06/2004 Optimism for the 2004 Nonresidential Construction Activity Eases, But 2005 Outlook Favorable
Inflation, construction materials problems, and international concerns slow recovery in commercial/industrial sectors

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

Entering 2004, the AIA Consensus Construction Forecast Panel expected this year to be the first year of growth in nonresidential construction activity since 2000. Total nonresidential activity was projected to increase by almost 3 percent, paced by a strong upturn in industrial building, modest growth in commercial construction, and small gains in the institutional sector.

However, entering 2004, our forecast panel couldn’t have been expected to anticipate fully the negative effect of rising international tensions on business confidence, the drag of rising oil prices on the broader economy, or the disruptions that rising costs and availability problems that construction material commodities would have on the nonresidential sector.

The net effect is that our forecast panel has scaled back their projected growth in nonresidential construction for 2004. At present, this panel expects a 1-percent decline in nonresidential construction activity this year, with a comparable performance across the major sectors. However, the panel is almost uniformly upbeat about the prospects for 2005.

The consensus forecast for 2005 is for more than 6 percent growth in overall nonresidential activity. Commercial construction is expected to increase by just under 6 percent, the battered industrial sector by almost 25 percent, and institutional building by just over 2 percent. The outlook for the commercial-building sector ranges from a slight decline to growth of almost 10 percent. Each of the major commercial sectors is expected to grow by at least 5 percent, with the consensus for hotel construction approaching 10 percent.

Industrial construction is the sector where our panelists see the most upside for 2005. Projected gains from our panel are typically in double-digits as the manufacturing sector of our economy recovers and exports grow. However, these strong gains, even if realized, would not nearly make up for the double-digit losses this sector has seen on average over the past five years.

The institutional sector is expected to see modest improvement in 2005. All of the major sectors are expected to see gains. Education, the largest component, is projected to grow by 5 percent, while health care, the second largest piece of the total, is projected to see 2-3 percent gains.

AIA Consensus Construction Forecast Panel—
Second Half, 2004

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The economy supports more improvement in construction
Although the turnaround in nonresidential construction has been gradual, a recent strengthening in the broader economy has given it a boost. Government estimates of gross domestic product have been very encouraging since mid-2003. The economy grew by almost 4.5 percent at an annual rate in the first quarter of 2004, and the economic-growth outlook for the year is in the 4.5 percent to 5.0 percent range.

An improving economy has encouraged businesses to reinvest. Business fixed investment increased on an inflation-adjusted basis by more than 9 percent between the first quarter of 2003 and the first quarter of 2004. Businesses have been able to make these investments because after-tax corporate profits increased by almost 15 percent over this same period.

As businesses have reinvested, they also have been adding payroll positions. Business payrolls have increased every month since last August, to the tune of almost 1.5 million net new jobs over this period.

In addition to general improvement in the overall economy, a healthy housing industry holds encouraging signs for the nonresidential sector. Housing starts totaled 1.85 million in 2003, the best year for housing since 1978. Most analysts feel that 2004 will produce a comparable level of housing activity. Over time, occupants of these new homes generate new demand for commercial as well as institutional facilities.

Regional construction trends mixed
Virtually every region of the country has felt the positive national economic trends. A recent report by the Federal Reserve Board concluded that manufacturing and service-based improvements have been broadly based across the major regions.

However, this same report indicates that commercial construction activity has been mixed, although generally quite weak. Federal Reserve banks serving the Boston, St. Louis, and Chicago districts report continued high vacancy rates, slow leasing activity, and flat rents. Federal regional banks in Dallas, Atlanta, Kansas City, Minneapolis, Cleveland, and Philadelphia report stable to improving conditions in commercial real-estate markets. The Richmond Federal Reserve Bank reported strong commercial real-estate activity, particularly for Washington, D.C.

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