U.S.: Still Hammering Away Just Not So Hard
During the winter months, the construction data often tell you more about the weather than about the amount of money consumers and businesses are shelling out for new homes, offices, and stores. A mild winter means more building. Snow and ice can temporarily shut the industry down.
But looking beyond the seasonal blips, how is the outlook for construction in 1999 shaping up? The answer depends on which sector you're looking at. Residential building will be supported by low interest rates, tight labor markets, and a strong stock market, although builders will not be as busy as they were in 1998. Nonresidential construction, already sagging in 1998, will continue to shrink in 1999, as capital budgets of businesses are squeezed by poor profits and cash flow and tighter credit conditions.
The trends are evident in the November data for construction spending, which showed that total outlays rose 0.9%, based on a 1.2% jump in residential building and no gain in nonresidential construction. Moreover, while soaring November home sales point to continued resilience in housing, data on new construction contracts highlight the ongoing weakness in the business sector (chart).
The value of new nonresidential contracts edged up in November, but they had tumbled to a 2 1/2-year low in October. Since August, contracts have dropped 17%, suggesting that last year's slide in business expenditures for new projects is intensifying. Nonresidential outlays fell in the first two quarters of 1998, did not grow in the third quarter, and monthly data show that spending so far in the fourth quarter is above its third-quarter level.
WITHIN BUSINESS CONSTRUCTION, two main trends in 1998 will continue in 1999. Office construction will expand further, while industrial building faces more erosion. After the overbuilding debacle of the 1980s, office developers have been more prudent in the 1990s. When the recession ended in early 1991, office vacancy rates for U.S. downtown, metropolitan, and suburban areas stood at 16.6%, 19.1%, and 20.8%, respectively. Since then, rates have fallen steadily to below 10% for all three categories, the lowest since the early 1980s.
The F.W. Dodge Div. of The McGraw-Hill Companies expects commercial office space to increase 5% in 1999, after surging 23% in 1998. Moreover, with office space tight, rents are likely to rise, enhancing the expected returns on new buildings. However, not all commercial construction will fare as well as office building. Recent rapid growth in retail stores and hotels makes those two sectors especially vulnerable to any slowdown in consumer spending.
Industrial construction faces the toughest road in 1999. Already, real outlays for new plants and warehouses have declined in each of the past three months, and they are down 8.6% from a year ago. Manufacturing companies have no incentive to expand their facilities: Production is stagnant. Employment and capacity use are falling. Foreign demand remains weak. Domestic demand is expected to slow. And pricing power has evaporated.
The sector's woes are evident in the latest report from the nation's purchasing managers. The purchasers' composite index of industrial activity fell in December to 45.1%, the lowest reading since the 1990-91 recession, suggesting a worsening contraction in the factory sector (chart). In particular, the purchasers' employment index fell to the lowest level in nearly seven years, suggesting more layoffs, and their price index dropped to the lowest level since 1949. Until manufacturing activity bounces back, companies simply will not be building new facilities.
WHILE MANY COMMERCIAL and industrial developers may be on shaky ground in 1999, homebuilders can look forward to another solid year, although not as spectacular as 1998. That's because household financial fundamentals will not be as powerful as they were in 1998, and because so much demand has already been satisfied.
Clearly, 1998 was a banner year for housing. Sales probably totaled 880,000 for all of 1998, the best year ever. In November alone, sales of new single-family homes shot up to a record annual rate of 965,000, up 7.6% from October's rate, which was revised to 897,000 from 851,000 (chart). Unseasonably mild weather--the warmest November since 1990--appears to have boosted the month's total. Still, builders tried all year to catch up with surging demand. The November inventory of unsold homes slipped to a record-low 3.7 months' supply. And starts of single-family houses in 1998 were the strongest in 20 years.
Four factors have bolstered demand: Strong labor markets made consumers confident about their job prospects, so they were willing to make the financial commitment of homeownership. Solid income growth gave them the means, and stock market gains gave many a source for the downpayment. Plus, low mortgage rates have made home buying more affordable.
THE OUTLOOK FOR EARLY 1999 remains upbeat, as long as Old Man Winter doesn't hinder construction. A December survey of homebuilders showed them very optimistic about sales over the next few months, while mortgage applications to buy a home in December remained close to November's high level.
Demographics is a key reason housing will slow this year. In the long run, the major determinant of demand is the number of new households formed. And for the past three years, builders have been putting up homes at a faster rate than young adults are moving out on their own. In addition, a record 66.8% of families are homeowners, making for fewer potential new buyers.
The financial landscape will also bring housing activity down a notch. The stock market is not expected to repeat its gains of the past few years, so consumers may have to channel more of their current income toward retirement accounts or college funds. And long-term interest rates are expected to rise over the course of 1999, lifting mortgage payments as well.
To be sure, housing isn't expected to fall back by much. For the entire year, the National Association of Home Builders expects starts to average 1.48 million. That's down from 1.61 million in 1998, but it would still be the second-best showing of the 1990s. And the economy will get a lift as the home buyers of 1998 continue to purchase furniture, textiles, and electronics for their new abodes.
Unlike 1998, however, when a roaring housing market offset the decline in nonresidential construction, this year should see both construction sectors on a downtrend. It's just that housing won't decline nearly as much as commercial construction. Even so, slowing building activity overall will provide another tap on the brakes to slow the U.S. economy in 1999.