By August 2005, single- and multi-family housing comprised 56% of all construction spending for a total of $404 billion. This record year, tracked by the U.S. Department of Commerce, comes after a cautiously optimistic forecast at the end of 2004 that predicted the end of the residential housing boom. Expecting long-term interest rates to rise, which would put an end to the hike in construction revenue driven by the residential housing market, economists anticipated that the bulk of 2005's construction growth would come from gains in private non-residential and public construction. This led to conservative projections — from 2% by McGraw-Hill Construction to 6% by the U.S. Department of Commerce and others falling somewhere in between.

However, the economists were right about non-residential construction. The institutional market — made up mainly of schools and public works — is showing significant gains from 2004 to 2005. In addition, commercial building has been able to fulfill its potential upswing by mid-2005, after a slow start due to shortages and higher prices for building materials. But what wasn't available for 2005's forecast was the devastation caused by Hurricanes Katrina and Rita in the Gulf Coast region — resulting in property loss estimated in the $200-billion range, more than 300,000 homes completely lost or uninhabitable, and an equal number likely in need of major refurbishing.

The impact of the damage may have two opposite effects on construction growth in the latter part of 2005, as well as in 2006: price hikes and shortages for petroleum, natural gas, and building materials and a boost from private and public reconstruction (which may not come into play until the latter part of 2006 or even 2007-08). The disruption caused by the storms is predicted to reduce overall growth of the U.S. economy by 0.5% to 1.0% during the last half of this year. Despite this news, McGraw-Hill says 2005 is on track for $637 billion in new construction starts, translating into an 8% increase.

According to industry forecast reports, the growth experienced by the construction industry in 2005 should continue for the next year but at a slower rate. In its 2006 Construction Outlook, McGraw-Hill estimates new construction starts for 2006 at $654 billion, a 3% gain. Construction industry consulting firm FMI, Raleigh, N.C., offers the highest projection for next year with an estimated 6.8% jump, whereas the Portland Cement Association (PCA), Skokie, Ill., predicts the lowest increase at 1.8%. (For more predictions on construction put-in-place, see Table 1 and Table 2.)

Market to market. The U.S. Department of Commerce predicts a 6% increase in residential construction in 2006. Although 6% is a healthy number, it pales in comparison to last year's 14% gain. The National Association of Home Builders (NAHB), Washington, D.C., predicts single-family housing starts to decline 6.6%, from 2.05 million units in 2005 to 1.59 million units (Fig. 1). Ken Simonson, chief economist for the Associated General Contractors of America, Washington, D.C., says the drop in residential building will be concentrated on single-family housing, but the condo market will also shrink, relying mostly on high-end conversions to keep its numbers up.

Taking the place of single-family housing as the cash cow for the construction industry may be income properties, such as office buildings, stores, warehouses, and multi-family housing. McGraw-Hill expects a 7% increase in dollar volume and a 3% increase in square footage for in income properties for 2006, following the 10% increase in 2005 and the 16% spike in 2004 (Fig. 2). For 2006, overall U.S. economic expansion is expected to be in the range of 3% to 3.5% — meaning there will probably be some job growth that may increase the demand for commercial space and multi-family rental construction. First-time buyers shut out of the home ownership frenzy by high prices in select markets around the country — and families displaced by Hurricane Katrina in Texas, Louisiana, Arkansas, Mississippi, Alabama (and in a few metro areas farther away, such as Atlanta) — will add to the demand for rental housing.

Certain non-residential markets are preparing for an upswing. The U.S. Department of Commerce predicts growth rates between 2% and 8% for most non-residential markets. Simonson predicts growth for private non-residential construction in 2006 will exceed the 5% year-to-date growth for 2005. He also predicts that alternative energy facilities, such as wind, hydro, and solar, will experience a modest boom, but the power plant market will not likely see a turnaround until 2007.

McGraw-Hill is also expecting significant growth in 2006 for other non-residential markets. Overall, the report predicts new non-residential building starts to increase 8% next year. Leading the way is the hotel and motel market, with an anticipated 18% increase in new starts. Office buildings starts may rebound with a 12% gain to $22 billion. In 2005, green building construction made up 2% of non-residential construction starts, at $3.3 billion. McGraw-Hill predicts that higher energy costs and a renewed interest in conservation and energy efficiency will fuel the green market by as much as 10%, or $20 billion, by 2010.

The most dramatic anticipated long-term gain in spending is predicted to come from education construction. Jim Haughey, economist for New-York-based Reed Business Information, says that a 39% increase is expected from the end of 2004 to the end of 2007. The increase seems to be an anomaly because while K-12 enrollment rose 518,000 per year from 1996 to 2002, it has been projected to increase by only 80,000 per year between 2003-2010 (Fig 3).

Deja vu. In their conservative forecasts for 2005, economists underestimated last year's construction economy, so why should we take their predictions for 2006 seriously? Working in a relatively healthy economy, is there any reason to remain cautious? For starters, last year's projections overlooked the creativity and persistence of mortgage lenders, as well as the risks speculators in the residential market have been willing to take. But most industry experts agree that these factors can't continue to drive the housing market indefinitely. This is most likely to be the year for the previously predicted decline in the residential market. Contributing to that prediction is the anticipation that the Federal Reserve Board will continue to raise long-term interest rates, following the current trend in short-term rates (Fig. 4).

Another factor affecting 2006's construction economy could be the increasing price of energy and materials, spurred by the September storms (Fig. 5). This may mean shortages and price hikes for petroleum, petroleum-based construction materials, and natural gas, as well as an increase in transportation costs and higher demand for energy-efficient products and systems. “Oil prices have been coming down but they are still higher than a year ago,” Simonson says. “Natural gas prices also will stay high this winter and probably through much of 2006.”

According to Ed Sullivan, Portland Cement Association's chief economist, higher inflation eventually will be evident in long-term interest rates, which may translate into slower economic growth in the future, starting in 2007. PCA predicts that this is the beginning of a slowdown in construction's growth rate, which may decrease to 0.9% by 2009.

While the economists offering their forecasts say there's no danger of a recession in 2006, they do remain cautious. Increased prices for fuel and feed-stock sources for materials mean that the cost of doing business may rise dramatically. In addition, firms must plan around materials shortages to prevent project deferments or last-minute redesigns. “Costs will continue to increase at a faster rate than for other industries,” says AGC's Simonson.

Force majeure. There is a general consensus that higher prices and shortages of construction materials will continue into 2006. Reed Business Information predicts that the construction materials price index will increase by 3.5% from December 2005 to December 2006 (Fig. 6). Backing up this information are reports of higher prices for specific materials. The Indianapolis Business Journal recently reported that strikes at copper mines in Arizona and Zambia and high demand for copper in China have raised copper prices from $1,800 to $5,400 per 1,000-foot spool. Analysts are projecting 2006 tin prices in excess of $4 per pound. Steelmakers are paying from $38 per ton to $58 per ton for iron ore, compared to $23 to $38 per ton in 2004, and analysts predict prices to jump by as much as 20% in the 2006 fiscal year, starting in April. In October, prices for zinc spiked to as much as 70 cents per pound, compared to 40 cents per pound in October 2004.

According to the American Institute of Architects, petroleum products, such as roofing, PVC, and asphalt paving, will experience near-term volatility in prices until regional facilities have fully resumed operations. Between now and the end of 2006, there should be price spikes for most commodities: Gypsum prices have increased 5.5%, and concrete prices have risen 2.5% (both of these products are currently in short supply and may see increases of up to 7% by the end of 2006). Between 2006 and 2008, prices for building materials are expected to be moderate, with increases averaging about 2% to 3% a year.

Prices are also higher for natural gas and petroleum, used for both fuel and feed stock for materials (Fig. 7). Natural gas prices averaged $8.04 million Btus for the first nine months in 2005, but the average price in October was $13.66 million Btus. This isn't surprising considering the wind damage and flooding caused by Hurricane Katrina to plants such as the one owned by Dynergy in Yscloskey, La., that process natural gas from wells in the Gulf of Mexico. Katrina's 135-mph winds ripped holes in the side of one building and submerged the facility, including its electric generators and digital control systems, in 15 feet of water.

Prior to Hurricane Katrina, refining capacity was running at 99%. After the storm, production dropped to 70% and has only regained 6% after the current reconstruction efforts. Before Hurricane Katrina, the U.S. Department of Energy (DOE) forecast for West Texas Intermediate crude oil next year was $56.70 per barrel. Now the DOE predicts the average 2006 price will be $63.46 per barrel. At the beginning of November, almost 53% of normal daily Federal Gulf of Mexico oil production and 47% of Federal Gulf of Mexico natural gas production still have not resumed operation. Petroleum shortages may be alleviated by foreign imports, but natural gas can't be imported. These price hikes and shortages may lead stronger investigation and investment in alternative forms of energy, such as solar panels and wind turbines.

There is some disagreement among analysts as to the extent of the impact higher prices and shortages will have on the construction industry. Kermit Baker, senior research fellow and project director of the Remodeling Futures Program at Harvard University's Joint Center for Housing Studies and chief economist for the American Institute of Architects, Washington, D.C., thinks that the materials shortage will be of nominal consequence to both the reconstruction in the hurricane-affected areas as well as construction in other areas of the country. “We're likely to see some short-term spikes and maybe some availability issues, but those will resolve themselves fairly quickly,” says Baker, maintaining that he's certain the downside of the commodity cycle will return — and that prices will ease by the first or second quarter of next year with just a few pockets of shortages and rising costs.

PCA's Sullivan isn't as optimistic, although oil represents less than 0.5 of 1% and natural gas (not including electricity) accounts only about 4% of the cement industry's total fuel and power requirements. So if there is a 30% increase in prices, there will be an overall small 3% increase in terms of cost structure. However, the industry is influenced by the direction of fuel to the extent that as oil prices move up, so do coal prices, which is the concrete industry's largest fuel stock. In addition, Sullivan worries about the effect higher energy prices may have to the overall economy in 2006. “You might be looking at a little bit slower construction activity, particularly in the first half of next year,” he says.

Lock, stock, and barrel. To alleviate concrete shortages, the United States has been importing from foreign sources, but the imports pipeline was disrupted by the hurricanes in the Gulf Coast. Three import terminals were damaged, but luckily the problem was only short-term: The owners of the damaged terminals rerouted the imports to other ports in the lower Mississippi Valley. Nevertheless, general traffic is still impaired. The hurricanes sank 10% of the 400,000 barges used to transport the raw materials.

To combat shortages in concrete, Sullivan suggests more communication between contractors and suppliers. Better project planning and management is the key to keeping costs down and preventing any work stoppages for lack of supplies. “You've got to work with advanced planning on the contractor side to help the influx,” Sullivan says.

John Cross, vice president of the American Institute of Steel Construction, Chicago, offers similar advice to contractors. In 2005, he explains that mills had a significant inventory of structural material) particularly wide flank shapes), and the structural steel industry was in a mode where service centers and fabricators were using an informal adjusted-time approach to ordering supply project needs. The result was a decline in the level of inventory that was being held by service centers, which handle about 60% of the structural material. In January 2005, service centers kept just more than three months worth of inventory on hand. By July, that amount was trimmed down to a little more than a month's worth of inventory. Then in August demand outpaced supply, with more than 800,000 tons shipped, compared to 600,000 tons shipped during a normal month. This has resulted in a significant reduction in mill inventory and a draw down of service center inventory to just less than two months.

This has moved the industry to a more typical pattern of advanced order for larger projects and a closer tracking of mill rolling cycles. “There's early involvement of the entire supply chain of projects,” Cross says. “Even on some rush projects, we're moving back to more of a design-to-material-available approach rather than just designing it and then finding the material.”

Cross encourages engineers and general contractors to work closely with the fabricator and service centers to understand the supply chain. Avoiding last-minute project changes that impact materials is a step in the right direction. If there are going to be last-minute changes, determine what material is readily available and design using that shape.

Higher prices for petroleum don't just affect transportation and material costs and availability. AGC's Simonson warns about the higher price for diesel fuel to run onsite equipment, such as cranes, dump trucks, concrete mixers, and earth movers. Currently, diesel prices are 36 cents higher per gallon than they were just a year ago.

Simonson is also concerned about the availability of natural gas for power plants. “Many electric power plants were built early in the decade and run exclusively on natural gas so some of them could conceivably have to shut down for short periods if there isn't enough natural gas to go around,” he says.

Natural gas shortages could also have an impact on the availability of PVC pipe, insulation, roofing material, paint, and plastic coatings and membranes that rely on the fuel as a feed stock. Periodic reports about shortages of large tires for heavy construction equipment, and construction equipment itself have been reported. “There's a very limited capacity in this country, and the tire producers are also making tires for mining equipment, which is in really short supply, and for the off-road equipment and vehicles in Iraq,” Simonson says. “Unfortunately, those tires are getting chewed up a lot. I don't see any relief in the near-term for tire shortages.”

Building materials aren't the only commodities experiencing shortages. One result of the building boom is that big machinery used in construction and mining is in high demand, causing depleted inventories and tight supplies. The Association of Equipment Manufacturers (AEM) says that demand for lift equipment, such as cranes and aerial lifts, may experience an 18% increase in 2006. AEM expects an overall increase of equipment sales to reach 9.3%, following a 13.9% increase in 2005 (Fig. 8). The slowdown in demand may bring some relief to the shortage, but while general equipment will be more available than larger machines, it will remain in short supply until 2007.

As even used equipment becomes scarce, producers continue to raise prices on new machines. One Illinois-based manufacturer of construction and mining equipment recently announced plans for a 1% to 5% increase starting in January. This is good news for rental companies. Rental rates gained 8% in 2004, 8% in 2005, and are expected to gain another 5% in 2006.

Because supply chain players are holding leaner inventories, sometimes shortages are inevitable. More manufacturers, distributors, and suppliers are relying on just-in-time deliveries. Rail lines are operating at capacity, ports are overcrowded, and finding truck drivers, especially after the storms in the Gulf Coast, can be difficult. According to Simonson, being prepared is the only way to complete your projects. “There are going to be times — no matter how much you think you've prepared — that a supply shock is going to come along,” Simonson says. “While you can't necessarily build up stockpiles of things, you do have to build in longer lead times.”

Building green. In correlation with anticipated rising energy costs is a renewed interest in energy efficiency and conservation. On Aug. 8, President George W. Bush signed into law the Energy Policy Act of 2005. The bill includes increased goals for federal energy efficiency — by 2010 U.S. agencies must use 35% less energy per square foot in their buildings than they did in 1985 — as well as provisions for funds for R&D for energy-efficient technology, construction and retrofit of buildings, and advanced energy-efficiency technology transfer centers. The law will also allow for tax deductions of $1.80 per square foot for efficient commercial property, which is defined as 50% more efficient than a building designed to ASHRAE/IESNA standard 90.1-2001. In addition, a provision of up to $0.60 per square foot is permitted for high-efficiency lighting, until the DOE and Internal Revenue Service decide regulations on how to handle individual systems that achieve 50% reduction for the overall building. This energy policy made law may be one of the biggest incentives for energy-efficiency in buildings in the nation's history, and it will certainly be the catalyst for green construction in 2006.

According to a survey by Phoenix, Ariz.-based construction industry consultants PinnacleOne, as many as 60% of public owners in the United States have implemented construction projects with energy-efficient design in the past year (Fig. 9). A recent survey of architects by St. Louis-based Fleishman-Hillard Research reports that respondents estimate that use of sustainable design techniques to realize ideas has increased 50% since 2000, and is anticipated to increase 100% in the next five years. The Green Index indicated that the rate of adoption of green building practices is increasing, with the use of high-efficiency heating, ventilating and air-conditioning (HVAC) systems leading the way, followed by increased use of design software to predict and evaluate HVAC operating costs, solar lighting, and retention basins for storm water run-off. The study queried practicing architects on their expected use of 16 green design practices and elements from five years ago, the previous 12 months, and the expected use of these practices five years from now.

Other elements and practices identified as important to incorporate into green buildings include monitoring devices for lighting, heating, and cooling; evaluation of building materials to maximize energy performance and minimize environmental impact; use of design software for energy modeling/baseline analysis; use of salvaged, refurbished, or reused building materials; use of interior solar lighting; and prediction and evaluation of the environmental impact and lifecycle of building materials. The study investigated the use of 16 practices based on the U.S. Green Building Council's LEED (Leadership in Energy and Environmental Design) standards.

The leading obstacle to adoption of green design practices, as reported by 52% of the architects, is cost, and almost one-third of the respondents cited lack of client education as the leading impediment. This means that if green design practices are to become more widely used, the industry needs to take a proactive approach to educate its clients about the long-term benefits of incorporating green building practices relative to their initial costs.

The study's architects believe that the best benefit of adopting green initiatives will be the lower energy costs for heating, cooling and lighting. This may induce clients to demand efficient, renewable sources. Government intervention, using regulatory requirements and incentives, will also influence adoption, but the final say will always come from the client: 64% of contributing architects said that client demand has the greatest influence on use of green initiatives. Of clients who are willing to build green, 85% are believed to be induced by rising energy costs, while 81% are influenced by regulatory requirements.