Construction: Still Building

-- With interest rates rising, residential construction will be off its torrid pace of 2004 -- Commercial developers will pick up the slack with new office and retail projects

For the first time in four years, the banging of hammers will be a bit quieter in 2005, as the pace of homebuilding cools. Squeezed by rising interest rates, 1.55 million single-family houses will be erected in 2005, down 3.6% from last year's all-time high, but still the second-best count ever. The big brake: The 30-year fixed-rate mortgage is likely to hit 6.75% by yearend, up from an average of 5.9% last year. The pace also will slow partly because last year's sales were so exuberant, says David F. Seiders, chief economist at the National Association of Home Builders.

On the commercial side, growth will surge past a robust 2004. Total construction for offices, stores, and multifamily dwellings will rise 9%, to $120 billion, according to McGraw-Hill Construction. That tops the $112 billion spent at the peak of the dot-com bubble in 2000. Retailers will continue to add oodles of stores: Home-improvement giant Lowe's Cos. (LOW ) will open 150 outlets in 2005. And continuing its aggressive expansion, Wal-Mart Stores (WMT ) Inc. will build or expand up to 250 supercenters. "There's a sense that the economy is improving, and new construction will help these players catch the upturn," says Robert A. Murray, McGraw-Hill Construction's (MHP ) top economist.

Office building is also on the rebound. The national vacancy rate remains high: 17.4% at the close of 2004, down from 18.2% a year earlier. So while developers are planning new construction, they are being more selective. Many are still gun-shy after being saddled with acres of new space following the dot-com crash. So projects are increasingly prefinanced. As much as 70% is preleased in new buildings, up from 20% historically, according to Maria T. Sicola, a senior managing partner at real estate services firm Cushman & Wakefield Inc. Overall, 170 million square feet of offices will become available next year, up 10% from 2004. Stronger public finances will help boost public construction by 3% in the new year as well, according to the Manufacturers Alliance/MAPI. This follows a slow 2004, when weak public finances across the country stifled building of schools, roads, and public edifices.

With few weak spots expected in 2005, overall construction spending will rise 2%, to $585.5 billion, according to McGraw-Hill Construction. And home-builders remain bullish. Arlington (Tex.)-based D.R. Horton Inc. (DHI ) expects to sell over 50,000 homes this year, up 15% from 2004. Never mind interest rates, recessions, or wars, says CEO Donald J. Tomnitz, "we're going to make our goals in 2005." Quieter hammers, for now -- but not silent.

By Brian Grow in Atlanta

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