Construction Market Outlook of 2003 Second Quarter CONDENSED FROM FMI ANNUAL CONSTRUCTION OUTLOOK PUBLICATION

Construction, like many other industries, suffered a disappointing start to 2003. However, residential construction proved to play a crucial role in the construction industry as a whole. To sum up the second quarter, the boom in residential construction may have peaked, the commercial construction depression may have bottomed, and a public construction sector isn’t looking so predictable. The reason, in part, for the discouraging outlook of the second quarter was the uncertainty created from the war with Iraq. Many companies put a freeze on hiring to see what the outcome of the war was, which further hindered the already stagnant labor pool. The number of unemployed who continue to file for benefits after the initial claim rose to its highest level in three and a half months, according to the U.S. Department of Labor. Poor employment growth created a decrease in consumer confidence. The Conference Board’s consumer confidence index was the lowest it has been since October of 1993 when it reached a low of 60.5.

However, this gloomy employment and consumer confidence data may not win out in the long run. There are a few key facts to note about February’s weak economic numbers, which may make the future look a bit brighter. One factor in the low numbers is the calling up of the reservists. According to the U.S. Department of labor, approximately 150,000 reservists were called into active duty in February. These reservists called to active duty are not included on employer payrolls. If the worker is not replaced, then the data shows a decrease in the employer’s job count. A second factor is the severe weather the nation had this winter, which probably lead to a decline in hiring, as well as consumer purchasing in February. A third factor is that February has fewer days than any other month, which most likely affects the retail sales data. Finally, the fourth factor to note is that people seem more confident with the job market than the employment numbers suggest. According to job trends analyzed by Challenger, Gray & Christmas, Inc., this is shown through the number of workers reentering the job market, voluntarily leaving their jobs, or starting their own businesses. Bottom line – even though the numbers seem discouraging, the economy still seems to be on the mend.

In the construction industry, as well as in the U.S. economy has a whole, residential construction has been crucial for the past two years. This is largely due to the ample demand driven by underlying demographic and lifestyle preferences. However, while the long-term demand should remain steady, the short term drivers of demand – weather, conditions, consumer sentiment, and builder sentiment – were off in February.

The value of new residential construction raised 0.3% to a seasonally adjusted rate of $328.1 billion. New home sales fell 15% to a seasonally adjusted annual rate of 914,000 units in January. By February, the seasonally adjusted annual rate was 854,000 units, the slowest pace since August of 2000. The total months’ supply of new homes for sale increased from an average of four months to four and a half. Sales of existing U.S. homes fell 4.3% in February to a seasonally adjusted annual rate of 5.84 million units, according to the National Association of Realtors.

Residential builders cut back on new housing construction in February. Single-family housing authorizations were at a seasonally adjusted annual rate of 1,315,000, below the annual rate in January. Housing starts dropped 11% from January to February. February’s rate is also down 9.3% compared to the estimate rate in February 2002.

Whether February’s weak numbers is a one-time occurrence or not, the possibility of rising mortgage rates and a level of mortgage defaults determined unacceptable to bank regulators are two factors that can potentially hinder the residential construction market in the next 12 months. While mortgages are a hot item of the year, over 80% of their volume was refinancing. Interest in obtaining financing for a new home is growing less quickly.

With an increase interest in mortgages came an increase in the number of mortgage bankers, which has grown by 122,000, according to the U.S. Department of Labor. This inflation of bankers results in a lot of new mortgage bankers approving a lot of new mortgages – some which should not be approved. The repercussions of such occurrences may be increased foreclosures, which could result in tightened standards on home mortgages. Evidence of such repercussions appeared for the second consecutive edition of the Federal Reserve Board’s January 2003 senior loan officer opinion survey on bank lending practices. Not to mention, the number of banks tightening their standards edged up 1% from the 10% reported in the October survey. The evidence is minimal at this point, but tightened home mortgages standards could in the end greatly influence residential construction.

Mortgage rates are not the only thing to keep an eye on in the months ahead. According to the Department of Energy, the U.S. average retail price for regular gasoline increased 2.8 cents per gallon as of March 3rd to reach 168.6 cents per gallon, which is 54.2 cents per gallon higher than a year ago. Mortgage rates and oil prices relate from a long-term perspective. Residential mortgage rates are influenced by the rate of consumer price inflation (as measured by the rate of change in the consumer price index), and oil and other energy prices constitute a portion of the consumer price index (CPI). In January and February, the CPI rose 0.3% in January and 0.6% in February, with increases in oil, energy and food prices. If oil prices continue to increase, then inflation is passed down the supply chain to consumers, borrowing rates, including mortgages, could be affected. In turn, producers, wholesalers, and retailers will swallow the increased oil-driven producer inflation, and corporate profits will continue to suffer. This would be followed by continued poor employment and investment growth. It’s a nowin situation that nobody wants, and can hopefully be avoided through victory in Iraq.