The construction industry may be rounding the peak of its lengthy expansion. A more modest gain of about 3% is anticipated for 2000.

In its recently released midyear construction forecast update, the McGraw-Hill Construction Information Group's Construction Outlook 2000 provided its take on a variety of construction markets. The edited text follows:

Single-Family Housing. Although homebuyer demand was brisk in 1999, the situation began to change by the second quarter of 2000. Employment growth eased back, and the stock market became increasingly volatile amidst anxiety over the possibility that inflation was re-emerging, which would lead to further rate hikes by the Federal Reserve. At the end of June, the Dow Jones Industrials and Nasdaq Composite had registered declines of 9% and 3%, respectively, from their positions at the start of the year, lessening the push given to homebuyer demand through the "wealth effect." Although mortgage rates steadied close to 8%, home sales began to soften, accompanied by a weakening of construction activity.

With more subdued homebuyer demand, construction of single-family homes is projected to recede 5% in 2000 to 1.18 million units (F.W. Dodge basis). One benefit of a slightly less torrid pace for homebuilding may be reduced pressure on building-materials prices. The Producer Price Index for gypsum products jumped 17% during 1999, but witnessed a somewhat milder 9% increase during the first seven months of 2000.

Public Works and Utilities. Construction of airports and utilities account for the bulk of the sales of electrical products in this sector.

According to Dodge data, airport-related work in 1999 saw dollar volume gains of 31% for runways and 143% for airport terminals. It's unlikely that the current year will be able to match the surge of activity in 1999, but the overall level should remain high by the standards of recent years. And aside from available funding, the growth in airline travel (combined with growing distress over the quality of airline service) should help maintain public support for proposals to upgrade airport facilities. The new federal aviation bill will also be a plus, especially for projects at smaller regional airports.

Electric utility construction took off in 1999, soaring 147% to $8.3 billion. Twenty-four states have now passed deregulation programs, mostly in the high-cost energy regions of the nation. This has eased some of the uncertainty surrounding the deregulation process, enabling independent power producers to accelerate plans for more cost-effective generating plants. First half results for 2000 show that there has been little slowdown in last year's torrid contracting pace.

Accordingly, electric utility construction in 2000 is now projected to rise 6%, reaching $8.8 billion. One legislative item to watch will be the progress of a national deregulation bill, which will probably not achieve passage this year. In June, the Senate dropped plans to advance a deregulation measure, given a lack of agreement on whether utilities should be required to buy power from renewable energy sources, among other sticking points.

Income Properties. The income property group (commercial building plus multifamily housing) witnessed moderate square-footage growth in 1999 of 3% pickup to 1.61 billion square feet. So far in 2000, there's been divergent movement among the various income property structure types, but the overall group is holding steady with last year's pace. As a result, income property square footage for 2000 is projected to stay at 1.61 billion square feet.

Store construction in 1999 climbed 5% to 309 million square feet, a record high. This structure type has closely followed the pattern for single-family housing, and the vibrant residential market at the end of the 1990s has spurred new store projects. Retail sales have also been very strong, boosting the justification for new construction. Significantly, a major impetus has come from the competitive retail landscape itself, in which retailers and developers feel the need to stand out with such new formats as entertainment-based complexes and large outlet centers. The first half of 2000 has seen continued strength for these types of projects. And, in one telling instance, the owners of the Mall of America (the nation's largest mall, located in Bloomington, Minn.) announced they are considering expanding the facility. The project, which would be carried out over the current decade, would add an additional 5.7 million square feet to the mall's current space (4.7 million square feet).

Internet-based retailing has been viewed as a threat to more traditional selling, and there's evidence suggesting that the "category-killer" format has been adversely affected. Still, the broad impact on the overall retail sector has not been severe. Many retailers are using Internet-based selling to supplement existing sales channels, in what have been referred to as "click and mortar" strategies. The impending downturn for store construction will instead be the result of more traditional factors - slowing retail sales, a sagging housing market, and greater scrutiny from lenders on the viability of proposed projects. For 2000, store and shopping center construction is projected to decline 6% to 290 million square feet, which is still a very healthy level.

Internet-based retailing may have more of an impact on warehouses. Warehouse construction showed steady improvement from 1994 through 1999, and it's on track to post another gain this year, rising 7% to 274 million square feet. In general, this advance is being spurred by the recent strength of the retail sector plus the growing needs of Internet-based retailers for warehouse space. Furthermore, there's an emerging trend for what have been called "telecom hotels," i.e., facilities that are used to house telecommunications and Internet switching gear.

Office construction. During the first half of 2000, the top 10 markets (ranked by square footage) featured five cities with increased construction (including Washington, D.C., which led all markets in new square footage), yet the remaining four cities showed decreased activity.

Office vacancy rates remain at low levels. As reported by CB Richard Ellis, downtown office vacancy rates fell to 7.4% in the first quarter of 2000, compared to 9.3% at the end of the prior year. The suburban office vacancy rate was reported at 9.9%, virtually the same as the 10% in the corresponding quarter of 1999. It's projected that suburban markets will see slower rent growth this year, and with that will come slower construction. For 2000, strength in downtown markets will offset the slippage expected in suburban locations, enabling the national total to hold steady at 275 million square feet.

Hotel construction in the high end of the lodging market has strengthened. For the current year, a greater number of luxury projects will help cushion the general construction downturn, as contracting eases back 6% to 81 million square feet.

Multi-family housing. At the national level, this market appears to be in rough equilibrium - the rental vacancy rate in the first quarter of 2000 was 7.9%, slightly below the 8.1% of the prior year. There has been volatility at the city level, though. Last year witnessed substantial construction gains in Orlando (up 51%), Atlanta (up 38%), and New York (up 35%), but also sharp declines in Houston (down 55%), Las Vegas (down 44%) and Dallas (down 30%).

Although young adults are not offering much of a demographic push for this market, anecdotal evidence suggests there's growing demand for condominiums from "empty-nesters" in their fifties. Facilitating this trend is the 1997 tax-law change that exempts from capital gains up to $500,000 on the sale of a primary residence. In addition, the real-estate investment community is increasingly targeting the multi-family property type. During the early 1990s, pension funds typically allocated less than 10% of their assets to multi-family properties, but that figure has moved up to the range of 15% to 20%. With multi-family housing being viewed favorably as an investment target, construction is expected to rise an additional 2% in 2000 to 455,000 units.

Manufacturing Buildings. Construction of manufacturing plants weakened considerably during 1998-99, sliding to last year's 138 million square feet. Although business conditions in the United States were robust during the latter half of the 1990s, the same was not true for overseas economies. One outcome is that the U.S. dollar became very strong relative to foreign currencies, making U.S. goods less price-competitive in foreign markets. In addition, imports of comparatively inexpensive foreign goods into the U.S. markets picked up substantially, and this caused the merchandise trade deficit to balloon to a new high of $347 billion in 1999.

So far in 2000, there's not been much improvement in the trade deficit. On the positive side, industrial production figures for the United States have seen a general strengthening trend, and capacity utilization at the nation's factories edged up to 81.3% during the second quarter. However, this does not appear to be enough to spur a rebound for manufacturing plant construction, at least for the present. Given the sluggish contracting during the first half of 2000, it's now projected that plant construction will fall an additional 4% to 133 million square feet.

On an industry-specific level, some support during 2000 has come from the automotive sector, including the start of a 1.5-million-square-feet truck manufacturing plant for General Motors in Louisiana. The semiconductor industry has also contributed - in February groundbreaking took place for a 600,000-square-feet semiconductor plant in Arizona. Given strong sales of such portable devices as Web-browsing phones and hand-held organizers, the semiconductor industry is anticipated to see stronger growth for the near term. A continuation of this trend, in combination with more broad-based export growth, may help manufacturing building regain an upward trend next year.

Institutional Buildings. The institutional sector jumped 12% in 1999 to 589 million square feet, an all-time high. The healthy fiscal position of state and local governments is providing a supportive backdrop, which should keep school construction robust for the next few years. At the same time, municipal bond rates at mid-2000 stand at 5.8%, versus 5% at the start of 1999, and the more business-sensitive institutional categories will soon lose momentum in a slowing economy. For 2000, institutional construction is projected to rise an additional 2% to 600 million square feet.

The educational building category surged 20% in 1999 to 244 million square feet. Primary schools (up 13%) continued to strengthen, but more significant were the huge gains for high schools (up 41%) and universities (up 58%). As the echo boom moves up the age ladder, the pressure of rising enrollments is being felt increasingly at the high school and college level. During the first half of 2000, even further growth has been reported for primary schools (up 7%), high schools (up 13%) and universities (up 17%).

School construction over the past few years has received increased financing, and this will keep contracting at a high level. In 1998, voters in California passed the $9.2 billion Proposition 1A (the largest school construction bond measure ever), and agreed to another $521 million measure in last November's elections. Other states have also passed substantial school construction bond measures in recent years. At the national level, the Clinton Administration has again called for using federal tax credits to pay the interest on school construction bonds. Although the Clinton proposal is not likely to be enacted, it does maintain attention on the need for additional construction funding. Renovation needs are also pressing, with the average age of the nation's school buildings estimated at 42 years old. The educational building category in 2000 is projected to rise a further 7% to 261 million square feet.

The health facilities category climbed 5% in 1999 to 102 million square feet, as a 10% gain for clinics and nursing homes more than offset an 8% drop for the smaller hospital segment. While the managed-care industry has recently been able to push through rate hikes of 6% to 8%, exceeding the cost of medical inflation, the near term fiscal environment will grow more difficult due to reductions in Medicare reimbursements that were part of the 1997 balanced budget agreement. First half results for 2000 show the impact of this tightening fiscal environment - clinics and nursing homes fell 17% compared to their year-ago levels. For 2000 as a whole, the overall health facilities category is projected to drop 7% to 95 million square feet.

Public buildings in 1999 advanced 18% to 50 million square feet, pushed upward by a 21% increase for prisons as well as a 57% jump for courthouses. The first half of 2000 has seen courthouses continue to strengthen, although prisons have settled back. Yet, given reduced federal funding for courthouses for fiscal 2000, it's anticipated that this project type will fade during the latter half of 2000. As a result, the public building category is projected to slide 4% this year to 48 million square feet.

Religious construction grew 3% in 1999, and another 6% gain to 52 million square feet is anticipated in 2000, as the strong economy has aided fund-raising efforts by church construction campaigns.

Amusement construction climbed 4% in 1999 to 88 million square feet, with greater activity reported for gymnasiums, field houses and auditoriums - all segments related to the upswing in college and university construction. At the same time, indoor sports arenas retreated 42% in new square footage, while theater construction began its pullback with a 16% drop. First half results for 2000 show a continued loss of momentum for theaters, although sports arenas surprisingly rebounded.

Even more noteworthy during the first half of 2000 has been a surge of convention center projects. As reported by F.W. Dodge, square footage for convention center work was five times the comparable 1999 amount, boosted by a 2-million-square-feet project in Washington, D.C., and a 1.7-million-square-feet project in Boston, among others. With this convention center push, the amusement category is projected to climb an additional 3% in 2000 to 91 million square feet.

The Shape of 2000. Adding up the various sectors results in total construction climbing this year to $458 billion, a 3% gain. This is a smaller increase than the 10% reported for 1999, and it gives the sense that the construction industry is now "rounding the peak" of its lengthy expansion. As the economy moves towards a "soft landing" in 2001, the sectors most likely to reflect the impact of slower economic growth will be single-family housing and income properties. Providing a measure of stability in the construction market should be the continued strength for institutional building and public works projects.

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