Lodging, Hospitals Fuel Nonres Growth

By Jim Haughey, Director of Economics, Reed Business Information | September 28, 2010


Illustration - Total Spending for 2007
The residential share of total construction spending will drop to 50 percent in 2007 from an unusually high peak share of 57 percent in 2005. It will remain near 50 percent for several years.
Illustration - Gross Domestic Product
Growth slipped to a 2.5-percent annual pace during the last three quarters of 2006 as soaring oil and other commodity prices forced a cut in consumer spending, and as business investment and new-home construction fell abruptly. Economic growth will recover to a 3-percent pace this year. Exports will continue to expand faster than the domestic economy. The strongest domestic sectors will be business equipment, nonresidential construction, and business services.
Illustration - Business Investment
Spending will expand 3.5 percent in 2007, slightly less than in 2006, and less than half of the peak growth in 2004-05. The usual growth slowdown at the mature end of an economic expansion is being aggravated by a cutback in vehicle purchases due to high fuel prices. Slower growth in private spending is also being partially offset by a strong upturn in public building and facility investment after three years of above-average in-creases in state and local government tax receipts.
Illustration - Interest Rates
Credit will remain cheap and provide a boost to investment and GDP growth. Fixed mortgage rates rose about 60 basis points during 2006 and will stay near the current 6.5-percent level through 2007. Rates for construction and equipment loans will be steady to slightly higher in 2007. The continuing net inflow of foreign capital into the United States and ebbing inflation ensure no risk to economic growth from credit rate increases. The next Federal Reserve Board credit move will be to cut interest rates, probably next spring. Nonetheless, the credit environment for first-time home buyers will continue to worsen as lenders tighten credit-approval standards and pull back from mortgages with deeply discounted initial rates.
Illustration - Housing Starts
Starts dropped abruptly early in 2006 as speculators despaired of quick capital gains and left the market, and as mortgage lenders tightened credit standards for marginally qualified buyers. Monthly housing starts will be volatile as homebuilders work off a large surplus of available new, existing, and sold but unoccupied houses. Starts will average around 1.7 million through 2007. The multifamily market has and will continue to hold up better than single-family because apartment construction is now increasing to replace fewer condos and single-family starts. The housing slow-down is heavily concentrated in the Southwest and Southeast, where over-building occurred in 2004-05, and in the Midwest where the regional economy is much weaker than the rest of the country.


Nonresidential construction's expansion will offset the gradual downturn on the residential side, allowing overall spending in 2007 to match the growth registered in 2006. Total spending will grow 5.2 percent this year, after growing 5.3 percent in 2006.

Nonresidential construction spending will expand 12 percent this year and will continue expanding into 2008. Yet the 0.4-percent decline forecast in residential spending limits total construction spending to $1.27 trillion.

This growth number is only useful for gauging the demand/supply balance for labor and materials used in all construction markets, such as credit, equipment rental or ready-mix. The price and availability of resources specific to the housing market (lumber, plywood, gypsum, framing crews and plumbing fixtures) adjusted to the smaller, no-growth, market last spring. Pricing weakened with some significant declines, hiring turned to layoffs, wage rate growth stalled, and contractors' margins shrank. These market conditions will generally prevail through 2007 with the weakest period likely early in the year.

Business conditions are markedly different in the nonresidential-building and heavy-construction markets, which will again expand at a double-digit pace in 2007. Everything is reversed. Pricing is firming for materials specific to these markets, such as asphalt, aggregates and structural steel. Labor availability is worsening, and wage gains are accelerating. Contractor margins are improving as are those of their suppliers. These business conditions will prevail well into 2008.

The housing market hit the sustainable maximum size of around 1.95 million late in 2004. The subsequent growth to 2.27 million in January 2006 was caused by excess demand from speculative buyers and by households that were enticed out of apartments and manufactured housing by temporarily discounted monthly house payments. The market collapsed below the sustainable level when these sources of demand disappeared. Housing starts will stay below the sustainable level until the surplus inventory is absorbed. There is no fundamental problem with housing demand; homebuilders and mortgage brokers simply borrowed some demand from 2007–08 and advanced it to 2004–05.

The ongoing multiyear boom in nonresidential construction is largely the usual strong market at the tail end of an economic expansion. The current expansion has the potential to persist well beyond 2008 if it matches the strength of commercial, institutional and civil building booms in previous building cycles.

The key drivers for the nonresidential boom are cheap credit; immigration, which doubles population growth; above-average consumer and business confidence, which gives the courage to turn cash into spending; the improvement of state and local government budget balances to above-average status; and rising space and facility capacity needs in a growing economy. These drivers should remain strong. Indeed, they have all strengthened in the past few months after a brief weakening at midyear when we were unsure how high gasoline prices would go.

The hotel market was the fastest-growing project type in 2006 with spending expanding 48.7 percent. Growth will be halved to 24.8 percent in 2007, but hotels remain the fastest-growing project type in 2007. Hotel revenues jumped 7 percent in the first nine months of 2006 compared to the same period in 2005. That boosts net income substantially in this highly leveraged business. The value of hotel starts, according to Reed Construction Data, increased 94 percent in the same period ensuring strong growth in spending beyond 2007.

Factory construction spending increased 22.9 percent in 2006, fueled by an earlier surge in starts. But factory starts have been halved in the first nine months of 2006, so jobsite spending will only rise 7.8 percent in 2007.

Highway construction spending jumped 16.8 percent in 2006, although as much as half of this gain was inflation. This followed a 73-percent rise in the value of highway starts in 2005 when the federal highway program was renewed and state tax revenue soared. Highway spending will increase only 5.8 percent in 2007 as the 2005 starts surge is built out.

Regionally, new project starts are expected to be strongest in the Northern Plains, Rocky Mountains and Gulf States. The weakest is in the Mid-Atlantic (outmigration), South Atlantic (hurricane-driven construction and property-tax increase), and especially, the Pacific (migration out of California to cheaper nearby areas) states. Nationally, the value of construction starts will grow more slowly in 2007, except in three regions. Starts will increase more quickly in the Mid-Atlantic where the dominant business and financial services industries always recover late in an economic expansion. Similarly, starts growth will be faster in the South Atlantic due to the delayed post-hurricane recovery. The small 2007 improvement in the Pacific region is largely due to more public spending in California.

2007 Construction Spending Outlook Spending to Grow 5.2%
  $ Bil. Annual % Change    
  2007 2005 2006 2007
Source: U.S. Commerce Department
Forecasts: Reed Research Group
Total spending will rise 5.2 percent in 2007. This is about the same as in 2006, but real growth will be higher because project-cost inflation will be slightly lower in 2007. Spending declined in the middle of 2006 as housing starts fell and nonresidential projects were slowed or postponed when costs exceeded budgets. This brief slowdown will be over by year end. The market mix changes significantly. New residential construction declines 0.4 percent, and the rest of the construction market expands 10 percent. This is fast enough growth to keep materials-cost inflation above overall inflation in the economy and marginally worsen the cost and availability of skilled construction labor for nonresidential contractors.
Total Construction Spending $1,265.9 10.7 5.3 5.2
Residential, new $465.0 15.3 -0.8 -0.4
Residential improvements $171.3 -2.1 8.4 8.2
Nonresidential $405.1 7.8 13.4 12.6
Nonbuilding $224.6 5.1 14.7 11.6

Heavy Construction Trends & Outlook
  $ Bil. Annual % Change    
  2007 2005 2006 2007
Source: U.S. Commerce Department
Forecasts: Reed Research Group
Spending will increase 11.6 percent in 2007, but more than half of the gain will be due to higher materials cost, especially cement, asphalt and steel. The second consecutive year of rapid growth is the continued build out of the 35-percent surge in the value of project starts in 2005.
Total Heavy Construction $224.6 5.1% 14.7% 11.6%
Highways & Streets $83.3 8.6% 16.8% 8.8%
Power $47.0 -1.3% 12.1% 13.7%
Transportation $35.0 2.1% 12.6% 16.3%
Communication $17.2 8.6% 14.6% 11.0%
Water & Sewer $36.1 6.7% 15.8% 12.3%
Conservation & Development $6.0 10.1% 10.5% 8.0%

Nonresidential Construction Trends & Outlook
  $ Bil. Annual % Change    
  2007 2005 2006 2007
Source: U.S. Commerce Department
Forecasts: Reed Research Group
Spending will increase 12.6 percent in 2007 following the 12-percent rise in the value of new project starts in 2006. The 2007 spending gain will be almost the same as in 2006 and the second consecutive year of market expansion faster than economic growth.
Total Nonresidential $405.1 7.8% 13.4% 12.6%
Education $91.9 5.7% 6.2% 10.2%
Commercial $89.7 7.6% 10.1% 10.4%
Office $61.8 7.6% 12.4% 14.9%
Health Care $49.5 7.7% 14.1% 17.7%
Amusement& Recreation $25.4 -1.5% 21.0% 13.3%
Manufacturing $41.1 30.6% 22.9% 7.8%
Lodging $24.3 4.6% 48.7% 24.8%
Public Safety $12.5 10.9% 9.6% 14.2%
Religious $9.0 5.9% 9.0% 12.5%