12/2003 Finally, Some Improvement in Nonresidential Construction Projected for 2004
AIA Consensus Construction Forecast Panel points to commercial/industrial sectors to lead reversal of four-year nonresidential downturn

by Kermit Baker, PhD, Hon. AIA,
Chief Economist

In 1999, nonresidential construction contract awards increased 3.2 percent after adjusting for inflation, according to McGraw-Hill Construction. The market then began a downturn that continues through 2003; four straight years of declining nonresidential construction levels. Cumulatively, nonresidential construction activity is off an estimated 25 percent from its peak in 1999.

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 percent, and even that understates the full impact, since the commercial and industrial construction downturn began a year earlier.

And even the normally stable institutional sectors have not been spared from the fallout of this downturn. From 1999 through the end of this year, construction contract awards for institutional buildings will have fallen an estimated 11.6 percent, with the bulk of the weakness coming in 2002 and 2003.

The nonresidential construction sector is finally ready to turn the corner. The AIA Consensus Construction Forecast Panel expects nonresidential construction activity to increase almost 3 percent 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.

Broader economy providing the tailwind for construction
It’s not a coincidence that the revival of the nonresidential construction sector is coinciding with a strengthening in the broader economy. The overall economy, as measured by Gross Domestic Product (GDP), is expected to grow by at least 3 percent this year, with the second half of the year much stronger than the first. Much of the strength in the second half is due to the $350 billion tax cut package passed by Congress in late May.

Even though the economy has been slowly improving, U.S. businesses had been hesitant to add new employees to their payrolls. There was a net decline of almost 1.5 million payroll jobs in 2002, and additional declines of about 350,000 jobs during the first half of 2003. However, beginning in the second half of the year, employers have been willing to fill positions, as almost 300,000 jobs on net were added through November 2003. Job growth helped lower the national unemployment rate to 5.9 percent in November, down from its high of 6.4 percent in June of 2003.

One important factor encouraging businesses to add more payroll positions was the return to profitability. Corporate profits before taxes dropped in 2001 and slipped a bit more in 2002. This past year has been much better from a profitability perspective, with the third quarter showing the strongest gain in business profits percentage-wise in more than a decade.

AIA Consensus Construction Forecast Panel—
First Half, 2004

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# excludes hotels
° private construction only
ˆ includes health,
education, religious only
' includes hospitals and nursing homes only
¨ includes stores and other mercantile buildings only
* includes manufacturing, utility buildings, and warehouses


Commercial/industrial construction outlook almost uniformly upbeat
Since commercial and industrial facilities led the nonresidential downturn at the beginning of the decade, it’s probably not surprising that these sectors are projected to lead the upturn. Our consensus forecast panel is projecting a 2.5 percent increase in commercial construction activity in 2004 and a very healthy 11.3 percent increase in industrial construction.

The office construction market is the one commercial market that our forecast panel feels is still in transition. After declining by double-digit rates in 2003, the outlook for next year is mixed. The consensus is for stable rates of construction, or possibly off just a bit, in 2004.

Offices have been the most volatile commercial construction sector in recent years. Office construction declined by more than 50 percent from its high earlier this decade. However, due to the “dot.com” craze that peaked in 2000/2001, the office sector was also the most overextended. During this period, companies were leasing space not only to accommodate their rapid growth rates, but also in anticipation of future growth. When the technology market crashed, a lot of office space went back in the lease market.

National office vacancy rates hit a low for this cycle of 7 percent to 8 percent in late 2000, and since then have climbed to over 14 percent in downtown locations and over 18 percent in the suburbs, according to CB Richard Ellis. The lowest vacancy rates are now in the Northeast and in California markets outside the Bay Area. The highest office vacancy rates are in heartland markets, reflecting the downturn in manufacturing and transportation.

After a modest decline in 2003, the consensus forecast is for a rather healthy rebound in retail and other commercial construction in 2004. All of the forecast panelists are expecting gains in this sector.

The reason for the optimism is that retail construction has held up remarkably well during this past construction cycle. Retail sales have managed to increase every year during this past economic cycle, so there has continued to be pressure on retail space. This helped to avoid the development of an overhang in retail space that would need to be worked off once the economy improved.

While strength in the retail construction market will help generate a rebound in the construction industry, it may not hold as many opportunities for architects. The strongest growth in retail activity has been in the discount category; a category dominated by large chains where store formats exhibit minimal variation and, therefore, where design input often is limited. On the foodservice side of the market, much of the growth has been in fast-food chains, again a sector where design involvement often is minimal.

The hotel and industrial building sectors are projected for strong gains next year. The consensus forecast is for 4.4 percent growth in hotel/motel construction and 11.3 percent for the industrial category. In both cases, however, these gains reflect only a small portion of the losses from the pre-recession highs.

Institutional market still recovering
Though the broader economy is beginning to recover, governments are still feeling the pinch from declining revenues. Traditionally, it takes a while for a weakening economy to be felt in government budgets. Likewise, it takes a while for a strengthening economy to produce increases in government revenue. While the federal government can deficit spend, many state and local governments must maintain a balanced budget.

Furthermore, while the stock market has made impressive gains since earlier this year, it is still well below the levels of early-to-mid 2001. Institutions that rely on endowments to finance their construction activity still may be hesitant to launch into new building projects.

The net result is that many of the institutional building categories are still a bit sluggish at present. The consensus forecast is for essentially flat levels of spending in the institutional category for 2004, with our forecast panel in a relatively narrow range of projected small declines to small gains for the category overall.

Our forecast panel projects a modest decline of 1.5 percent in health-care construction in 2004. The health-care construction market has dipped a bit in recent years, mostly in response to private market forces like cost management, consolidation, and other efforts to boost profitability. There continues to be a shift away from large regional hospital complexes toward clinics, managed-care facilities, and assisted-care facilities. However, the aging of the population (seniors are the group spending the most on health care) will keep this market strong in the years ahead.

Our forecast panel is projecting flat levels of education construction activity in 2004, although forecast panelists who track only private construction activity are more upbeat about the prospects for this sector for 2004. Although demographics remain very favorable for the education sector, particularly at the college level, state and local government budget problems have slowed spending in recent years.

The consensus forecast for religious facilities is essentially flat for 2004, with small gains projected in the public-safety (police/fire, detention facilities, courthouses) and amusement and recreation categories. Religious-facility construction has been hampered along with most nonprofit categories with the downturn in charitable giving.

Public-safety construction, relying on public funding, has slowed with government budget problems. However, some targeted federal spending programs should provide modest growth in this category. Amusement and recreation construction spending generally tracks the economy, so a stronger economy will help this sector.

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