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2006 Industry Report: construction

Increased cost of materials hammers builders' margins

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TREND: Prices for materials such as steel and cement remain at all-time highs, and the cost of other construction materials is 4.6% higher than in 2004.

OUTLOOK: Rebuilding along the Gulf Coast is expected to tighten the market for materials more, pushing up prices and likely delaying some public projects.

Be careful what you wish for: You might get it. North Carolina contractors have been hoping for more private work for the past three years but instead had to settle for lower-margin public projects. Now private-sector work is back: Retail and multifamily residential building are booming, and even speculative office projects have begun to stir.

The problem is, the market is hot everywhere, including rapidly industrializing China and India. That has meant competition for building materials, which has driven up prices for such staples as steel, drywall and cement. “There’s nothing good about these prices going up so quickly,” says Bob Barnhill, president of Barnhill Contracting in Raleigh. “The unpredictability has been hard for us and subcontractors to deal with.”

Escalating steel prices forced officials at UNC Chapel Hill to cut a floor from each of three dormitories being built by Barnhill, and the concrete package for the Raleigh Convention Center that Barnhill is building with Parsippany, N.J.-based Skanska USA came in 10% higher than budget.

Rebuilding after hurricanes Katrina and Rita will only add to demand and price instability. Tony Plath, an associate professor of finance at UNC Charlotte who follows the construction industry for Charlotte-based Carolinas Associated General Contractors, expects increases of 5% to 10% this year for many materials and even higher for those produced with petroleum. “I’m telling contractors to put 20% wiggle room in their contracts for materials costs.”

Some public-sector jobs might get put on hold while government figures out how to pay for them, Plath predicts. The private sector, however, will proceed. “A lot of companies need physical plant capacity, and they have been waiting to build. They’ve been profitable over this time so they have the money to go ahead.”

Retail construction is especially strong in the state’s three largest metropolitan areas and includes plans to expand Crabtree Valley Mall in Raleigh and projects in western Burlington and near a Dell computer factory in Winston-Salem. Even office construction, once stagnant because of high vacancy rates, is perking up. “We haven’t seen speculative office building for almost three years,” says Brian Reece, managing partner of Karnes Research in Raleigh. But it’s beginning to creep back in some markets, including Chapel Hill and parts of Charlotte. In other places, office-vacancy rates remain in double digits. “We are starting to see developers get a little aggressive.”

Overall, Plath expects the construction industry in the state to grow about 7% in 2006, up from 5% in 2005. Middle-tier to smaller builders may get a boost as the large regional and national builders help rebuild New Orleans. “I think Katrina and Rita will benefit the Southeast construction industry once we get past the spike on the cost of materials.”

The completion of several marquee projects in Charlotte, including NorthLake Mall, a $265 million pro-basketball arena and a $143 million courthouse, may precipitate a dip in construction work there, Plath says, though he adds that seven proposed high-rise residential towers downtown might keep the market hot.

In the Triangle, hospital construction, Chinese computer maker Lenovo’s planned $84 million campus in Morrisville and buildings for the drug industry will keep contractors busy. Work is scheduled to begin in February on what will be Raleigh’s tallest building — a 42-story Westin hotel and condominiums near Crabtree Valley Mall.

Rising mortgage rates might have slowed the state’s strong residential housing market, but that didn’t happen in 2005. By fall, the rate on a 30-year mortgage remained at 5.7%. It was predicted to hit 6% in early 2006 and 7.5% by 2007. Even so, residential construction continued its strong performance, especially in the Triangle, Triad and Charlotte where job creation has created demand, says Carl Van Horn, an analyst with Rocky Mount-based Market Opportunity Research Enterprises.

He says fears that housing prices are ready to fall may be warranted in places such as Boston, New York and Chicago, where home values have doubled or tripled, but not in North Carolina, where price gains have been more modest.

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