March 29, 2007

Local construction market taps on the brakes

  • Nonresidential construction should buoy the slide in home building this year, but watch for more materials price hikes next year.
    AGC of America

    Construction in Washington appears to have lost a bit of momentum but is in much stronger shape than in most states. Nonresidential construction activity may be strong enough to offset the slide in home building, but surging materials costs may force cancellation of some projects.

    Seasonally adjusted construction employment in the state reached 200,000 for the first time in December before slipping back a notch to 198,700 in January. Still, the January figure was more than 6 percent higher than a year before. That was double the growth in all nonfarm payroll employment in the state, putting Washington in the top 10 states for construction job gains. The industry accounts for nearly 7 percent of all nonfarm employment in the state, compared to a national average of 5.6 percent.

    There are several favorable omens for construction in the state. First is population growth, which stimulates demand for many types of construction, including rental and owner-occupied housing, retail, schools and more. From July 2005 to July 2006, Washington’s population increased 1.7 percent, 12th in the nation.

    That net increase came almost equally from internal growth (births less deaths), migration from other states and immigration. Thus, the state is not dependent on any one source of population growth and not so vulnerable to a downturn in immigration or state-to-state patterns of movement.

    Housing prices hold up

    Strong population and employment growth help explain why housing prices have held up well in the state. The Office of Federal Housing Enterprise Oversight reported earlier this month that prices of houses resold or refinanced in the fourth quarter of 2006 appreciated nearly 14 percent over the past year in Washington, more than double the national appreciation rate of 5.9 percent. In the fourth quarter alone, appreciation was slower but still robust at 1.9 percent or an annualized rate of nearly 8 percent.

    Appreciation for the year was even higher in the Puget Sound metro area. The Tacoma metropolitan division ranked 16th out of 282 ranked metro areas and Seattle was 18th, both with annual appreciation approaching 15 percent.

    Washington had six metro areas in the top 20, more than any other state, led by Wenatchee at 21 percent, just behind the national leader, Bend, Ore. Mount Vernon-Anacortes and Longview were ninth and 10th, with a 16 percent gain, and Bremerton-Silverdale was 20th, with a 14 percent rate of appreciation.

    Although appreciation is likely to cool this year, Washington should continue to have gains, unlike several states. The gains will encourage more residential construction.

    Hotels, offices are hot

    Nonresidential construction should also remain positive. Several categories look promising, based on national construction trends as well as the region’s economy.

    Monthly figures from the Census Bureau show that nonresidential construction spending nationwide jumped 14 percent from January 2006 to January 2007 at a seasonally adjusted annual rate. The biggest increase in construction spending, 66 percent, occurred in lodging. Throughout the country, hotel chains continue to enjoy high occupancy rates and rising room rates. That combination suggests more hotel and resort construction in 2007, with growth expected in both resort and business centers throughout the state.

    Office construction soared 34 percent, as falling vacancy rates in many markets lured developers to put up new buildings and rehab existing ones to stay competitive. Office demand should be strong in the Seattle-Tacoma-Bellevue metro area, judging from the region’s low unemployment rate. The rate slipped to 4.3 percent in December compared to 4.6 percent nationally that month and 4.6 percent a year earlier in the metro area.

    More hospitals coming

    Private hospitals nationwide boosted their construction spending 25 percent in the past 12 months. As they race to catch up with new technology in diagnosis, treatment and recovery rooms — and to locate near new population centers — hospitals appear poised to keep building for years to come. The Seattle market will share in this growth.

    Manufacturing construction climbed 17 percent nationally from January 2006 to last January. The bulging order books at Boeing should spur related new investment in factories in the Seattle region.

    Other growth categories include energy and power plants, both conventional and experimental. Public projects, from education to transportation to military facilities, are expanding as well.

    Higher prices coming

    One big challenge for the industry, and for public agencies that budget for construction, will be materials costs. Ever since steel and lumber prices spiked in early 2004, the construction industry has struggled with much higher price increases than the overall rate of inflation would suggest. While the consumer price index has been rising at about 3 percent each year, the producer price index (PPI) for construction materials and components spurted up 10 percent in 2004, 6 percent in 2005, and 4.3 percent last year. Even that figure would have been higher but for recent declines in lumber and diesel fuel prices.

    Aside from wood products and diesel fuel, most construction inputs still had hefty year-over-year increases. For instance, from December 2005 to December 2006 there were double-digit increases in the PPIs for copper and brass mill shapes, up 44 percent; asphalt paving mixtures and blocks, 27 percent; aluminum mill shapes and steel mill products, 12 percent each; and cement, 10 percent. Although materials that are extensively used in home building, notably gypsum and copper products, should fall sharply in price as new housing starts keep sinking, most other construction materials costs are not likely to drop.

    Two factors make construction materials costs susceptible to steeper increases than the overall rate of inflation.

    First, construction requires generally fixed quantities of materials, unlike industries that can substitute cheaper materials or can design products to be smaller or lighter than their predecessors. Many materials used in construction are also in demand from other sectors, both in the U.S. and in fast-growing economies, such as those of China, India and elsewhere in Asia. Yet supplies of some materials expand only slowly. An example is copper, where all of the major mines have been subject to labor unrest or political turmoil. As a result, prices jump.

    Second, materials must be physically delivered, using a transportation network that is often stretched to its limits. Transport costs are high and bottlenecks frequent. In addition, fuel price spikes add to transport costs as well as the direct costs of operating equipment. As a result, construction materials costs may show a year-over-year increase of as little as 2 percent to 4 percent for the next few months, matching the overall inflation rate as measured by the consumer price index. But a year from now, construction materials are likely to resume their recent 6 percent to 8 percent cost increases, with higher spikes possible.

    Ken Simonson is chief economist for the Associated General Contractors of America, a national construction trade association. He writes The Data DIGest, a weekly summary of economic news relevant to construction.

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