Robert L. Lurensky
In 1989 the constant-dollar value of new construction put in place will decline slightly, while repair and remodeling work will increase. The number of housing starts, especially single-family homes, is expected to decrease Commercial construction will continue to decline because business investment will be weighted toward new equipment rather than structures. Public works construction will increase slightly. Foreign construction contractors are expected to increase their market share in the United States while US. contractors lose market share abroad.
The constant-dollar value of new construction put in place declined slightly in 1988 from the record set in 1987. (However, the 1988 current-dollar value of about $400 billion was a new record.) Small increases in public works construction were more than offset by declines in private construction. Although the number of housing starts fell 10 percent to 1.45 million units, the value of residential construction only decreased 2 percent because of a marked gain in average house size and an increase in home improvement spending. Public works construction increased slightly, led by strong spending for highways and schools. The lack of growth in private nonresidential construction was largely attributable to high vacancy rates for commercial buildings in most cities, as well as to the repeal of various tax benefits by the 1986 tax reform act.
In 1988, the value of new construction put in place was equal to approximately 8.4 percent of gross national product (GNP). This represents a substantial recovery from the cyclical low of 7.7 percent of GNP in 1982, but is well below the post-World-War-Il peak of 11.9 percent attained in 1966. By this measure the construction share of GNP is expected to decline in 1989 (Figure 1-1).
During the past decade, several types of construction activity that are not included in new construction data have grown rapidly. These include maintenance and repair, commercial/industrial renovation, and hazardous waste cleanup.
Construction costs increased about 2 percent between the summer of 1987 and the summer of 1988, as measured by the Census Bureau’s composite construction cost index. This represents the seventh consecutive year of moderate construction cost increases. However, builders have experienced substantial cost increases for some of their inputs, notably building materials, land, and insurance. Building materials prices rose an average of 5.9 percent in 1988 (see Chapter 2, “Building Materials”). Land prices rose dramatically in some of the strongest construction markets because of market forces and antigrowth restrictions. (Land prices are not included in the construction cost index.) Insurance and bonding costs have continued to increase, although the availability of insurance appears to have improved. Labor costs have been relatively steady, with average hourly earnings of construction workers increasing about 3 percent. Nevertheless, labor costs have run up faster in some of the strongest construction markets, where labor shortages have reduced efficiency, increased overtime, and raised wage rates.
Construction industry employment rose 0.4 percent in 1988 to a record 5.1 million employees and probably would have been greater if there had not been labor shortages in some of the strongest construction markets. In addition, nearly 1.5 million people were self-employed as proprietors and working partners (Table 2). Despite the recent moderation in construction wage increases, construction remained one of the highest paying industries, as measured by average hourly earnings and average weekly earnings.
International Construction and Investment
The construction business has become increasingly internationalized during the past 15 years. US. contractors continue to be leaders in international contracting, winning $18 billion in international construction contracts in 1987. However, the US. market share abroad has declined, while foreign construction contractors are beginning to make significant inroads into the U.S. construction market. These trends are expected to continue in 1989 and for at least several years thereafter because of declining prospects in Third World markets and increasing foreign interest in the U.S. market. (For a further discussion of international construction contracting, see the final section of this chapter.)
Many of the largest foreign contractors have entered the US. construction market during the past decade, because of declining prospects in Third World markets. Most of these contractors have entered the US. market by buying American construction companies, but some of the largest ones have established branch operations in the United States. Foreignowned construction firms won $8.9 billion in US. construction contracts in 1987, 3.5 percent of all US. construction contracts that year and more than double the $3.6 billion recorded in 1982. Most of these foreign entrants are based in Japan, West Germany, the United Kingdom, and France, although nearly a dozen additional nations are represented.
International trade and capital flows are having an increasing effect on the domestic construction market. Because of record levels of foreign investment in the United States, a growing share of US. construction projects is being built for foreign owners. Foreign direct investment in the United States is chiefly in manufacturing facilities, warehouses, office buildings, and hotels. Recently, foreign developers and builders have tested the U.S. housing market. Foreign financial investments, such as US. Government bonds and mortgagebacked securities, have helped to keep interest rates lower than they would have been otherwise. On the other hand, the large foreign trade deficit is reducing the need for new US. manufacturing facilities, by as much as $2 billion in 1987.
Outlook for 1989
The total value of construction in 1989 will decline slightly from the 1988 value, but some areas will experience growth (Table 1). The most promising markets appear to be home improvement, manufacturing facilities, hospitals, schools, water supply, and public service buildings. The weaker construction markets will be homebuilding, office buildings, hotels, other commercial buildings, conservation and development, large power plants, and sewer systems.
Forecasts for 1989 are based on the following economic assumptions: slightly rising interest rates; moderate economic growth through 1989; strong increases in plant and equipment expenditures because of surging export demand and the need for plant modernization; reduced demand for new apartments and commercial buildings because of high vacancy rates; government investment that will grow slightly faster than inflation in 1989; the continuing impact of the 1986 tax reform law on construction demand; and demographic factors that are bullish for construction of single-family homes, schools, and hospitals, but are bearish for apartments.
The number of housing starts will continue to decline, to about 1.4 million units in 1989, but the value of residential construction will be supported by increases in average house size and continued growth in home improvement expenditures. Private nonresidential construction will decline, primarily because of high vacancy rates for commercial buildings and the elimination of major tax benefits for commercial real estate investment. Public works construction will increase for the sixth consecutive year, as modest increases in state and local spending offset small declines in federal construction expenditures.
Construction activity is likely to hold up better in the Midwest and the South than in the Northeast and the West. The Midwest may even buck the national pattern and enjoy an increase in construction because of the revival of manufacturing output and plant investment. Numerous jurisdictions, especially in the Northeast and California, have adopted antidevelopment policies, which raise costs and otherwise inhibit new construction. The South, which has received a disproportionate share of industrial construction during the past 2 decades, will probably benefit from the narrowing trade deficit.
During the 1988-93 period, new construction is expected to remain near the current record levels while remodeling and repair construction increase steadily (Table 3). The macroeconomic forecast predicts conditions that are favorable for construction-continued economic growth, fairly stable interest rates, slow inflation, declining federal budget deficits, and declining trade deficits. Given this scenario, the overall value of construction put in place should decline slightly in 1989 and 1990, and then set new records in the early 1990s.
Growth in new construction, however, is likely to be significantly lower than overall GNP growth, in part because of the time needed to absorb the current oversupply of commercial buddings. High “real” interest rates will also inhibit construction, especially single family homes. The federal budget deficit will limit spending for public works, despite the wellpublicized need for additional infrastructure investment.
The recovery of the US. manufacturing sector is expected to continue over the long term, boosting demand for industrial construction. Hospital construction wiU continue to gain because of demographic and institutional factors. Maintenance and repair work, both residential and nonresidential, are expected to increase more rapidly than the overall economy, as the US. stock of structures becomes older and more extensive.
Construction demand is sensitive to tax law revisions that affect real estate investments. The complex effects of the 1986 tax reform law will affect construction demand well into the 1990s. For the most part, the initial depressing effects of this law will be absorbed during the late 1980s, while the stimulative effects will steadily increase. Thus, by 1990, construction activity may well be higher than under the tax law existing in 1985. However, further changes in the tax code are possible during the next 5 years, as major tax revisions have occurred every 2 years, on average, since World War II.
Among the supply-side challenges facing the industry are foreign competition, supply of workers, and liability insurance. Most of the foreign construction contractors in the US. market are extremely well-financed, and often they possess construction expertise equal or superior to that of most US. builders. The supply of young workers available to the construction industry will dwindle because of demographic trends and low unemployment rates. Barring substantial productivity gains, labor shortages and labor quality could become major problems. The cost of liability insurance will probably stabilize during the next several years, but longrun trends in liability insurance depend largely on legislative and judiciary developments in tort reform.-Patrick MacAuley, Office of Forest Products and Domestic Construction, (202)377-0132 September 1988.
PRIVATE RESIDENTIAL CONSTRUCTION
The value of private residential construction declined by about 2 percent in 1988. Housing starts fell from 1.62 million in 1987 to 1.45 million in 1988, with the most severe decline in multifamily housing. Residential construction (excluding land) was valued at $190 billion in 1988, of which 60 percent was for new single-unit homes, 12 percent for new multiunit homes, and 28 percent for improvements to existing homes. Residential construction accounted for 4 percent of the GNP in 1988.
The cyclical recovery in residential construction started in 1983, as mortgage interest rates declined from the record levels of 1981 and 1982. Construction activity responded to a steady decline in mortgage interest rates from 16.6 percent in 1982 to a 9-year low of 9.7 percent in 1987. Interest rates declined slightly after the October 1987 stock market drop, but began rising in the spring of 1988 and are expected to increase by an additional half percentage point in 1989 (Table 4).
The rise in interest rates curtailed both new and existing home sales. Sales of new homes in 1988 were 8 percent below 1987 levels, while the sales volume of existing homes declined 3 percent. Sales of existing homes tend to stimulate residential construction by providing equity for trade-up homebuyers and by causing a large amount of home improvement expenditures.
Shifts in social patterns have implications for the size and design of housing in the future The number of households-totaling 89.5 million in 1987-continues to rise faster than the population. The US. population is growing by nearly I percent annually, while the number of households is increasing by nearly 1.2 percent, with the difference caused by a continuing drop in the average household size In 1986, the average household had 2.67 members, down from 2.76 in 1980.
Income levels and housing prices are two of the most important factors in housing affordability. Disposable income per capita rose about 43 percent between 1982 and 1988, while median new home prices rose 70 percent. Declining interest rates were able to more than offset rising home prices between 1983 and 1987, but in 1988 both housing prices and interest rates rose.
Outlook for 1989
The number of private housing starts is expected to decline about 50,000 units in 1989, to about 1.4 million units. Most of the declines will be in single-family units, which are more sensitive to interest rates. Mortgage interest rates are expected to increase by one half of one percentage point in 1989, to a weighted average effective rate of 10.4 percent (Table 4). Home improvement expenditures will probably increase again in 1989, although the rapid growth rates of the past 5 years appear to be leveling off.
The major uncertainty in any forecast of homebuilding is the trend in interest rates, which are extremely difficult to predict. A major increase in interest rates could lead to large declines in single-family housing starts, while multifamily housing starts are not nearly as sensitive to interest rates in the short run.
Homebuilding is expected to grow more slowly than the overall economy during the next 5 years, given the macroeconomic scenario described earlier. Demographic demand factors for single-family housing will be strong through the early 1990s, although high interest rates and house prices will limit effective demand. Demographic factors will remain weak for multifamily housing, but new construction has nearly fallen to the level that can be sustained by market demand. Expenditures for home improvement and repair are expected to remain strong throughout the 1990s as the housing stock ages.
An important factor in forecasting long-term housing demand is the maturing of the baby boom generation, those born between 1946 and 1965. Those born in the earlier years of the baby boom purchased their first homes in the mid-60s to the mid-70s at a time of low prices, low real interest rates, and high value appreciations. This group has now entered the peak earning years and is trading up to larger homes. People born in the later years of the baby boom and those that delayed housing purchases face a different market. They have affordability problems caused by high prices, slower real income growth, high real interest rates, and a changing economy. They are entering the housing market more slowly than people did in the previous decade.
A study by the National Association of Home Builders shows that homeownership rates of people between the ages of 25 and 49 declined during the 1981-86 period; this group, compring 36 percent of the population, purchases the most housing. The greatest declines were in the 25-29 and 30-34 age groups, the two largest categories of the population. tahe declines were smaller in the 35-49 age groups, and the home ownership rate was stable among people over 50. The declining homeownership rate probably represents affordability difficulties more than declining consumer preference for housing, pointing to strong pent-up demand for housing in the 1990s.
Single- Unit Structures
Private single-unit housing starts totaled nearly 1.05 million units in 1988, down 8 percent from 1987. Constant-dollar value of single-family home construction, however, declined only 2 percent. The average amenities of new homes increased about 7 percent in 1988 (Table 4). The median sales price of a new single-family home rose about 13 percent during the period, to $118,000. To a large extent, the 1988 decline in starts was caused by the small increase in interest rates that year. Other factors also probably played a part, notably the large increase in home prices and the steady elimination of the “pent up demand” that resulted from high interest rates and high unemployment during the early 1980s.
Single-family housing starts in 1989 are forecast to decline by 40,000 units to about 1 million units, chiefly because of an expected small increase in mortgage interest rates. The size of the average new house will probably be about the same as in 1988, as higher prices and interest rates make it more difficult to afford additional amenities.
Of the 1,050,000 starts of single-family homes in 1988, 935,000 were detached houses and 115,000 were townhouses. (An additional 32,000 townhouse-style homes built in 1988 were classified as multifamily housing.) Detached singlefamily homes have accounted for an increasing portion of single-family homes since 1985. This is due to the drop in interest rates, which made larger houses more affordable, and to increased demand for space and amenities, resulting from the trade-up housing trends. Prior to 1985, townhouses had a rising share of the single-family home market because of rising house prices, high interest rates, and the demand for starter homes by the first half of the baby boom generation. Since 1985, the number of townhouses and the market share of townhouses has fallen. Unless there are major shifts in consumer tastes, or unless housing affordability deteriorates substantially, the townhouse share will continue to remain low.
The average size and amenities of new single-family homes, as measured by the Amenities Index for New Homes (Figure 1-3), rose more than 7 percent in 1988. The median price of a new home rose 13 percent, reflecting a 6 percent price increase plus the 7 percent increase in size and amenities.
The supply of used starter homes will increase substantially as homeowners move into larger houses. The strongest category of demand for new housing will therefore likely be for trade-up single-family housing. As a result, the total value of residential construction put in place may increase slowly, even though the number of homes built may decline slightly.
Multiunit Housing Structures
In 1988, about 400,000 multiunit residential structures were started, representing declines of 15 percent from 1987 and 40 percent from 1985. Multifamily housing starts will probably decrease again in 1989 and then level off in 1990.
Multiunit structures had an increasing portion of total housing starts from the mid-70s until the mid-80s. Favorable tax incentives stimulated investor demand for multifamily housing that was stronger than the tenant demand for space, resulting in overbuilding and high vacancy rates, particularly in the South. The 1986 tax reform law eliminated most of these tax advantages.
Multiunit housing consists of buildings with two to four units, some townhouse-style buildings with more than five units, and apartment buildings, as shown in Table 5. Apartment buildings accounted for 79 percent of multiunit housing starts in 1988.
Condominiums accounted for nearly 26 percent of multiunit housing starts in 1987 (the most recent year for which data are available), down from 29 percent in 1984. Condominium construction has abated because of slower appreciation in condominium prices and the large stock of existing condominiums.
Construction of new federally subsidized housing declined from about 30,000 units in fiscal year 1986, to 18,000 in fiscal 1988. Most federal housing subsidies are now provided in the form of subsidy vouchers and funding on rehabilitation activities to use the existing housing stock more intensively. However, federally-subsidized construction is likely to increase ftom its current levels because of passage of the Homelessness Prevention Act of 1987, which would provide Federal assistance for up to 63,000 new units.
Multiunit construction is likely to decline in 1989 because of high vacancy rates, less attractive tax incentives, and relatively weak demand from renters. The tax law changes-lengthening depreciation schedules and eliminating limited partnership tax breaks-have reduced the profitability of rental buildings, even though rents have risen slightly. Higher rents are reducing tenant demand for
rental housing at the same time that lower profits are reducing investors’ incentives to build more rental housing. Condominium ownership has been made more attractive by the 1986 tax reforms, since tax deductions for homeownership were cut back less than for most alternative investments. This may boost condominium construction but it would probably reduce demand for rental apartments, since most condominium customers would be former renters. Demographic factors are unfavorable for apartment construction, because of declining numbers of people in the 20-34 age group, the group most likely to rent.
Demographically-based demand from people who choose to rent or cannot afford to purchase will require probably less than 400,000 rental units annually over the next few years. A long-term decline in unsubsidized multifamily home construction is projected as the baby boom generation continues to move into single-family housing. Although potential exists for a large increase in subsidized housing and/ or public housing, the funding requirements would be enormous,
Manufactured housing (also known as mobile homes) is a low-cost starter-home option, accounting for about 80 percent of housing under $50,000. The average price of a manufactured home in 1987 was $23,000 compared with $19,700 in 1982.
However, shipments in 1988 continued their recent downtrend, slipping 5 percent to 220,000 units (valued at about $3.7 billion), from the 232,800 units shipped in 1987. Manufactured housing comprised 13 percent of new additions to housing (manufactured housing shipments plus private housing starts) in 1988, similar to its share in the 1981-87 period. Shipments of mobile homes increased 23 percent in 1983 at the beginning of the economic upturn, but failed to increase in 1984 and then declined 26 percent through 1988.
During the same period, the mix of single- and multi-wide units changed. During the economic downturn, the portion of double-wide homes shipped declined from 28 percent in 1980 to 22 percent of all shipments in 1982. Between 1982 and 1987, multi-wide manufactured homes rose steadily to 39 percent of total shipments.
There are several explanations for the downturn in total shipments. The drop in oil prices resulted in a 27 percent decline in shipments to the oil-producing South Central states, the second largest regional market for these units. Further, manufactured housing is a low-cost and starter-home option, and the number of first-time home buyers in the 25-44 age range is declining. Finally, about four-fifths of manufactured homes purchases are credit-financed, of which 90 percent are financed by revolving retail credit and 10 percent with mortgages. Retail credit interest rates for manufactured housing are typically 2 to 3 percentage points higher than new mortgage rates, creating a disincentive to the purchase of manufactured homes.
Mobile home shipments in 1989 are expected to decline another 5 percent to about 210,000 units. This assumes that interest rates on mortgages and consumer credit will rise modestly while GNP growth continues to be moderate. Although the traditional market of first-time home buyers in the 25-44 age range is declining, a new market of retired people of moderate and low income is growing and will strongly influence future growth.
Residential Upkeep and Improvement
In 1988, constant-dollar expenditure by owners for upkeep and improvement of residential properties increased 4 percent. Upkeep and improvement includes expenditures on maintenance and repairs as well as new construction improvements, but does not include the value of do-it-yourself labor. As is the case with new housing, 1983 through 1988 have been strong years. Lower interest rates and tax law changes have caused increased refinancing; in the process, homeowners are increasing their mortgages or using equity loans to remodel.
About 40 percent of upkeep and improvement expenditures were spent on maintenance and repairs, which are defined as property maintenance costs, including activities such as painting and appliance replacement and repain These maintenance and repair costs are shown in Table 3. The remaining 60 percent was spent on “construction improvements’,’ which include major changes inside and outside of existing residential structures, as well as large individual expenditures for items such as water heaters and furnaces.
Residential upkeep expenditures for owner-occupied units will continue to increase in 1989 as the lagged result of the high rate of homebuilding and existing home resales from 1983 to 1987. Nearly two-thirds of all home improvement expenditures occur within 1 year before moving out or 2 years after moving in, which indicates strong home improvement expenditures in 1989, but a leveling off in 1990. Further support for home improvement should come from the increasing availability of home equity loans, which make it easier to finance major improvements.
Expenditures in all categories of home improvement should grow steadily in the long run because of the increasing size and age of the existing housing stock. In addition, the demographic trend toward more single parents and twoincome families, who may have less time to devote to do-ityourself remodeling, indicates that they may contract for more work. On the other hand, stores oriented toward the do-it-yourself market have experienced sizable annual sales gains. Increased demand for energy-efficient structures and building modifications to accommodate high-technology innovations will also buoy the renovation market. Landlords must maintain rental properties to attract new renters, particularly in markets with high vacancy rates. Finally, homeowners wishing to increase investment value find that some renovations (such as bathrooms and fireplaces) can offer resale value gains above the cost of the improvement.-Patrick H. MacAuley, Office of Forest Products and Domestic Construction, (202)377-0132 September 1988.
PRIVATE NONRESIDENTIAL CONSTRUCTION
In 1988 the constant-dollar value of new private nonresidential construction was about equal to the 1987 value, but was 8 percent below the record set in 1985. The 1988 value in current dollars was $132 billion, of which $94 billion was for buildings and $38 billion was for other structures. The declines were most severe for hotels and motels, office buildings, other commercial buildings, and farm structures. Although the South and West accounted for about two-thirds of total nonresidential construction, the Northeast and Midwest increased their shares slightly during 1988.
The weakness in nonresidential construction reflects a downturn in the phenomenal commercial building boom, which peaked in 1985. The unprecedented commercial construction during 1983-88 has resulted in record vacancy rates for office buildings, stores, hotels, and warehouses. These high vacancy rates will depress the demand for new construction for several years, until supply and demand for commercial space are brought into balance This correction is being exacerbated by the 1986 tax reform act, since part of the building boom was caused by tax shelter investors.
Outlook for 1989
Private nonresidential construction will decline about 3 percent in constant-dollars in 1989, despite the expected growth in GNP and total business investment. Business plant and equipment expenditures are expected to increase in 1989, but all of the increase will be in capital equipment rather than in buildings and other structures (Figure 1-2). This is primarily because of overcapacity in some of the most structureintensive sectors of the economy, such as commercial real estate and electric utilities. The largest declines will be in commercial construction, especially office buildings and hotels, where capacity surpluses are greatest. On the other hand, investment in several
types of nonresidential construction-notably manufacturing plants and hospitals-will increase in 1989.
Given the 5-year macroeconomic forecast for continued economic growth and fairly stable interest rates, the expected correction in private nonresidential construction could be relatively mild. The downturn is likely to last for 2 or 3 years, followed by a recovery during the early 1990s. Shopping center construction will rebound fairly quickly, whereas office construction will probably be the last category to recover. Industrial construction Will gain for most of the period, especially if the trade deficit continues to drop. The correction in hospital construction that was caused by costcontainment initiatives is largely over, and spending for this purpose will resume its long-term uptrend. Electric utility construction will remain weak for most of the period, although it will probably turn around during the early 1990s.
The need to modernize existing US. capital stock will provide strong underlying demand for both new construction and commercial remodeling. Although most modernization expenditures tend to be for new capital equipment rather than for buildings and other structures, the amount invested in replacing and modernizing structures will also be large. There are no government data on the size of the investment in nonresidential building remodeling, although some private analysts estimate that these expenditures are equal to about one-third of the total value of new construction of private nonresidential buildings. This renovation market appears to have grown rapidly during the 1980s and is likely to be stronger than the new construction market during the next 5 years.
The constant-dollar value of industrial construction put in place increased more than 5 percent in 1988, ending a 2-year slump caused largely by lower capacity utilization rates and lower profitability in manufacturing. Further gains in industrial construction are expected in 1989 because of tighter capacity and increasing profitability in many manufacturing industries.
Although international trade competition has depressed the need for US. industrial construction, this factor will be less of a depressant in 1989 and beyond. It is estimated that the 1988 trade deficit in manufactured goods of about $105 billion will reduce annual construction of US. manufacturing facilities by about $2 billion. If the trade deficit continues to be reduced by surging US. exports, industrial construction will benefit.
Although the long-term outlook is subject to many uncertainties, industrial construction is likely to be one of the stronger market segments during the next 5 years. Steady growth in the US. economy and US. exports should contribute to a favorable climate for industrial construction.
The need to modernize the stock of existing buildings and other structures also will stimulate industrial construction. Since the 1970s, the tendency has been to defer replacement of manufacturing plant. The cost of replacing the manufacturing structures that existed in 1983 is estimated at $470 billion in 1988 dollars, which indicates a potentially huge demand. The extent to which manufacturing plants will be modernized or replaced depends on factors such as U.S. international competitiveness, interest rates, business profitability, technological developments, and economic growth.
The constant-dollar value of new office construction fell in 1988, as office construction declined from the unsustainable levels of the mid-1980s. Further declines are expected in 1989 and for several years thereafter because of high vacancy rates and the elimination of many of the tax benefits of commercial building, Nevertheless, a sizable amount of office construction will continue because of strength in a small number of cities and market niches, as well as continued interest from institutions and foreign investors.
Demand for office space was strong in 1988, as 1.7 million additional office workers were employed. Nevertheless, office vacancy rates have continued to climb in most cities because of the record amounts of new space becoming available. Although the situation varies from city to city, ofice building vacancy rates are at very high levels and are still climbing. Office rents have generally been falling in response to these conditions.
Even if the rate of increase in white collar employment is sustained in 1989, vacancy rates will probably increase further as new office space reaches completion. Over the next 5 years, demand for office construction will be heavily influenced by the need to absorb the vacant office space and to raise rents to profitable levels. New construction will decline substantially until this is done. It could take up to 5 years to use up inventory of vacant office space, but this could be greatly shortened if large numbers of older office buildings are retired or converted to other uses. Another important medium-term factor is the extent to which foreign investors (notably Japanese) participate in US. real estate.
Hotels and Other Commercial Buildings
Construction of hotels and motels declined in 1988 because of overcapacity and elimination of many of the tax incentives. A further 10 percent decline is likely in 1989, with an additional decline in 1990, in order to eliminate excess capacity. Steady growth in demand for hotels over the next several years will help to ease the adjustment and support construction at historically high levels. (See chapter 59 for a discussion of the hotel industry’s prospects.)
“Other Commercial Buildings” (all except office buildings and hotels) includes warehouses, grain elevators, shopping centers, parking garages, banks, fast-food restaurants, and gas stations. In recent years, shopping centers have accounted for about half of the value of construction work in this category, and warehouses, for about a fourth.
The constant-dollar value of other commercial construction declined in 1988 and will decline again in 1989. The primary causes of the downturn are overcapacity and the effects of tax reform. However, the overbuilding problem is not as serious for stores and shopping centers as it is for office buildings and hotels. Other commercial construction will probably become a growing market by the early 1990s because of solid economic growth, stable interest rates, investor interest, and a fairly high level of homebuilding.
Construction of service stations and auto repair garages has increased for several years and is likely to remain strong for the rest of the decade. The auto service business has benefited from the increasing complexity of automobiles and the increasing proportion of older cars that need more maintenance. Although the number of gasoline stations will probably continue to decline, many of the remaining stations are investing large amounts in construction to become highvolume sales outlets, convenience shops, or specialized service stations. The continued economic growth forecast for the next 5 years should lead to further increases in the number of vehicle-miles driven and in the demand for auto service and repain
Private Electric Utilities
The constant-dollar value of electric utility construction declined slightly in 1988. Further declines are expected in 1989 and for the next 5 years. This category includes new power plants, transmission lines, pollution control facilities, conversion of existing power plants from oil and gas to coal, and modernization of existing power plants and other buildings. The weakness in this category is attributable to declines in new power plants; construction of transmission systems and modernization of existing plants has increased rapidly.
Very few new power plants have been started during the 1980s, and this trend will continue. The two principal reasons for this are the fairly widespread surplus of generating capacity and the utilities’ reluctance to undertake the financial risk of new construction programs, even where there is a forseeable shortage of generating capacity. The financial risks of new power plant construction have grown dramatically during the past decade because of changing regulations, nuclear power disasters, lawsuits, Wall Street disfavor, and recent rulings by state regulators against passing on to consumers the costs of canceled construction projects. The 1986 tax reform act has further discouraged power plant construction by requiring that interest incurred during construction be capitalized rather than expensed.
The declines in construction of new power plants will be partially offset by growth in the retrofit market and in transmission facilities. Retrofit of existing power plants to improve efficiency and extend generating life involves much less risk and requires fewer permits than does “greenfield” construction. Utilities will continue to invest heavily in transmission systems in order to accomodate growth and make optimum use of existing power plants.-Patrick H. MacAuley, Office of Forest Products and Domestic Construction, (202) 377-0132. September 1988.
PUBLICLY OWNED CONSTRUCTION
The constant-dollar value of publicly owned construction put in place rose 3 percent in 1988, led by solid gains in highways, water supply facilities, and schools. There were, however, several weak areas, notably sewer systems and conservation and development. The total value of publicly owned construction in current dollars was about $80 billion, of which $26 billion was for highways and bridges.
Public works construction has increased substantially in the past 5 years. The long-term downtrend in public works investment from 1968 to 1983 appears to have ended, at least temporarily. It is not yet clear whether this recovery is merely cyclical or represents a reversal in long-term trends. Part of the recent increase in public construction is attributable to the general economic recovery, which has improved the ability of state and local governments to finance construction. The rapid pace of residential and commercial construction has also stimulated building of related infrastructure such as roads, water and sewer lines, schools, and fire stations. In addition, the public appears to be more willing to pay for infrastructure improvements.
Three recent infrastructure-related laws will have significant long-term effects on public works construction. The Water Resources Act of 1986 authorized 181 new water resources construction projects-the first since 1977-and provided for costsharing reforms. As a result, construction of dams, canals, harbors, navigation improvements, irrigation systems, and flood control projects will remain high for the next decade The Clean Water Act of 1987 will provide up to $3 billion annually for sewage system construction over the next 5 years. The Surface Transportation Assistance Act of 1987 extends the Federal-aid Highways program for 5 more years, at approximately the 1986 level. This program is funded from the Highways Trust Fund at approximately $14 billion annually and is by far the largest public works program in the United States.
Outlook for 1989
The value of publicly owned construction will continue to increase at a moderate rate in 1989. The biggest gains will probably be in schools, water supply, hospitals, and other public buildings. Highway construction will rise about 2 percent. The biggest declines will be in military construction and publicly owned electric power plants.
The increase in public works construction will occur in spite of a slight decline in Federal Government expenditures for construction. Continued economic growth will provide incremental tax revenues to enable state and local governments to finance more infrastructure improvements. Developer-contributed public works construction will remain high, despite the expected declines in housing starts and commercial construction, because of greater infrastructure impact fees. Although municipal bond sales have declined from their record levels of 1984-86, they are still high enough to sustain substantial construction.
Public works construction will continue to increase modestly during the 1989-93 period, given the macroeconomic forecast of continued economic growth and fairly stable interest rates. Under these conditions, state and local governments could increase their expenditures enough to offset the expected declines in federal construction expenditures. Although several state and local governments are undertaking dramatic new infrastructure initiatives, most states appear unlikely to commit themselves to massive increases in construction spending. Maintenance and repair spending will probably increase faster than new construction spending as the stock of infrastructure steadily becomes older and larger. While increased maintenance and repair expenditures will pay for some construction, they will often consume funds that could have been spent on new construction.
Efforts to control the federal budget deficit will probably prevent the Federal Government from undertaking a massive infrastructure renewal initiative The 5-year federal budget calls for federal capital spending to decline substantially in inflation-adjusted terms. In contrast, OMB’s “current services” estimate indicates a more modest decline in real investment spending by the Federal Government (Table 6). Nevertheless, recent Congressional actions have shown that there is strong support for the remaining federal public works programs. By the early 1990s, it may be possible to provide substantial federal funds for construction through innovative financing techniques, increased user fees, or diversion of spending from nonconstruction programs.
Highway construction will probably level off after 1989, unless there is another increase in federal motor fuel taxes or a decision to draw down the Highway Trust Fund. Water resources and marine construction are expected to increase substantially because of the Water Resources Act of 1986, which authorized 181 new construction projects. Water and sewer construction will remain at high levels, but will not increase much after 1988. Construction of schools and other public buildings will probably increase throughout the period. Military construction probably peaked in 1987 and willlikely decline for several years. The level of federal industrial construction will depend in large part on prospects for the $4.4-billion Superconducting Supercollider (SSC).
Highways and Bridges
New road and bridge construction recovered strongly in 1988, but it will barely increase in 1989. An impasse over renewal of spending authority for the Federal-aid Highways program delayed some construction work scheduled for 1987, so that most of the 1988 increase was actually postponed 1987 work.
The Surface Transportation Assistance and Uniform Relocation Act of 1987 renewed the Federal-aid Highways program until 1992, providing a total of about $80 billion for highway construction over 5 years. The Act increases federal outlays by raising the obligation ceiling slightly, partially funding 152 new demonstration projects, and providing a more generous minimum allocation formula. Unlike the landmark 1982 Surface Transportation Assistance Act, the 1987 Act does not provide a massive increase in construction funding, and the real value of federal highway spending may actually decline over the 1988-92 period, unless obligational ceilings are raised during the annual budget process.
In 1989, new highway construction will increase about 2 percent (Table 1). A small increase in federal highway funds, plus continued increases in state and local highway funds, will barely offset gains in construction costs. Infrastructure contributions by developers will be at high, but declining, levels as the pace of commercial and residential construction declines.
In the longer term, highway construction expenditures will probably continue to increase in order to prevent a decline in the condition of the Nation’s highway infrastructure. Any increase in federal funds would require an Act of Congress, but the large balance in the Highway Trust Fund can accomodate a substantial surge in expenditures. Although only a few states have committed themselves to massive roadbuilding programs, several states are considering more modest undertakings such as toll roads.
In 1988, about 25 percent of the value of highway construction put in place consisted of bridges, overpasses, and tunnels, while flatwork accounted for 75 percent. Bridge work is expected to grow faster than flatwork during the next several years because of the need to replace obsolete or unsafe bridges. According to the Federal Highway Administration, 23 percent of the highway bridges in the United States were structurally deficient, and an additional 21 percent were functionally or structurally obsolete.
Highway maintenance and repair expenditures have grown during the past 2 decades as the road network has become larger and olden The 1988 cost of highway maintenance and repair was about $20.5 billion, compared to the $26 billion value of new highway construction put in place. While some of this work was routine maintenance such as mowing grass, much of it was construction activity such as repaving roads and painting bridges. Highway maintenance and repair expenditures will probably grow more rapidly than new construction over the next decade. Sewer Systems
The constant-dollar value of sewer system construction put in place declined 8 percent in 1988, after four consecutive annual increases. Most of this decrease was attributable to the slower pace of housing starts and commercial construction, which necessitated less construction of sewerage infrastructure. Another important factor was the decline in federal funding for new sewage treatment plant construction.
This category includes solid waste disposal facilities, including resource recovery facilities, which are a small but rapidly growing market. Resource recovery facilities will become increasingly common because of improved efficiency, rising land prices, and environmentalist objections to landfills.
The Clean Water Act of 1987 provides $18 billion for sewage collection and treatment between 1987 and 1994. This Act has checked the decline in the EPA Construction Grants program and resulted in increased obligations of about 12 percent in fiscal year 1988. However, because of lags in this program, outlays may not increase until 1990. The Act provides for major changes in this program after 1989, when direct grants to communities will be replaced with grants to states for low-interest revolving loans to communities for construction of sewerage facilities.
After 1989, sewage construction will probably level off or even decline further because of reduced federal spending and slightly lower housing starts. The major uncertainty is the extent to which state and local governments will support the new loan program established by the Clean Water Act. If states augment federal loan funds with their own funds, construction might increase substantially. On the other hand, if the loan program is much less popular with local governments than the grant-in-aid program, sewage system construction could decline.
Water Supply Systems
Waterworks construction has increased sharply during the past 5 years, recovering from its slump of the early 1980s. Two of the most important factors in this upturn have been the recovery in housing starts and the record amounts of municipal bonds issued for water supply systems. Waterworks construction will continue to increase in 1989 because of the improved financial condition of most local governments and the moderately high level of homebuilding.
In the longer term, waterworks will probably be one of the more rapidly growing categories of public construction. The fairly high level of single-family housing starts expected for the next 5 years will provide substantial underlying support for new water supply facilities. Further, the aqueduct systems of most older cities are so ancient that extensive replacement work must be done each year. For the United States as a whole, construction is much less than that needed to replace the waterworks every 50 years, as recommended by engineers. Most water utilities are in a good position to raise the capital needed, so a steady increase in replacement construction is likely for the rest of the century. The Water Resources Authorization Act of 1986 has expanded the role of the Federal Government in municipal water supply and, although it does not provide major funding directly, may eventually facilitate major federal funding for water supply construction. Educational Building
New construction expenditures for schools, libraries, and museums increased about 12 percent in 1988 (constant dollars). About 70 percent of these construction expenditures was for primary and secondary schools, and about 25 percent for colleges and other higher education facilities. Nearly 75 percent of educational construction expenditures was for publicly owned buildings, and 25 percent, for privately owned buildings.
School construction will probably increase about 5 percent (constant dollars) in 1989 and then level off during the early 1990s. The number of births in the U.S. rose between 1976 and 1982, and enrollment in the lower grades has begun to increase, while high school enrollment has been declining. Universities are likely to increase their construction spending substantially over the next 5 years to rebuild deteriorating campuses, according to a recent survey by the Society for College and University Planning. Other factors favoring further school construction are the improved fiscal condition of state and local governments, relatively high levels of new housing construction, and increasing emphasis on the quality of education.
Conservation and Development
Conservation and development construction includes water resources development and protection expenditures, as well as the electric power construction programs of the Federal Government. Federal expenditures account for about 80 percent of conservation and development construction, and three Federal agencies-the Corps of Engineers, the Bureau of Reclamation, and the Tennessee Valley Authority (TVA)-expend most of these federal funds. (State and local government-owned electric power plants are classified under “miscellaneous construction!’)
Conservation and development construction declined slightly in 1988, chiefly because increased federal spending for water resources construction was offset by declining nonfederal expenditures. The Water Resources Act of 1986 authorized 181 new water resources construction projects, the first since 1977, which will help to keep water resources construction high well into the next decade. A decline forecast for conservation and development construction in 1989 is largely attributable to a reduction in the TVA power system construction program. Nearly all of the other federal water resources programs will increase or remain level in 1989.
Military construction includes a wide variety of structures such as housing, airfields, incinerators, warehouses, docks, radar installations, and roads. In recent years, the value of new military construction put in place has been less than 2 percent of the Defense Department’s budget outlays. This category (Table 1) differs markedly from Congress’ annual military construction appropriation, more than two-thirds of which is spent on overseas work, land acquisition, family housing, and maintenance and repair.
Military construction has grown rapidly since 1981, but it appears to have peaked. The 1988 value (in 1982 dollars) of new military construction put in place was 1 percent lower than the 1987 value but 78 percent higher than that of 1981. The 5-year outlook for military construction is much less bullish than it was during the last 5 years. Projections by the Office of Management and Budget indicate that defense investment spending will not keep up with inflation. (Table6)
Federal Industrial Construction
This category consists of federally owned manufacturing, assembling, and processing buildings and related facilities. More than 60 percent of it is funded through one Department of Energy program-Atomic Energy Defense Activities. Most of this construction is related to weapons R&D and production, but a sizable percentage is for atomic waste isolation and reprocessing. Much of the remainder is for energy R&D facilities
Federal industrial construction declined in 1988 because of budget cuts to reduce the deficit. In 1989, a slight decline is expected, but engineering work is scheduled to begin for a massive new construction project, the Superconducting Supercollider (SSC). The SSC is a $4.4-billion atom smasher that is proposed to be built over a 7-year period beginning in 1990.
The longer term outlook depends largely on the prospects for the SSC, as well as federal budget developments. The largest program in this category, Atomic Energy Defense Facilities, is dependent upon defense policy decisions.-Patrick H. MacAuley, Office of Forest Products and Domestic Construction, (202) 377-0132.
Americas infrastructure., Effects of Construction Spending, Associated General Contractors; 1957 E Street, NW, Washington, DC 20006.
Cahners Building & Construction Market Forecast, (monthly) Cahners Publishing Co., 275 Washington, Street, Newton, MA 02158-1630.
Census of Construction, 1982, Bureau of the Census, US. Department of Commerce, Washington, DC 20233.
Construction Review (bimonthly), International Trade Administration, Room H4045, U.S. Department of Commerce, Washington, DC 20230.
Decisions for the 1990s, NAHB Publications; National Association of Homebuilders, 15th & M Streets, N.W., Washington, DC 20233.
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Housing Starts (Construction Reports, Series C-20), Bureau of the Census, U.S. Department of Commerce, Washington, DC 20233.
Manufactured Housing Financing, 1987.- 37th Annual Survey, Manufactured Housing Institute, 1745 Jefferson Davis Highway, Suite 511, Arlington, VA 22202.
Value of New Construction Put in Place (Construction Reports, Series C-30), Bureau of the Census, U.S. Department of Commerce, Washington, DC 20233.
Despite an abundance of opportunities in the international construction market, particularly in the developing countries, U.S. contractors have lost position. Successful elsewhere, aggressive foreign contractors have sought a larger share of the U.S. construction market.
The lower valued dollar assisted US. international contractors in 1988. However, offsetting constraints in the form of inability to match the financing packages of foreign contractors, the intractability of the debt crisis in less developed countries (LDCs), and closing of the technology gap wiped out this advantage. Aggressive foreign contractors invested more than their US. counterparts in research and development and, in addition, gained from technology transferred by joint venturing with US. firms.
Participation by US. international contractors, in fact, has declined for the past 6 years in all areas of the world. This has been partly because of a general malaise in the market. However, the US. suppliers’ inability to compete with foreign contractors accounted for the larger share.
In the past, many competitors also have benefited from their countries’ aid programs appropriately synchronized to trade needs. For example, while the 1987 US. share of international construction contracts in Africa slipped 18 percent from the previous year to $600 million, Italian firms, supported by a $1 billion Italian aid program, won $2.3 billion of contracts, and, in so doing, emerged as the leading international contractors on the African continent.
The vital importance of assembling attractive financing packages became more apparent during 1988. Weaker demand in certain third country markets for construction services, owing to lower oil prices, combined with more intense competition from developed and developing country construction companies brought about the increased awareness. Yet the U.S. Government did not allocate more funds for export financing, and commercial banks increasingly turned away from international lending. Engineering News Record (ENR) has reported that more than 57 percent of 1987 bids Oatest data available) and about 10 percent ($7.3 billion) of total 1987 awards required contractor financing.
To develop materials and technical innovations that would help meet foreign competition and increase the productivity of the US. construction industry, the US. Army Corps of Engineers has promoted a joint effort with private industry-Construction Productivity Advancement Research (CPAR). Designed to reverse the trend of low levels of investment in construction R&D by both government and private industry, the program would effectively transfer construction technology developed in federal and university laboratories to the US. construction industry.
Access to the lucrative but closed Japanese construction market has long evaded the US. industry. In May 1988, the US. and Japanese governments entered into an agreement-culminating 2 years of negotiations-to give US. contractors the opportunity to bid on 14 major public works projects involving $18 billion of potential work. The agreement provides for (1) procedures to establish an open and transparent bid and tender system and (2) review of the agreement after 2 years.
Outlook for 1989
During the forthcoming year, financing will continue to be a key competitive element. Major financing vehicles will remain: commercial banks, bilateral and multilateral government loans, countertrade, and equity financing.
Aid and trade will increasingly move in close parallel in 1989. US. international construction firms also need to invest more funds in independent proprietary R&D during 1989. The U.S. industry’s failure to invest heavily in innovative technology will continue to hamper its regaining highly competitive markets. According to the Congressional Office of Technology Assessment (OTA), most U.S. construction R&D does not occur in the industry, but takes place in federal laboratories, at universities, by owners of large facilities, and at firms which supply construction equipment and materials. Foreign competitors, on the other hand, have developed “proprietary technical positions” that become the cornerstone of their competitive strategies. US. firms have developed new techniques only as needed on the job. Consequently, declining business results in decreased R&D. This will place U.S. suppliers at a further competitive disadvantage during 1989.
The international construction market will continue expanding through the remainder of the eighties and well into the next century. Japan will embark on a huge $48-billion home investment program. The European Community’s removal of internal trade and technical barriers and the creation of a free trade zone through the removal of trade barriers between the United States and Canada will stimulate construction activity. Peace in the Middle East could lead to recovery of that area’s construction market. A new Soviet Union approach to private sector involvement in development projects will improve the prospects for Western participation in needed East European construction work. Current improvements in the international debt situation should enable developing countries-particularly China, India, Indonesia, Pakistan, and Thailand-to complete vast and vitally needed infrastructure including, but not limited to, bridges, airports, tunnels, water supply and sewerage, hospitals, telecommunication facilities, housing, schools, energy resources, and roads.
Foreign competition will remain keen. Obtaining awards in this market will require aggressive management as well as systematic and intelligent pursuit of market opportunities by US. international contractors.-Robert L. Lurensky, Capital Goods and International Construction, Office of International Major Projects. (202) 3 77-4002. September, 1988.
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Foreign Builders Target the United States, Implications and Trends, by Patrick MacAuley, 1988, US. Department of Commerce, Washington, DC 20230.
International Competition in Services, 1988, Congress of the United States, Office Technology Assessment, OTA-ITE-328, Washington, DC (U.S. Government Printing Office).
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World Development Report 1988, International Bank for Reconstruction and Development, Washington, DC 20433.
COPYRIGHT 1988 U.S. Department of Commerce
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