2007 Industry Report: Construction

Commercial builders do not expect to hit the wall in '07
By Laura Williams-Tracy

Change Orders

TREND: Growth is slowing in China and India and in the residential sector in the U.S.

OUTLOOK: Costs for materials should increase more slowly than in 2006.

Even in good times, life in the construction industry can seem like a nerve-racking creep along an I-beam several stories high. When work is easy to find, prices for building supplies go up and labor gets harder to find and keep. But having too much business is better than the alternative.

With commercial construction continuing its rebound and North Carolina's housing market holding up better than just about anywhere else, builders had plenty of reasons to be happy in 2006. Tony Plath, an associate professor of finance at UNC Charlotte who follows the industry for Carolinas Associated General Contractors, forecasts inflation-adjusted growth of 6.9% in construction spending statewide. Residential construction was flat, but commercial construction was up. High-quality office space lagged, but many big projects were under way and on the drawing board.

Raleigh-based RBC Centura Banks, the U.S. banking arm of Toronto-based Royal Bank of Canada, broke ground in September on a $100 million, 33-story headquarters. In December, Charlotte-based Wachovia unveiled plans for a 48-story tower to be surrounded by two art museums and a theater in its hometown. Charlotte-based Bank of America announced plans in late 2006 for a $450 million, 32-story office tower near its headquarters.

For much of the year, builders strug-gled with high costs. In August, the price of construction materials in the U.S. Department of Labor's Producer Price Index was 8.8% above the same month in 2005. But by November, the percentage had dropped to 5%. Plath says prices for steel and other materials used in commercial construction could rise in 2007, but prices for lumber and other home-building materials should stabilize.

Contractors also worry about labor costs. Legal and illegal immigrants provide cheap construction labor, and politicians have talked about curbing illegal immigration from Mexico. "Our biggest fear is that we are seeing all of this work and wonder if the labor infrastructure is in place," says Scott MacLeod, executive vice president for the Carolinas and Virginia operations of Swedish builder Skanska.

Still, with oil prices down and corporate profits and stock prices up, some observers expect construction this year to match or exceed 2006. Commercial builders should be aided by pent-up demand from businesses that avoided expansion during the first half of the decade. "We'll do 10% better in sales next year, and we improved by 10% this year," MacLeod says. Plath expects overall growth to slow to 5.6%, with nearly double-digit growth in commercial construction and virtually none in residential. Builders he's talked to are pessimistic, expecting growth to slow in the second half. The Triangle has six major projects under way, each costing more than $100 million. In the Triad, FedEx continues work on its $300 million air-cargo sorting hub, scheduled to open in 2009. In Charlotte, four high-rise condo towers are under construction, including EpiCenter, a 53-story, $275 million mixed-use project.

What's missing from many developers' plans is speculative office space, says Brian Reece, managing partner of Karnes Research in Raleigh. Office rental markets are healthy - rates are rising and unleased space is being absorbed - but developers and their bankers aren't yet bullish enough to launch many speculative projects.

Though home building statewide leveled off, Tar Heel builders have avoided the problems plaguing the Northeast and other regions. And there was at least one bright spot: Charlotte. Through November, Mecklenburg County had issued more home building permits, 11,780, than in all of 2005. On the coast, the market has begun to soften. New-home closings in New Hanover County were down 33% in the third quarter, according to Rocky Mount-based Market Opportunity Research Enterprises.