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Pacific Northwest Construction Forecast Remains Rosy for 2007

Analysts in some parts of the country may be looking at recent softness in their local real estate markets and worrying that a slowdown in construction is near at hand, but that's not the case in the Pacific Northwest. With property values continuing to climb, local economies holding steady and a strong 2006 construction year in the books, 2007 looks like more of the same for nonresidential con...

January 01, 2007

Analysts in some parts of the country may be looking at recent softness in their local real estate markets and worrying that a slowdown in construction is near at hand, but that's not the case in the Pacific Northwest. With property values continuing to climb, local economies holding steady and a strong 2006 construction year in the books, 2007 looks like more of the same for nonresidential contractors throughout the region.

One measure of heavy construction activity in the Pacific Northwest, the monthly Contract Awards Summary compiled by this magazine, reported that the year-to-date volume of publicly reported nonresidential construction contract awards through November 2006 was running 15-percent ahead of 2005's record-setting pace. Reed Construction Data, the source of the figures accompanying this article, also found growth in the Pacific Northwest heavy construction market during 2006, though at a lower rate. For 2007, Reed is projecting that the dollar volume of nonresidential construction awards will grow at a vigorous 14 percent, led by Buildings and Roads/Highways construction.

Of course, dollar value doesn't tell the whole story. The real question is how much work will be available, and here the Pacific Northwest is subject to the same affliction as everywhere else: inflation in material and labor costs. While inflation doesn't figure to eat up all of the growth in contract-awards value during 2007 — or worse, mask an actual downturn — it likely will take a bite out of the number and scope of projects that owners will be able to afford.

Jim Haughey, economist for Reed Construction Data, gave perspective on the housing decline in an October report.

"The 20-percent decline in housing starts since the beginning of the year has, so far, had little negative impact on nonresidential project starts, but will be more significant in the year ahead, when planned residential developments are delayed or cancelled," Haughey wrote. "However, the weakening of the housing market has caused slower inflation for construction materials, especially lumber, and has provided a small amount of skilled construction labor to nonresidential contractors."

Ken Simonson, economist for Associated General Contractors of American, took a different view in a Nov. 13 report.

"There is still a huge gap between construction materials prices and the generally benign inflation in most of the economy," Simonson wrote. "Moreover, two factors make future construction cost explosions likely. First, the industry must generally use a fixed quantity of materials, unlike manufacturers that can make products smaller and lighter, or service businesses that use few materials. These materials are often in high demand worldwide, with limited supplies. A current example is the nickel used to make stainless steel. Second, materials must be physically delivered, making them subject to high freight and fuel costs, as well as transportation bottlenecks. Falling diesel prices helped contractors last month, but those prices have leveled off. I expect construction materials costs over the next year to rise at least 6 percent to 8 percent, versus 2 percent to 4 percent for the overall economy."

Haughey went on to note some trends to the coming year.

"Hotels and hospitals continue to be the fastest-growing construction markets," the economist said. "The hotel boom is being sustained by ... persistently rising occupancy and room rates in most parts of the country. The surge in hospital construction is being funded by the large increase in hospital income in 2004-2005. This resulted from rapid gains in health insurance premium income (when employers added 4.1 million jobs) and a large increase in state general fund appropriations to cover the hospital bills of insured people.

"Starts of public buildings, other than offices, are up 21 percent year to date, following three years of rapid improvements in public budget balances. The amount of work under way and soon to be bid is enough to keep spending on public project job sites expanding for several more years."

Northwest Region

In a presentation to the Northwest Construction Consumer Council in November, noted economist John Mitchell described the current state of the regional economy as "barreling along with some trepidation."

"There's lots of work out there, and I think it will continue," said Mitchell, western regional economist for U.S. Bancorp.

For one thing, vacancy rates for office space have declined, pushing rents up and inducing new construction, Mitchell observed. At the same time, owners are finding no shortage of money available to borrow for construction projects. And of the five states covered by PB&E, only Alaska is below the top 10 nationally in job growth.

Still, questions about the future persist.

One concern, Mitchell said, is how the housing boom will end, and how that will play out throughout the construction industry.

"We saw the incredible run (in housing construction), but it's over," Mitchell observed. "The thing about housing is it's not just about builders; it's all the other things tied to housing."

The other pressing issue is the aging work force. Mitchell took a deeper view of the problem than has been prevalent among construction industry leaders in recent years, but the implications are no less troubling.

Citing the Bureau of Labor Statistics, Mitchell pointed out that the annual average growth rate of the labor force is projected at 1 percent for the period 2004–2014. That's a 39-percent drop from the 1984–1994 rate and a clear indication that the Baby Boom is over. The bad news is those boomers are still alive and maintaining high demand for goods and services.

So while the construction industry has been playing catch-up by trying to attract a larger portion of new workers, the dropping growth rate in the labor force means competition from other industries for those people is increasing as well.

"You're having trouble finding people now," Mitchell said to the NWCCC audience. "It's not going to get any easier."

An additional problem related to slow growth in the labor supply is that labor costs can be expected to rise.

"Labor costs will remain an issue for a long time," Mitchell said in answer to a question. "Labor will have and expectation of wage growth."

One factor that could further complicate the workforce picture is the possibility of further crackdowns on illegal immigration. Mitchell said illegal aliens make up about 4.9 percent of the labor force already, and the proportion is even higher in construction, so it would make more sense to educate and assimilate them than to deport them.

The economist is more optimistic about other components that affect construction costs, such as materials and petroleum products. He noted that while the overall consumer price index stood at 2.1 percent in September 2006, construction cost inflation was much higher at 7 percent to 9 percent.

"Lots of cost pressures are making bidding much more difficult, but I think you're going to see some moderation there," Mitchell said. "I don't expect another energy shock."

Reed Construction Data predicts the combined value of nonresidential construction contracts awarded in the five states of PB&E's coverage will grow by 7 percent in 2007.

Washington

Heavy construction in Washington, which accounts for nearly half of the Pacific Northwest market, had a banner year in 2006 and likely will have another one in 2007.

"Washington's economy is on a tear. All the sectors are strong," economist John Mitchell observed, and the facts back him up.

Job growth stood about 2.7 percent in the fall, more than double the national rate. Helping to drive that growth are The Boeing Co., which is adding jobs in preparation for the launch of its new 787 Dreamliner jet, the reviving high-technology industry, travel and tourism, and even some segments of the agriculture industry, Mitchell said.

And though home sales and construction were slowing down, they were still far better than most areas of the country. Perhaps even more important, home prices were holding steady or continuing to rise, which means homeowners can continue to borrow against their equity to support retail spending. That's good news for a state government that depends retail sales tax as a main source of revenue, and indeed Gov. Christine Gregoire has announced that she will not seek higher taxes in the new budget she will submit to the Legislature in January.

Highway construction is being supported by major boosts in the state's gas tax in 2005 and 2003, and the Washington State Department of Transportation announced that it had added 96 new miles of highway lanes in 2006, plus a net nine new bridges. That progress should continue in 2007. Some of the big highway projects on tap include two in King County on I-405 estimated at over $200 million each — 112th Avenue SE to SE Eighth Street and Northeast Eighth Street to SR 520 Braided Crossing — and a $78-million, six-mile section of the ongoing North Spokane Corridor project.

In addition, Seattle voters approved a $365-million, nine-year proposal on the November ballot that will boost property taxes to pay for city streets, sidewalks and bridges. The tax increase will triple the available funding for paving, double the amount for sidewalks and quadruple the amount for bike paths. For starters, the city expects to put out major paving projects on Mercer and Madison streets and Denny Way this year.

The markets for vertical construction also should continue strong in 2007. Quite a few large building projects — in the $100-million-plus range — are in contractors' backlogs for 2006 in the Central Puget Sound area, including medical facilities, hotels and office buildings. In addition, federal jobs such as a $400-million housing project at Fort Lewis, a $150-million production and storage facility at Naval Facility Bangor, a $70-million barracks at Naval Facility Everett, and a $56-million Peace Arch border station in Blaine will add to the competition for equipment, materials and skilled workers during 2007.

On the other side of the state, engineering offices in Spokane are scrambling to keep up with the volume of work coming in, which bodes well for contractors in the foreseeable future.

Jolene Logue, vice president and branch manager for Ingersoll Rand equipment stores in Seattle and Spokane, keeps a close eye on both markets.

"For the whole state, we are up (in 2006). But we can feel a softening due to housing starts — not just here but throughout the United States," she said. "Business can be cyclical, but overall we have been up for four years."

Logue's branches will be adding some new lines and will get some new models (milling machine, pavers, rollers) within the Ingersoll Rand line in 2007. Also, she will be hiring some resident mechanics in several Washington communities to improve the company's service capabilities.

"2007 is going to be good, but not gangbusters," she said. "Just talking to people, they are more wait-and-see. They want more backlog."

That opinion squares with the assessment by Construction Market Data, which expects heavy construction contract volume to grow by 2 percent in 2007.

Oregon

In November 2006, PB&E's Contract Awards Summary showed Oregon running 35-percent ahead of 2005, year to date, with Sewer/Water project value up an astounding 201 percent. Construction employment remains the fastest-growing segment in the Portland metropolitan area, and that's not likely to change.

Like in Washington, Oregon heavy construction is riding in the wake of the housing boom. In fact, the Bend, Ore., metropolitan area produced the highest rise in housing prices in the nation — 37 percent — last June, while the state ranked fourth in the nation at 19.5 percent.

As economist John Mitchell noted, the state has experienced a more significant decline in housing sales than Washington, but it also has similar strength in most other sectors.

"Retail follows rooftops," Mitchell observed, voicing optimism for commercial construction in 2007.

Office space in Portland is essentially filled up, which suggests the likelihood that new office towers will be sprouting up as long as the economy remains stable. But whether developers will respond to the changing market quickly enough to get any projects under during 2007 remains to be seen.

Building contractors are more confident about the markets for schools, mixed-use developments and health care facilities, which they expect to continue strong through at least 2007. The federal government will chip in with a big project, the Wendell Federal Building rehabilitation in Portland, which is estimated at $105 million. And the Port of Portland may start work on its new 160,000-square-foot headquarters building and garage at Portland International Airport, a $189-million project.

On the highway side, Oregon Transportation Improvement Act funds will continue to support an aggressive construction program, through the Oregon Department of Transportation has expressed concerns about the rising cost of asphalt products.

"The state's investment in its transportation system has doubled in the past several years, and we want to involve as many people and as many businesses as we can in these efforts," said ODOT Director Matthew Garrett.

ODOT's current four-year construction program is producing about $500 million in work per year, but the department also notes that the inflation in construction has been running at 10 percent annually for the past two years. That cuts into the number of projects that the funding can support.

"We will slow down, but we will continue to grow," Mitchell said of his home state. Reed Construction Data also forecasts another good year ahead for Oregon, with nonresidential construction growing by 28 percent.

Idaho

As expected, construction markets in Idaho flattened during 2006. Still, activity remained at a very high level, particularly in the Boise area, where construction and mining employment was up by 13.2 percent at midyear and the permit value for commercial buildings was up nearly 40 percent.

The farm economy remains steady, which bodes well for East Central Idaho, and smaller communities in North Idaho reportedly are getting aggressive about attracting new businesses, which should boost the construction industry there. State economist Mike Ferguson expects the Idaho economy to decelerate over the next few years, but he doesn't foresee it reversing into negative territory.

"The primary reason behind this expected slowing is the cooling of the real estate and construction sectors," he said in a published interview.

The population is expected to continue growing in the Boise area for the foreseeable future. In fact, the Community Planning Association of Southwest Idaho foresees an additional 53,000 housing units being built in Ada County alone between now and 2020.

Where that kind of growth occurs, infrastructure must follow. The Forum on Transportation Investment recently suggested that the state will need $20 billion in the coming years for its transportation system to keep pace. Connecting Idaho is a new funding program that will allow Idaho to plan, design and build more highway projects in less time than through traditional transportation funding methods. In May 2006, the Idaho Legislature authorized the sale of nearly $200 million in Grant Anticipation Revenue Vehicle bonds to finance the first phase of Connecting Idaho. GARVEE financing allows Idaho to sell bonds and use the proceeds to build highway projects. The bonds will be paid back with future federal highway dollars.

Currently, six corridors are financed through GARVEE bonds: U.S. 95, Garwood to Sagle, Bonner County and Kootenai County; U.S. 95, Worley North, Kootenai County; I-84, Caldwell to Meridian; I-84, Orchard to Isaacs Canyon; Idaho 16, I-84 to South Emmett Corridor; and U.S 30, McCammon to Soda Springs.

Military construction isn't a large factor in Idaho, and most of it is centered at Mountain Home Air Force Base. The base doesn't appear at risk in the latest round of base closures, but its workforce will be downsized over the next five years as F-15C and F-16 fighter units are moved out and F-15Es arrive from Alaska. In the meantime, a multi-year program of replacing housing on the base will continue in 2007, with a $12-million temporary lodgings project in the pipeline.

According to Reed Construction Data figures, the value of heavy construction starts should grow by 30 percent in the coming year.

Montana

Montana lacks a dominant population center, which makes it less vulnerable to boom-and-bust economic cycles than most states. So even though construction activity leveled off overall during 2006 in Montana, the industry need not worry about a serious downturn.

Paul Polzin, director of the University of Montana's Bureau of Business and Economic Research, said he expects the state's economy to keep growing at a historic rate. The state has seen four consecutive years of economic growth greater than 4 percent, the first such growth since the 1970s.

Construction-equipment dealers continue expanding and upgrading their facilities around the state, showing confidence that the strong market for their products is secure. They have good reason to feel that way. One indicator is highway and bridge work: Federal highway funding to Montana amounts to about $300 million a year, giving it one of the highest per-capita shares of SEAFETEA-LU money in the country.

The oil boom in Eastern Montana is reversing a long trend by propelling some counties there past western and urban counties in economic growth. Economist Polzin said that traditionally western counties had been in the top 10 for economic growth.

Newly released statistics from the U.S. Bureau of Economic Analysis show that the fastest non-farm labor income growth was found in Fallon, Richland and Blaine counties. Polzin said the shift is caused by the energy and natural resource boom that started in 2003. Fallon, Richland and Blaine counties are all in Montana's "oil patch."

"It will be interesting to compare future trends in county non-farm labor income with those for county population in the coming years," Polzin said. "The latest estimates still show Western Montana leading in population growth."

On another front, the Senate passed a 2007 Military Construction Appropriations Bill that includes more than $158 million for military projects in Montana. The bulk of the funding — $140 million — will go for 493 housing units at Malmstrom Air Force Base in Great Falls. Another significant project at Great Falls will be the $9.6-million Air National Guard Operations and Training Facility, which will be used for large group training to prepare Montana's men and women for military operations at home and abroad. The facility will also be used for chaplain, financial and legal services. The House has already passed its version of the bill and a conference committee will work out differences between the two bills.

Barring the onset of a national recession, which is not expected to happen, Reed Construction Data predicts the Montana construction market will continue strong in 2007, with the value new projects growing by 32 percent.

Alaska

At the beginning of 2006, Alaska was facing the possibility that a deal to build a natural gas pipeline through the state could happen and that Congress could open the Artic National Wildlife Refuge on the North Slope to oil exploration. Neither of those things happened, but the state still had a banner construction year.

Thanks to high oil prices, a generally favorable economy and the large amount of federal spending in the state (SAFETEA-LU alone contributes $425 million a year for highway construction), heavy construction in Alaska should continue to thrive through 2007 and beyond.

After several years of stagnancy in retail construction, two new shopping centers will open in Anchorage in the spring. Plans for a third center to open in 2008 also have been announced.

P.O'B Montgomery and Co., builders of the Glenn Square in Mountain View, said last summer that a new store was nearly ready to sign an agreement on its last larger space. Cook Inlet Region Inc. announced last summer it plans to build a $100-million-plus shopping center on land it owns in the Muldoon area, down the highway only a few miles from the Glenn Square. Also announced recently were plans by group of Hawaii investors to build North Star Center, a 16,000-square-foot, 16-tenant strip mall located at 36th Avenue and the Old Seward Highway.

State economist Neal Fried noted that when new retailers come to Anchorage, they generally don't stop with one store because of the economies of scale involved in doing business in Alaska. Soon after opening in Anchorage, other stores often crop up in areas such as Wasilla and Fairbanks, and occasionally go into smaller markets like Juneau or Kenai.

The Alaska Department of Transportation and Public Facilities also has a busy year on tap. Some of the more interesting projects tentatively listed include these:

Haines Terminal Improvements, $10 million to $20 million; Sitka Sawmill Creek Road, $5 million to $10 million; Metlakatla Walden Point Road and Ferry Terminals on Annette Bay (paving, rock excavation, storage/maintenance building, transfer bridge, floating barge, and pilings), $5 million to $10 million; AMHS Ferry Terminal to Third Avenue Surfacing on Tongass Avenue in Ketchikan, $5 million to $10 million; Petersburg Airport Runway Safety Area Improvement, $20 million to $30 million; Hyder Causeway Reconstruction and Extension (replace existing pile supported trestle to boat harbor with earthen causeway or other alternative(s) and improve/widen existing causeway from shore to existing trestle), $5 million to $10 million.

Reed Construction Data projects a 32-percent increase in construction contract values during 2007.

Misc Civil Roads/Highways Other Civil Total Civil Building Total
2003 $1,289,759,907 $732,716,314 $1,643,483,620 $3,665,959,841 $7,166,363,318 $10,832,323,159
2004 $817,107,677 $707,669,650 $1,238,793,463 $2,763,570,790 $9,463,713,140 $12,227,283,930
2005 $1,307,804,863 $1,330,557,953 $2,621,596,102 $5,259,958,918 $8,855,560,069 $14,115,518,987
2006 $636,837,909 $1,381,556,240 $2,427,673,235 $4,446,067,384 $10,014,843,212 $14,460,910,596
2007 $955,194,993 $1,474,283,214 $1,843,128,159 $4,272,606,366 $12,308,567,756 $16,581,174,122

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