Volume 41, Issue 12 - December 2006

Construction Forecast: Sunny with a Few Clouds 
Experts Say Non-Residential Market on the Rise; Economy is Strong 
by Tara Taffera

When McGraw-Hill Construction hosted its annual Outlook 2007 Executive Conference October 27, in Washington, D.C., the conference’s six speakers agreed that the landing for the housing industry will be a soft one-but not without challenges.

Many speakers pointed out that the astounding home prices are also the case around the world. 

“Home prices are up 70 percent since 1997. That is average compared to the rest of the world,” said David A. Wyss, chief economist for Standard & Poor’s, who presented an economic outlook. “In other countries, prices are cooling off and it’s not a disaster.”

He said the housing market peaked last summer but points out that it is stalling rather than plunging. And, while many lament high home prices, Wyss said housing remains affordable due to low mortgage rates. Though he does add that the ratio of home price to income is at a record high. But rather than a national bubble, he said there are only local bubbles in areas such as New York, California, Boston and Florida.

Other economic high points: oil prices are coming down from record highs, restoring some purchasing power; and the stock market will recover but slowly.
“The bottom line is that the economy recovers, but slowly,” he said. “Uncharacteristically, I’m not being as dismal as usual.”

World Economic Outlook
Nariman Behravesh, chief economist for Global Insight, started off his presentation concerning the world economic outlook in a positive light. “We’re in a pretty good period—not just for the United States but for the global economy.”

He said the world’s economic expansion will continue as there has been very strong growth this year. “Every region has done better than the previous period (see chart, page 55),” said Behravesh.

He noted that developed economies have been able to shrug off terrorist attacks, thanks to large diversified economies. “Perhaps the most notable trend of the last few years has been the resilience of the world economy in the face of multiple shocks.”

But he said the big story is the commodity boom. “This is the tide that has lifted all boats.”

He noted that long-term interest rates remain low and said this is what has driven up home prices. Like Wyss, he pointed out that this is not a U.S. phenomenon.

“To blame the Fed for a ‘housing bubble’ misses the mark by a long shot,” said Behravesh. 

“To us, the biggest problem is that there isn’t enough independent growth (consumer spending) outside the United States,” he added. “So as the U.S. slows that’s trouble for other regions who export to the United States.”

Talk of exports and international growth is incomplete without talking about China. But Behravesh is quick to point out that Chinese growth statistics are very unreliable. “Our best guess is that China is growing about 13 percent a year.”

He also mentioned that some risks loom large such as a hard landing in China. He added though that even if this happens, “Canada would be hurt, not the United States because oil prices will go down.”

Behravesh asked the rhetorical question: “What’s a recession in China?” The answer: 5 percent growth. “They really need to sustain 8 percent growth,” he said. 

When talking about world growth he showed a chart (see page 55) showing world GDP growth contributions.

“That’s the problem. Thirty percent only contribute to 15 percent of growth,” he said. But look at what China did.”

He added that Asia is supporting world growth while there are “significant long-term issues with Japan.”

But the global outlook is strong. 

“Financially, the emerging markets are much stronger than ten years ago. They are not as vulnerable to external finance but they are vulnerable to external demand,” he said.

Talk then turned back to the United States and a possible hard landing of the U.S dollar. How big of a problem is this? “People have talked about this for 20 years and it hasn’t happened yet,” said Behravesh.

Regarding oil prices he said that though prices have come down, capacity is still limited and markets remain tight. “There is no shortage of oil but producers aren’t investing. By definition we will never run out of oil.”

While many economic forecasters point to low saving rates in the United States as cause for alarm, Behravesh said this doesn’t mean a full crisis is ahead. 

“We are the engine of growth. Period.”

Roger Flanagan, professor of Construction Management at the University of Reading, also talked about the global market, specifically what is shaping the global construction market and design and construction businesses. He noted a few projects around the word, one of them being the Burj Dubai which will include 30,000 homes, 9 hotels, 6 acres of parkland and 19 residential towers. The project, which will cost about $8 billion, will be the tallest tower in the world.

Flanagan noted that through construction of projects such as this one, “We are pushing the boundaries of technology. 
He also had some good news and bad news regarding project costs. 

“The days of doing jobs for ridiculously low margins are coming to an end,” he said. 

The bad news is that design is treated as a commodity. “Design has become too cheap and undervalued,” he said.

Material Prices
John Mothersole, principal, Industry Practice, Global Insight, talked about building material prices and whether or not there is any relief in sight. The bad news is that collectively, building materials process rose by more than 8 percent in 2004 and by more than 6 percent in 2005. 

“Material price increases will continue to outpace inflation through early 2007,” said Mothersole. “Expect another 6-7 percent increase again this year.”

The good news is that collectively, material prices look flat in 2007 as material price escalation begins to slow (see chart, page 55). 

When talking about costs, Mothersole said there is one big trend to watch—and it’s not here in the United States—it’s that of Chinese primary metal consumption. “This is the wildcard in the forecast,” he said. “We won’t see a slowdown in Chinese growth until after the Olympics.”

Looking at steel specifically, Mothersole said prices will come down. Then, the talk again turned to China and another trend to watch—its production of steel. In 1995, China’s production equaled that of the United States, in 2005, China made 3.7 times more steel than the United States. 

“This will be a significant factor in the lowering of steel prices in 2007,” said Mothersole. 

2007 Outlook 
Robert Murray, vice president of economic affairs for McGraw-Hill Construction, ended the day with the much-anticipated 2007 Outlook for U.S. Construction Activity. He pointed out that single-family housing decreased 11 percent in 2006 (see chart above). “When you have a decline of that magnitude obviously it will have an impact.”

He reiterated the message that a soft landing is expected for the U.S economy though long-term rates will creep back up. 
He addressed the Energy Policy Act of 2005, which didn’t have much of an impact. “Our view is that incentives weren’t sufficient enough for people to take action.” 

Murray showed attendees a chart regarding U.S. single-family housing, showing construction falling sharply after a robust 2004 and 2005. 

“Yes, it’s down but it’s returning to levels seen a decade ago. I use these charts to give perspective (see chart above).”
“The expectation is that remodeling will hold up as well, “ he added.

What has caused the market to fall apart? Asked Murray. “It’s not the mortgage rates. It’s that investor demand is decreasing-second homes.”

Murray continued, “Relative to the last 15 years the housing market is still healthy—to the last few years—no.”
Moving to the commercial construction market, Murray said that housing forecasts always show what will happen in retail constriction.

“It’s virtually guaranteed that retail will decline as this always follows housing,” said Murray. “It’s still growing but not at the same pace.” 

But, overall, Murray’s forecast for the commercial construction industry shows many categories on the rise.

Following are some trends Murray projects in non-residential construction:
• Warehouses. Construction is rising in a hesitant manner, and vacancy rates are declining.
• Hotels. Construction is soaring in 2006, due in part to Las Vegas projects and convention-center related hotels.
• Offices. After a pause in 2005, construction is strengthening once again due to less vacancy rates and several major high-rise projects that are expected. 
• Multi-family housing. Construction has strengthened gradually, yet steadily. Recent strength has come from condominium development.
• Educational Buildings. School construction has turned a corner and is headed up again. Numerous states have passed school construction bond measures, California being one. 
• Healthcare. Healthcare facilities surged in 2005, but are now easing back, though there is still a need to replace aging facilities. 
• Manufacturing. Plant construction, in terms of square feet is weak, but growth is reported in dollars. 

Tara Taffera is a contributing editor for USGlass magazine.

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