2004 Construction Forecast:  2004 OK, 2005 Better

By Craig DiLouie, Lighting Controls Association

Published February 2004

Many in the construction industry would be surprised to learn that the United States has officially been in period of economy recovery for about two years. In fact, some might say that if they get any more of this recovery they’ll go out of business. But now economists are saying the recovery is about to ramp up and that this will impact nonresidential construction mildly in 2004 and surge in 2005. While put-in-place construction will increase only marginally in 2004, contract awards are predicted to increase dramatically over previous years.

The Economic Picture
“In 1999, nonresidential construction contract awards increased 3.2% after adjusting for inflation, according to McGraw-Hill Construction Dodge,” Kermit Baker, PhD, Hon. AIA, chief economist for the American Institute of Architects (AIA) writes on the AIA web site in December 2003. “The market then began a downturn that continues through 2003; four straight years of declining nonresidential construction levels. Cumulatively, nonresidential construction spending is off an estimated 25% from its peak in 1999.”

He adds, “While that downturn is significant, the story has been even worse in the commercial and industrial sectors. Here, the cumulative decline is likely to be in excess of 37%, and even that understates the full impact, since the commercial and industrial construction downturn began a year earlier.”

The lighting industry has had its fair share of the difficulties resulting from the downturn and anemic recovery. According to the U.S. Census Bureau, total value of shipments of electric lighting fixtures was $6.8 billion, a 9% decrease from the 2000 total value of $7.5 billion. Residential type fixture shipments declined 24%; commercial and institutional type fixtures declined 8%; industrial type fixtures declined 13%; and outdoor lighting equipment declined 2%.

By all accounts, the U.S. economy should be roaring. The Federal government is overspending again with a massive deficit, infusing the economy with hundreds of billions of dollars. The U.S. dollar has weakened by 20% over the past two years, with a further 10% devaluation predicted in 2004-2005, which will further promote exports and protect domestic manufacturing. Enormous tax cuts are putting hundreds of billions of dollars back into the economy via consumer spending, the latest round, passed in May 2003, worth $350 billion. Interest rates are low with the Federal Reserve enacting 13 rate cuts since 2001. Congress has been deregulating many business activities. And consumers have already been carrying the recovery by spending themselves into massive debt. Talk about pulling out all the stops!

The problem, according to some economists, has been that the business community has to improve capital spending and hire workers if the recovery is to be strengthened and sustained. Otherwise, consumer spending, much of it debt-financed, will likely not be able to sustain itself while facing continued job losses. Fortunately, business confidence is improving. According to Edward Sullivan, chief economist for the Portland Cement Association (PCA), business confidence improved fourfold between the end of major hostilities in Iraq and the late fall of 2003. As confidence improves, businesses invest in capital and people, boosting the economy. As people are hired and experience real wage gains, they earn disposable income that they in turn give to businesses for goods and services, who in turn spend more on capital and hiring … Nigel Gault, economist with Global Insight, forecasts a 9.4% increase in total fixed investment by business this year, compared to 2.4% last year.

The good news, therefore, is that this recovery finally appears to be gaining traction, with McGraw-Hill Construction Dodge pegging economic growth in 2003 at a very respectable 2.7% and forecasting a strong 4% in 2004. In fact, 3.5-4% is being predicted as the growth rate for 2004 by a number of economists who now feel optimistic, PCA’s Sullivan among them. Global Insight, an economic analysis, forecasting and financial information company that participated in the AIA Consensus Construction Forecast Panel, is very optimistic, predicting 4.7% growth in the U.S. and 3.7% in the global economy. As the recovery becomes robust, this jobless recovery -- with job losses up to 22 months into the recovery -- may begin to create real job growth. Meanwhile, Sullivan predicted at Reed Construction Data’s 8th Annual North American Construction Forecast that the job market would turn the corner in October 2003, followed by small but sustained new job gains into 2004, in addition to increased wage and capital gains.

Once again, Global Insight is more optimistic. “Most labor market indicators are decidedly upbeat and, despite lower-than-expected job gains in November [2003], payroll employment should increase by 150,000 to 200,000 per month over the next year,” Nariman Behravesh, chief economist for Global Insight predicted on the company’s web site.

Bottom line: The economy is expected to grow next year with a whole spectrum of fiscal and economic stimuli coming together to push the economy into higher gear, including capital spending by businesses.

Construction Outlook
So that’s the good news. As a result, economists have more good news, that nonresidential construction appears ready for a rebound. Residential construction, which has been surging over the past two years, however, will begin to cool.

The bad news is not only that the residential market will cool off (although maintain its current high levels, say experts), but also that the nonresidential construction rebound is predicted to be mild in 2004 and not kick into high gear itself until 2005. The economy and the construction market are predicted to turn the corner in 2004, but not see robust activity until 2005. These predictions concern put-in-place construction.

However, a high level of contract awards may come in 2004. One of the most significant indicators is McGraw-Hill Construction Dodge, which looks at contract awards rather than put-in-place construction. McGraw-Hill Construction Dodge forecasts solid growth of 4% in nonresidential construction contract awards for 2004, based on an assumption of the overall economy growing at about 4%.

Bottom line: The consensus construction forecast seems to be: 2004 okay, 2005 better.

Optimism, Caution and the Crystal Ball
There are so many factors affecting the economy that one gets dizzy looking at the enormity of it. There are also a lot of reasons why the recovery might return to puttering at the same level of 1.9% growth we’ve seen in recent years, or why the recovery might be derailed entirely. But I think we’ll stop there without diving into inflation, interest rates, labor markets, state fiscal crises, Federal Reserve response, consumer debt and the like, along with all the potential gloomy scenarios that make economics the “dismal science.”

What’s more, economic forecasting makes 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 accurate 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 2004.

Residential Construction
We’ll start with the star performer of the construction market in the past few years. Total housing starts increased 17% between 2000 and 2003. Eight percent growth in 2003 almost single-handedly carried the construction market and drove total growth up 1%.

A press release issued by PCA states, “This sector, despite its relative size [25% of overall construction activity], has been raging during the past two years and is responsible for providing essential support to the construction industry and overall economy during the past two years.”

According to the National Association of Home Builders (NAHB), the housing production component of Gross Domestic Product (GDP) -- residential fixed investment -- expanded 10% in 2003. Today, the household sector has about 30% of its assets in homes and Americans hold more than $7 trillion in home equity.

Economists appear to agree that residential construction is going to maintain its historical high levels, at least for the first half of 2004, but cool in terms of growth for the year. As the economic recovery finally gains traction, the Federal government and the private sector will compete for funds, driving up interest rates. Interest rates for fixed-rate mortgages are predicted to increase to 6.2% in 2004 and 6.9% in 2005.

As interest rates increase, so does the cost of buying a new home, cooling demand. NAHB, McGraw-Hill Construction Dodge, U.S. Department of Commerce and FMI all predict that total residential construction will either remain flat or decline slightly in 2004. NAHB also predicts further decline in 2005 and says that nonresidential will most likely become the next growth performer in the construction market.

“We expect the nonresidential business sector to assume a stronger role in the evolving economic expansion,” says David F. Seiders, chief economist for NAHB.
Canada is expected to buck this trend with 2.6% growth forecasted in 2004 and 4.9% in 2005, due to a growing economy, low mortgage rates and migration into the country, according to the Canadian Construction Association and Informetrica.

Multifamily construction may experience a further decline in put-in-place construction but begin to find cause for optimism as interest rates increase and homebuyer affordability decreases. In recent years, low mortgage rates have made homebuying highly competitive and increased apartment vacancy rates to an average of 9.6%. According to PCA, the average monthly mortgage payment was about 200% of the average rent; by the middle of 2003, this had fallen to 125%.

Below are the predictions from major organizations conducting 2004 construction market forecasts:

NAHB Forecast. NAHB forecasts 3.6% decrease in total starts in 2004, with a 3.4% decrease in single-family starts and 4.4% decrease in multifamily starts. Total starts will continue to decline 3.7% in 2005, with a 3.4% decrease in single-family starts and a 5.2% decrease in multifamily starts. Sales of new single-family homes are forecasted to decrease 3.5% in 2004 and 3.4% in 2005.

“Based on our expectations for mortgage rates, house-price performance, household formations and overall economic conditions, we’re very optimistic that demand for new homes and apartments will settle at a slightly lower, but still-robust level in the new year,” says Kent Conine, president of NAHB and a home and apartment builder from Dallas.

“The housing sector will do quite well through 2004 … There will be some fade in home sales and housing starts as interest rates gravitate upward in 2004, but sales for the year are likely to be the second highest on record and total housing starts are likely to be around 1.7 million units -- off only 5% from 2003’s surging pace,” Seiders writes in the association’s Eye on the Economy publication.

In an NAHB press release, he adds that the factors offsetting the higher interest rates are stronger job and income growth, and maintenance of strong demographic foundations, bolstered by robust immigration.

Seiders also sees remodeling as increasing in volume despite the softening of the overall residential market. “Remodeling of existing housing -- primarily improvements to owner-occupied homes -- will also continue to be a major factor in terms of housing-related spending in this economy,” says Seider. “We’re projecting about $182 billion of residential remodeling activity in 2003 and $192 billion in 2004.”

McGraw-Hill Construction Dodge. McGraw-Hill Construction Dodge forecasts a 1% decrease in total residential construction contract awards in 2004, flattening out after a 7.6% increase between 2002 and 2003. Single-family housing contract awards will decline by 2% in 2004, while multifamily construction, a smaller market, will increase by 5.5%.

U.S. Department of Commerce. Commerce forecasts flat growth in the residential construction market in 2004 after 8% growth from 2003 to 2004.

“Homebuilding has been pulling the economy along for the past couple of years, but in 2004, the economy will pull homebuilding a bit,” says Patrick MacAuley, a U.S. Department of Commerce economist.

FMI. FMI, the Raleigh, NC-based management consulting firm, forecasts a nearly 2% decrease in total residential construction in 2004, with a 2.9% decrease in single-family construction put-in-place and 3% decrease in multifamily construction. Home improvement construction alone is expected to increase, by 0.6%.

Nonresidential Construction
Nonresidential construction, which accounts for about 25% of overall construction activity, declined 5.1% between 2002 and 2003, according to the AIA Consensus Construction Forecast Panel, but economists are optimistic for 2004 for certain markets, resulting in forecasts of positive growth for the sector in 2004.

AIA Consensus Construction Forecast Panel. Hosted by the American Institute of Architects (AIA), this Panel included McGraw-Hill Construction Dodge, NAHB, Global Insight, Portland Cement Association, Economy.com and FMI. Nonresidential construction growth is forecasted at 2.9% in 2004 after a 5.1% decrease between 2002 and 2003. There is a small decline forecasted for office construction (-0.7%), education (-0.3%), health care (-1.5%) and religious (-0.2%), while retail/other commercial (4.6%), hotel (4.4%), industrial (11.3%), public safety (2.1%) and amusement/recreation (1.7%) are predicted to achieve solid gains in growth.

“The nonresidential construction sector is finally ready to turn the corner,” writes Kermit Baker of the AIA on the association’s web site. “The AIA Consensus Construction Forecast Panel expects nonresidential construction activity to increase almost 3% in 2004 even after adjusting for inflation, with gains expected in most of the major construction sectors. Leading the upturn will be the harder hit, and more volatile, commercial and industrial sectors.”

McGraw-Hill Construction Dodge. According to McGraw-Hill Construction Dodge, total construction contract awards doubled between 1992 and 2002, from about $250 billion to about $500 billion. In 2004, the market will hit $509 billion.

In the nonresidential area, McGraw-Hill Construction Dodge forecasts solid growth (4%) in terms of contract awards for 2004, based on an assumption of the overall economy growing at about 4%. Office buildings (9.6%), other commercial (15.1%) and other institutional (1.9%) markets will turn the corner after losses in 2003, while hotels and motels (14.6%), shopping and shopping centers (6.9%) and manufacturing (9.1%) are predicted to enjoy another year of solid gains. Educational buildings market growth is forecasted to decrease by 1.9% after gains of 3.1% in 2003. Health care facilities market growth decreases by -1.7% after a decrease of 6.2% in 2003.

U.S. Department of Commerce. Commerce is forecasting virtually flat growth in total construction and nonresidential construction based on a mix of up and down vertical market segments. In Commerce’s view, office (-5.1%), commercial (-5%) and amusement & recreation (-3.2%) will lose ground, while solid gains are forecasted for health care (5%), education (1.9%) and manufacturing (5.2%).

FMI. FMI is forecasting a small 1.2% gain in total nonresidential construction in 2004 in an overall construction market that is basically flat. FMI sees few real losers in 2004 with the exception of education (-3.5%) while predicting solid gains for industrial buildings (1.4%), parking garages (5.8%), public safety, administrative (11.4%), service stations and repair (5.6%), stores and other mercantile (5.8%), military facilities (7.2%) and other vertical markets.

For More Information …

“Robust Construction Activity Unlikely Until 2005” (Portland Cement Association)
http://www.cement.org/newsroom/fallforecast20031218.asp

AIA Construction Consensus Forecast (American Institute of Architects)
http://www.aia.org/ecomark/tw1212/1212kermit_consensus.htm

Top 10 Economic Predictions for 2004 (Global Insight)
http://www.globalinsight.com/Highlight/HighlightDetail720.htm

“Construction Markets Are in Transition as Growth Remains Slow”
(Engineering News-Record)
http://enr.construction.com/features/bizlabor/archives/031117.asp

North American Construction Forecast (Reed Construction Data)
http://www.nacf.com/past_shows/2003/sullivan.html

Canadian Construction Forecast (PDF)
(Canadian Construction Association, Informetrica)
http://www.cca-acc.com/factsheet/stats1102.pdf

“North American Construction Outlook Moderate in 2004,
but Assumption of Growth Expected in 2005” (Reed Construction Data)
http://www.reedconstructiondata.com/press_release/view.cgi?id=257...

“U.S. Office Construction Not Showing Signs of Life, Yet” (Global Insight)
http://www.globalinsight.com/Perspective/PerspectiveDetail519.htm

“Construction Forecast Mixed, Generally Favorable for Long-Term Growth”
(Door & Window Maker)
http://www.usglassmag.com/Door_and_Window_Maker/Backissues/Jan-Feb04/feat8.htm

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