Mid-Year Mark:Industry Growing at Record Pace

Mon June 28, 2004 - National Edition
Pete Sigmund

Midway through 2004, the construction industry appears vibrant and poised to set some new records, but don’t start cheering yet. The industry still has problems.

The good news is that the total value of construction put in place thus far in 2004 continues at its record-setting pace of the past three years.

“The total figure for April was a seasonally-adjusted annual rate of $970 billion, already up 8 percent from the $898 billion for 2003,” Ken Simonson, chief economist of the Associated General Contractors of America (AGC) in Washington, D.C., told Construction Equipment Guide (CEG). “April was a record, up more than 1 percent from March, which was also a record, as was February.”

Simonson said that, if the pace continues, 2004 will set yet another record for the entire year.

Robert A. Murray, vice president of economic affairs of McGraw-Hill Construction in New York, NY, told CEG that “in general, now we’re looking at about a 3 percent increase in the value of new construction starts on the basis of stronger-than-expected single family housing.”

Murray said he expects the economy to grow approximately 4.7 percent during 2004. He authors McGraw-Hill’s annual construction outlook, one of the industry’s most respected forecasts.

The Commerce Department reported on June 16 that the economy grew at an annual rate of 4.4 percent in the first quarter of this year. Industrial production surged 1.1 percent in May, the strongest performance in nearly six years.

Not All Rosy

A rosy scenario? Not entirely.

“That’s very strong growth, but it’s still very uneven, just as we’ve seen in the last two years,” Simonson said. “It’s dominated by strong residential construction, including single-family new, multi-family new, and improvements like remodeling. The April figure also included an unusual jump in public construction, which may be an aftermath of slow winter months, because, in general, public construction has been weakening slightly. The private non-residential segment is still very weak, less than a quarter of the total.”

And, although highway and bridge projects are steamrolling along at near-record levels, new contracts are down, a bad omen for the future. Congress is nine months behind in authorizing a new six-year highway and transit bill, sowing uncertainty among states and contractors. State departments of transportation (DOTs), meanwhile, are experiencing delays in receiving federal funds already appropriated, so they’re holding up some contract lettings. Materials shortages, including steel and cement, are bedeviling the industry, increasing project costs and inflationary pressures.

Housing Starts Approach Another Record

One of the driving forces behind the recovery has been the tremendous growth in purchases of new single-family homes. These houses set a record of1.499 million starts last year. The pace so far this year is even better.

“Mortgage rates remained quite favorable during the early part of 2004, so that boosted single-family starts in the first half of the year, with total starts at an annual rate of about 1.9 million,” Michael Carliner, economist of the National Association of Home Builders (NAHB) in Washington, D.C., told CEG.

“We think these starts will begin to fall below 1.5 million in the second half of the year but it looks like we will finish 2004 a little above 2003 for another record.”

Carliner said starts of multi-family housing also have been strong (though not as strong as for single families). “I keep thinking it’s time for them [multi-family] to slow down, but they haven’t slowed down very much,” he commented. “We are seeing — and I think we will see more — multi-family condo units, which are probably being under-built. But rental units are still being produced at a pretty hefty clip, about a third of the record pace back in 1952.”

Though single-family starts will remain an important part of gross domestic product (GDP), Carliner said they won’t boost GDP growth as much as during the last year or two.

“This sector will stay at a high level, and may go up a little bit, but in terms of the amount of growth it contributes, it will probably be pretty flat,” he said. “It will probably stay level, at a high level, during the second half, but could actually hold GDP growth back a little bit.”

Low Mortgage Rates Continue

Low mortgage rates (under 6 percent in December 2003) have been a big reason for the increasing sales of single-family homes. Rates are now running approximately 6.3 percent and NAHB expects them to rise to approximately 6.6 percent by the end of 2004.

Is the record-setting pace this year a surprise?

“We started to see mortgage rates rise last July,” Carliner said. “We thought that was the end of the cheap mortgage money. Yet by this March rates were second only to June of 2003 considering the last 45 years. So we got a second wind out of mortgage rates, which we didn’t really anticipate.

“We’re thinking that by the end of 2005, rates will be around 7.25 percent or a little more,” Carliner added. “That’s a little bit, but not a lot, higher. If we start moving much above 7 percent, I think it will start to bite [affect purchases] quite a lot more. The difference between six and seven would be less than between seven and eight.”

Discussing the federal funds rate that banks charge each other on overnight loans (now 1 percent), Carliner said, “These short-term rates by themselves don’t have a huge effect on housing. They do affect the cost of borrowing for builders, but the really important thing is what happens to the cost of borrowing for homebuyers. Most homebuyers are getting fixed rate loans and those are much more tied to long-term interest rates.”

Mixed Results for Highways and Bridges

Highway and bridge projects pushed ahead at a torrid pace this year, though new contracts slowed down.

“We have two pretty divergent indicators of what’s going on,” said William Buechner, vice president of economics and research of the American Road & Transportation Builders Association (ARTBA) in Washington, D.C.

“First, the value of construction work actually performed on highways and bridges from January through April was close to a record, with a dollar value of $14.7 billion, up 10 and a half percent compared to the first four months of last year, which were pretty weak because of the weather. So we saw four very strong months of construction this year. Part of that may be due to very good weather. Of course, four months don’t make a year, and there’s still plenty of time for things to go bad, but so far things are going better than anybody expected.

“On the other hand, things are not going so well in new contract awards, the other indicator which we follow. New awards for highways and bridges by state and local departments of transportation were $16.2 billion for the first five months compared with $19.6 billion for the first five months of last year, down 17 percent, and $20.8 billion for the first five months of 2002.”

So ongoing work is up but new awards are way down.

“Contractors have a lot of ongoing stuff and they’re working hard on what’s out there, but the pipeline on new work from state DOTs is kind of emptying out,” said Buechner. “The fact that we don’t have a new federal highway program in place is contributing to this decline, but that only explains a small part of what’s going on. States are still having budget problems.”

Buechner said that even worse than the uncertainty over the highway bill is the fact that “states have been getting this year’s federal money [already appropriated] in dribs and drabs.”

“If they had received the money [$33.6 billion] at the beginning of the year, and they knew how it would be distributed among the states, I don’t think they would be holding back as much,” he said. “Part of the problem is that the Federal Highway Administration [FHWA] is distributing this year’s money on the basis of last year’s formulas. If Congress enacts an authorization bill that changes the formulas, they may have to go back to the states and take money away from some of them. I don’t think they would do that, but it’s another thing that is causing uncertainty. We’re three quarters of the way through the fiscal year. States can’t be obligating federal money and then have that money taken away.”

Buechner said this picture is “mixed at the moment, can always turn around, and hopefully it will, since we are getting right into the middle of the main construction season which runs from March through September.”

Uncertainty Delays Contracts

McGraw-Hill’s Murray, who bases his studies on the value of new lettings rather than the value of ongoing projects, gave the following explanation for the slowing of new highway contracts.

“The public works sector, specifically highways and bridges, is turning out weaker because uncertainty over the shape of the new federal transportation bill has dampened construction in the near term. McGraw-Hill will forecast a 5-percent decline in highway and bridge construction [starts] during 2004. Other major sectors are pretty much holding on target.”

AGC’s Simonson said the highway and bridge sector “has been especially hard hit by the run-up in steel and asphalt prices and now the cement shortages, so it’s much more questionable.”

He agreed with Buechner and Murray that another negative factor is that Congress is unable to complete work on a new six-year highway-authorization bill that provides federal aid for construction.

“States are going to rein in their new contracts until they get certainty about how long, and at what level, the federal money will be coming in,” he said. “Usually, the states like to have a long lead time knowing that the federal aid will be coming for several years. The last bill expired Sept. 30 and Congress has just been passing two-to-four-month extensions while they try to work things out. It looks now as if Congress won’t get by beyond the end of July or August with the next extension [expected during the week of June 27].”

Asked about a possible decline in work because of this, Simonson said, “Certainly we’ve seen some specific cases that are very dire. Virginia is in the process of cutting $1.2 billion from its six-year highway program because the state money is not coming in. Other states are really scrambling to fund either their match for the federal dollars or the purely state-funded programs.

“I think total dollars [on highway construction] are going to be flat or slightly up compared with 2003. If they have to put more dollars into a given mile of bridge or asphalt, that means fewer contracts, so it’s not inconsistent with what McGraw-Hill is saying [a decline in construction starts]. If a state expected to spend $100 million on a bridge and, because of steel and cement costs, the lowest bid is $125 million, that’s $25 million which they don’t have for some other contract.”

Delay Affects Dealers

“Uncertainty over reauthorization, and the slowdown in state spending on future projects, are impacting equipment sales because they affect purchases by contractors,” said Charles Durocher, associate Washington, D.C., counsel of the Associated Equipment Distributors (AED), Oak Brook, IL.

“According to what I’m hearing from members, the construction equipment business is going pretty well and improving with the economy,” he said. “Economic prospects are better than the last couple of years. However, if they can pass a reauthorization bill relatively soon, it will help solidify that recovery, which is still not absolutely solid.”

Durocher said the Bush Administration, criticized for Medicaid reform and revised cost estimates, “unfortunately has chosen the transportation bill for taking a fiscally conservative stand, standing firm with its $256-billion proposal.

“In the opinion of many people, this was the wrong bill for taking that stand,” Durocher said. “The funds are dedicated from the Highway Trust Fund, so you’re not taking money from the general fund, and you’re creating jobs while addressing an important need.”

Upturn in State Revenues

On a more positive note, Simonson said that states have seen a big upturn in revenues during the past two quarters, so they will feel they have more money for construction by the time their legislatures meet again next spring.

“The report for the first quarter of 2004 shows an 8.1-percent gain in state revenues, which was the biggest quarterly gain in 14 years,” he said. “That’s from sales taxes, personal income tax, and corporate income taxes. This bodes well over the longer haul for construction. I think the era of cutbacks is coming to an end.”

In CEG’s December 2003, forecast for 2004, Simonson said construction of highways had remained strong, despite shortfalls in state income, because projects were using the pipeline of money appropriated several years ago.

“Now we’re seeing the other side of the coin,” he said. “The delays were good at a time when other industries were in recession and the states were starting to cut back on spending because their revenues had fallen. Now the states are seeing a pickup in revenues but it takes a long time before the construction pipeline fills up again.

“It will take a while to appropriate the money and then go through the design and bid process, so contractors should not expect an immediate pickup in new contract awards on the public side. I’m confident that at least the pipeline will stop emptying out. Right now, in the shorter term, however, I keep hearing that their order books are really thin on public construction except for highways and school districts,” he added.

Simonson said some areas of private non-residential construction, meanwhile, “are starting to get well,” pointing out that the pickup in business and tourist travel should spill over into new hotel construction. But he added that the office, factory, and warehouse sectors “are still weak and likely to be weak for the rest of this year.”

Price Increases

Rising prices of materials — including steel, cement for concrete, diesel fuel, wallboard and plywood — severely impacted the industry during the first six months.

AGC’s Simonson commented, “I’ve been taken aback by how extensive price increases have been. It varies a lot by material, but I think 2004 will be a year in which we’re likely to see a lot of unpleasant surprises on prices. We’ve already seen a lot of increases on steel. There’s some signs that those may start reversing, or at least flatten out, now but any contractor who bid a job before the beginning of the year is still stuck with those [prices]. I don’t expect finished-steel prices to come back down to where they were last year.”

Simonson also expects higher delivery costs, “Motor carriers have been quite successful for the most part in passing through their higher fuel costs [to customers].

“Fuel costs of course are also affecting contractors directly in operating their off-road equipment and dump trucks, bringing equipment like cranes and dozers to their sites, and purchasing material that incorporates petroleum, notably asphalt but also some insulation or roofing materials. I don’t think any of those costs have gone up as much as gasoline, however. Diesel prices rose about 25 cents since the beginning of the year while gasoline jumped as much as 60 cents.”

Do rising prices mean that inflation has hit the industry?

“Unfortunately, you might characterize this as the worst of both worlds,” Simonson replied. “There are certainly big price increases on the materials side, the input side, but they [contractors] are not necessarily able to pass them through. I think that for the most part owners have still been pretty resistant to accepting increases, partly because they are not yet showing much pricing power in passing them through to consumers or to renters. Office buildings and shopping centers are still a very soft market, with a lot of vacancies.”

Though materials costs loom large, especially for subcontractors, Simonson said labor costs are even more important, “and we’re still not seeing any run up in wage rates.”

NAHB’s Carliner said that some of the sharp price increases for materials are starting to ease off.

“Wood prices are down from their peak in April and are no longer on an uptrend,” he said. “We’re starting to see the price of steel scrap, which drove steel up in the first place, easing off. I think increases in the price of steel and metals will probably be at least slowing down, if not reversed. Shortages are beginning in a few other products like insulation and gypsum wallboard, but I don’t they will be huge problems.

“Cement, however, is a pretty serious problem in some local areas, especially Florida, and I think this is likely to get worse before it gets better. The problem is not price as much as allocation, and that can disrupt construction schedules. These delays may be more costly than a higher price.”

Interest Rates Rising

The Federal Reserve is widely expected to raise the federal funds rate by at a quarter of a point at its next meeting on June 29. How will this affect construction?

“I’m still optimistic that rates will go up slowly and in small increments,” Simonson said. “The first effect will be on housing, which I think will taper off but not plunge, but I see little direct impact on construction.”

NAHB’s Carliner told CEG, “We think the Fed will raise interest rates when they meet and that rates will be at 3.5 percent, or maybe even higher, by the end of 2005. That’s still not very high by historical standards. The anticipation of short-term rate increases has already been reflected in long-term rates and will be reflected further.”

Job Growth

Hiring has increased rapidly this year in construction and many other industries.

The Bureau of Labor Statistics (BLS) reported that the construction industry employed approximately 337,800 people in April 2004, compared with 318,200 last April.

Other sectors of the economy have also been hiring during the past six months.

“The economy had been expanding for two years with no increase in employment; it is only since the beginning of this year that we’ve seen employment pick up at a pretty rapid pace, about 300,000 jobs a month, and people feel like it’s a recovery,” NAHB’s Carliner said.

“That will offset some of the negative impact of higher interest rates. However, employment declined in 2002 and through most of 2003 so we’re still below where we were at the beginning of 2001. While it [the rate of growth] is not dramatically higher than it was during the 90s, it’s an awful lot better than the last few years.”

Looking ahead, Carliner said, “We still have a lot of ground to make up in terms of employment. We still have a lot of slack in the economy so I don’t think we’re on the verge of a new recession. Most industries still have a fair amount of room for growth in terms of capacity, though that hasn’t been true for a lot of building materials industries which are running pretty much flat out [at capacity].”

The unemployment rate, meanwhile, was 5.6 percent in May, according to BLS.

Boom in Equipment Manufacturing

The market for construction equipment has been strong, almost booming, this year.

“Our survey for the first quarter of 2004 showed a real solid turnaround,” said Nick Yaksich, vice president of government affairs in Washington, D.C., of the Association of Equipment Manufacturers (AEM) in Milwaukee, WI.

“It has been positive on all fronts, including strong domestic demand plus international demand stimulated by weakness in the U.S. dollar. We’re seeing a strong demand for equipment after the down cycle of the last two or three years when manufacturers have gone through inventories. Now they’re starting to build again. Factories are humming. They’ve become more efficient through the lean times and they’re using that productivity now to have a very solid year in manufacturing construction equipment, which I would almost characterize as booming.”

Yaksich added, “Equipment is needed in almost all sectors in the current economic recovery. Housing starts and commercial development are continuing. States are now putting money into highway funding to provide continuity and growth. We’re seeing a combination of positives, which began in the fourth quarter of last year and just took off this year. The upturn is pretty much across the board — from manufacturing plants themselves to dirtmoving, roadpaving, excavating and utility equipment.”

Yaksich also sees several uncertainties: the war in Iraq, the price (and sometimes unavailability) of steel — which hurts manufacturers’ profits and may cause some to add surcharges — and the delay in extending the highway program.

But he’s optimistic on the need for roadbuilding equipment:

“There has been continuity. States are able to move some money around to match the federal money so they don’t lose funding. Any time you have that uncertainty out there, it causes some uncertainty within the states but I haven’t seen a significant impact on lettings or contracts. So far we’re not seeing an impact on equipment sales.”