US Construction Outlook

Jim Haughey, Director of economics for Reed Business Information -- Industrial Distribution, 4/27/2005

Unseasonably bad weather held the growth in construction spending to 0.9% over the first two months of 2005. This was about 0.7% more project work after subtracting rising prices for construction materials. Now, normal spring weather and the January-February surge in housing starts to a three decade high are probably causing a temporary pickup in market growth.  By mid-year, the slowing trend in construction spending will reappear.  The period of peak growth in construction activity in this economic expansion cycle is now behind us. Nonetheless, construction will continue to expand faster than the economy for several more years.

Construction spending, after subtracting inflation to be comparable with GDP, increased 7.0% last year compared to a 4.5% rise in GDP.  The real value of construction work will increase 5.5% this year and 4.0% in 2006 while GDP is expected to grow 3.5-4.0% in both years.

Contractors will continue to be an attractive market for distributors for several more years. Construction employment will expand faster than overall employment.  Contractors will add 15-20,000 workers per month through the end of next year.  The mix of project work will tilt from entry level homes and apartments, a market dominated by large homebuilders that often buy direct from manufacturers, to custom homes, home remodeling, nonresidential buildings and public works.

The slowdown in the residential market will be concentrated in the large, rapid growth cities in the southeast and southwest.  Cheap mortgage rates have boosted these markets for several years.  But mortgage rates have risen already from 5.3% to near 6.0% for a 30-year fixed rate loan and are expected to reach near 7.0% late next year. Some of the households now looking for a home will have to stay with parents or in apartments. Apartment rents are stable in the South and West which have over 12% vacancy rates.

No slowdown in home construction is likely soon in the Northeast, South Florida and California where a complicated and often very expensive permit process has caused a shortage of homes and soaring prices.  But, market by market, be alert for the housing bubble to burst when home prices increases stop and speculators scramble to sell their investment homes. 

Several other housing segments will also largely escape the market slowdown.  This includes luxury and second homes where higher mortgage rates have less impact than rising bonuses, investment returns and self-employment profits.

The two hottest growth markets in 2005-06 will be hotels (49%) and manufacturing plants (43%).  But both are very small markets.  Education, the largest nonresidential market, is expected to expand 21% over 2005-06.  The next two largest markets, highway and retail will expand only about 11% over the two years, only slightly faster than their growth in 2004.  Other large and rapidly growing markets will be office (29%) and health care facilities (25%).

Share of Construction Spending Growth