The U.S. economy is set to move into high gear in 2004 according to the latest economic forecast from the Portland Cement Association. The optimistic outlook arrives courtesy of recent improvements in U.S. labor markets; however, the Portland Cement Association (PCA) does not expect robust construction activity to arrive until 2005.
Chief economist Edward Sullivan explains, "The seemingly contradictory outlook is based on the prospects of cooling single-family construction under the weight of rising interest rates, a delayed and muted improvement in commercial construction activity, and a public construction sector still coping with state-level fiscal crises."
PCA reports the emerging economic recovery will create jobs, escalate wage gains, and lead to stronger capital gains. Combined, these factors will strengthen states' tax base, resulting in a gradual easing of fiscal stress.
Long-term Replete with Optimism
Optimism, absent from the U.S. economic outlook for some time, is now permeating nearly every corner of the economic spectrum. This spirit of optimism arrived on the scene only recently with improvements in the U.S. labor market. However, there remain skeptics whose thinking is still colored by prolonged anemic growth conditions that endured from the fourth quarter of 2000 until the second quarter of 2003 (with economic growth averaging a meager 1.9%).
Fortunately, those days are behind. The economy is poised for a sustained period of relatively robust conditions, with real GDP growth to average between 3.5 to 4% annually.
Residential Construction Outlook
The residential sector accounts for roughly 25% of overall construction activity and is comprised of single-family construction, multifamily construction and home improvements. This sector, despite its relative size, has been raging during the past two years and is responsible for providing essential support to the construction industry and overall economy during the past two years.
While single-family construction will remain at historically strong levels, the economic conditions that are expected to materialize by mid-2004 are adverse. Mortgage rates will begin a sustained ascent beginning late in the second quarter. The increase will adversely affect homebuyer affordability. However, it is important to note that housing starts will remain near record levels during the first half of 2004.
Furthermore, adverse consumer affordability issues are not overwhelming they are just strong enough to take the edge off the extremely strong market conditions that currently prevail and induce a modest decline in building starts and single-family construction spending.
Without a more rapid increase in interest rates than currently anticipated, a single-family housing bust is not in the cards. Indeed, in some key cement consuming states such as California, Texas and Florida, extremely favorable population and demographic conditions will soften the declines in single-family activity.
Multi-family construction activity has been adversely impacted by the low mortgage rate environment. Low interest rates have decreased the spread between the average monthly mortgage payment and average monthly rent. In 2000, the average monthly mortgage payment was roughly twice that of the average rent. By mid-2003 the mortgage payment premium was only 25%. This measure does not take into consideration the tax benefits of home ownership.
As monthly payments approached parity, more and more apartment dwellers were able to become homeowners resulting in rising apartment vacancy rates. As vacancy rates moved upward, landlord discounts and a general easing in rental prices materialized, translating into a dismal picture for multi-family investors. Unfortunately, the current adverse conditions are not going to change anytime soon.
The 9.6% average apartment vacancy rate will probably worsen before it gets better. Even as interest rates climb and keep more potential first-time homebuyers in apartments, it will take the better part of a year before vacancies decline to a level prompting acceleration in multi-family construction activity. Nonetheless, the revival in multi-family construction is expected to be very modest.
Nonresidential Construction Outlook
Nonresidential construction accounts for roughly 25% of overall construction activity. Soft economic conditions have resulted in dismal performances by the sector's three largest players industrial, office and retail construction activity.
Among these sectors the anemic performance of the economy has resulted in low industrial capacity utilization rates as well as rising office and retail vacancy rates, diminishing the need for new investment. At the same time, the soft economic conditions punished corporate profitability and created a harsh lending environment diminishing the ability for new investment.
With the exception of retail construction, one or two quarters of favorable economic news is not going to favorably turn the conditions facing the office and industrial sectors. It typically takes a year before industrial construction activity turns positive. If this trend holds, it implies a 2004 recovery for industrial construction. In the meantime, industrial construction activity will continue to record negative growth, albeit at more moderate rates than encountered during 2003.
Public Construction Outlook
It is important to recognize that more than 90% of public sector construction activity is carried out by the state and local governments. As a result, the fiscal conditions of state governments largely dictate their ability to carry out construction activity. The sustained period of anemic economic growth has caused historic budget deficits at the state level.
The composition of construction growth is on the verge of change. In past years, residential activity has been the principal source of strength in the construction market. Growth in public construction activity has been under fiscal stress and nonresidential has suffered as a result of anemic overall economic growth conditions. Moving forward, PCA expects nonresidential and public spending construction activity will increasingly become the growth leaders with residential construction recording negative growth.
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