While warning sirens sounded during the last two months of 2000, pockets of the electrical construction scene should still see growth.
Construction fuels major amounts of electrical industry business. The ebb and flow of this market determines the fate of many electrical manufacturers, distributors, representatives, engineers and contractors alike. It's also important to the economy as a whole, so it attracts numerous forecast makers.
According to the F.W. Dodge's Outlook 2001, the U.S. construction market is expected to record barely any growth for 2001, but that still leaves the construction business at near-record levels. While some markets - like multi-family housing, school construction and manufacturing building - look better than others, the coming year's business prospects still look decent. There should be "a slight 1 percent increase for total construction contract value in 2001," according to Robert Murray, vice president of economic affairs for the Construction Information Group, a division of The McGraw-Hill Companies.
"It's true that the construction industry as a whole will not be posting the strong gains of the late 1990s, but it's also not likely to see a sharp downturn, either. In effect, the construction industry has reached `cruising speed' - in which the level of activity should continue to be reasonably healthy." F.W. Dodge contract awards provide an advance indicator of construction activity because the awards take place a number of months before the projects get underway.
Looking at the prospects for construction in 2001 from a different point of view, Thomas R. Loy, chief economist for FMI Market Information Group, Raleigh, N.C., said, "The current forecast indicates that construction put-in-place will increase 5 percent in 2001."
By major classification, that amounts to 2 percent growth for residential in 2001, 4 percent for nonresidential and 7 percent for nonbuilding structures. All represent a couple percentage points cooling off from 2000. New construction put-in-place is a government data measure of monthly outlays for on-going work.
Weighing in with a more general point of view, Bill Toal, chief economist for the Portland Cement Association, speaking at CMD Group's annual North American Construction Forecast, thought that total inflation-adjusted construction activity would dip 1.9 percent in 2001. He expected the construction industry to remain strong for the foreseeable future. "We are not significantly overbuilt in most areas of construction, and this is important as we look down the road," he noted.
Here are the 2001 business prospects for several key segments of the construction market.
HOUSING MARKET Single-family housing. Single-family housing will continue to settle back from its torrid 1998-99 pace, with 2 percent slippage in dollar volume arising from a 5 percent decline for dwelling units. At a projected 1.125 million units, single-family housing next year will still be about 10 percent above the annual average for the 1990s.
The downturn by region is not expected to diverge too much from the 5 percent retrenchment for the United States in total single-family housing construction. The decline in the West is expected to be smaller than that for the nation, given the increased housing demand arising from this region's strong population growth. At the same time, restrictions on development in some markets may dampen activity. The Northeast is also projected to see a comparatively small decline, since this part of the nation did not experience the 1990s housing boom to the same extent as other regions, thereby lessening its downside risk.
The weakening for the other three regions during 2001 is expected to be slightly more than the national average. The North Central will continue to see tight labor markets placing limits on growth. On the plus side, an improving export market would benefit this region's industrial sector.
The South Atlantic has witnessed strong economic growth in recent years, helped by its ability to attract firms due to its business-friendly climate. The heightened levels of residential and commercial developments have also generated discussion over smart growth policies, which will have some dampening impact on construction activity. For 2001, it's expected that single-family housing in the South Central region will settle back to previous levels.
In recent years, one of the healthiest segments of the single-family home market was vacation-home construction, said Murray of McGraw-Hill's Construction Information Group, as the strong economic expansion also spurred greater purchases of vacation or second homes. However, he said there may now be some vulnerability for second-home demand in the near term given flat-to-declining stock prices, which will contribute to the overall slowdown for housing construction in 2000 and 2001.
Murray said the second home market was also supported by strong growth of households headed by individuals 45 and older, and that the 55- to 64-year-old group will surge by 3.5 million households during the 2001-2005 period, followed by an additional 3.4 million during 2006-2010. These demographic trends imply a continued push for second homes, even with some near-term softening due to a sagging stock market. They also imply continued support for larger trade-up housing with more amenities, as well as adult/retirement communities.
This market segment may also be receiving help from the 1997 change in the tax law that in effect reduces the financial penalty for "empty nesters" looking to downsize from a suburban house into a condominium.
Multi-family housing. Although apartment buildings are built, renovated and run with a profit motive, as are the other commercial building categories, it's demographics that largely determine the need for them. The current situation for the market: Apartment vacancy rates have been holding at 8 percent for the last four years nationally, so supply-demand balance exists. (Individual geographic markets may vary, of course.) To change the demand side, and thereby trigger more construction, there needs to be a demographic push from somewhere. The typically, young adults first forming households create this demand, but growth from that group is still down the road five years. There's more potential from empty-nesters at the moment. In some places, smart growth movements are encouraging multi-unit housing to save open spaces. Multi-family housing is expected to see slight improvement in 2001, given potentially favorable demographics and tight rental markets in various cities around the United States.
COMMERCIAL MARKET The electrical industry's health derives more from the commercial market than most at first realize. When new construction and renovation (and to some extent maintenance) of office buildings, hotels and motels, commercial warehouses, shopping centers, restaurants and other retail space heats up, as happened in the late 1990s, electrical business looks and feels good. When that market falls off a cliff, as it did for office space after the overbuilding spree of the 1980s, it makes it very tough going for electrical industry companies.
Until the last month of 2000, signs looked pretty positive for the commercial market. With lessons learned from the 1980s debacle, developers and lenders alike appeared more inclined to caution. In 2000, supply of commercial space was not outstripping demand significantly, by all known measures.
Noted Murray of McGraw-Hill in October 2000, "When weaker economic conditions eventually lead to reduced demand for (commercial) space, the correction ... should not be as severe as in the past." That view, of course, fits with a scenario that has the economy easing gently in 2001. The abruptness of the economy's cooling down at the end of 2000 brought wariness and could put a damper on plans already in the works.
The majority of commercial business for the electrical industry comes from new construction and renovation, and the specific economic factors that shape commercial construction vary somewhat by the type of structure. Each market's potential for continued electrical maintenance work and product purchases hinges on its overall health.
Store construction. Store construction, first of strip malls, then of regional shopping centers, tends to follow housing construction in locale. The record levels of housing starts through 2000 bode well for continued store construction activity in 2001. But declining retail sales and tighter lending standards could put some plans on hold.
Likewise, continued declines in retail sales in 2001 could lead to a contraction in the retail business. A spur to continue new construction and renovation, however, is the competition among retailers for presence and position in geographic areas, as well as new formats (like outlet centers and retail complexes). "New retail construction will rise 5 percent, or approximately $1.3 billion in 2001," according to the FMI Construction Outlook. Moderate declines in 2001 are projected for stores in F.W. Dodge construction contracting terms.
For the retail business as a whole, it will decidedly see some slacking off in 2001. Consumer spending had moderated by the end of 2000. In the opinion of one analyst, "Despite the current volatility, spending growth will settle at more moderate and sustainable, yet still healthy levels." Higher interest rates, higher oil and gas prices and poor performance of equity markets will keep retail sales growth in check in 2001. The electrical industry's retail maintenance market should remain steady.
Warehouses. Again, new construction provides the bulk of the electrical industry's business in this market. Recent strength in the construction of warehouses had been evident, but in 2000 the market was not overbuilt. Demand for such buildings should decrease as the economy slows in 2001, with some offset by new factors - Internet retailers constructing new warehouses to keep up with increasing business and tech companies using warehouses as inexpensive office space. Also, telecom hotels are proving an emerging trend, both in new construction and renovation. The latter are especially lucrative for electrical industry companies. Warehouse construction should stabilize at the levels reported in 2000.
Office buildings. A continued strong economy in 2000 with healthy employment growth had the effect of absorbing any new office space that came on the market. Vacancy rates continued low, coming in at the lowest level yet - 7.7 percent national average - in the third quarter of 2000, as reported by CB Richard Ellis. That usually triggers more construction, but this time around, a "modest pullback" was already underway in 2000 after a surge 1997-1998, according to the F.W. Dodge forecast.
"The construction industry is seeing a faster correction take place for markets on the verge of overbuilding," said McGraw-Hill's Murray. An abruptly slowing economy threatens a surge in unemployment (and less need for office space to house workers.) Couple that with discipline on the part of lenders and developers that makes financing harder and costlier to come by, and even projects on the boards could get shelved.
When it was still a soft landing in sight, Murray had this forecast: "It's projected that office construction will respond to this mildly dampened demand by retreating 4 percent to 260 million square feet."
In its most recent report on office vacancy rates, issued in late 2000, CB Richard Ellis predicted, "Through the remainder of 2000 and into 2001, office construction will hold steady." In addition, the report said, "Low vacancies have sparked development and as these projects are completed, there will be some relief for pent-up demand. However, increased wariness of an economic slowdown will limit future ground-breakings while still allowing for a healthy balance of supply and demand." The forecast from FMI Construction was that, "New construction of privately owned offices will increase 5 percent, or $1.7 billion, in 2001."
Hotels and motels. Construction of hotels and motels already saw a dropoff in 2000 and another was already anticipated for 2001. Hefty activity in the mid 1990s had a negative impact on the industry's occupancy rate and revenue per available room. The lodging industry responded by concentrating on luxury hotels and holding back on low-end ones through 2000. With less demand from both business and vacation travelers as the economy contracts in 2001, this market could fall off even further from the moderate declines already being projected for 2001.
INDUSTRIAL MARKET Combined, industrial maintenance and repair, renovation, factory automation and new construction provide a major source of business for electrical industry companies. The market's importance to you varies depending on your business's focus, but the health of manufacturing in the U.S. is rightly of concern to electrical manufacturers, distributors, representatives, engineers and contractors alike.
So how is it likely to do in 2001? All signs indicate a less healthy year than 2000, a year that already had its problems. Yet with the Fed signaling its willingness to step in to adjust interest rates, manufacturing could avoid a rout in 2001.
In 2000, as higher interest rates translated into heftier financing costs for businesses, it slowed the economy. Through the end of 2000, manufacturing had been impacted solidly by the slower growth. Capital spending weakened, new orders slowed, corporate profits warnings abounded, costs of financing rose, labor remained tight. The industrial production index released by the Federal Reserve showed the third quarter rising at an annualized rate of 2.8 percent, the slowest since early 1999. Negative industrial production results for two consecutive months, October and November of 2000, provided confirmation that manufacturing growth was struggling, and that the economy was slowing abruptly. Much of weakness in the past two months came from production slowdowns at auto makers and in other industries directly affected by consumer spending, which was tamping down as 2000 ended.
Transportation equipment (motor vehicles and aircraft) often swings industrial production numbers; and that market's prospects affect the business plans of many electrical industry companies, too. The outlook for motor vehicles is not the best: "The weakening transportation sector is expected to have an adverse effect on the sales of electrical equipment, such as lamps, small electric motors, and wire and cable products that supply the motor vehicle industry," according to Steve Wilcox of the National Electrical Manufacturers Association, Rosslyn, Va.
With industrial production slowing, the capacity utilization rate (the percent of total available capacity being used by manufacturers, mines and utilities) not unexpectedly showed decline through this period. In November 2000 it stood at 81.6 percent. The capacity utilization rate is key in determining industrial firms' capital spending - a rate under 80 percent and falling is considered a sign that capital spending will be weak. The current trend would indicate that industry is moving into that range soon.
The extent of capacity utilization also factors into the need for new factory construction. Since this construction work is planned in advance, the 2001 prospects have already taken shape. According to Murray of McGraw-Hill, "Contracting for manufacturing buildings in 2001 is projected to advance 6 percent to 132 million square feet, which is still fairly weak by historical standards."
To put perspective on the situation, however, both industrial production and capacity utilization were ending 2000 well above year previous levels in most categories. Production activity was coming down from its peak earlier in 2000.
The business outlook on the part of the manufacturing industry grew more pessimistic as 2000 ended. The NAM/Fortune Manufacturing Index showed the percent of large NAM member companies with a positive business outlook as of the third quarter of 2000 at 72.2 percent, for small and medium-sized companies at 78.3 percent. Both figures had been trending steadily downward since the fourth quarter of 1999. Another well-watched indicator, the Purchasing Managers' Index compiled by the National Association of Purchasing Management (NAPM), fell to 47.7 percent in November. A reading below 50 percent indicates that the economy is generally contracting. This was the lowest level the index had reached since November of 1998, and it suggested "a mild contraction in the manufacturing industry in November that continues a downward trend" that began in the fall of 1999, according to Michael Burt, analyst for The Dismal Scientist. He characterized this economic weakness as "systemic" and saw "no signs of improvement apparent."
Anyone looking to export markets to offset slowdowns at home will find slow going. A record high international trade deficit continues to hamper business possibilities. Imports continue to flood in, while exports have had a hard time rising.
INSTITUTIONAL MARKET Institutional properties. Institutional building should rise 3 percent, due to further growth for school construction. Elementary school enrollment is just off its peak year, and the amount of new construction and retrofit work in elementary schools has been at near-record levels. Because solid demographic trends are still in place and are supporting high levels of school enrollment, school construction will expand 3 percent to 267 million square feet in 2001, with the regions of the country with the largest population increases seeing most of the action.
According to the McGraw-Hill forecast, elementary school enrollment peaked in 2000 at 35.2 million students and is expected to drop to 34.4 million students by 2006.
As this population bulge moves to the high school and college years, you can expect the construction opportunities in this market segment to follow. The report said the enrollment of secondary schools will rise from 17.8 million students in 2000 to 19 million students in 2006. Renovation work in the education market will increase 12 percent to $16.8 billion dollars, according to FMI's report.
Hospitals and health-care facilities. In contrast to the educational market, health-care facilities will see slippage, particularly in its clinic segment. Industry observers do not expect construction in this market to expand much over the next few years because of continuing uncertainty over the transition of the health-care market. The McGraw-Hill report forecasts that construction of hospital clinics will decline sharply next year and that hospital construction will stabilize, resulting in a 6 percent drop overall in this segment to 87 million square feet. Renovation work in this market will be at $11.7 billion, according to FMI.
Other institutional market segments. Amusement-related projects (sports arenas, theaters and convention centers) will also lose momentum in a more subdued business climate. Religious building is another healthy segment in this market.
OTHER KEY MARKETS
Public works. Airport work will be strong, boosted by funding coming from the new federal aviation bill. Major airport projects are underway in Boston; Chicago; Detroit; Newark, N.J.; Orlando, Fla.; and Philadelphia.
Utilities. About half the states have enacted deregulation plans, which in combination with capacity shortages, should keep power-plant construction close to this year's robust amount