Broader economy slowing
The prospects for nonresidential construction activity growing at the pace predicted by the AIA panel depend largely on the national economy avoiding a significant slowdown. There are a few vulnerabilities developing in the economic outlook, as our gross domestic product grew more slowly in the second half of 2006 than it did in the first.
At the top of the list of weaknesses is the homebuilding market. New housing starts declined 13 percent in 2006, and are expected to drop as much again this year. A weaker housing market not only directly cuts into our economic output, but indirectly affects consumer spending activity. Rising house prices increased the level of equity homeowners’ held in their homes, and many owners tapped into this equity to support other household spending activity, such as home improvements, college tuition payments for their children, automobile purchases, and so forth. As house price gains continue to moderate—and even fall in some markets—owners will have less equity to withdraw and will be more hesitant to extract what they have built up over the years.
A weaker housing market not only directly cuts into our economic output, but indirectly affects consumer spending activity.
Other sources of concern with the economic outlook include a weakening U.S. dollar, continuing high oil prices, and emerging weakness in the manufacturing sector. The dollar has fallen relative to the currencies of our major trading partners for the past two years, and this weakness is expected to accelerate this year. While a falling dollar may help boost U.S. exports, it also increases the prices of imports, which means higher inflation for foreign products. Oil prices have stabilized and even eased off a bit, but they remain well above levels we saw earlier this decade, and are unlikely to fall back to these levels anytime soon. The manufacturing sector of our economy, which traditionally has supported higher wages than for comparable service-sector jobs, has recently shown signs of weakness. The Institute of Supply Management Manufacturing Survey, which surveys purchasing managers at major manufacturing companies, has been reporting much slower growth for the past two quarters. A downturn in manufacturing would severely weaken overall economic growth.
Despite these vulnerabilities in the economic outlook, the consensus is that our economy will grow in the 2.0 percent to 2.5 percent range in 2007. Although below the pace of growth of the past few years, that level indicates a reasonably healthy economy that can support a vibrant nonresidential construction market. Trends that point to continued growth in the economy include strong profits encouraging growing levels of business investment, stable levels of inflation—particularly in construction materials—that allow interest rates to remain stable, and improvement in consumer confidence levels.
Despite these vulnerabilities in the economic outlook, the consensus is that our economy will grow in the 2.0 percent to 2.5 percent range in 2007.
Rising stock market prices over the past year indicate that U.S. businesses are basically healthy. This in turn has encouraged increased levels of investment in their operations. Business investment increased 7.5 percent last year on top of 6.8 percent in 2005, and most projections are for another 5 percent or so increase this year, producing a healthy climate for nonresidential construction.
As the economy has begun to slow in recent quarters, inflation has begun to ease. Oil prices have been moderating, and construction materials used in nonresidential buildings have increased only 4.1 percent over the past year, according to U.S. Department of Labor figures, even declining 0.6 percent during the fourth quarter of 2006. Prices for some materials remain much higher than a year ago (e.g., asphalt, copper, steel, aluminum, and cement) but even these materials have seen a significant moderation in prices over the past quarter. If inflation in the broader economy remains under control, and the economy stays in a slow-growth mode, there is room for the Federal Reserve Board to cut short-term interest rates.
A final positive for the economic outlook is improving consumer confidence. Both the University of Michigan and Conference Board measures of consumer confidence have improved recently and are above the average for 2006 as a whole. Rising consumer confidence scores generally indicate that consumers are willing to make consumption and investment actions necessary to keep the economy growing.
Healthy construction outlook
Commercial and industrial facilities—offices, retail space,
hotels/motels, and manufacturing and distribution space—tend
to be the strongest nonresidential sectors when the economy is expanding,
and 2007 looks to be no exception. Our AIA Forecast Panel expects
commercial construction to increase 6.5 percent this year, including
9.0 percent for office space and 13.1 percent for hotel facilities.
National office vacancy rates continue to show improvement, declining
from 13.9 percent in the fourth quarter of 2005 to 12.6 percent in
the fourth quarter of 2006, according to the CB Richard Ellis National
Office Vacancy Index. Only 13 of the 51 metro markets tracked in
their surveys failed to see a decline in office vacancy rates over
the past year, and many saw significant declines. While vacancy rates
below 12 percent generally can support new speculative construction
activity, 11 markets currently have rates below 10 percent, topped
by Manhattan (5.7 percent), Orlando (7.0 percent), and Ft. Lauderdale
Our AIA Forecast Panel expects commercial construction to increase 6.5 percent this year, including 9.0 percent for office space and 13.1 percent for hotel facilities.
The health-care market looks to be the strongest institutional category
in 2007, with gains of 6.8 percent projected on top of 8.0 percent
in 2006. Education construction, the other big institutional category,
is expected to increase a solid 4.2 percent after inflation adjustments.
Together, health care and education account for about 60 percent
of institutional construction activity. The upturn in health-care
construction is resulting from increased profitability, in part due
to consolidation, which has allowed greater efficiency of operations
and often less competition. Additionally, Medicare reform has improved
the financial position of many hospitals. And, given the aging of
our population, with the record wealth of today’s retiring
population, health care looks to be a growth market for years to