Steady the course for 2005 growth, Yet 'risks remain'
Despite the variables in the U.S. economy, analysts and economists at Reed Construction Data's North American Construction Forecast conference late last year voiced optimism for a strong rebound. Gene Sperling, former director of the National Economic Council, told attendees at the Washington, DC, meeting that the forecasters remain bullish about a recovery. Many predict 3.5-to-4 percent growth in the first half of 2004; others see moderate growth. Sperling was cautious: "I'm not in the pessimist camp, but I'm certainly not overly optimistic."

Following a mild recession, the United States has had a disappointingly mild recovery, Sperling said, pointing out that the nation continues to suffer from job losses and considerable uncertainty nearly 22 months after a recession.

Edward Sullivan, chief economist of the Portland Cement Association, was more optimistic. He sees the economy continuing to gain strength in 2004, with a growth rate of 4 percent or more throughout the year.

The year 2005 will bring an assumption of growth in construction, said Sullivan. Moving forward, as interest rates begin to rise, residential construction will no longer be the segment leader-the growth rate for nonresidential construction will push ahead. Furthermore, "We have sustained consumer spending strength and the investment environment has improved dramatically," he said.

Commercial Market
Glenn R. Mueller, managing director of real estate investment strategy at Legg Mason Inc. and professor and investment strategist at Johns Hopkins University Real Estate Institute in Baltimore, suggested that office demand will come back. By 2005, the United States should return to the long-term average of 2 percent growth and see some new demand coming along. At the same time, hotel construction may remain depressed as a result of a 35 percent vacancy rate. The retail-construction segment continues to do well in most regions; and with continued urbanization, the United States could expect to see more neighborhood community centers, he noted.

Raymond E. Owens, vice president and senior economist for the Federal Reserve Bank in Richmond, VA, said signs of economic pickup, combined with sharp curtailment of new construction, have laid the foundation for more solid performance in the future. However, he said risks remain, as much of the improvement in commercial real estate may be tied to improvement in the labor market. He sees some encouraging signs of job creation, yet continued sluggish growth could limit demand for offices and other commercial properties. He said construction demand may not grow as rapidly as after the last recession in the 1990s. Nevertheless, the turnaround in net absorption of commercial space is powerful evidence that economic conditions improve.

Owens explained, "Virtually all job losses have been centered in manufacturing, and we know that the manufacturing sector continues to be hard hit. But other sectors don't look quite as bad." Vacancy rates in central business districts continue to increase. There has been some leveling of vacancy rates in suburbs due to minor improvement in their labor markets-a hint that perhaps their local economies start to level out. Class A space shows the most improvement, according to Owens. In past economic cycles, office-market improvement was led by demand for the best spaces.

Residential
David Seiders, chief economist for the National Association of Home Builders, said that the nation can maintain the ongoing strength of home sales and housing production. However, he would be surprised at such growth without also getting reasonable job growth.

He sees this sector falling into place soon because rates for 30-year mortgages are rising. On other fronts, residential remodeling performs well and grew to a $180 billion market in first quarter 2003. Seiders expected 4-to-5 percent growth in this sector during 2003, and the same for 2004-05.

Economic Growth for Canada and Mexico, Too
Canada is expected to post the strongest construction growth in North America for 2004, according to Roger Grant, vice president of Reed Construction Data in New York City. He said residential construction, like that in the United States, was very strong with more than 205,000 starts expected last year, spurred by low mortgage rates. Housing construction there exhibits a fairly cyclical pattern and appears to be near a peak.

Commercial construction in Canada presents a mixed picture. The hotel and motel business was devastated by the SARS epidemic, Grant told attendees at Reed Construction Data's North American Construction Forecast conference late last year in Washington, DC. Hotel occupancy rates declined as much as 15-to-20 percent in the first half of 2003, virtually stopping any construction not already on the boards. Forecasters expect hotel construction to rebound in 2004, posting fairly strong growth, but on a very low base with some already planned projects coming through for resort areas in the West and in Ontario.

The picture is much brighter in the Canadian institutional sector for a number of reasons including pent-up demand, particularly for health and welfare projects, with many provinces in fiscal positions to address backlogs. In the school market, while population analysts forecast lower demand on the elementary side, they predict increased demand for higher education facilities.

Grant also sees a rise in philanthropy benefiting cultural projects. This trend is expected to continue for several years, with major projects in the pipeline. Institutional starts have been projected at 35.5 million square feet for 2004.

Some return is expected in the office-building market during 2004. The vacancy rates for office buildings, currently around 11 percent, have increased only nominally in the last year, with some pent-up demand based on locations within selected metropolitan areas.

The one bright spot in the Canadian commercial construction forecast, as in the United States, is the retail segment. Actual 2003 starts are expected to near 16 million square feet, up significantly from last year's forecast of slightly greater than 9 million square feet. This appears to be a stable and strong market segment, driven by consumer spending and strong residential construction.

Delayed recovery of the U.S. economy and the rising value of the Canadian dollar have affected the Canadian economy negatively. The currency value has risen recently, affecting manufacturing demand and all related construction. According to Grant, the Canadian dollar is currently worth about 75 cents in the United States, and many economists are concerned about it. Looking at 2004, however, economic growth is projected to be more than 3 percent in Canada-moderate growth, but stable and positive, based on the key assumptions of U.S. economic growth and a Canadian dollar worth less than 75 cents in the United States.

Mexican Construction
As Mexico emerges from a sharp cyclical recession, observers of its economy look to reforms to strengthen performance, according to Grant. Because Mexico has very low personal tax rates, the country has difficulty raising funds for infrastructure, housing and educational construction. Proposed reforms address that situation and reduce reliance on the state-controlled energy sector for funds. To attract outside capital to run the country, Mexican officials must keep relatively high interest rates, thereby affecting the country's ability to generate funds for internal construction. High energy prices provide some additional government funding for construction projects, however.

In the commercial sector, office-vacancy rates for new buildings in Mexico City were expected to approach close to 28 percent by the end of last year. There has been quite a bit of overbuilding and rental rates are expected to drop drastically. Few new projects are being started, yet the numbers of project starts increase among resort and business-class hotels.

Grant reported that the nonresidential building sector is expected to see growth of more than 5 percent during 2004, with the public buildings category expected to grow nearly 4 percent. And faced with strong demand for educational facilities, the Fox administration has committed to redirecting more funds for this purpose.

Commercial Markets, at a Glance
Arkansas, Mississippi and Kentucky: Commercial construction does a little better in parts of these states.
Atlanta: Small improvements in net absorption.
Boston: A steady market, some positive net absorption.
Chicago and the Midwest: Not much change; conditions continue to soften.
Cleveland: Signs of improvement.
Dallas: Commercial real estate markets look optimistic.
Kansas City: Slight weakening in recent months-after previous signs of stabilization- with vacancy rates inching higher.
Minneapolis: Quite slow, some signs of improvement.
New York City: Some improvement led by strong recent activity in Class B commercial spaces; overall, vacancy rates have declined.
Philadelphia: Conditions steady and virtually unchanged in recent months. Rental rates continue to decline somewhat.
Richmond, VA: Generally flat, but improvement in some areas. Positive absorption for the first time in quite a while.
San Francisco: High vacancy rates continue to characterize a few areas; little construction.

-Federal Reserve Bank, Richmond, VA

Source: Glass Magazine, January 2004.