Spending on new residential construction has peaked in this cycle, but all other construction markets still have considerable expansion potential, according to Jim Haughey, director of economics for the Reed Research Group.

Construction spending on both residential remodeling and the "for lease," or non-institutional, part of the non-residential building market (including lodging, office, retail, and other commercial) is expanding at about the rate that had been forecast.

While the growth rate will slow somewhat later this year, it will remain positive for another year—longer if the U.S. GDP growth does not quickly subside from the current 3.5 percent to 4 percent rate.

As always, institutional buildings and heavy or engineering projects lag behind. Construction spending on both of these sectors has only recently moved firmly into the expansion phase of the construction cycle. The growth pace will pick up progressively over the next year, Haughey says.

The Census Bureau has considerably revised its previous estimates for construction spending. It's now estimated to have soared 7.5 percent in February and then declined 2.5 percent from February to May. Previously, small, steady monthly increases in construction spending were reported for the December to April period. The spring decline is largely due to new estimates for residential remodeling (which accounts for more than 100 percent of the decline now measured from February to May), Haughey writes in the latest issue of Construction Forecast Monthly.

While there was a marginal drop in materials costs over the period, contractors added 94,000 new employees.

The May revisions increased April 2005 spending estimates by 7 percent for residential remodeling, 9 percent for power facilities, and 61 percent for manufacturing plants.

Haughey said he expects more revisions to early 2005 construction spending estimates in the next few months.

"We still believe that the spring/summer spending trend is flat after inflation, and that the trend will improve slightly by year end and next year," he says.

The Census Bureau also revised construction spending for manufacturing facilities by 60 percent over the past few years. However, Haughey points out, that sector remains depressed compared to the boom in manufacturing construction in the late 1990s.

The outlook for a spending boom remains through next year because the forecasts for business investment in equipment and factory production are unchanged.

"Industrial equipment investment is up 10 percent over the last year, and it will keep rising at near that pace through 2006," Haughey writes in the latest issue of CFM.

Factory production is now 3.2 percent higher than a year ago, but is expanding quickly again after a winter pause and is expected to grow by at least a 5 percent annual pace for the next 18 months. Factory capacity utilization has risen to more than 78 percent. By fall, when capacity additions are needed, the rate will hit the 80 percent threshold, according to Haughey.

Meanwhile, spending on water treatment plants has jumped 20 percent since the end of 2004 after two years of steady spending at an approximate $3.8 billion pace. The 20 percent spending increase is about double the cost increase for these facilities over the same period. Haughey says he expects activity to expand a further 15 percent to 20 percent by the end of next year, with additional growth in 2007—all good news for construction distributors who sell to this sector.

Six cities in the southern United States have seen a large expansion in residential building so far this year: Houston, San Antonio and Austin, Texas, and Tampa, Cape Coral, and Jacksonville, Fla. In these cities, high domestic and foreign immigration is boosting demand, and relatively low land and permitting costs are keeping builder costs low. Meanwhile, the national permit count is only up 3.3 percent.

Houston, San Antonio and Austin have low home price appreciation and therefore room for expansion in housing starts before the rise in home prices shuts off demand growth.

Tampa, Cape Coral and Jacksonville have had much higher home appreciation, but their housing booms are not over yet.

State tax receipts plunged more than 10 percent in the aftermath of the last recession, a far steeper decline than occurred in the much more severe recessions of the early 1980s and 1990s.

Public building projects were postponed or canceled in fiscal year 2002 to 2003, resulting in the decline in real value of state and local government construction spending in the fiscal year just ended. Now, after two years of well-above-average gains in tax receipts that have restored state budget reserves to a comfortable level, the cycle is reversing. Only Michigan and Mississippi have had a drop in tax revenues in the past 12 months. Thirteen states had more than a 10 percent gain.

What all this means is that spending on construction for public and other municipal buildings will increase. But the 2005 to 2007 expansion will not match the seven-year, 80 percent boom during the 1990s.

Source: Reed Construction Forecast Monthly, Vol. 2, Issue 8. For subscription information, visit www.reedconstructionmonthly.com or call (800) 424-3996.