Construction Expands, Project Mix Changes

By Jim Haughey, Director of Economics | September 28, 2010


Gross Domestic Product
GDP growth will begin 2006 at more than a 4-percent annual pace, but it will quickly slip to nearly 3 percent by the end of the year. It may dip even lower in 2007. The four-year economic expansion will be tiring under pressure from rising inflation and credit rates. Business investment and exports become the key drivers of economic growth, replacing housing investment and consumer spending on durable goods. The hurricane-related disruption of normal activity and later rebuilding has no net impact on growth. Yet, the loss of energy supplies due to the hurricanes does shift some spending from late 2005 to early 2006. The economy and construction spending remain unusually vulnerable to energy-supply disruptions for the next few years.
Business Investment
Spending will continue growing at about a 10-percent annual pace in 2006. Principal growth drivers will be nonresidential construction as well as energy and transportation facilities. Manufacturing capacity utilization begins 2006 at about 80 percent, the usual threshold for a surge in capacity-expansion investment.
Interest Rates
Thirty-year fixed mortgage rates rise to an annual average of more than 6.2 percent. Short-term interest rates increase from 4 to 5 percent over the year. Credit costs are being held down by the influx of foreign capital. Contractors will find credit-approval standards slightly easier in 2006 due to a brighter construction-spending outlook, but financially marginal homebuyers will face tougher approval standards with variable-rate mortgage rates noticeably higher.
Housing Starts
Housing starts peaked early in 2005 and remained near the record level until late in the year. But homebuilders did not cut starts fast enough, so 2006 begins with a small surplus of new homes available for sale. Starts will decline from more than 2 million late in 2005 to 1.85 million by the end of 2006. The major depressants in the market are the surplus inventory, lowered expectations for home-price appreciation, slightly higher mortgage rates, and slightly tighter credit-approval standards. Starts may not decline in the Northeast, Florida and California.
Total Spending for 2006
The residential share of total construction spending remains above the long-term average in 2006 although it will be declining over the course of the year. Expect the residential share to decline from 56 percent in 2005 to 54 percent in 2006.


Real construction spending after inflation will grow about 3 percent in 2006, slightly slower than the overall economy for the second year in a row. Including inflation, spending will increase 6 percent in 2006 after an estimated 8.4-percent gain in 2005. As new-residential construction slows this year, growth shifts as nonresidential and heavy enter into a multi-year expansion.

Construction inflation will be lower this year with only cement and concrete product prices certain to rise substantially. High materials prices were a serious problem for contractors last year. The abrupt price increases between the planning and construction phases changed project finances enough to cause the delay or cancellation of some tax- and bond-funded projects as well as private projects built to be leased. Yet the timing of the price increases — a big burst early in 2004 during the world commodity shortage and a smaller burst late in 2005 after the hurricanes — means that 2006 began with the materials price index only about 3 percent above a year earlier compared to more than 12 percent at the beginning of 2005.

Materials prices are now perceived to be high, but there is no domestic or worldwide inflation driver that will cause another period of accelerated inflation. Energy-based prices will be declining slightly in 2006, although they remain very high. Plastics prices may be an exception, because the price of the natural gas feedstock for petrochemicals jumped 50 percent when one-third of the natural gas production in the Gulf of Mexico remained shut for two months after Hurricane Katrina. The adequacy of natural-gas supplies is precarious. A cold winter will quickly boost the already high prices of all plastics construction products.

Construction spending is forecast to strengthen over the course of the year and into 2007 because most of the expected decline in new-home construction spending will occur late in 2005 or early in 2006. The forecast rise in nonresidential and heavy construction spending will continue into at least 2008 as work continues on new projects started in 2006–07.

The strongest regional economies in 2006 will again be the Atlantic and Pacific states with the interior states lagging. The fastest-growth job and construction markets will be in the northeast from Norfolk to Boston, especially in Washington; south Florida; and southern California, spilling into Nevada and Arizona.

Houston and Baton Rouge have a substantial boost from the influx of New Orleans evacuees. But the rebuilding of public and commercial facilities and homes in the New Orleans area will be slow and much less complete than the rebuilding of private energy and transportation facilities.

The favorable economic environment for construction continues through 2006. Growth in 2005 gross domestic product will be about 3.5 percent. Growth will be more than 4 percent early in 2006 as spending rebounds from the impact of the hurricanes. But it will slip to nearly 3