"If 1998 was Mark McGwire hitting 70 home runs, what we'll see in 1999 is 62 home runs:something that would have been a record breaker, except for the previous year." This statement, by economist Robert Barr of Fannie Mae, sums up quite nicely what we can expect this year.
The unemployment rate is still impressively low (4.7% as of this writing), and consumer prices are up very little. The stock market stabilized as '98 ended and regained its lost ground. Certainly, we can expect construction activity to parallel economic activity, but it's expected to lag the economy somewhat in '99.
Residential construction grew by a solid 11% in '98, spurred by the lowest interest rates in a generation. These low rates also pushed single-family home sales to a record increase of 13.5% in '98 (per the National Association of Realtors):the third consecutive annual record. According to FMI, the nation's largest construction management consulting firm, residential improvements grew 6% in '98. The driving forces behind home improvements are many and complex, but two of the major ones are:
New homeowners fixing up their recently purchased houses, and
Existing homeowners fixing up their houses to sell so they can buy larger and more expensive ones.
In either case, housing starts and sales of existing homes are major generators of home improvements. Furthermore, last year's sales of existing homes add to the correlation, too, reflecting fix-up of newly acquired homes. Because 1998's strong home sales will still buoy 1999 home improvements, the latter category will not decline as much as starts or this year's sales. Essentially, residential improvements are forecasted to drop 1% in 1999.
Single-family housing starts are expected to decline 3% in 1999 (per FMI). But, the value per start will increase because the low end of the market is anticipated to drop off more than the high end. The net result expected is a drop of 1% in the value of new single-family housing. Nevertheless, 1999 will qualify as the second best year ever for single-family housing.
Multifamily construction was up 6% in '98. But, first-timers vacated many rental units when they bought their own homes, thus reducing the demand for multifamily housing. Investors still remember the lessons of the late '80s and early '90s and are, in general, avoiding the temptation to overbuild. FMI forecasts construction in this category to be down 1% in '99.
Nonresidential construction, up 2% in '98, is expected to decline 1% in '99 (per FMI). Overall construction activity, up 5% from the previous year in '98, will most likely show no growth from this level in '99. Construction of public safety, administration, and other buildings should be the star (in terms of growth rates):expected to grow 8% from the '98 level, which was 7% above the '97 level.
Public safety represents a large part of this category and includes prisons, courthouses, and law enforcement buildings. Growth in this area reflects our concerns with effectively combating crime, adequately housing prisoners, and efficiently administering justice. Other growing publicly owned building types included in this "catch all" category are transportation terminals (air and rail) and roofed sports stadiums.
Privately owned office and professional building construction rose 14% in '98 (per FMI). Vacancy rates, according to CB Richard Ellis (CBRE), continued the decline begun in '92 and now stand at 9.2% nationwide. That's the lowest level since the survey series began in the mid '80s. CBRE reports that, in the most recent quarter surveyed, 51% of the new space brought to market was already leased. This rate is about 15 points above the very bleak days of the late '80s, but already 10 points down from a year ago.
Of the 57 geographic areas surveyed by CBRE, only seven showed vacancy rates higher than a year before: four in the West and three in the Southeast. The Western red flags are Albuquerque, Fresno, Las Vegas, and Salt Lake City. The Southeastern areas are Atlanta, Charlotte, and Palm Beach County.
Restraint will be the norm in '99, with office construction expected to grow at 5% (per FMI). While this is much below the '98 rate, it's still one of the best growth areas of the year.
Improvements to nonresidential buildings increased by 2% in '98 and are forecasted to increase at the same rate in '99. Additions, alterations, and improvements to retail facilities, hospitals, schools, and offices make up a large share of the group. With the exception of hospitals, each of these will show some degree of positive growth in '99. Hospitals may decline, as in '98, reflecting the lack of resolution still surrounding our health care situation.
The only other major category of nonresidential building construction expected to show positive growth in '99 will be schools and other educational facilities. This category grew only 3% in '98, which was surprising on two counts. First, it was a big drop from the 14% growth shown in '97. Second, the privately owned sector held up (showing a 12% growth), while the publicly owned sector fizzled, with only 1% growth.
The public sector drop results from a change in public perception of the need for school construction, combined with increasingly tough choices required in establishing budgets, both on the consumer and governmental levels. You should expect a slight further softening in '99, to a growth of only 2% (per FMI).
Construction of stores and other mercantile facilities declined 6% in '98, the first decline in this category since 1991. The frenzy of building big boxes is over. These facilities will certainly continue to be built, but not seemingly everywhere as in recent years. The struggle for survival now takes center stage. There will be no letup in pressure on the smaller stores, who will continue to renovate as one of their primary strategies. The economic slowdown will intensify the struggle and hasten its outcome. FMI forecasts construction of new stores to decline 5% in '99, although, as mentioned, store improvements will show growth.
Industrial building construction dropped 6% in '98, an improvement over the 12% drop in '97. Throughout most of '98, manufacturers continued to make heavy capital investments. But, unfortunately for us, most of the investment was in equipment rather than buildings. The result: an increased output at lower costs with a minimal increase in square footage. Although there's clearly a limit to how far manufacturers can take this, they haven't reached the point where it's no longer profitable. As such, this concept of increasing productivity to increase production will continue to receive major focus.
The industrial vacancy rate, as reported by CBRE, rose to 8.6% in the latest quarter, from 8.1% a year previously. Vacancy rates in the 46 metropolitan areas covered in CBRE's survey range from Baltimore's 22.3% to Oklahoma City's 2.6%. Twenty-six areas showed increases in vacancy over the previous year. The top four gainers, all east of the Mississippi, are Jacksonville, Fla., Baltimore, Nashville, and Wilmington, Dele. The four with the biggest drops in vacancy rates are Miami, Portland, Oreg., Orlando, and Stamford, Conn.
As the economy slows and markets contract both domestically and overseas, investments will decline, leaving even less capital for new construction. FMI forecasts industrial building construction to decline 8% in '99.
Nearly all warehouses are used in moving goods to manufacturers, retailers, or consumers. With store and industrial construction declining, it's no surprise that warehouse construction declines too. Warehouse construction was down 6% in '98 and forecasted to be down another 9% in '99 (per FMI).
Hotel construction, which grew 3% in '98, will show the largest decline of the major construction categories: It's expected to drop 11% in '99 (per FMI), the first drop since 1992. Over the seven-year span from 1992 through 1998, this category averaged a 22% per year growth, to four times its 1992 level.
Construction of non-building utility structures, the other major category in this group, grew by 6% in '98. FMI cites continuing strength in the telecommunications industry and niche opportunities in electric power (as a result of deregulation) as the driving forces for a 4% growth in '99.
Should you be aggressive or play it safe in '99? Obviously, our discussion here is based on forecasts and no one has a very clear crystal ball. Most think the U.S. economy will probably downshift again but keep right on moving ahead in '99. As such, your best bet is to approach your market in a very prudent and cautious manner, yet be aggressive in your strong suit or niche. Just make sure you plan with extra care and stick to your plans. Yes, the economic climate may chill a little, but don't panic and abandon your plans. Keeping a close watch on your overhead costs and cash flow will get you through in fine fashion.