Commercial construction costs will increase on average by 6% to 8% in 2007 — two to four times faster than inflation — despite a slowing economy, according to Kenneth Simonson, chief economist for the Associated General Contractors of America (AGC). Driving those increases are international demand for materials, limited domestic supplies and high energy prices. Labor costs will grow more slowly, 5% to 6% over the course of 2007, but still well ahead of last year’s 2.5% core inflation rate, which excludes food and energy.

But wait a minute. The plunging housing market should lower demand both for materials and labor, right? Shouldn’t a less constrained supply be reflected in prices for commercial construction?

Well, yes. But that’s already included in Simonson’s forecast. Had single- family construction this year barreled along as before, commercial construction costs might be increasing 10% annually, as they did in 2004. In other words, deflation of the housing market is taking the edge off the severe price growth of the past three years, but prices keep rising.

Slowed housing activity is bringing price relief for some products used in commercial construction, including copper, plastics, plywood and gypsum, used in wallboard. Gypsum prices climbed 20% annually from 2003 into 2006, fell slightly in December, and at year’s end were only up 5.4% over year-ago prices. Milled copper and brass, which spiked up 30% annually in 2004 and 2005, climbed another 44% last year, but a 1.6% price drop from November to December suggests slower increases ahead. “We will still have to expect price increases in 2007, but hopefully they won’t be as dramatic as in recent years,” Simonson says.

Most of the materials (and the labor sets that go with those products) that are expected to experience slower price growth going forward are used in residential and non-residential construction, including sheetrock, fiberboard, plumbing and wiring.

A lack of substantial overlap between residential and commercial construction, however, means prices will climb unabated for many building materials. The same is true of labor; few homebuilding skills are transferable to the construction site of an office building, hospital or mall. “You can’t take a framing carpenter and put him in a tower crane,” Simonson says.

In 2004, demand by developing economies, like China, contributed to a 49% spike in the price of steel. Today, China has stepped up manufacturing and now exports about as much steel as it imports. As a result, steel prices dropped 4.3% in the fourth quarter and were only 11.6% higher than year-ago prices at the end of the year.

Concrete, on the other hand, is expensive to transport and is usually purchased near a job site. Concrete demand for buildings, roads and sewers has grown in recent years, while U.S. cement production is little changed from a decade ago.

At the same time energy prices, which climbed 4.5% in December, have increased the price of concrete and other materials, and raised the cost to mine and transport the aggregates that are mixed with cement to form concrete. Concrete prices climbed 10.1% in 2005 and 7.9% in 2006.

What does the AGC’s forecast mean for developers and investors? For one, expect further price spikes and shortages on materials this year, as well as bottlenecks and high transportation costs in getting those supplies to the job site.

Given a choice, contractors will prefer to deal with developers that include materials price- adjustment clauses in their contracts and will be reluctant to work with government agencies and developers that insist on fixed budgets.

Frequent commodity shortages are a sign that the U.S. economy is operating at capacity, says Craig Thomas, research director at CBRE Torto- Wheaton Research. Once builders begin to calculate anticipated price spikes into their contracts, inflation kicks in, potentially ushering in the end of the economic expansion.

Hopefully some of the smart money will help to alleviate this serious situation in 2007 with development — not of office buildings or retail centers, but with cement plants, copper mills, and the infrastructure this nation needs to thrive and grow.

Source: NREI Newsline

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• DESCRIPTION: Funding to support small and mid- sized organizations for projects that extend the reach of the arts to underserved populations -- those whose opportunities to experience the arts are limited by geography, ethnicity, economics, or disability.

• China
• China's National Statistics Bureau released a revised estimate of the country's 2005 gross domestic product, reporting growth of 10.4 percent, state news service Xinhua reported. The new figure is 0.5 percent higher than the original estimate, boosted by surging growth in the industrial and tertiary sectors.

• Oil and Gas Inventories
• Crude oil inventories rose 0.7 million barrels for the week ending January 19th, according to the Energy Information Administration. The rise in inventories was below the expected uptick of 1.1 million barrels. Distillate inventories rose by 700,000 barrels, a stark contrast to the market's expectations of an 800,000 barrel drawdown. Motor gasoline inventories soared by 4.0 million barrels last week, far exceeding expectations of a 1.3 million barrel uptick. Refinery activity declined for the second consecutive week to 87.4%. In sum, the report will be viewed as bearish for oil traders.

• New Home Sales (C25)
• New home sales were surprisingly strong in December. The pace of sales increased by nearly 5% m/m to 1.120 million annualized units. November sales were revised upward as well. Months of inventory ticked down from November to 5.9. The average price is flat from one year ago, but the median is down by about 1%.

• MBA Mortgage Applications Survey
• Mortgage demand decreased 8.4% in the week ending January 19. Purchase applications decreased 8.4% and refinance applications decreased 9.6%.

• Chain Store Sales
• Chain store sales were little changed in the week ending January 20, according to the ICSC. The index ticked up 0.1%, while year-over-year growth inched down to 4.8% from 4.9% the prior week. Cold weather was reportedly a mixed blessing, stimulating demand for seasonal merchandise, but negatively impacting store traffic.

• Weekly Natural Gas Storage Report
• Underground storage of natural gas decreased by 179 billion cubic feet during the week ending January 19. This was slightly above expectations calling for a 170 Bcf draw. Inventories are now 20.7% above the five-year average. This report is likely to have a neutral effect on prices.

• Existing Home Sales
• In line with expectations, existing home sales dropped in December, according to the Realtors’ data. Sales of existing homes declined 0.8%, with the pace of sales down to 6.22 million units in December. House prices were flat from a year ago, and the months of inventory stands at 6.8 months.

Source: Economy.com, Financial Times