The period of peak growth in construction spending in this economic expansion cycle may be now behind us but construction activity will continue to expand faster than the economy for several more years, according to Jim Haughey, economist for the Reed Research Group.

Haughey, writing in Construction Forecast Monthly, points out that unseasonably bad weather held the growth in construction spending to 0.9 percent during the first two months of 2005. However, with a return to normal spring weather, there has been a surge in housing starts to a three-decade high, causing a temporary pickup in market growth.

The two hottest growth markets in 2005–2006 will be hotels (49 percent) and manufacturing plants (43 percent). Manufacturers have boosted their construction spending 19 percent since September, after two years of little change. The gain was mostly for electronics, food and beverage and chemical facilities. "While materials inflation may account for up to half of the gain, this appears to be the beginning of the surge in factory construction that occurs at this stage of every economic cycle," Haughey says.

The building surge will likely add another 50 percent to manufacturing construction activity when it hits its peak in 2007. The monthly newsletter forecasts that manufacturing capacity utilization will reach 80 percent this summer, the usual threshold for a several-year boom in factory investment.

Some of the demand for manufactured products is not only coming from the U.S. but from exports, up 6.6 percent in the past year, and continues to increase much faster than domestic demand.

The export surge will strengthen as U.S. manufacturers capitalize on the continuing decline in the value of the dollar to raise their share of the world market for manufactured goods. The U.S. dollar has declined 24 percent against the nation's major trading partners since late 2001.

Only in recent months has the U.S. trade balance begun to improve with Europe, Canada, and Japan where the dollar has depreciated substantially. More of the gain from the weaker dollar is still ahead.

Construction spending for electronics factories had dropped 73 percent since 1998, mostly due to the industry decision to move the production of Dynamic Random Access Memories microprocessors and other standard parts to lower-cost countries.

Construction spending for transportation equipment plants is now less than half the peak in 1998. The 1990s were an unusual period when a flurry of European and Japanese vehicle manufacturers built U.S. production facilities to avoid the penalty tariffs the North American Free Trade Agreement (NAFTA) imposed on foreign vehicles.

Construction in the education segment is expected to expand 21 percent over 2005–2006.

Highway spending rose 4.4 percent in January to a record high $72.25 billion. Reed Research expects the rest of the year to average below the January level but overall will still yield a 6.8 percent gain in 2005.

The Reed forecast still calls for sustained expansion, above inflation to be underway by midyear with improved state and local budget balances being the key turnaround factor.

Price appreciation for existing homes slowed to a 9.0 percent annual pace in the fourth quarter of last year. The appreciation rate likely declined a little more in the winter quarter and will average 7 to 8 percent during 2005.

"So far housing starts have not declined in reaction to the rise in home inventory, but a decline is inevitable soon," according to Reed.

Meanwhile, multi-family starts matched the 2003 total in 2004 and are forecast at the same level in 2005 to 2006, even though the apartment vacancy rate continues to be high at 10 percent.

Multi-family permits are declining in most of the country, consistent with the reported rental vacancy rates. But, economist Haughey notes that the permits are rising in a number of large markets where they are experiencing either rapid population growth or rapid income growth without significant population growth.

Multi-family construction in these cities is increasingly condominiums, condominium conversions, second homes and rental vacation property. None of these market segments are sensitive to the apartment vacancy rate. Permits for multi-family permits in the 20 largest markets soared 39 percent in the 12 months to January 2005, while declining 10 percent in the rest of the country. The same dual trend will occur this year.

Source: Reed Construction Forecast Monthly, Vol. 2, Issue 4. For subscription information, visit www.reedconstructionmonthly.com or call (800) 424-3996.