.3% in July and 0.6% in May and June. That is consistent with the still growing but weakening index of the Institute for Supply Management. Furthermore, manufacturers are still using only 74% of capacity, far too little to lead them to call in the engineers and construction crews. Manufacturing capacity has actually grown faster than production in the past year. Manufacturing construction put in place was off by 49% from July 2001 to July 2002 and a revival appears unlikely before mid-2003. Utility output also has risen by less than capacity, according to the Fed's release. This month week the biggest utility company, American Electric Power, announced it would seek to shut down 16 power plants in Texas alone, while Duke Energy suspending construction on plants in Nevada, New Mexico and Washington.

Inventories may have finally stopped their long skid. The Census Bureau said last Monday that total business inventories rose for the second straight month in July, by 0.4%, seasonally adjusted. But sales rose even more, 1.2%. Clearly all levels of business are keeping inventories lean and reducing their demand for warehouse and storage space. Warehouse construction fell by 33% from July 2001 to July 2002 and will likely stay flat or fall more, even though the economy should keep growing modestly.

Similarly, office construction in most regions is likely to remain depressed until current vacancies are absorbed. With employment levels holding steady at best, that means new office construction won't pick up until well into 2003. One other categories of private construction deserve mentions-health care. In July, private health care construction stood 17% higher than in the previous July, with hospitals, medical buildings, special care facilities and drug stores (part of "other commercial") all growing. Private health-care spending is not showing any signs of slackening, and the doctors, drug and device companies, and other providers will continue to convert some of their higher revenue into expanded offices, clinics, labs and manufacturing plants.

Government-funded construction may be soon in the worst shape of any construction grouping, after having shown the strongest growth. Federal funding for highways and several other categories of construction are at or near all-time highs in fiscal 2002. But the federal fiscal year ends September 30, and next year is sure to be a different story. Revenue has fallen and spending priorities have shifted toward defense and domestic security. AGC and its members are leading the fight to keep federal highway funding level in fiscal 2003 but the pressure to cut all types of construction funding, at all levels of government, is intense. The state story is particularly bleak, because most states must balance their budget every year. In nearly every state, revenues have tumbled compared to the projections made when fiscal 2002 budgets were adopted in early 2001, while outlays for unemployment relief, health care, and public safety officers have climbed. Construction has been deferred or cancelled and will continue to be.

Construction costs should remain well-behaved for the most part. Most producer prices are flat or falling and, as noted, there is capacity to spare throughout the manufacturing sector. However, the patchwork of steel quotas and tariffs announced by the Administration last spring has caused some construction steel to become pricey or scarce. And construction firms that use lots of asphalt or diesel fuel may find those prices soaring unless fears of conflict with Iraq die down. Nevertheless, the one cost most likely to go up by large amounts is insurance of any type. Premiums for all types of insurance have increased by an average of 30% and in some cases much more, and coverage has been substantially reduced. In particular, lack of terrorism insurance has choked off as much as $11.5 billion in construction and renovation projects, according to a recent Real Estate Roundtable survey. That is why AGC is working closely with the Coalition to Insure Against Terrorism to enact a federal insurance backstop.

In sum, the next several months will be very uneven for construction. Construction related in some way to consumer activity should remain strong, business-related construction will pick up gradually in 2003 if the economy keeps strengthening, but government-funded projects are likely to diminish once current jobs are completed.

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