’04 Economic Outlook

Held up by stalwart consumers of cars, new homes and their associated accoutrements, the U.S. economy fared better than expected in 2003, helped by a welcome, yet surprising surge from retail construction. Unfortunately, as 2004 approaches, economists remain cautious as the fear of continued job loss may kill the golden goose.

By Jim Crockett, Editor-in-Chief December 1, 2003

Held up by stalwart consumers of cars, new homes and their associated accoutrements, the U.S. economy fared better than expected in 2003, helped by a welcome, yet surprising surge from retail construction. Unfortunately, as 2004 approaches, economists remain cautious as the fear of continued job loss may kill the golden goose.

“There’s still a lot of uncertainty out there,” said Gene Sperling, former national economic advisor to the Clinton Administration and former director of the National Economic Council. “We’re still in a period of job loss that has lasted 22 months—a new record. And while Wall Street is predicting an average growth of 5%, and other economists are generally bullish, I find myself in the ‘blasemist’ camp.”

Sperling was one of several economists and construction industry experts speaking at Reed Construction Data’s 8thannual North American Construction Forecast at the National Press Club in Washington, D.C. earlier this fall. ( Visit csemag.com , go to More CSEMag.com news stories, and click “Economy for ’04: Blase,” for more of Sperling’s comments. )

Providing a more scientific projection of 2004, but not necessarily with better news, was Glenn Mueller, Ph.D., a professor at John Hopkins University’s Real Estate Institute. Mueller, who is also an investment strategist with the real estate research group Legg Mason, Inc., has developed an economic projection model based on a 30-year economic cycle. Briefly, the model—interspersed throughout the story as a series of graphs depicting a skewed bell curve—is fairly reflective of the nation’s economic ups and downs and is made up of 16 points that indicate various stages of economic growth and decline on a time vs. building-type occupancy curve. On the charts, “1” indicates the absolute bottom, with no new construction and declining vacancies. Moving along on the chart, 6 indicates the start of growth and 11 represents the peak of the economic cycle. Positions 12-14 represent continued construction, but increasing vacancy, with 14 and beyond indicating decline.

Based on this model, Mueller’s graphics forecast where the major market sectors—industrial, office, retail and hotel construction—will lie come the second quarter of next year, as well as where the nation’s major cities will fall in the cycle with respect to these markets.

To begin to get an accurate feel for when such growth spurts might start—about position 8 on the curve—one has to be aware of where these markets are in the cycle. In a nutshell, for 2004, Mueller projects hotels, industrial/research and development, suburban office and factory-outlet retail construction to be at position 2; urban office construction at position 3; warehouses, multi-family housing, senior housing and power center retail, such as Target/Kohl’s combinations, at position 4; regional malls and neighborhood shopping centers at position 7; and finally, health-care facilities at the top in position 9.

The markets

In his estimate for 2003, Mueller projected the office market to vary between positions 2 and 4, but with a number of cities closer to the latter. In fact 2003 activity hit bottom at level 1, with stronger cities in the Southeast—Richmond, Nashville, Memphis and Ft. Lauderdale—dropping to level 2. For 2004 he sees a slight improvement with most cities moving from positions 1-2 to 2-3.

On the industrial side, in ’03 Mueller projected most cities to be between levels 4 and 7. In actual ’03 activity, the market experienced a similar decline to office construction with almost all cities falling back to positions 1 and 2. For 2004, the majority of cities will improve slightly to positions 2 and 3, respectively, but some cities—Houston, Los Angeles and Milwaukee—could jump to position 5, while Denver, San Diego and parts of Orange County, Calif., may hit position 6.

Retail promises the most

In 2003, Mueller forecasted that retail construction in most cities would vary between positions 3 and 7. What actually happened was that the numbers were all down a position, with some cities, like Boston, slipping to position 3 from a projected position of 7. Yet there were some cities that posted solid retail construction numbers at positions 5 and 6—signs of growth, he says. For 2004, Mueller projects marked improvement, with the most active cities, like Miami and San Diego, moving to as high as position 8. Even down-market cities, like Boston and Chicago, are expected to rebound to as high as position 6.

Retail, of course, is doing well, according to Mueller, as it coincides with the housing boom the nation has experienced. “Refinancing gave people more money to spend, and retailers have been building new store space to meet this demand,” he said.

That being said, he points out that only three major malls were constructed last year. Regional malls, however, are doing well, as are strip centers in areas where new homes are being built.

Hotels also saw some signs of life in 2003, but remain problematic as a whole. Mueller says hotels need to be at about 65% occupancy to be profitable. Since 9/11 and the downturn in tourism, 61% has become an acceptable figure. However, the problem, according to Mueller, is that the market is only at about 60%. But, he notes that regional hotels are faring well. Vacationers are staying closer to home, but are willing to spend on nicer accommodations because they’re saving on airfare. Hotels that depend on business travel, however, are still suffering.

For 2004, Mueller forecasts that hotel construction in most cities will remain at position 2, but several cities should also move to positions 3-5, including New York. Almost all hotel activity in 2003 was at positions 2 and 3, but he says activity should really pick up in 2006-7.

Elsewhere, Mueller notes that the building industry should soon be feeling the effects of the Echo Boomers entering the job market and the Baby Boomers entering retirement age. This should translate into more multi-family housing, senior-living housing and continued health-care construction. However, the economy is currently throwing the cycle a curve. Due to a lack of jobs, many younger adults are choosing to live at home or are tripling up in apartments instead of renting on their own.

But despite Spartan numbers overall—Mueller expects about a 2% national economic growth—he says there are reasons for optimism: First, there are really two cycles that must be noted—the physical market of supply and demand and the financial cycle, where capital flow affects the construction of new buildings. The good news, he says, is that the two don’t have to parallel, and in his research he’s found that there are investors with literally millions of dollars waiting to buy good properties. Historically, he says, property cap rates really drive such acquisitions, and the rates, right now, are becoming more favorable. Further, property is always a good investment, and in his opinion, right now is a much more attractive option than bonds, the market’s other “stable” investment area.

Mueller’s peer, Ray Owens, vice president and senior economist with the Federal Reserve, was a little more optimistic about the economy’s general health—he projects about a 4% economic growth—but did offer a warning about overzealousness in real estate.

“One of the troubling concerns is the deficit,” said Owens. “If it continues to grow it will likely push up interest rates, which will push inflation, which in turn, may take the steam out of the residential and commercial markets, lowering the leverage of real estate.”

He further warned this condition could combine with growing fears about the need for social security investment, which may also lead to negative building conditions. “It’s certainly a slippery slope,” he said.

Owens and the Federal Reserve publish the “Beige Book,” a periodic snapshot of economic conditions across the country. In citing their most recent findings, Owens noted net absorption of office space saw a slight uptick in 2003—a positive, given several years of negative numbers. Class-A space, in particular, has shown the most improvement. Office rental rates, finally, may be finding a bottom.

Anecdotal evidence from across the country is consistent with this story. For example, Boston experienced some positive market absorption for the first time in more than two years. In Philadelphia, Owens noted rental rates continue to decline as landlords offer tenant improvement allowances and even rent-free periods.

But results are obviously mixed, as places like Chicago and San Francisco have no demand for new office space.

“Signs of an economic pickup, combined with a sharp curtailment of new construction, has laid the foundation for more solid performance going forward,” said Owens. “But on balance, even with an improving picture, the pace of improvement may be uneven.”

Please visit the web site of our sister publication—Building Design & Construction—( bdcmag.com ) for a forecast from Reed Construction Information’s director of economics, Jim Haughey. Simply click on the cover photo, and scroll down to “Sustained GDP Growth Returns.”

Hot Trends for A/E/C Firms in ’04

A/E/C industry market analyst ZweigWhite, Natick., Mass., has just published the “2004 AEC Industry Outlook: Strategy and Insight for Design & Construction Firms,” a 154-page market research report.

In a nutshell, report author Jerry Guerra notes that while conditions are improving markedly for the overall economy, it will take some time before A/E/C firms fully realize the effects of that improvement as a whole.

“Hot markets in recent years, such as single-family housing and education construction, may cool off slightly in 2004. Meanwhile, it’s going to take time for struggling markets such as manufacturing and office buildings to fully recover, particularly if the pace of employment growth doesn’t pick up,” says Guerra.

The Congressional Budget Office, he notes, predicts a nearly 4% increase in the gross domestic product during calendar 2004. However, the design and construction industry, he says, is likely to see another year of 1-2% growth.

Other notable trends to be aware of, according to the report:

A/E/C firm leaders expect net revenue to increase by 10% and pre-tax, pre-bonus profit to rise by 8% in 2004.

Merger and acquisition activity should rebound behind better industry performance and renewed interest in ownership transition.

Design firms will be required to use the new Standard Form 330 for all federal projects six months after it is published.

Retail and lodging have the inside track among recovering commercial construction markets.

Health care will dip.

For more details on the report visit