How’s the construction industry — and the economy — doing half-way through 2003?
Construction Equipment Guide (CEG), in its annual mid-year outlook, asked leading economists and other observers from main sectors of the industry for frank appraisals.
Their overall assessment: The industry is still working hard to move up to its usual strong activity at the crest of the economic wave — but it’s not easy. The economy is still growing, but at a very slow rate, and states are hard-put to balance their budgets. Highway projects are grinding ahead, but there’s still a big question mark about next summer’s construction season.
Hope focuses on the booming single-family housing market, the stimulus from the Jobs and Growth Tax Act, passed in the spring, and a hoped-for whopping increase in six-year funding for highways and bridges in the new six-year transportation bill, which Congress must pass this year.
Positive on Economic Growth
Robert A. Murray, vice president of economic affairs for McGraw-Hill Construction in Lexington, MA, told CEG that gross domestic product (GDP) — the rate of real economic growth in goods and services — will grow approximately 4 percent this year.
“The second quarter was up 1.9 percent and we expect that to pick up to the 3-percent or 4-percent range by the end of the year,” he told CEG. “I do think the corner [on economic recovery] is being turned, but it’s being turned very slowly.”
With the conclusion of major hostilities in Iraq, he said, “There are signs that the economy is beginning to show some improvement, but we need to see more discernible signs of that taking place in terms of output for the economy. Employment has continued to languish [at about 6.1 percent].”
One of the industry’s most-respected economists, Murray said his January forecast for a slight decline in a continued healthy pace of total construction starts is holding up, “with some modest adjustments.”
“We’re still looking for a 2 percent decline [the figure that he had suggested in CEG’s January 1 forecast] in total construction during the year,” he said, “We’re now looking at an upturn for hotels. Construction of single-family homes is a little stronger than the forecast, but is expected to be down 1 percent or 2 percent for the year. Highways and bridge projects are down about 3 percent from several months ago and will probably be down about this much for the year. Total public works are also down 3 percent. The dampening being experienced by some of the institutional building categories, like schools, prisons, and hospitals, is a little bit more severe than expected, with further erosion possible this year and next.”
Murray told CEG that “retail construction continues to move at a decent clip” but said that “It’s still too early to see much sign of a commercial building upturn; offices and warehouses continue to be very weak.” But he sees a potential for more broad-based strengthening in this sector during 2004.
The McGraw-Hill economist prepares a quarterly forecast, which the company markets to building-product manufacturers. His next forecast is due in July.
Not All Agree
Asked about the projection of a 4-percent increase in GDP this year, Ken Simonson, chief economist of the Associated General Contractors of America (AGC) in Washington, D.C., replied: “Nothing that good yet. That’s the mirage that economists think they keep seeing just one quarter down the road. For the fourth quarter of 2002 and the first quarter of 2003, the figure was less than a 2-percent gain for GDP measured at an annual rate. That’s too slow to sustain job creation, and, indeed, we’ve seen the unemployment rate move up to a nine-year high of 6.1 percent as of May. Even the treasury secretary has predicted that it could go to 6.3 percent.
“I don’t see much relief coming yet in terms of job expansion. Therefore, I think consumers will remain cautious. We will have only slow growth in retail spending and not much need to put up new office buildings. Business travel will probably remain in the doldrums. That has consequences for convention center building, hotel building, and so forth. The figures that I’ve reviewed in the first half of June all show a very-tentative recovery, even a continuing retrenchment, whether you’re looking at manufacturers’ orders or supposedly more predictive indicators like purchasing managers’ indexes. I’m not saying it [4 percent growth] can’t happen, but I’m from Missouri on that. The stock market may be right more often than not, but there are plenty of misses too. I don’t have the confidence to pull my money out but I’m not putting more in either. All I’m doing is refinancing my house every few months as mortgage rates keep dropping.”
Low Inflation Continues
“Last year there was very little inflation, and pretty moderate wage gains,” Simonson observed. “The May consumer price index [CPI] figure, released on June 17, shows a 1.6-percent inflation rate over the previous 12 months, the lowest in quite a few years. While the Fed was a little too spooked about deflation, meaning a drop in the general price level, we are almost in that golden state of no inflation to worry about. Companies are really having trouble pushing their prices up; the only way to squeeze out a profit is to get more efficient. That’s pushing down employment and, to some extent, wage rates. Meanwhile, interest rates will continue to remain very low.
“Most commodity prices are holding steady or, in some cases, dropping. Obviously, petroleum-based products have had quite a ride up and down. At this point in the year, they are somewhat higher than a year ago and I think that’s what we’ll see for most of 2003, with some pressure on asphalt, diesel fuel and other things that use petroleum. The really big cost increase is natural gas, and therefore also PVC pipe and other products that use natural gas as an input in their fabrication.”
Home Builders Upbeat
Michael Carliner, economist of the National Association of Home Builders (NAHB) in Washington, D.C., said the housing market is strong at mid-year and will continue to be vibrant.
“It’s possible that we are seeing the lowest mortgage rates since the mid-1950s,” he told CEG. “That has to stimulate home sales. New home sales were a record last year. It looks like there’s a very good chance they will exceed that. They have already exceeded that so far this year. We expect to see a little slowdown the second half of the year, but, even there, that’s based on the expectation that mortgage rates will start to move up by the end of the year — but every time we think rates can’t get any lower, they keep going lower.”
Carliner said mortgage rates have been running approximately 5.3 percent. “The context in which rates would rise would be a strengthening in the overall economy,” he added.
“That strengthening would have a positive effect. So we do expect to see things slow down during the second half of the year and in 2004, but not by much.”
Carliner said NAHB data indicates that starts of single-family homes were up 3 percent for the first five months of 2003, while multi-family starts were down about 5 percent. One reason for the latter slowdown, he observed, is that “We have drawn people out of renting and into homeowning.
“We expect about 1.7-million new housing starts this year [seasonally adjusted annual rates], just about what they were in 2002,” he added. “About 1.38-million of those are single-family homes.”
Carliner noted an interesting fact: “The average age of housing stock is older now than it has ever been in U.S. history. We’re having cases where people are tearing down older houses in order to find land to build on.”
He also pointed out that “Most people buying new homes are people who have owned homes before; only 25 percent are first-time buyers, but there is strong demand from these first-time buyers for existing homes.”
AGC’s Simonson commented: “I have been pleasantly surprised by how strong residential construction, both single family and multi-family, has been. It’s much stronger than I had been expecting at the beginning of the year. My advice to contractors is that, if you can get involved with housing in any way, that will be the ticket to more business.
“I really thought multi-unit housing would weaken by this point in the year but figures, which the Census Bureau released on June 17, show that permits are holding up at a little above last year’s level. Meanwhile, single family housing is streaking ahead because we keep setting new record lows on mortgage rates. Even if mortgage rates turn around by mid-year, I think that comparisons with a year ago will remain favorable for new construction and also remodeling and improvements.”
Simonson added however: “On the non-residential side, I wasn’t gloomy enough. I and nearly every other economist have been saying all along that we’re close to a turnaround but, in fact, it’s hard to see that we’ve touched bottom yet. The disastrous drop in factory, office, and most kinds of retail, and hotel/motel construction characterized 2002, where the decline was anywhere from 25 percent to 45 percent. The best you can say is that the decrease has slowed a little bit, with double-digit declines from last year’s already-low levels.
“I keep looking at the indicators that have come out in May and June on general economic activity and there’s no sign of a pronounced upturn in the overall economy,” Simonson continued. “And because private construction can lag, particularly when you have lots of vacant offices or excess capacity in factories, I think it will be many more months before you can expect a real upturn in those construction categories, probably well into 2004.”
AED Cites Optimism
Christian Klein, Washington, D.C. counsel of the Associated Equipment Distributors (AED), cited “a tremendous sense of optimism and uptapped potential” among equipment dealers.
“With the war in Iraq behind us, and some of the geopolitical uncertainties resolved, combined with the passage of the tax bill, it really puts us in the position where things can take off over the next few months,” he said. “We’ve been working quite hard on expanding the depreciation bonus and increasing the amount which small businesses can expense.
“AED and the National Utility Contractors Association [NUCA] did a study early this May on the impact of the depreciation bonus and proposed capital investment incentives. We surveyed NUCA’s members and the results were pretty compelling. They showed that the 30 percent depreciation bonus, which was enacted in March of 2002, had a very substantial impact on equipment purchasing by utility contractors over the past year, prompting them to buy equipment. Results also suggested that expanding the bonus to 50 percent, in the Jobs and Growth Tax Act, which was enacted last month, and increasing Section 179 expensing levels, will have a very substantial impact on future equipment purchasing. In fact, 72 percent of respondents said they would consider buying new equipment if the expensing levels were increased, and 26 percent said they would definitely purchase new equipment if this happened.”
Klein said the tax savings on a $100,000 piece of equipment under the 30 percent rule totaled $9,600 on the first year since you could actually depreciate another 20 percent of the remaining value after the initial depreciation.
Under the new 50 percent rule, total first-year tax savings on the piece of equipment, using the same procedures, is estimated at $16,000, Klein said, adding that “We’re receiving a lot of calls from people and the level of interest indicates the new law will have a very big impact.”
In the new law passed this spring, Congress also substantially increased the expensing levels for small businesses. Previously, a business with a small enough amount of capital equipment purchases could elect to write off the cost of up to $25,000 of new equipment the first year rather than depreciating it. The new expensing provision increases this to $100,000.
“Congress has now given contractors an incentive to buy,” Klein commented. “Now it has to give them a reason to buy. What we’ve been telling people on the Hill is that the best way to get the construction industry moving again and stimulate employment in the industry, with more equipment purchases, is to pass a six-year highway bill, which substantially increases funding for the highway program. We’ve really been pushing the TEA-21 reauthorization very hard, including the $375 billion, which the bipartisan leadership of the House Transportation Committee is proposing. Their goal is to get us to a program where the Department of Transportation is spending the minimum to maintain current performance.”
Klein’s mid-year assessment is that happy days are here again: “There was this sense that, when the situation in Iraq was resolved, when the stimulus bill was passed, including removing the capital gains tax that the economy would improve. Now, all these things are going to combine to encourage more investment in the stock market; and people will continue to buy homes because of the low interest rates.
“Also, the House has voted 264 to 163 to permanently repeal the Death [Inheritance] Tax, which is scheduled to come back in 2111. We’re telling Congress that permanent repeal is a form of stimulus because it would free up resources which business owners still have to devote to estate planning [for beyond 2011]. State budgets are a big problem, but from the national perspective, there’s reason to be optimistic.”
States Pin Hopes on Transportation Bill
“Many states are experiencing their worst budget-crisis in 50 years,” said Jennifer Gavin, a spokesperson of the American Association of State Highway and Transportation Officials (AASHTO) in Washington, D.C. “At this [mid-year] point, it seems that, for this construction season, work is continuing. That appears to be largely because some of these projects were already under way as we went into this budget year, and also because the Feds came through and put a decent amount of money into the pot for the current fiscal year, which is a baseline or measuring point for the next six-year transportation bill.”
One reason funds are adequate for this year, Gavin told CEG, is “because we worked so hard on avoiding a severe cut in the RABA [Revenue Aligned Budget Authority] funding.”
RABA is “extra money” that comes into the Highway Trust Fund (HTF) over and above what Congress had formally appropriated, and which the transportation bill allows to the states as extra funding.
The problem, Gavin said, was that Congress overestimated this when looking back on past revenue, but, when it looked forward and saw the economy going sour, Congress responded by cutting $8 billion from what states thought they would receive, which was a huge shock to states’ multiple-year advance planning. AASHTO and other industry groups managed to restore most of the cuts so that the baseline is not severely eroded.
“States did their planning based on the expectation of that money for this current time, the summer season of construction,” she said. “They’re doing all right for the moment, except for one or two cases where some paring of programs has taken place. I was asked to do a survey on the number of workzones and found the number is largely the same as last year — down just a hair.
“The issue is whether overall total funding is going to start being a serious problem in the next fiscal year, next year’s construction season beginning next summer. It depends on whether the federal government reauthorizes to the levels that are necessary. The new six-year bill must be reauthorized by Oct. 1. The dollar figure for that is a big fat question mark right now. Will the money be there or will the states really have to cut back on work next summer?
“The states also have to do their matching [often 20 percent of the federal funding]. That can be a problem. In the last several months we’ve seen that the states, almost all of which have a constitutional requirement for balanced budgets, are just getting chewed up by budget crises and they have to turn to whatever pots of money they’ve got to make their budgets balance out. In many cases, unless there’s a further constitutional ban, the [state] highway fund is a reliable and likely pot of money for these folks. They will turn to it when it’s the only thing they can do. Some states are doing this. Others are gritting their teeth and waiting to see what happens in the next few months.
’It is terribly grim. Not only are state budgets getting cut — not just once but multiple times — but there are big personnel cuts and all kinds of serious difficulties. The economy has gone soft and the states are not collecting their usual tax sources. We haven’t seen state-funded road projects suffering yet on a major scale yet, but we think that’s coming down the line.”
Gavin pointed out that every billion dollars spent on highways and transit creates 42,000 jobs, so that “It’s not just a question of keeping work going without interruption; adequate funding is very important to the economy; if highways get so congested that you can’t move freight efficiently, it will have an economic impact.”
Industry Groups Assess Public Sector
Contractor organizations are worried about the dilemma that states face, but are also hopeful that the new Transportation Bill will be a shot in the arm for highway work and both manufacturer and dealer business.
“A high level of funding would directly stimulate the construction equipment manufacturing industry,” said Nick Yaksich, vice president, government affairs, in the Washington, D.C., office of the Association of Equipment Manufacturers (AEM). “The uncertainty of the reauthorization bill, and what kind of commitment the federal government will have, is affecting road construction right now. A new six-year bill will provide contractor confidence. Contractors will see that the federal government, and their states, will be committed to these programs for the next few years. Equipment manufacturers, who are a capital-intensive industry, need consumers who are confident enough to invest in machines. Steps like the depreciation bonus are great if people are buying, but you must first have the fundamentals of consumer confidence.”
Pat Monroe, AEM’s director of public relations in Milwaukee, WI, told CEG: “The equipment manufacturing industry has been negatively affected by general economic conditions. The business situation right now is volatile, with uncertainty as to how the industry will fare overall in the coming months.”
In this climate of uncertainty, equipment manufacturers also are challenged by higher costs of steel, health insurance, and the requirements of doing business in a somewhat-flat economy, AEM sources said.
Bill Buechner, chief economist of the American Road & Transportation Builders Association (ARTBA) in Washington, D.C., concurred with the need for confidence: “Of course, the big driver beyond 2003 will be what happens with reauthorization of TEA-21 [The Transportation Equity Act of the 21st Century]. That’s still way up in the air, but it could be anywhere from barely enough to maintain current activity to as much as almost a doubling of the market by 2009. There’s a potential for the [highway construction] market to come back strongly in 2004 if Congress passes a reauthorization bill, on time, which has adequate funding.
“A lot also depends on the economic recovery, but the recovery is not yet a strong one. It is not yet getting money back into state coffers. There will still be some pressure on highway funding at the state and local level until the economy does start to accelerate. There may also be some pressure on states to stretch out their programs because of the late arrival of federal funds.”
Drop in New Highway Contracts
Buechner said the data which ARTBA tracks “suggests that 2003 will not be quite as strong as we expected. The critical item is new contract awards by state and local governments for highways and bridges. We’re seeing a pretty significant dropoff from last year. Since Jan. 1 of this year, these awards are down about one billion dollars. I was more optimistic at the beginning of the year, but we are not seeing the numbers that we anticipated. I don’t think our members are very happy. They had anticipated a stronger year.”
Buechner said the decline is even more telling for the first 10 months of the 2003 fiscal year, which most states follow [July 1 through June 30]: “New contract awards during this period were off about three billion dollars. Some of this is due to just normal ups and downs. A bunch of states were doing special projects last year. They all had increases in lettings which have gone back to normal. However, the decline is way too broad. About two-thirds of the states have awarded less dollar-value contracts this year than last year.
“The decline is pretty widespread and that suggests that it’s related to the fiscal crisis of the states. Because of this crisis, states, in one way or another, have been using money that they had originally intended for highways, for other purposes. Over the past few months, we’ve observed about $4 billion diverted this way. Some of it may be from unnecessarily large balances in their highway trust funds, and it may not significantly impact their construction programs immediately. In fact, most states, even when they take money from their highway programs, do it because the projects are much farther down the pike than they need the money for right now. Nevertheless, that diversion is not a good sign. Nothing that has been happening recently is what you would call a good sign for this year.
“Last year, I thought highway spending would experience a minor increase of two or three percent, but I don’t think that’s going to work out. I think we will be lucky to be flat with last year, considering everything which has been going on, and what the states are doing with their own money and with federal money. It’s not going to be an outstanding year. It’s turning out to be kind of a disappointment — no growth over last year that we’re seeing. Of course, we’ve had some weather problems this year; it doesn’t help when you can’t get out on the street because of rain and snow. That still hasn’t let up throughout the East. Everything seems to be conspiring against a good year, even the weather.”
AGC Sees Mixed Picture
AGC’s Simonson likewise expressed worry and hope: “On the public side, state budget receipts keep getting worse and worse; that’s a very bad indicator for the next fiscal year. The legislators have pretty much finished their work for 2003 as of mid-June and, by and large, were able to stitch together balanced budgets with minimum pain for construction, but there is definitely a slowdown for public construction and I think that will continue and intensify for 2004 [the fiscal year which begins June 30 for most states]. Most categories of public works are in for a further slowdown. General public construction, whether it’s conservation and development parks, state office buildings, correctional institutions and higher education, is vulnerable to the slowdown in state revenues.”
But, like other interviewees, Simonson is hopeful about increased funding proposed for the Transportation Bill: “Fortunately, the two biggest categories of public funding are each protected somewhat. Highways are funded to a large extent by monies passed through from the Feds and that money has held level for the federal fiscal year for 2003, which runs through Sept. 30, and therefore will get to the states over the next several months and will continue to bolster state highway construction. Local roads and state-funded projects are under somewhat more strain, but, by and large, highways are running close to even with last year’s spending, and there will be some momentum in 2004.”
Simonson addressed the other big public funding category, school construction, as follows: “You have a two-part story. K through 12 schools are pretty well insulated [from a downturn] because record bond issues passed last fall, most of them dedicated to school construction or reconstruction. Also, many local school districts depend on residential property taxes. Keeping their assessments up to date, they’ve benefited along with the homeowners in the appreciation of housing. So I would also advise contractors to look for work in the K through 12 area as well as in housing and the health-related area.”
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