01/2005 Nonresidential Construction Poised for Solid Gains in 2005
Worldwide uncertainties notwithstanding, panel predicts strongest construction growth in nearly a decade

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

The bad news for the nonresidential construction sector is that the industry apparently didn’t emerge from its five-year recession in 2004. Although the decline in construction activity is estimated at just 0.6 percent for 2004, nonresidential construction has declined by more than 25 percent since 1999, with most of the shortfall coming in the commercial/industrial categories.

The good news is that the improved numbers we have seen in recent months will almost certainly translate into solid gains in 2005. The AIA Consensus Construction Forecast Panel is projecting a 5.5 percent increase in nonresidential construction activity (after inflation adjustments) in 2005, with gains of close to 6 percent in commercial buildings, almost 14 percent in industrial facilities, and more than 2.5 percent for institutional buildings.

This impending upturn was anticipated by the trends over the past year in the AIA’s Work-on-the-Boards’ Architectural Billings Index. U.S. architecture firms reported a sharp upturn in billings through the first six months of 2004. Given an estimated design phase averaging about nine months for nonresidential projects, we would have expected an upturn in nonresidential construction activity during the fourth quarter of this year and extending into 2005.

AIA Consensus Construction Forecast Panel—
First Half, 2005

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National economy recovers
The upturn in nonresidential construction has been built on solid fundamentals in the broader economy. Economic growth, which was disappointing through the middle of 2003, is seeing marked improvement. After a lackluster 3.0 percent growth in our economy in 2003 (inflation adjusted), 2004 growth is estimated to have been around 4.5 percent, which would make it one of the best performances for our economy over the past decade. Economic growth this year is expected to slow a bit, to around 3.5 percent.

The general improvement in the economy has generated new demand for nonresidential facilities. First, businesses are reinvesting in their operations. While the economy has been growing by 4–5 percent in recent quarters, business investment has been increasing by 10–15 percent. With stock prices rising, businesses have been more willing to invest in their operations. Also, a rising stock market boosts the endowments of nonprofit institutions, encouraging them to expand their operations.

Secondly, business payrolls have begun to see stronger gains. Payrolls declined nationally by over 2.5 million between the end of 2000 and the middle of 2003. However, most of these losses have been recouped since then, as businesses have added more than 2 million payroll positions since mid-2003.

These positive economic trends have generated growing confidence among leaders in the construction industry. The 2005 CIT Construction Industry Forecast found that construction industry leaders are predicting a strong year ahead as their confidence rose to the highest-ever rating since the survey was developed in 1995.

Concerns remain on the economic outlook
Still, 2005 is shaping up as a year that will have its share of economic challenges, several of which will affect the nonresidential construction sector. Soaring prices, often coupled with availability problems, that hit several construction commodities in 2004 (e.g., steel, concrete, lumber, and wallboard) are likely to continue to linger into 2005. Coupled with high oil prices, we’re likely to see continued inflation in construction costs this coming year. Higher inflation is likely to drive up interest rates, which also will add to construction costs.

Inflation is likely to be particularly high for imported construction products. A falling dollar—mostly as a result of our large trade deficit—makes U.S. products less expensive abroad, but foreign products more expensive in U.S. markets. The decline in the dollar has averaged about 10 percent per year over the past two years relative to the currencies of our major trading partners and is likely to decline a comparable amount in 2005.

International economic slowdown likely
The U.S. economy is not the only one that is expected to see somewhat slower growth in 2005. According to the International Monetary Fund, world economic growth averaged about 5 percent in 2004 and will slow to just over 4 percent in 2005. Economic growth in Japan is expected to slow from 4.4 percent to 2.3 percent, remain flat in the Euro area at 2.2 percent, fall in China from 9.0 percent to 7.5 percent, fall in Russia from 7.3 percent to 6.6 percent, and rise slightly in India from 6.4 percent to 6.7 percent.

All of these estimates predate the earthquake and ensuing tsunami damage in the Indian Ocean region. While it is much too early to factor in the impact of this destruction on world economies, it certainly will mean more construction activity in the affected areas, as rebuilding efforts get under way, and more pressure on international capacity to produce and distribute construction products.

Commercial/industrial sector leads nonresidential rebound
Our consensus construction panel is most optimistic on its commercial/industrial outlook for 2005. Construction of commercial facilities increased less than 2 percent in 2004, and industrial construction declined by 4 percent, according to our panel. Both sectors are expected to see a much stronger performance this coming year. Hotel construction is projected to be the strongest commercial market in 2005, as all members of our forecast panel predict solid gains in this sector.

With declining office vacancy rates nationally, according to reports from CB Richard Ellis, office construction is also expected to see healthy gains. As of the third quarter of 2004, the national office vacancy rate was 16.3 percent, down a half point from a year earlier. Vacancy rates in downtown locations were down to 14.4 percent nationally, with several major markets (midtown Manhattan; Washington, D.C.; San Diego; Orlando; and Charlotte) reporting downtown vacancy rates below 10 percent.

The institutional construction sectors, which didn’t fall off as much as commercial/industrial buildings earlier this decade, are expected to see more modest growth in 2005. Construction of education facilities, in the midst of a three-year drop-off, is projected to recover nicely in 2005. Health-care facilities, which haven’t seen much in the way of gains over the past two years, likewise are projected to see stronger growth this coming year.

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