Picking up the slack: will other construction segments make up for the slump in new single-family housing in 2007?

The construction industry enters 2007 plagued by two worries: How bad will the housing slump be, and will it "infect" other construction segments? Will materials costs soar again? Fortunately, there is reason for optimism on both accounts.

The worries are not irrational. The boom in home building did a lot to make the 2001 recession shallower and shorter than it would have been otherwise, so it is logical to infer that the current plunge in home construction and sales would drag down the economy, or at least other forms of construction.

But the economy today appears to have many sources of strength that will support an expansion of construction other than housing in 2007 and probably beyond.

BRIGHT SPOTS

Several construction sectors are showing strength in the face of housing's weakness. For example:

Hotels--Chains have been reporting higher room rates and occupancy rates. As a result, they are renovating, adding to existing properties where there's enough space available and starting up new chains. Those trends should continue in 2007, thanks to high levels of business and leisure travel and a weak dollar that encourages visitors.

Hospitals--Every metro area is experiencing new construction and rebuilding. Rapidly changing medical technology requires hospitals to redesign the spaces for patient intake, diagnosis, treatment and recovery. New population centers are encouraging the spread of hospital and outpatient facilities outside their historic locations.

Energy and Power--Sustained high oil prices are triggering investments in both traditional and non-conventional energy sources, from refineries to ethanol and biodiesel plants to wind farms. The likely extension and possible expansion of tax incentives for alternative energy could stoke even more construction. Meanwhile, the power plant construction business is awakening from a five-year slumber, with 100 or more plants in the works over the next decade.

Public Construction--All states benefited in 2005 and 2006 from unexpectedly high sales and income tax receipts. Many local governments and school districts received windfall property tax receipts from fast-rising house valuations. And Congress chipped in by passing higher levels of federal aid to highways and many "earmarked" appropriations in 2005. These bonanzas will not be repeated in 2007. But the budget increases for construction that were approved by last year's legislatures, city councils and school boards will fuel activity through 2007. A record volume of construction bond issues that voters approved last November will also keep the pipeline bulging.

Housing--Even the residential market is not in a free-fall. Would-be homebuyers are likely to keep their checkbooks hidden as long as they think prices will fall further. But that makes them candidates for rental housing. Already, a number of projects designed or started as condos have been repositioned for the rental market, and buildings designed for rentals are going up after a long hiatus.

Commercial--Two nonresidential categories are likely to feel some spillover from the housing freeze: retail and office. If a new subdivision is not built, there is no need to build the local retail that would otherwise go with it. Nor is there as much demand for stores selling home building and remodeling supplies, furniture, furnishings or yard and garden materials. The small-office market will suffer as the number of real estate, mortgage broker, title and property insurance agents falls in tandem with reduced home sales.

MATERIAL WORLD

Steel and wood product price spikes in 2004 were the first of many materials prices that have shot up in the last three years. Copper, asphalt, plastics, gypsum, aluminum and concrete each had at least one year of double-digit increases. Worst of all was diesel fuel, which jumped for four straight years. Shortages and allocations of several items also made estimating and finishing jobs a gamble.

By late 2006, construction materials costs were tamer and shortages were not an immediate worry. Slower economic growth and shriveling demand from home building should keep a lid on most prices in 2007. In fact, wood and gypsum products prices should drop further in 2007, while plastics and copper prices have retreated from their record levels of early 2006. Concrete, aluminum and steel prices will probably rise less than in recent years.

But two factors make construction vulnerable to further spikes and shortages. First, the ever growing demand from fast-modernizing Asian economies for raw and finished materials puts pressure on any industry, like construction, that has little ability to substitute materials. Second, materials must be physically delivered over a worldwide transportation network that is frequently stretched to capacity and that depends on petroleum to move the goods.

TRENDSETTERS

Putting these cross-cutting trends together, 2007 looks like a good year for most categories of nonresidential construction, with more moderate materials price increases than in the past three years.

But the drop in housing construction may mask the good news for casual data scanners, because the total construction spending and employment are likely to decline despite the upturns in nonresidential numbers.

Nonresidential construction jobs up in January.

Nonresidential construction jobs jumped in January, while homebuilding employment grew chillier, according to Ken Simonson, chief economist of the Associated General Contractors of America (AGC), commenting on the January employment report from the Bureau of Labor Statistics (BLS).

"In January, construction accounted for one out of five net new jobs in the entire non-farm economy--22,000 out of 111,000," Simonson notes. "Not bad for an industry that constitutes less than 6 percent of total non-farm employment."

Simonson continues, "Nonresidential construction employment growth has been sizzling. Over the past 12 months, nonresidential building contractors and nonresidential specialty trades have boosted employment by 160,000, or 5 percent. Heavy and civil engineering construction has added 25,000 or 2.5 percent. Those rates greatly outstrip the 1.6 percent growth rate for non-farm payroll employment as a whole."

Architectural and engineering employment has risen more than 5 percent in the past year, which Simonson says is another favorable sign for the nonresidential construction sector. "That should translate into additional construction work in the next several months," he says, adding that he expects several nonresidential categories to do well in 2007, including energy and power-related construction, hospitals, hotels and resorts.

"In contrast, residential building and specialty trades employment slipped again in January, bringing the year-over-year decline to 84,000 jobs or 2.5 percent of the January total," Simonson says. "I expect home builders will continue to shrink for most of 2007, until they see a marked upturn in home sales."

Construction wages rose 4.5 percent in the last year, outpacing the 4 percent increase for all private industry production workers, says Simonson. "Part of this reflects a changing mix of construction jobs, away from lower-skilled homebuilding and remodeling to skilled nonresidential crafts. But it may also indicate that contractors are ratcheting up pay to find the workers they need," he says.

Simonson continues, "BLS sharply increased its estimate of total construction employment as part of its normal annual revision process for all industries. The January 2007 count of 7,715,000, seasonally adjusted, is more than 200,000 higher than appeared likely a month ago."

More information is available at www.agc.org.

Editor's Note: The following is based on a presentation given by the Associated General Contractors of America (AGC) Chief Economist Ken Simonson at the C&D World Convention & Exhibition held Jan. 14-17, 2007, in San Antonio.

Ken Simonson is the chief economist for the Associated General Contractors of America (AGC) and can be contacted at [e-mail].