A Healthy Outlook

Projections for 2006 Show Growth

by Eileen Schwartz

For a forecast of the state's 2006 construction outlook, we spoke with Jennifer Coskren, senior economist with McGraw-Hill Construction Dodge Analytics group, which like Texas Construction, is a part of the McGraw-Hill Cos. Inc. Coskren's crystal ball shows the Texas construction industry experiencing another year of growth despite a downturn in some markets.

TXC: Texas has seen a steadily improving commercial construction market over the first half of the decade. Will prospects continue to look up as we head into 2006?

Coskren: After a 4 percent increase in total value for Texas commercial construction in 2004, the recovery will take a small breather as we look back on 2005. Activity is expected to fall 2 percent in 2005 as offsetting patterns in the various sectors mitigate the potential for another gain.

Both hotel and office construction will see a brisk rise in 2005, while warehouses and stores contract. Hotels were buttressed in 2005 by the start of several large projects, including a convention center hotel in San Antonio, the W Dallas Victory Hotel and Residence in Dallas and the Hyatt Regency Lost Pines Resort and Spa in Bastrop near Austin.

Warehouses, on the other hand, will fall by double-digits in 2005 as the sector fails to recapture the robust gains of 2004. The size of the projects that began in the first nine months of 2005 is much smaller in scale compared to year-ago levels. However, one large-scale project did break ground in 2005: a 2-million-sq.-ft. addition to the Baytown Wal-Mart Distribution Center.

Store construction will also take a hit in 2005, as the large, big-box chains retreat from their Texan expansion plans. In the first nine months of 2004, among the new starts in excess of $5 million, 45 were big-box (i.e. Wal-Mart, Home Depot, Target). In the first nine months of 2005, that number dipped to 28.

In 2006 we do anticipate a gain for commercial construction, though the mix will shift slightly. Offices will register another gain, boosted by projects such as the planned Advanced Micro Devices corporate campus in Austin. Hotels will fall compared to the vigorous growth of 2005. Meanwhile, stores will see a mild upturn as the downturn in big-box construction is offset by the start of several large shopping centers, including the Village at Fairview Shopping Center and the Laredo Town Shopping Center.

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TXC: Construction materials and fuel prices spiraling upward is on everyone's mind. What unique impact will these factors have on the Texas marketplace?

Coskren: The rising materials prices have been a concern. According to the Associated General Contractors of America, construction material costs have climbed 11 percent in the 12 months ending in September. On the plus side, the input prices for residential buildings have moderated, while labor costs, which can equal more than one half of a project's total cost, continue to rise only mildly.

Moreover, fuel prices have also been trending downward since the run-up after Hurricane Katrina.

In terms of the impact on Texas, it appears rising materials costs have not derailed the total construction expansion in 2005. While rising prices have extended the period for which projects are deferred and redesigned, in general, projects have moved ahead. Emblematic of this trend, voters approved a $13 million stadium for the Dickinson school district in April, but the district has been delayed in presenting the final design for the stadium because of rising materials costs.

However, the district has stressed that the project will not be abandoned and will break ground soon with an expected completion date of January 2007.

TXC: How might the devastation from the Gulf Coast hurricanes affect the various construction markets for Texas in the coming year?

Coskren: The largest impact, so far, has been on the housing market. Evacuees have been absorbing apartments at a breakneck pace. The Houston Chronicle reported that in a single month, September, more than 17,000 apartment units were absorbed in Houston alone. North Texas also received a large boost from the influx of Hurricane Katrina evacuees. The Dallas Morning News reported that Dallas/Fort Worth apartment occupancies hit 92.2 percent in September, a 2 percentage point year-over-year gain.

The other category that has been affected is education. The total impact, however, is a bit hazier. The state estimates that it will have to spend more than $300 million in the current fiscal year to educate the 45,000 students displaced by Hurricane Katrina, according to the Houston Chronicle. The state is looking to get reimbursement from the federal government for most of the costs.

However, the impact of the student surge on school construction is likely to be negligible. Most school districts have absorbed the Louisiana students without too much strain on current facilities.

Most analysts had also predicted a sharp uptick in demand for office space, as Louisiana firms shift their operations to Texas, in particular Houston. But that scenario has not materialized. Most displaced firms that set up temporary operations in Texas will return to New Orleans. The low Katrina-evacuee demand is evident in the third quarter 2005 vacancies.

Houston office vacancies dropped only slightly in the third quarter, according to CB Richard Ellis, to 16.7 percent (from 17.1 percent in the previous quarter), while downtown vacancies actually rose slightly.

TXC: Texas has been leading the nation in recent years in highway, educational and health-care markets. Where did Texas rank in relation to other states for 2005 and where do calculations put the state in 2006 for those markets? Where did Texas rank in terms of total construction dollars?

Coskren: In terms of education construction, Texas continues to lead the pack. In the first 10 months of 2005, education construction in Texas was up 7 percent in terms of total value, with levels ranking second among the 50 states.

For health-care construction, Texas ranked third in the first 10 months of 2005, trailing Ohio and California. Among the larger health projects that boosted 2005 include the $200 million Memorial Hermann Medical Plaza in Houston and the $70 million Scott & White Center for Advanced Medicine in Temple.

Texas tends to outrank most states for health-care construction not only because of its population growth, but because, unlike most states, Texas does not have a Certificate of Need Law. Thirty-six states in the U.S. have CON laws, which require investors to gain certification and approval from state regulators that the need for a proposed facility exists before it is constructed.

The CON requirements create a barrier to entry and can reduce competitive pressures among the health-care industry.

In terms of highway construction, in the first 10 months of 2005, Texas ranked as the most active state. Moreover, Texas' highway construction value was 35 percent higher than the next state - California.

For total construction, Texas ranked third in the first 10 months of 2005, behind California and Florida.

TXC: How will Texas fare in other commercial sectors such as industrial and multifamily?

Coskren: The Texas' multifamily market remains extremely robust. The multifamily market consists of for-sale (condos/town houses) and for-rent (apartments) structures. With Texas single-family home prices remaining affordable, most of the state's new multifamily construction has focused on the for-rent side.

Among the larger projects to boost Texas activity in 2005 were the 422-unit Colonial Grand Apartments in Round Rock, the 374-unit Ranch at Savano in San Antonio and the 369-unit Mandalay on the Lake Apartment in Dallas.

Manufacturing (industrial) construction will register strong gains in 2005, thanks primarily to the January 2005 start of the $325 million Texas Instruments plant in Richardson. Other projects that began this year are relatively smaller in scale, including the $20 million Toyota suppliers' building in San Antonio. No projects of a similar size and scope as the Texas Instrument Plant are currently in the planning pipeline, suggesting a decline in manufacturing for 2006.

TXC: What are your predictions for the value of all construction in Texas - minus single-family housing - for 2006? And if growth is predicted, at what rate?

Coskren: For total construction (minus single-family), we anticipate another year of growth. After a 7 percent gain in 2005, we're looking for at least a 4 to 6 percent growth rate for 2006.

TXC: Last year Dodge Analytics predicted roughly $24.5 billion for 2005, how accurate was that forecast?

Coskren: The forecast was fairly accurate. For 2005, we are estimating a value of construction (minus single-family) at $25.7 billion, 5 percent higher than last year's forecast. Much of this came from stronger-than-expected growth in education, highways and bridges and multifamily construction.

TXC: Any thoughts on employment and/or interest rate trends in the state?

Coskren: Texas employment has been advancing at a brisk clip. Year-over-year job gains for the state have been positive. From January 2004 through September 2005, the economy added more than 220,000 new jobs. The state, in terms of job growth, should remain an above-average performer in 2006, adding an element of support to the state's construction outlook.

Interest rates however will remain a source of concern. With the Fed raising rates, and indicating that the tightening is not done, borrowing costs will shift even higher and likely put a damper on construction, housing in particular. However, stable job growth will mitigate the potential negative impact, allowing for a deceleration in construction growth rather than an outright decline.