Beige Book: National Summary
May 18, 1983
National Summary This summary is organized around the answers to four key questions about current levels of construction activity. 1. How robust is the current upturn in housing sales and construction? 2. How serious is the current downturn in nonresidential construction activity? 3. How sensitive would activity in the housing sector be to interest rate changes of different magnitudes and directions? 4. What is the likelihood of bottlenecks and upward price pressures in the construction supplies industries? Housing Sales and Construction The recent upswing in housing is widespread geographically, with all Districts reporting substantial improvements over the extremely depressed levels of the first quarter of 1982. Moreover, a moderately high rate of housing construction appears to be sustainable at least through 1983. Cautious estimates by economists in the construction supply industry indicate an annual rate of housing starts of at least 1.5 million units, and the consensus among forecasters centers on levels between 1.5 and 1.6 million. The general feeling is that a marked pickup in the underlying demand for houses has occurred, and it was not just January and February's good weather that generated the remarkably high figures for those months. Moreover, the bad weather in March was probably responsible for that month's small drop in seasonally adjusted starts, especially in the Richmond, Atlanta, and San Francisco Districts. Most Districts reported that sales of low priced homes had picked up especially rapidly and there is an apparent tendency toward construction and sale of smaller houses. While the houses may be smaller than ever, they are apparently still being equipped with a full array of appliances. In some regions, Cleveland and Philadelphia for example, sales of medium or luxury priced homes have also picked up, but the performance of the middle and upper markets has been spottier. While all the Districts reported current improvement, the medium term outlook is more mixed. St. Louis and Dallas have started off very strong, but starts are expected to slow considerably by the end of the year. New York and Boston report activity that is already rivaling previous peaks and regional industry observers anticipate continued growth. In the other Districts the current level of activity falls well below previous peaks, and analysts are uncertain as to what the rest of the year will bring. Nor is there a nationwide pattern in builder confidence. San Francisco reports speculative building in anticipation of healthy sales later this year. In Richmond and Dallas contractors are only completing already-sold homes, and Philadelphia reports a substantial, but diminishing, inventory of unsold houses. Construction of rental housing has also increased, but the strength of the upswing varies from District to District in line with the tightness of local markets. Rental markets are tight in New York and Minneapolis; loose in Atlanta, Chicago and Dallas. In general then, while there is little doubt that a strong recovery in housing is underway, it is not at all certain that the rest of 1983 will continue as strong as the first quarter. Nonresidential Construction The nonresidential construction sector remained generally strong over the course of the last recession. Now, however, a slowdown is beginning nationwide as large office projects are completed and fewer new starts are planned. Vacancy rates have started to climb in most reporting regions--exceeding five percent in most places and as high as 8 percent in Chicago and 9 percent in Minneapolis. Advertised rents for office space have not declined, but several Districts report an increasing incidence of rent-reducing special deals such as one year's free rent, extensive remodeling, and free amenities. Under these conditions developers are taking a "wait and see" attitude about future construction plans. vacancy rates will have to decline and effective rents will have to increase before office construction starts begin to increase again. The Districts differ in the expected duration of the slowdown in commercial starts. Indeed activity has just started to pick up in Florida and in some of the smaller Texas cities. Industry analysts in New York expect 1984 to be a good year, and new projects are being talked about actively in Boston and St. Louis. By contrast, observers in Minneapolis fear that it will be three to five years before commercial construction activity begins to pick up in that District. None of the Districts reported large amounts of new retail construction. Work on smaller shopping malls can be expected to begin later this year, about six months after the increase in housing construction activity. Only Kansas City reported current work on a large shopping mall, and an analyst of large regional retail centers does not expect any such projects to be started this year across the nation. Sensitivity to Interest Rates It is generally agreed that the decline in mortgage rates is the single most important factor behind the increase in housing activity. Indeed, most respondents tended to feel that a further increase in housing sales could still happen even without any additional decline in rates. The basic question, however, appears to be whether another large drop in conventional, fixed rate, 30 year mortgage interest rates--to 10.5 or 11 percent--would bring out a great many more potential buyers. Observers in Boston, Philadelphia, Atlanta and Minneapolis believe that lower rates would touch off something like a boom in housing sales. Analysts in Chicago and Dallas are more dubious on this point. The use of variable rate mortgages, which might reduce the sensitivity of housing activity to interest rate fluctuations, does not appear to be gaining in consumer acceptance. District reports that discussed this issue indicated that the practice of "creative" financing had diminished markedly with the drop in rates. The conventional 30 year fixed rate mortgage remains, by far, the most popular home finance instrument. The general optimism about the sustainability of a healthy market appears to be based on a widespread belief that interest rates will not increase. Several Districts report the fear that any increase in mortgage interest rates, of say fifty basis points or more, could dampen recent growth rates. Market analysts in the New York region, however, believe that activity could be sustained, even given a small interest rate increase--especially if this were taken as a sign that mortgage costs had "bottomed out" and would be increasing further in the future. Input Prices While there have been a few instances of temporary input shortages (notably for lumber and dry wall) and some price rises, observers do not expect any sustained pressure on construction costs through this year. Construction supply industries are operating far below capacity and are apparently capable of increasing production quickly; so it is unlikely that anything more than temporary and localized shortages will occur in the near future. However, if mortgage interest rates do fall another percentage point or more, and if, as some predict, this leads to an annual level of housing starts closer to 1.8 than to 1.6 million, input bottlenecks and upward price pressure could begin to become problems.