On the Brink of Recovery
Economist Forecasting Slight Jump in Construction Spending for 2004
By Natalie Keith

With the worst of the economic hard times ended, McGraw-Hill Construction is predicting a slight increase, or 1 percent, in total construction activity nationwide for 2004.

A 1 percent increase would translate into $508.9 billion in total construction spending for 2004, up from 2003 spending of $505.6 billion.

"I do think that the worst of the commercial correction has taken place and we're now poised for some improvement, but the timing is uncertain," said Robert Murray, McGraw-Hill Construction's vice president of economic affairs. "It may not show up fully in the first half of 2004, but by the time we get to the latter half of 2004 and into 2005, it should be there."

Murray addressed industry professionals in breakfast sessions across the country this fall. With the nation's macroeconomic climate as a backdrop, Murray outlined historic data of the U.S. construction market by sector and delivered McGraw-Hill Construction's predictions.

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When Murray delivered his speech in late October, the economy appeared to be showing signs of steady improvement, a marked change from the type of fragile and unsteady expansion it had seen in 2002 and 2003. The gross domestic product for the third quarter grew by 7.2 percent, outpacing predictions of 4 to 6 percent. Economists are projecting a 4 percent growth rate for 2004.

"This hesitant expansion we've been seeing does seem to be getting legs," said Murray. "This expansion finally seems to be taking hold."

He was quick to point out, however, that two factors could potentially damage the economic outlook over the next year - the unemployment rate and tepid level of business investment.

"We need to see a pickup of employment to sustain momentum," and job creation tends to lag the pattern of the economy, he said.

Steps taken by the federal government, including 13 rate cuts by the Federal Reserve and the tax cut in May, were having an impact on consumer spending. But business investment has been slower to respond, with banks showing lending constraint in recent years.

This has caused plans for some commercial projects to stall. For example, in New York City plans to build new headquarters for The New York Times have been delayed because the developer was having difficulty obtaining financing for the project.

"If the stock market does show more of a sustained upward movement it would bode well for a sustained pickup in business investment," Murray said.

Despite the fragility of the current economic climate, there is reason for optimism in 2004, in part because the construction industry has weathered the economic storm of the last few years "pretty well," Murray added. Across sectors, spending was "in retreat, but not collapse," he said.

The resilience of the industry has been due, in large part, to the single-family housing market. Construction spending in this sector has been on the rise since 2000 when $177 billion was spent. In 2003, spending rose to $230.5 billion.

"Single-family housing has been the savior," said Murray. "It's headed (in 2003) for its strongest level of activity since 1978, eclipsing any year in the 1980s and 1990s."

Despite its strength, McGraw-Hill Construction is predicting a 2 percent decrease in single-family housing spending for 2004 to $226 billion, although the reduced number would still reflect the highest spending level since 1978, he said.

One sector where marked improvement is expected is income properties, such as offices, hotels, stores and multifamily housing. McGraw-Hill Construction is predicting a 9 percent increase in spending from $92.9 billion in 2003 to $100.9 billion.

"This is a sector that responds to the overall economy," Murray added.

In the office market, despite higher vacancy rates and softening rents, there were geographical locations that saw increases in starts in 2003, such as Chicago, which saw a 66 percent increase, and San Francisco, a 724 percent increase. This was a marked change from 2002 where nearly all of the cities in the top office markets saw decreases in office starts. This is noteworthy because it is "a pickup among weak fundamentals," Murray said.

McGraw-Hill Construction is predicting a 2 to 3 percent rise in store construction spending, a 13 percent increase in warehouse spending and a 10 percent increase in hotel spending.

"When you look at the plans of various lodging firms, you get the sense that they're trying to catch the upturn," Murray said.

With construction undertaken by the public sector, the outlook is not as bright. The weak fiscal position of the federal and state governments is having an impact on public works spending and institutional spending.

For example, Virginia cut its highway building program by 29 percent, Illinois halted construction of a prison and California delayed highway projects in Southern California as a result of budgetary constraints.

Nationally, spending on highways and bridges was down 6 percent, from $43.5 billion in 2002 to $41 billion in 2003. Environmental public works spending on water supply systems, sewers and dams was down 13 percent, from $27 billion in 2002 to $23.5 billion in 2003. Overall spending on public works projects was down 10 percent in 2003.

"As states have struggled to get themselves into balance, they have cut back on public projects," Murray said.

Although little change in expected in state funding for 2004, the federal government could make up some of the lost ground in public works.

At the time of Murray's speech, there seemed to be support in Congress for increased public works spending despite a projected deficit level of $480 billion.

"It's as if they're saying, 'deficit be damned, it's full speed ahead for public works projects,'" Murray added.

With the projected increases in mind, McGraw-Hill is predicting a 2 percent increase in public works spending for 2004 to $80.5 billion, although the projection is contingent upon the federal government passing a budget at proposed rates of spending.