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Introduction to the Real Estate
and Construction Industry:
For the 2000 through 2004 period, housing was the big story
in real estate and construction, while other sectors were
a mixed bag. However, commercial construction has been rebounding.
Through the first quarter of 2005, all indicators pointed
to a strong construction market in such sectors as office
buildings, shopping centers and state and local government
construction projects. Some weakness will occur in new housing
starts if rates on fixed-rate mortgages rise much above 6%
or if the economy falters.
Commercial real estate and construction:
The commercial and government sector is seeing new growth.
Values of existing properties have soared and total new construction
volume has begun rising as of 2004. Existing commercial structures
such as office buildings and shopping centers have seen their
values skyrocket, propelled by low interest rates and hot
competition among real estate investment companies (REITs
in particular) for properties to acquire. Nonetheless, office
building vacancies remain high in many metro markets, as corporate
tenants are cautious about new commitments for space.
Commercial construction spending rose to record levels, reaching
$1.05 trillion, in fiscal 2004. That year saw a rise of 9.2%,
according to the U.S. Census Bureau, the largest spike since
1996. Fueling the growth are steep rises in construction costs.
The Bureau of Labor Statistics reports that prices for iron
and steel products rose 35% in 2004, while steel rebar and
copper wire skyrocketed by as much as 60% in some markets.
PVC pipe and other petroleum-derived materials went up between
15% and 20%. Steel prices have been especially high, doubling
since mid-2003, although prices abated to some extent in early
2005.
The commercial sector will enjoy the fruits of a firming economy.
In particular, the hard-hit office rental market may firm
up, and there will be good demand from the ever-hot health
care sector for new or remodeled properties. Also, the hotel
market has enjoyed a healthy rebound after the devastating
effects of 9/11 on business and tourist travel. Analysts at
PricewaterhouseCoopers anticipated that revenue per available
hotel room would rise 6.3% in 2004.
State and local governments are struggling to balance budgets,
but construction for governmental buildings and public infrastructure
remains steady, and is high in some markets.
Residential real estate and construction:
Housing is one of the few industries that managed to flourish
during the economic slowdown in the U.S. that began in late
2000. For 2004, 1.49 million new single-family homes were
built, up from about 1.36 million in 2003. 2004 capped an
intense increase in new housing starts for the past several
years.
Home sales are so brisk that the percentage of American households
that own their own homes rose to 69% in 2004—an all-time
record. Housing prices, especially those in desired markets
such as San Francisco, San Diego, San Jose, Fort Lauderdale
and New York City, among others, have seen significant appreciation,
leading many to speculate that a housing price bubble may
exist.
From the beginning of the house value boom in 1995 through
2004, prices of existing homes rose 65% on average nationwide.
High-demand areas have seen skyrocketing values. Boston, from
2000 through 2005, experienced 44% growth. Southern California
prices more than doubled, while New York City housing prices
grew 94%.
Sounds great, right? Maybe not. Problems can arise when housing
prices in highly desirable areas (mainly major urban centers)
rise at a rate much higher than the increase in average household
income. This is the situation in all of the hottest housing
markets today. Many home purchasers have been stretching to
buy their homes. Some have gone into too much debt. Some buyers
are using “interest only” loans to reduce the
amount of their monthly payments. Others have used risky adjustable-rate
mortgages (ARMs) to reduce their payments. For example, ARMs
that adjust interest rates once each year offer rates that
are about 1.5% lower than those of fixed-rate mortgages. However,
if interest rates continue to go up (they were increasing
steadily in early 2005), homeowners with ARMs are going to
see their mortgage payments increase. Foreclosure rates could
go up—home values could be hurt as a result.
Atypically, the housing market was strong during the recent
economic slowdown. Credit is easier to get than ever, and
interest rates remain low (in early 2005, homebuyers were
able to get 30-year mortgages at 5.6% to 5.9%), helping home
sales soar. A $2,400 monthly house payment afforded a buyer
a home worth $424,000 in 2000 (net of taxes and insurance
and factoring in a 20% down payment). In 2005, that same payment
affords a $525,000 home.
Apartment house operators have been particularly hard-hit
by the boom in home ownership. Vacancy rates have skyrocketed
while renters have taken advantage of extremely low interest
rates (and mortgage plans with low or no down payment) to
buy a piece of the American dream.
However, home values in less populated areas, such as parts
of the Rust Belt and the Central Plains, have not seen the
tremendous appreciation experienced in more populous regions.
For example, a home priced at $300,000 today in Fort Wayne,
Indiana is worth roughly the same amount as it was 20 years
ago, when adjusted for inflation. The square footage of that
house, though, is likely to be several times that of a $300,000
home in the San Francisco or New York City area. The real
estate market is driven by demand, and the amount of house
that a dollar will buy varies wildly across the nation according
to the state of the local economy, the size of the population
base, local average household income and the health of the
job market.
Here’s an example of how wide the disparity in home
values can be from one part of the nation to the next: For
2004, Beaumont-Port Arthur, Texas recorded the lowest median
home price in the nation, at $87,800. In San Francisco, the
most expensive market, it took more than seven times that
amount to buy the median-priced home at $656,700. The U.S.
was not alone in the rapid rise of home values. Canadian markets
like Toronto have been hot. London’s residential market
rise has been nothing short of amazing.
What’s in store for the housing market? If interest
rates stay low, houses will continue to sell briskly. However,
that’s a big if.
What will happen to the real estate market if the economy
starts a strong, sustainable trend of growth? While a stronger
economy might have the negative effect of raising interest
rates, it would have an extremely important positive effect—the
creation of more jobs. Today’s better job market is
a vital contributor to the creation of new households. Consumers
need reliable, well-paying jobs before they sign mortgages
for new homes. The large numbers of new college grads who
were forced to go home to live with Mom and Dad in the early
2000s are now forming new households thanks to overall economic
growth. A strong job market could easily help overcome somewhat
higher interest rates and fuel strong demand for houses.
The National Apartment Association reports that there were
1.48 million more households in the U.S. in December 2004
than there were in December 2003. This is up significantly,
as household growth for the year ended December 2003 was only
627,000. In addition to increases due to a better job market,
new household formation is also on the increase because of
strong growth in income among immigrant populations.
A stronger job market also leads to greater demand for office
and warehouse space, while boosting demand for retail space.
The bottom line, as always, is that the health of the real
estate and construction industry hinges on interest rates
and the health of the economy.
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