Midway through 2007, the industry can be guardedly, but not overly, optimistic about the outlook for the rest of the year.
The economy and the construction industry face big questions that may play out as positives or negatives.
When will the downturn in single-family housing starts bottom out?
Will mortgage rates continue to increase as they have in the first weeks of June?
Will highway and bridge construction continue the strong surge that occurred in May?
Will inflationary trends continue? If so, what will the “Fed” do about it?
Will the construction industry ratchet-up a campaign for higher gas taxes to forestall bankruptcy of the Highway Trust Fund at the end of 2009?
The single-family residential housing market did not fulfill predictions that it would snap out of its recession this spring. The National Association of Home Builders (NAHB) in Washington, D.C., had predicted such a spring rebound in Construction Equipment Guide’s forecast for the industry this past December.
“We’ve become much more negative,” Bernard Markstein, NAHB’s director of forecasting, said. “We’ve pushed back the bottom, or any recovery, until late this fall, the third or fourth quarter of 2007. Last spring, we thought we were reaching a bottom and things were coming into balance. Then the problems in the subprime market, involving lower-quality loans, emerged, and hurt demand in the housing market more than expected. This has left builders with too-high inventory. We now forecast 1.13 million single family housing starts in 2007, compared with 1.47 million single family housing starts in 2006.”
(In December’s forecast, NAHB had predicted 1.3 million starts in 2007.)
Housing is a significant leading indicator for the economy (and the construction industry). Markstein said the total housing market, including multi-family construction and all housing services “was as high as 17 percent of gross domestic product last year; is now down to 16 percent, and is likely to come down toward 15 percent.”
So how bad is the downturn?
“It’s not digging the economy into recession,” Markstein said, “but it impacts the economy because it (the slowdown in building) reduces the rate of growth. There’s no question that there are not as many jobs, but I doubt this will pull us into recession. We’re talking about reaching a bottom, with supply and demand being in balance, by late this fall.”
Worst Impact in Florida, California
Markstein told CEG the decline in single-family starts was “worse in the South, particularly Florida, and in California and some resort areas like Las Vegas and Phoenix; the Midwest also has been hit but that’s more due to economic woes than other factors.”
On the other hand, he said the Northeast, Northwest and Texas are “doing reasonably well.”
“There are some soft spots in the Northeast, however,” he said. “Boston is one of the few areas with significant overbuilding, but, even there, we’re seeing better balance, with lower supply. Manhattan seems to be fairly well balanced. There’s some overbuilding on Long Island and in its suburbs like Westchester and northern New Jersey. Philadelphia has a little oversupply but is not terribly overbalanced.”
Mortgage Rates Rise in First Six Months
Markstein told CEG that mortgage rates for a 30-year fixed mortgage have risen from 6.18 percent in the first week of January 2007, to 6.69 percent the week of June 17.
“That’s a significant increase of roughly one half a percentage point,” he said.
Mortgage rates had been 6.62 percent in June 2006, but had come down since then. They were 6.16 percent early this May.
Markstein said the rise in rates “is enough to squeeze some people out of the market or affect the size of the house they will buy.” He said the rise, combined with a tightening of lending standards in the past few weeks, “is another kick in the shins in housing.”
“There’s really not much good news in the housing world,” he said. “We know things will get better. The real question is when.”
Where will rates go during the next six months?
“We are forecasting that the Freddie Mac fixed mortgage commitment rate (30 year) will be 6.65 percent in the second half of this year, essentially where it is now,” Markstein said.
(Mortgage rates tend to follow the 10-year treasury note rate.)
Highway, Bridge Projects Bolster Economy
Construction industry groups expressed optimism about the level of highway and bridge construction.
“I think non-residential construction is holding up very well through the first four months of 2007, and I expect it to hold up for the rest of the year,” said Kenneth Simonson, chief economist of the Associated General Contractors of America (AGC) in Washington, D.C. “I think there has been very little spillover from the housing slowdown, either on construction or the economy as a whole. I’m optimistic that this will continue to be the case, though I think the housing slowdown will continue until the second quarter of 2008.
“I have gotten more pessimistic about housing than I was a few months ago. There appear to be a lot of problems with subprime lending.”
William Buechner, vice president, economics and research, of the American Road & Builders Transportation Association (ARTBA) in Washington, said, “At the moment, things still seem to be going quite strongly. So far this year, the dollar value of work put in place on highways and bridges is about 15 percent above last year. This is caused in part by the higher cost of construction materials, which is still an issue.”
Buechner sees a cautionary flag, however, in the fact that the value of new contract awards for highway and bridge projects is up less than 1 percent from last year.
“This is kind of a precursor of what will come down the pike,” he told CEG. “The value of work will stay at very high levels, but growth (new contract awards) may level out as we get into the summer season.”
“One good factor for highway contractors and dealers is that the rapid inflation in materials prices over the last three years seems to be taking a breather,” Buechner added. “This will make it easier for state and local governments to hit their financial targets. I expect that until housing comes back in another year or so, prices of materials will not increase greatly. It’s not that projects are getting any cheaper; they’re just not getting more expensive, which is a good sign for our industry.”
Said Christian Klein, vice president, government affairs, in the Washington, D.C., office of the Associated Equipment Distributors (AED), “My sense is that infrastructure spending has been very robust, offsetting some of the downturn from housing. Two thirds of respondents to an AED survey of a cross section of dealers in late March said they were optimistic on business prospects for the coming year. More than half, 58 percent, of them expect to add workers and new positions in 2007. Only 5 percent said they plan to lay off workers or eliminate positions.”
Klein said AED members listed their top three markets (in order) as residential, commercial/industrial and highway construction and maintenance.
Equipment Manufacturers Improve Efficiencies
The equipment manufacturing sector seems to be doing well at mid-year.
“Many manufacturers have gone through their inventory; now they’re taking steps to improve efficiencies in meeting continued demand,” said Nick Yaksich, vice president of global public policy in the Washington, D.C., office of the Association of Equipment Manufacturers (AEM), Milwaukee. “Except for the home construction market, roadbuilding, mining, farming and utility sectors remain strong.”
“Inflation due to energy costs is having some negative effects on manufacturers,” Yaksich added, “but exports are increasing as they look at new overseas markets. We’ve seen an increase in competition from overseas on some products but remain confident in the quality and diversity of our products.”
Highway Funding Rises
Congress in February appropriated almost $39.1 billion to states for the federal aid highway program and $8.97 billion for transit through the end of the current 2007 fiscal year on Sept. 30. The increased highway funding under the 2005 transportation bill is $3.5 billion over Fiscal 2006. This has spurred construction, meeting, for the current year, most of the increased highway funding guarantees under the six-year SAFETEA-LU Transportation Equity Act signed into law Aug. 10, 2005, covering the fiscal years from 2004 to 2009.
Highway and bridge construction soared 44 percent in May, according to McGraw-Hill Construction, a division of the McGraw-Hill companies. The transit appropriations also are high — $470 million above 2006.
Higher Gas Taxes?
Congress is not expected to increase the federal tax on motor fuels during its current session, but this “hot topic” is expected be discussed a lot.
“The Highway Trust Fund (HTF) will be bankrupt by the end of 2009,” said Klein.
U.S. Secretary of Transportation Mary Peters told Congress earlier this year that the HTF will have a $230-million deficit by Fiscal Year 2009.
“There’s a strong level of consensus that the most viable, fiscally responsible source of the needed revenue is an increase in the gas tax,” Klein said. “We’ll be hearing more from construction industry groups about this. The next reauthorization of the highway bill will be extremely important because it will be the first time that not enough money is coming in to support the current level of spending. People are talking about an increase of five to ten cents a gallon.”
ARTBA has released a proposal to continue expanded funding for highways through such an increase, combined with new user fees on shippers for a new “critical commercial corridor program.” ARTBA also is proposing that exemptions (from gas taxes) for state and local vehicles, including school and inter-city buses, should be funded from the General Fund rather than the HTF.
“A one-penny increase in the gas tax puts $1.7 billion to $2 billion into the Highway Trust Fund; with some of this going into transit funding,” Buechner said.
Jennifer Gavin, a spokesperson of the American Association of State Highway & Transportation Officials (AASHTO) said, “Look for this issue to be discussed a lot more as legislators start working on a new transportation bill; this is normally about two years before the current authorization ends (at the close of the 2009 fiscal year).”
Dealers Respond on Death Tax, Business Prospects
The industry will continue its effort this year to permanently repeal the estate (“death”) tax, which is due to be reinstated in 2011.
“We’re not holding our breath on getting anything done this year,” Klein said. “Total repeal is off the table at the present time with the Democrats in control; however, we’re helping people on The Hill understand that uncertainty is making it impossible for dealers to plan for the future. We think that some permanent solution in the future is a real possibility. Given the escalation in home prices which we’ve seen in recent years, this will become a bigger issue for the middle class as we get closer to 2011.”
“The AED survey of dealers in March showed that 79 percent of dealers whose companies had engaged in estate planning were keeping those estate plans in place,” Klein added.
Is Inflation Under Control?
Many economists expect the government to report that the annual pace of core inflation, which excludes food and energy prices, fell from 2 percent to 1.9 percent in May, which is within the generally accepted “comfort zone” of 1 percent to 2 percent. They believe this would increase the possibility that the Federal Reserve Board will not raise interest rates. (A rise in rates would be a negative for construction.)
The Bureau of Labor Statistics (BLS) told CEG that the core consumer price index (CPI) for the nation rose 2.2 percent from May 2006 to May 2007. When food and energy are included, the CPI rose 2.7 percent.
The “Fed” has seen risks of higher inflation, however, from the lack of spare capacity in the economy, leading to higher demand and higher prices.
Other economic indicators affecting the economy, and construction:
• The unemployment rate remains at 4.5 percent, near a six-year low.
• Global growth is increasing demand for U.S. exports. The U.S. trade deficit fell 6.2 percent in April, to $58.5 billion. Worldwide capacity shortages, and rising demand, may increase inflation.
• The federal funds rate stood at 5.25 percent on June 20, compared with 5 percent a year ago. This is the interest rate at which banks and other financial institutions lend money to each other, usually on an overnight basis. The Fed has held short-term interest rates steady since June 2006, after it had raised them a quarter point at a time in 17 meetings over two years.
• The average 30-year fixed mortgage rate was 6.29 percent.
• The federal discount rate — the interest rate at which eligible financial institutions may borrow money from a federal reserve bank — was 6.25 percent on June 20, compared with 6 percent a year ago.
• The prime rate — the overnight rate which the Federal Reserve charges banks — remained at 8.25 percent on June 20. CEG