Multifamily, retail will drive construction sector in 2003

Real Estate Weekly, March 5, 2003 by Jeffrey M. Brown

With economists trimming their growth predictions from the already sluggish forecast for 2003, the construction industry -- still one of the country's strongest sectors -- will turn to retail and multifamily housing to maintain profitability over the next several quarters.

According to a construction report released at the beginning of the year by the U.S. Commerce Department, apartment construction rose by a strong 0.5% in November. Meanwhile, spending on non-residential construction projects fell by 0.1%. The nonresidential sector -- namely, office, warehouse/distribution, health care, institutional and hospitality -- lagged for most of 2002.

In large part, the sluggishness is due to the reluctance of businesses to commit to spending on new plants and offices because of the uncertain economic outlook. That uncertainty will only increase as the nation faces possible military action against Iraq, which could further affect oil prices and overall economic prospects.

The real action in construction these days is in housing and retail, due in large part to low interest rates and stable consumer spending patterns.

The multifamily sector is probably the strongest and most stable of the markets heading into 2003. In New York City, the demand for new housing -- both rentals and condominiums -- continues to be very strong. To a considerable extent, this demand reflects aggressive Federal Reserve policies over the past year, which have kept interest rates at their lowest levels in four decades. The low interest rates have resulted in strong apartment sales. This is obviously a boon for the construction industry.

Investors still seek returns, multifamily housing is one of the safest investments. Multifamily housing provides investors with a better option than just putting money in the bank. It can produce solid returns, and is less risky than the volatile stock market. On the flip side, condominium sales also are being bolstered by the low interest rates, as people who may only have considered renting are finding it easier to purchase and establish some much-needed equity. This environment is allowing multifamily housing investors to move forward with projects, and creating work for construction management companies.

Low interest rates also have spurred demand for big-ticket retail items. As has been frequently reported, consumer spending has helped offset weakness in new business investment, keeping retail relatively buoyant Consequently, construction companies have set their sights on new retail development projects. It's a pattern we've seen and will see again and again.

Strong, big box retailers such as Target and Wal-Mart continue to expand. The luxury goods market is healthy, for example. As consumers continue to look for value, convenience and variety, companies like Crate & Barrel and Ikea are growing, thus creating new opportunities. To a considerable extent, these big box retailers tend to be "recession proof" -- particularly when you consider that people tend to spend more on home improvement during economic lulls.

In the tri-state area and along the eastern seaboard from Boston to Philadelphia, many of these successful retailers are searching for and fighting over sites for new development.

More significantly, construction managers in this region are staying busy through rehab projects. Weaker retailers have departed from the market, and this has provided a significant inventory of buildings in ideal locations, which stronger retailers are recycling into new facilities. They know what to do with those sites, so smart retailers are cherry-picking the best ones.

While some sites can't be made profitable, these stronger retailers continue to look for them. Finding an empty, high-quality site for new construction can be a lengthy and expensive process. By finding and recycling an existing property, these retailers save much time and money. The presence of an existing infrastructure, zoning, utilities and road systems present retailers with the potential for tremendous cost savings, and allow companies to get up and operational in a much shorter period of time.

The other main construction industry sectors -- warehouse/distribution, health care/medical, office and hospitality -- will continue to be uneven over the next year.

Development of speculative warehouse/ distribution facilities will remain soft in 2003, as developers will focus on site-specific projects for credit tenants. The strong connection with the retail market, however, will keep this sector buoyant.

The healthcare sector will continue to be weak for new construction as institutions struggle to finance new projects. However, stronger hospitals will be active with renovations to accommodate new technologies.

Hospitals also will likely be active turning administrative spaces into such income-producing space as patient rooms and labs, as they move other services off-site. This will keep many construction firms busy throughout 2003.