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Experts Offer Sunny Forecast for Industry in ’06

Mon December 12, 2005 - National Edition
Pete Sigmund



Economists from many areas of construction predict that the industry should fare well in 2006.

They cite many reasons for optimism. The economy is growing at a good clip. Federal appropriations authorized by the new six-year highway and mass transit act are stimulating highway and bridge construction. Benefiting from increased tax revenues after past shortfalls, states are awarding many more contracts.

Although the long-predicted drop in single-family housing starts is anticipated to occur, this sector is expected to remain a healthy stimulant.

Growing Economy

The Bureau of Labor Statistics (BLS) stated that productivity increased 4.7 percent during the third quarter of 2005, compared with the third quarter of 2004. Gross domestic product (GDP) — total domestic output of goods and services — grew 4.3 percent in these three months compared with last year. This was the fastest rate since early 2004, despite hurricane-related shutdowns and disruptions.

GDP growth is expected to accelerate in the first half of 2006 as rebuilding activities gear up in the wake of this year’s hurricane damage.

The 12-month increase in inflation was 4.3 percent in October. The unemployment rate in November was 4.8 percent.

BLS reported that nonfarm payroll employment increased by 215,000 in November, showing that employers are not hesitating to add workers in the wake of the hurricanes. Approximately 37,000 of these new jobs were in construction. Over the past year, the industry has added 296,000 workers, an increase of more than 4 percent from the November 2004 total. Seasonally adjusted employment in the construction industry was a record 7.4 million in November.

The Census Bureau, meanwhile, reported that the value of construction put in place set a fourth straight monthly record in October — a total of $1.13 trillion when converted to an annual rate — and that construction spending was up 9 percent in the first 10 months of 2005.

Ken Simonson, chief economist of the Associated General Contractors of America (AGC) in Washington, D.C., said all segments of construction are sharing in the uplift in employment, with 6 percent growth in residential specialty trade contractors and heavy and civil engineering construction, 4 percent growth in residential building construction employment, 3 percent growth in nonresidential specialty trades and 2 percent growth in building construction.

Simonson said another “indicator of economic vigor” was the Beige Book, which the Federal Reserve issued on Nov. 30. This compilation of informal soundings of business conditions in the 12 Federal Reserve districts reported that “economic activity continued to expand from mid-October through mid-November.”

Robert A. Murray, vice president of economic affairs of McGraw-Hill Construction in New York, NY, sees continued growth on the industry in this setting. “Moderate growth, that’s the picture,” he told Construction Equipment Guide (CEG).

Highway Bill Spurs Construction

Congress recently appropriated $36.8 billion for the federal highway program in Fiscal 2006, a 4.6 percent increase in guaranteed funding. The funding was authorized by the new six-year $286.4-billion “SAFETEA-LU” transportation act. Signed into law this past August, the new law ended many months of uncertainty and allowed states to plan, and let, contracts, confident of funding.

William R. Buechner, vice president of economics and research of the American Road & Transportation Builders Association (ARTBA) in Washington, D.C., said in the association’s forecast that “The U.S. highway construction market should grow 5.4 percent in 2006,” spurred by the new law, renewed economic growth, and emergency repair work following Hurricane Katrina.

“The value of construction work performed on highway and bridge projects is projected to be a record $70.3 billion in fiscal year 2006, up from $66.9 billion in fiscal 2005,” he added.

Buechner explained the renewed confidence and vigor this way: “The federal highway program finances about 45 percent of highway construction. During fiscal year 2004 and much of fiscal year 2005, the program operated under short-term extensions of TEA-21 [the previous transportation act], which made it difficult for state and local governments to plan and start highway and bridge construction projects. SAFETEA-LU provides predictability in federal funding.

“Transportation construction is the second-largest construction market in the U.S. behind single-family homes and typically shows the most stable growth from year to year,” Buechner said. “During 2002 to 2004, however, this market was flat due largely to weak state and local budgets, uncertain federal funding for highways and mass transit, and the post 9/11 downturn in air traffic. All of these have recently improved, sending the value of construction work performed on transportation projects up a strong 8 percent in 2005. This market should continue to perform well in 2006, although rising construction costs could absorb much of the increased spending, leaving little to finance additional projects.”

States Increase Highway Projects

ARTBA said that, as their revenues increased, “two-thirds of states increased the amounts awarded to contractors for highway construction projects in fiscal year 2005, compared to only one-third in fiscal year 2003 and 2004.

“Continued economic growth should provide a solid base for more state and local government investment in highway construction in 2006 and beyond,” the association said.

Decline in Housing Starts Predicted

Many economists had predicted that there would be a decline in single-family housing starts in 2005 after a record year in 2004. This sector, fueled by low interest rates, generated much of the economic recovery and the industry’s growth. However, despite rising mortgage rates, this market surprised everyone and continued to expand in 2005, reaching record levels. Now the National Association of Home Builders (NAHB) in Washington, D.C., is predicting that this and other housing activity will “flatten out” in 2006.

“We’re expecting things to cool down in the year ahead; this is pretty much the baseline forecast from most people in this industry,” Jay Shackford, a spokesperson of NAHB, told CEG. “From 2002 through 2005, we’ve had four consecutive very strong years [in the single-family market]. Now things are starting to wind down. Interest rates are up. Demand is slackening a bit. We’re expecting a moderate cooling down out there in 2006.”

Shackford said NAHB expected seasonally adjusted single-family housing starts to total 1.7 million (a record) in 2005, then slacken to 1.59 million in 2006 and 1.53 million in 2007.

“That’s an adjustment downward but still a very strong level of production,” he said.

Shackford added that overall housing starts, including multi-family, are expected to total a seasonally-adjusted 2.54 million (another record) in 2005, compared with 2 million in 2004. NAHB has forecast that total starts will next decline to 1.94 million in 2006 and 1.883 million in 2007 before settling at approximately 2 million units a year after that.

The new record in single-family housing starts surprised a lot of people.

“I will cheerfully admit that people spent more to build houses than I had expected,” said AGC’s Simonson. “I would be glad to be proven wrong in that direction again next year.”

Seasonally adjusted figures measure the pace of construction and mean that, if the pace of construction continued at that rate for 12 months, these figures would be the accurate measurement.

Mortgage Rates Increase

Mortgage rates have increased during 2005, with the average for the year of approximately 5.8 percent for a 30-year fixed mortgage. NAHB expected them to average at least 6.5 percent during 2006.

David Seiders, NAHB’s chief economist, told the organization’s Construction Forecast Conference on Oct. 19 that “the housing market is seeking out a peak.” He predicted that the Federal Reserve will continue to boost its federal funds rate by one quarter of a percentage point at its meetings, bringing the rate to 4.5 percent at the end of January.

The federal funds rate has increased from 2.03 percent last December to 4 percent on Nov. 30, 2005.

Despite rising rates, sales of new single-family homes jumped an unexpected 13 percent in October to a record seasonally adjusted annual rate of 1.424-million units.

Responding to rising rates and other factors, single-family home builders showed lower confidence in the NAHF/Wells Fargo Housing Market Index (HMI) for November, which declined eight points to 60, a level well below the midpoint, which indicates that a majority of builders still see conditions as positive in their markets.

AGC’s Simonson, however, said, “I’m optimistic about non-residential and even single-family construction. The first few months of 2006 should be positive for homebuilding, although for the year as a whole residential will probably be down a bit. On the multi-family market there may be some revival of rental housing and construction because people will not be buying as many houses or will be sticking around in rental properties longer.”

Costs of Materials Increasing

On the down side, economists are wary that costs of materials may continue to rise.

“Though the total value put in place in the highway market should be slightly higher than in 2005, many contractors will find that, though they’ve taken in more, they’ve also spent a lot more,” Simonson said. “The costs of diesel fuel are a big item. Who knows where it will end up? Asphalt costs will also be substantially higher and cement costs will continue to rise at a double-digit pace.”

ARTBA’s Bill Buechner said, “The real question is how much of the [highway construction] growth will be absorbed by rising construction costs. Higher construction costs caused by dramatic increases in steel, cement and petroleum prices could absorb much of the expected growth in 2006. Materials used in highway and bridge construction are on track to cost about 13 percent more in 2005 than 2004 while total costs, including labor and overhead, will be up about 7.5 percent.

“Even if prices stabilize at their current levels, highway construction projects will cost about 4.5 percent more in 2006 than in 2005. This could absorb much of the projected 5.4 percent investment increase, leaving little to finance additional projects. If prices continue to rise, higher costs would consume all of the projected investment increase and could even force states to postpone or cancel some budgeted projects.”

Equipment Distributors Optimistic

Approximately 86 percent of equipment distributors and rental company executives attending the Associated Equipment Distributors (AED)/Qualcomm Conference in Chicago, IL, on Sept. 9 to 10, said they expected revenues to increase in 2006. 30.9 percent of these predicted increases of more than 10 percent while 40 percent expected increases between 5 percent and 10 percent. 97.2 percent of equipment manufacturers at the executive forum expected revenue increases next year.

AED also polled attendees about expectations for 2005. 93.6 percent of distributors and rental executives said they expected revenue to increase this year, and 70 percent of these predicted increases of more than 10 percent.

Christian Klein, AED’s Washington, D.C., counsel, was particularly optimistic about equipment business resulting from the new transportation bill.

“Based on a formula we use, about 7 percent of each dollar spent on highways makes its way into the equipment industry,” he told CEG. “We calculate $2.5 billion in equipment industry activity next year as the result of the federal highway program.”

Klein said the federal transit program, authorized at $8.6 billion — a $1 billion increase in transit spending — also is positive for dealers as is the $3.55 billion appropriation for airport construction.

“That’s the good news,” Klein said. “The bad news, the only cloud in the sky, is that the federal water program, while it has been cut by more than 33 percent in the last two years, will continue to be cut. The estimated water infrastructure needs next year are between $12 billion and $13 billion. The federal government is spending less than $2 billion. The needs are dramatic and we will work to boost the program.”

“Dealers will also benefit from the significant and dramatic rebuilding across from the South from the devastation caused by Hurricane Katrina,” Klein said. “I think you will see an increase in demand across the South for all types of equipment, generators and everything else, in the months ahead.”

Equipment Manufacturers Expect Strong Growth

The annual business forecast of the Association of Equipment Manufacturers (AEM) in Milwaukee, WI, looks for a 9.3 percent growth in construction equipment business in 2006 after a projected 13.9 percent increase in 2005.

AEM expected machinery sales to increase 8 percent in Canada in 2006 after a 13 percent increase in 2005. In other worldwide markets, it predicts a 9 percent increase in sales next year, and an 8.4 increase in 2005.

“Our economy has been robust, and equipment sales very strong, with 2004 and 2005 among the industry’s best in recent years,” said AEM Chairman Charles Stamp, vice president, public affairs worldwide, of Deere & Company, Moline, IL.

Stamp added, however, “Business volume remains solid but our members collectively do not believe this level will be sustained … we continue to face materials shortages, including steel and higher commodity costs. The negative effect of these is a serious concern during this current expansion. While supplies and prices have eased in recent months, we still face production bottlenecks.”

AEM said that earthmoving equipment sales, including excavators, loaders, haulers, motorgraders and other machines, are expected to increase 6.6 percent in the United States in 2006 while increasing 6.8 percent for Canada and 11.3 percent for other export markets. For year-end 2005, earthmoving sales are anticipated to increase 12.9 percent in the United States, 14.3 percent for Canada, and 8 percent for other worldwide markets.

Still Some Worries

Industry sources still voiced some worries.

“I feel positive but worried about future highway funding,” said AGC’s Simonson. “I think 2006 will see higher spending because of SAFETEA-LU, and states do seem to be cranking up their spending somewhat, but I’m worried that the money is going to dry up because higher gasoline prices mean less gasoline purchases and therefore less money going into the federal and state trust funds. I think that by 2007, or certainly 2008, highway spending is going to level off or dip. Trust funds will be depleted because gas tax revenues are not coming in at as high a level as had been projected.”

Simonson said that it also appears that wages are not keeping up with the rise in the cost of living, but that consumers are able to continue financing their spending from additional income, including dividends and capital gains.

“In terms of construction wages, they have been rising even more slowly than wages in the economy as a whole because the construction industry appears to be using more and more immigrant labor,” Simonson added.

But, all in all, 2006 looks like a good, profitable year for construction. CEG