Construction spending weakened at the end of 2004 but the Reed Research Group still forecasts an expansion of spending early this year that will accelerate through 2006. The weak close was expected since the construction market was caught in a brief period between the peak of the housing cycle and beginning of sustained growth in the balance of the market.

In fact, a new government report showed that construction spending increased 0.7 percent in January, higher than the 0.4 percent that many economists had predicted, indicating growth is still occurring in the sector.

One trend that is particularly obvious, according to Reed Research, is that the residential construction market is slowing at a fast pace, meaning that much of the slowdown has already occurred. Another trend is in residential remodeling. This market, Reed says, has progressively strengthened at a strong pace in the past few months, which means that most of the expected market improvement is still ahead.

Both the commercial and institutional non-residential sectors are expected to expand at a 13 percent annual pace this year and 2006. Beyond 2006, the commercial sector will expand at a much faster rate than the institutional sector.

Construction spending growth in the "for lease" or commercial non-residential buildings (retail, office, lodging, warehouse and parking) stalled at the end of 2004, declining slightly after inflation is factored in. However, in the two quarters before the decline, these two sectors expanded at an 18 percent annual pace, which represents a marked recovery from an unusually long and deep period of declining activity.

Reed Research also reports that all of the funding sources for public construction in the United States are improving, namely federal, state and local tax receipts, state and local government reserve funds and investment earnings. These improvements will permit construction spending in that sector to rise 5.3 percent this year and 7.1 percent next year.

A sustained upturn in construction spending for heavy and engineering projects will not be noticeable until the end of winter. At the federal level, the outlook is for a 5 percent to 6 percent gain in highway and transportation funding, which is expected to begin this spring when the 18-month delayed reauthorization of the federal highway program is completed.

The construction equipment market has already tightened for buyers at the end of 2004 and will tighten slightly more this year than in 2006. Expect unusually long delivery lead times and equipment price increases that come at a faster pace than overall inflation.

Construction equipment shipments from U.S. manufacturing sites have increased 42 percent over the past year to the highest level in more than 20 years, while year-to-date net imports of equipment have nearly tripled.

As for good news, building materials have stabilized overall, while the availability of materials has improved substantially. Lumber prices were steady to slightly lower through September while steel product prices have eased. Recent slower growth in Chinese steel consumption has stabilized prices at a point slightly below the peak 2004 level.

Cement and concrete supply problems last year were primarily concen-trated in coastal regions—where much of the supply was imported—so the national price indexes only increased modestly.

Cement and concrete prices were still rising at the end of 2004 and will increase 2 percent to 3 percent more in 2005.

The 2005–2006 residential forecast is for strong housing starts compared to historical averages; the key difference from the stronger starts count in 2003 to 2004 is reduced home affordability (when the minimum needed to obtain a mortgage rises). Some mortgage applications that were marginally approved in 2003 to 2004 would not be approved this year or in 2006.

The decline in housing starts will primarily be at the bottom of the market—starter homes for first-time buyers. However, luxury and seasonal home starts at the top of the market will continue to expand.

Source: Reed Construction Forecast Monthly, Vol. 2, Issue 2. For subscription information, visit www.reedconstructionmonthly.com or call (800) 424-3996.