2006 Construction Forecast: "Best Year for Nonresidential Construction Since 1998"

By Craig DiLouie, Lighting Controls Association

Published January 2006

In 2006, construction industry analysts are again forecasting that the residential construction market will cool, with losses that should be offset by an increase in nonresidential construction. In addition, research suggests that the construction industry—from general contractors and equipment distributors to electrical and lighting manufacturers—is generally optimistic about 2006.

The AIA Consensus Construction Forecast Panel, made up of a number of organizations, is forecasting an increase of 7.9% or more in 2006 in the nonresidential market, after adjusting for inflation, on top of a 3.7% increase in 2005. The commercial market will lead the institutional market, according to the Panel, while the industrial market is positioned for significant expansion. Meanwhile, most organizations individually are forecasting a decline in put-in-place residential construction.

“After a reasonably strong performance during the second half of this year, 2006 looks to be easily the best year for nonresidential construction since 1998,” Kermit Baker, PhD, Hon. AIA, Chief Economist for the AIA, wrote on the association’s website.

Some analysts, however, warn that construction inflation, advancing at a faster rate than other industries, could inhibit growth.

In this report from the Lighting Controls Association, we will examine a number of leading market indicators and research regarding what we can expect over the course of this year. While analysts often disagree on the finer points and even the basic numbers, all foresee an upswing in nonresidential construction, a decline in residential construction, and continued worries about inflation impacting projects and profits in 2006.

The Economy & Construction: 2005 in Review

The year 2005 was another year of improving economic numbers but mixed signals. For 2006, economists are again mixing their optimism with caution. The economy grew at a rate of about 3.5% in 2005, and is projected to grow at a 3.3% rate in 2006—slowed, but not derailed, by the impact of Hurricane Katrina, soaring Federal deficits and rising energy prices, inflation and interest rates, according to some economists. On the plus side, in 2005 the economy grew 4.1% in the third quarter, oil prices have begun to moderate, corporate profits reached double-digit rates, and some economists are predicting the Federal Reserve will soon stop its march toward higher interest rates (although if inflation continues to increase, a halt in interest rate hikes may be unlikely).

The construction industry, a major driver in demand for electrical products such as lighting and lighting controls, is looking for this growth to produce significant business investment that will boost nonresidential construction.

Over the past two years, industry analysts have predicted that residential construction would decline in 2004 and 2005, to be offset by increases in nonresidential and public construction. The homebuilding market, however, continued to defy expectations in 2005 with strong growth of about 14% that prompted the United States to achieve, according to preliminary estimates by the U.S. Department of Commerce, a new record of $1.136 trillion in put-in-place construction, an increase of 10.5% over 2004 and more than doubling from just 10 years ago—with housing driving 57% of the market.

Meanwhile, the value of put-in-place nonresidential construction increased by about 6.2% between 2004 and 2005 after a turnaround that had begun in 2004, in which nonresidential construction increased by about 2%, according to Commerce. This would seem to be welcome news and about time, as you will likely recall that the years 1999 through 2003 saw four years of declining demand for nonresidential construction—culminating in a 25% reduction from its peak in 1999. Industry analysts say that the rebound in this sector is really just starting to gain steam, and should accelerate in 2006.

However, rising inflation in construction costs can erode the actual value of growth. For example, average construction costs increased by 7.6% from 9/04 to 9/05 for nonresidential buildings [see Table 1 for more data, and click here for an insightful analysis of construction inflation by the Associated General Contractors of America (AGCA)]. A relatively high rate of inflation is expected to continue.

Looking ahead at 2006, Ken Simonson, Chief Economist for AGCA, offered a good snapshot when he said, after stating that he believes the economy is essentially healthy: “[2006] will pay off for the nonresidential construction industry while residential construction will decline but not immediately or steeply. However, costs will continue to increase at a faster rate than for other industries.”

Figure 1. Actual put-in-place construction in 2004 and preliminary estimates for 2005, according to the U.S. Department of Commerce.

Table 1. Changes in costs among construction types (%). Shown is the percentage change in the 12 months ending December 2001, December 2001, December 2003, September 2004 and September 2005. The rate of inflation in the construction industry has outpaced the rate in other industries. Source: Associated General Contractors of America, 2005.

Construction, Electrical & Lighting Industry Market Indicators

Before looking at the 2005 construction industry forecasts, a number of market indicators suggest that 2006 will be a good year for nonresidential construction:

CIT Construction Industry Forecast: The construction industry’s contractor and distributor communities are optimistic about 2006, according to CIT Construction, which recently published its 30 th annual CIT Construction Industry Forecast, based on interviews with more than 900 contractors and equipment distributors across the United States. “For the third consecutive year, the leaders of the U.S. construction industry share an optimistic outlook for the coming year,” says Ron Riecks, Executive VP for CIT Construction. “While their optimism is more cautious than the previous year, their positive predictions for 2006, in terms of equipment rentals and purchases, net income, business strategies, technology and issues and opportunities, give hope for what’s to come.” Forty-five percent (45%) of surveyed contractors said they view their overall business outlook in 2006 as “better” than 2005, while 42% view it as “equal to” 2005. Fifty-seven percent (57%) of surveyed distributors said they view their overall business outlook in 2006 as “better” than 2005, while 36% view it as “equal to” 2005.

Table 2. National optimism quotient trend, CIT Construction Industry Forecast. This year’s quotient fell seven points overall, but continues to indicate a positive outlook for 2006.

Architecture Billings Index: The American Institute of Architects (AIA) reported that in November 2005, the Architecture Billings Index (ABI), a leading economic indicator of nonresidential construction activity, showed growth for the eleventh consecutive month. Due to the approximately six-month lag time between billings for architectural services and construction activity, nonresidential construction activity is expected to be a strong economic sector in much of 2006.

“It is especially noteworthy that if architecture firms report even modest billings gains in December, 2005 will be the first year since 2000 that that gains were reported every month of the year,” said Baker. “We are expecting improved business conditions for construction firms that specialize in commercial/industrial, as well as institutional projects.”

The November ABI rating of 58.4 (any score above 50 indicates an increase) represents slightly higher growth than the 57.5 score in October (November 2004 ABI was 51.6, November 2003 ABI was 48.5).

CIBC World Markets Industrial Multi-industry Senior Analyst, Robert McCarthy, stated: “We are very encouraged by the continued strong readings indicated by the AIA billings index. We believe that many electrical equipment suppliers, particularly electrical product and lighting fixture manufacturers, will be prime beneficiaries of this likely pickup in nonresidential construction activity.”

Figure 2. The AIA Architecture Billings Index indicates that nonresidential construction activity is expected to be a strong economic sector in much of 2006.

Electroindustry Business Confidence Index: The electrical industry maintained a somewhat high level of optimism regarding current conditions in 2005, as measured by the National Electrical Manufacturers Association (NEMA) Electroindustry Business Confidence Index, which is based on a monthly survey of senior managers at NEMA companies representing more than 80% of the electrical industry. The measure of confidence decreased overall by about 7% from January’s 62.9 points to December’s 58.3 points, peaking at 83.3 points in September but declining over the last quarter following Hurricane Katrina. Katrina put a dent in the U.S. economy and resulted in a great deal of uncertainty. However, it is also predicted to result in a construction boom in the Southeast due to rebuilding efforts. As a result, the electrical industry can expect that strong replacement demand for housing and commercial and industrial structures will increase demand for building equipment. However, it is likely that rising building materials and energy costs will detract from potential gains.

Figure 3. NEMA Electroindustry Business Confidence Index, reflecting electrical industry confidence in current conditions, 2005.

NEMA Lighting Systems Index: Looking at the lighting segment, NEMA tracks the industry’s health using a metric called the Lighting Systems Index, a composite measure of NEMA member companies’ U.S. shipments of lighting products such as lamps, ballasts, fixtures and emergency lighting and exit signs. Product shipments data are drawn from statistical surveys conducted regularly by NEMA and are adjusted for inflation and regularly recurring seasonal fluctuations. The Index increased 1.4% in the first quarter of 2005, 1.1% in the second quarter, and 2.4% in the third quarter, reaching its highest point in more than four years—8% higher than the trough in early 2003—but still lower than the levels seen at the end of the prior economic expansion.

Figure 4. NEMA Lighting Systems Index (as of Q305), based on product shipments for NEMA member companies that manufacture lighting products.

2006 Lighting Industry Outlook: Manufacturers of lighting fixtures, lamps, ballasts and controls are also demonstrating qualified optimism about 2006, according to the 2005-2006 Lighting Industry Outlook produced by ZING Communications, Inc. based on surveys distributed to about 1,150 North American lighting manufacturers with approximately a 10% response. The research suggests that a sizable portion of fixture manufacturers believe that construction activity and their sales will increase in 2005-2006, but are much less optimistic about their net profits increasing, likely due to pricing competition and rising costs. In fact, the research suggests that the most important threat trend perceived by fixture manufacturers is gross margin costs (raw materials to produce products), followed by general lack of education about lighting’s value in end-user markets, pricing competition, and competition from cheap imports. Even with more than one-half of fixture manufacturer respondents saying they manufacture products in foreign, lower-cost labor markets such as Asia—and a majority of manufacturers of lamps, ballasts and controls saying they do as well—the research suggests that manufacturers perceive cost reduction as the most important opportunity trend, in addition to R&D/technological development and marketing/promotion to build brand and provide superior product quality to the market. Indeed, the research suggests that North American manufacturers increasingly perceive innovation as the key to higher profits.

Table 3. The research contained in ZING’s 2005-2006 Lighting Industry Outlook suggests that North American lighting fixture manufacturers are generally optimistic about construction activity and sales in 2006, but much less optimistic about increasing profitability. As a result, manufacturers appear to be focusing their business strategies on cost reduction, price increases and innovation, to increase profitability.

Table4. The research contained in ZING’s 2005-2006 Lighting Industry Outlook suggests that North American lamp, ballast and lighting control manufacturers are generally optimistic about construction activity and sales opportunities in 2006, but much less optimistic about increasing net profits.

2006 Construction Forecasts

Economic forecasting can make fascinating study, but the forecasts, of course, must be taken with a grain of salt. John Kenneth Galbraith, economist and ambassador, once said, “We have two classes of forecasters—those who don’t know and those who don’t know they don’t know.” Laurence J. Peter, U.S. educator and writer, adds, “An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.” (Special thanks to Jim Lucy, editor of Electrical Wholesaling, for digging up these gems.) These statements are both humorously on the market but also, of course, unfair. With so many factors influencing the economy synergistically, with a sudden event in each completely throwing off the best prediction, it’s no wonder that economic forecasting is such a tough game to play. But play it we will—and while we check our blind faith at the door, we can certainly learn a great deal from the economic predictions from the major construction organizations.

Here they are, the best and brightest predictions for 2006:

Residential Sector: Residential construction is likely to decline from its 2004-2005 growth rate of 14% to a much lower rate, say analysts. The reason: Interest rates, which have been steadily ratcheted up by the Federal Reserve, will finally create a drag on demand for homes. The prime rate increased from about 4.1% in 2003 to about 6.2% in 2005, and is projected by the National Association of Home Builders (NAHB) to reach about 7.5% in 2006 and stay at that level in 2007. Commerce is more optimistic than many industry analysts, saying inertia in the market will continue to propel the homebuilding market. Commerce has forecasted 6.1% growth in this segment from 2005 to 2006—a decrease in the rate of growth, but not entirely disappointing, either. Industry analyst FMI agrees. The Portland Cement Association (PCA) is bearish in its assessment, believing residential construction will decline 2.2% in 2006 after inflation takes its cut. NAHB has forecasted that the market, in terms of single-family and multifamily starts, will decline from its peak of more than 2 million starts in 2005 to 1.94 million in 2006 and 1.88 million in 2007.

Table 5. NAHB 2006 Housing Forecast.

** Annual data are averages of seasonally adjusted quarterly data and may not match annual data published elsewhere. 

“For the year as a whole, the value of residential construction put in place is likely to be slightly less than in 2005, with the drop concentrated in single-family construction,” said Simonson. “The condo market will also shrink but multi-family rental construction should make a comeback, as people shut out of home ownership fill more rental units instead.”

Families displaced by Hurricane Katrina will add to demand for housing in surrounding areas of Texas, Louisiana, Arkansas, Mississippi, and Alabama and in selected metro areas farther away, notably Atlanta, says Simonson. Residential rebuilding in the storm zone is unlikely to take place on a large scale in 2006, however. Too much must be done first in terms of debris removal, demolition, infrastructure strengthening, and land-use and financing decisions.

“Homebuilding activity continues to bolster demand for lighting equipment,” Brian Lego, Director, Economic Analysis for NEMA, said in late 2005. “Despite steadily rising mortgage rates, which recently hit three-year highs, the pace of single-family home construction remains very strong. Moreover, the housing market should boost lighting equipment demand over the very near term, particularly as hurricane-related reconstruction activity picks up in earnest along the Gulf Coast. As mortgage rates continue to creep higher, however, the residential construction sector is expected to put a damper on sales of lighting systems.”

Nonresidential Construction (Consensus Forecast): A number of organizations publish construction forecasts, and reconciling them can be confusing. While a large number of forecast are presented in the remainder of this report, one of the most helpful forecasts is the AIA’s Consensus Construction Forecast, which brings different forecasts together to create a consensus forecast. All members of the AIA Consensus Construction Forecast Panel are forecasting an increase of 7.9% or more in 2006 in the nonresidential market, after adjusting for inflation, on top of a 3.7% increase in 2005. (Note, however, that one participating organization, the Portland Cement Association, later downgraded its forecast due to inflation concerns.)

Within the nonresidential market, the commercial market—such as office, retail and hospitality—is expected to lead the institutional market—such as health, education and houses of worship—while the industrial market is set to expand significantly. Table 4 shows nonresidential construction market forecasts for the Consensus Panel as well as three participating organizations—Global Insight, Economy.com and Reed. The other participants are discussed in greater detail in the next section.

Table 6. AIA Consensus Panel Forecast for 2006, with detail shown for Global Insight, Economy.com and Reed Business Information. Source: American Institute of Architects.

* Global Insight, Economy.com, Reed Business Information, McGraw-Hill Construction, FMI, Portland Cement Association, Economy.com.

Nonresidential Construction (Individual Forecasts): Commerce, FMI and the Portland Cement Association, shown in detail in Table 5, are all forecasting that nonresidential put-in-place construction will increase in 2006. Commerce has forecasted a 5.9% rate of growth in 2006—slightly less than the 6.1% growth rate in 2005, which would mean the party has begun slowing down as soon as it got started. The highest rates of growth are forecasted in the conservation and development (e.g., flood control—mostly due to the Katrina-related rebuilding effort) (15.1%), highway and street (12.1%), manufacturing (10.2%), healthcare (8.2%) and commercial (5.9%) markets, the latter three potentially having significant implications for lighting. Patrick MacAuley, the construction economist who developed the Commerce forecast, believes private nonresidential construction is in position for a long, sustained upswing. Regarding manufacturing, he says the long decline in construction has bottomed out and that industry has begun to reinvest to maintain its base.

Table 7. Summary of 2006 construction industry forecasts by the U.S. Department of Commerce, FMI and the Portland Cement Association.

FMI and PCA are more optimistic in their forecasts for nonresidential construction. FMI has forecasted a 7.7% rate of growth in 2006, with the highest rates of growth forecasted in the power (12.2%), manufacturing (10.2%), office (10%), lodging (9.9%) and commercial (8.9%) markets. PCA has forecasted a bullish 10.4% rate of growth for nonresidential construction in 2006, with the highest rates of growth forecasted in the manufacturing (28.2%), hotel and motel (12.4%), office (12.3%), public buildings (6.3%) and education (5.7%) markets.

McGraw-Hill Construction (MHC)’s forecast looks at value of project starts rather than the value of put-in-place construction. The company is forecasting about $654 billion in total project starts in 2006, up from about $636 billion in 2005, or a 2.8% increase. MHC has forecasted the value of nonresidential project starts to increase by 8% to about $182 billion. This is a strong indicator that the comeback in nonresidential construction is beginning to gain substance. Hotel and motel construction, which enjoyed a 17.4% increase in the value of project starts between 2004 and 2005, is forecasted to increase by 17.6% in 2006. Office buildings are also expected to experience significant gains after significant declines in recent years, with more than $21 billion in new project starts forecasted for 2006, or a 12.4% increase. Other significant forecasted gains: “other commercial” (11%), educational buildings (9.4%), manufacturing (8.5%).

“At the moment, private nonresidential construction in 2006 looks better than the 5% year-to-date growth in 2005,” says Simonson. He points to healthcare and lodging as two categories that grew strongly late in 2004 but have faded in recent months and should do better in 2006. While the retail sector will see selective growth again, the office construction market has not resumed steady growth and it will be late in 2006 at best before office construction picks up in a big way, Simonson adds.

“Although still performing below previous expectations, the nonresidential construction sector has slowly begun to bolster demand for lighting equipment,” says Lego. “Given the anticipated slowdown in homebuilding, this expected future expansion in commercial and industrial construction activity would likely provide some prospects for growth in lighting equipment demand.”

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