Over the Top

The surging construction market may have finally peaked out with starts expected to drop for the first time in 16 years.

By Bruce Buckley

Over the past several years, as the industry has continued to tally record-setting construction starts, executives have been left wondering, "How hot can this market get?" With starts hitting an estimated $672 billion in 2006, McGraw-Hill Construction forecasts that total construction starts have finally peaked. For the first time since 1991, the industry is headed for a cool down with starts forecast to drop 1 percent to $668 billion in 2007, according to McGraw-Hill Construction.

Single family homes - the sector that buoyed the market in recent years - will largely be responsible for dragging total starts back down. A 5 percent decline in housing starts is predicted for 2007, as single family home starts are expected to drop from $281 billion to $268 billion and multifamily housing starts will fall from $70 billion to $66 billion.

In California, residential construction will see a 1.8 percent drop in 2007 over 2006.

Robert Murray, vice president of economic affairs at McGraw-Hill Construction, said single family housing represented roughly 38 percent of total construction starts at the beginning of the decade and by 2005 it was up to 48 percent. With the sector becoming such a prominent portion of the total market, any drop was bound to have an effect, he said.

"A decline of that magnitude will obviously impact what we're seeing in overall level of construction activity," he said.

Although the housing market is cooling off quickly, the market will remain relatively stable thanks to other strong building sectors, Murray said.

"Going into 2007, it's going to be the institutional building and public works sectors that will be key to keeping all-around activity at a good clip," he said.

Murray announced the 2007 forecast at the annual McGraw-Hill Construction Outlook in Washington, D.C., Oct. 27.

Although a cooling the residential market was expected, Murray said the market is experiencing a dramatic correction. In 2000, median home prices were roughly 4 times the median income in the U.S. In 2006, that ratio climbed to 5.2, throwing the market "out of whack," Murray said.

Faced with ebbing demand from homebuyers, developers called for a retreat in housing starts in 2006. By the second quarter, single family housing was dropping faster than widely anticipated, matching a pace on par with the market downturn of the early 1990s, Murray said.

As a result, the total number of single family homes dropped 15 percent in 2006, from 1.63 million units to 1.37 million units.

As goes the housing market, so goes the retail market. New homes have historically led to construction of new retail centers. Total square footage of store construction rose 4 percent in 2005, mirroring the hot housing market.

With housing begin to cool this year, retail starts are estimated to drop 2 percent to 300 million sq. ft. by the end of 2006. Big box retailers will be among those pulling back. Murray noted that Wal-Mart announced in October it would cut global expansion from 8 percent to 7 percent.

Subsequently, McGraw-Hill Construction estimated that store construction will slide an additional 7 percent to 278 million sq. ft. in 2007.

Office buildings continue to rebound since bottoming out at 144 million sq. ft. of starts in 2003. Vacancy rates are dropping in many parts of the country and major towers are underway in cities such as New York and Chicago. Overall, McGraw-Hill Construction estimated that office construction will advance 5 percent in 2007 to 197 million sq. ft.

"The market fundamentals are strong," Murray said. "It's conducive to more construction taking place."

Although the U.S. health care system should experience tremendous demand from aging Baby Boomers in the coming years, health care construction is expected to ease back in the coming year. The sector hit an all-time high of 107 million sq. ft. of starts in 2005. McGraw-Hill Construction estimates that starts leveled at 105 million sq. ft. in 2006 and forecasts suggest it could drop to 97 million sq. ft. in 2007 - a 7 percent decline compared to 2006.

Public building construction, fueled in part by increased federal appropriations for courthouses, will experience a modest rise from 33 million sq. ft. in 2006 to 35 million sq. ft. in 2007, Murray said.

McGraw-Hill Construction also forecasted increases other institutional sectors, such as religious, amusement-related and transportation terminal buildings in 2007.

Overall, Murray says the combined construction market is remarkably stable heading into 2007. Although the single family housing sector may have spoiled the party for the surging construction market, Murray said the impact could have been worse. If single family housing was taken out of the equation, the market would see an overall 3 percent gain in 2007. It's an example of how construction cycles in various sectors can keep construction activity level as a whole.

"It's a more stable picture now," he said. "We're been seeing this offsetting pattern by sector that has created overall greater stability for construction… In 2008, you might see a pullback in public works and institutional building, but it might be the time then for single family housing to once again be a source of expansion."

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