We’re Halfway There: Nonresidential Construction Rebounds During Slow Economic Recovery
If the economic recovery were likened to a college basketball game, the nation would be in the early to mid-stages of the second half. Mid-June marked the tipoff of the seventh year of economic recovery.
The current recovery could end up challenging the lengthiest recovery in U.S. history, which lasted precisely 120 months between March 1991 and March 2001. Once upon a time, recoveries were much shorter. The average post-World War II recovery has lasted about 58 months, or slightly more than four and a half years. The previous three economic recoveries lasted an average of 95 months, or nearly eight years. The average duration of economic expansions between 1860 and 1945 was just 26 months.
The mid-phase of the recovery is typically the lengthiest part and ultimately gives way to the late phase when the economy overheats. Already, signs of overheating are evident, particularly with respect to emerging skills shortages in key industry categories such as trucking and construction. Despite that, average hourly earnings nationwide across all industries collectively are up only 2 percent in the past year, well below the Federal Reserve’s goal of 3.5 percent. There are also indications that certain real estate and technology segments have become overheated, with purchase prices rocketing higher and capitalization rates remaining unusually low.
What’s more, job growth has begun to soften recently. After adding an average of nearly 250,000 jobs per month during the one-year period from July 2014 to July 2015, the nation added only 136,000 net new jobs in August, according to a revised estimate, and 142,000 jobs in September, according to a preliminary estimate. While two surprisingly tepid months of end-of-summer data should not raise alarm bells, something is not quite right with the economy.
Job growth is typically a lagging indicator, meaning that something else has happened to the economy to cause the recent softness. At the top of the list of many possible explanations is a slowing global economy.
One theory suggests Brazil, Russia, India and China (BRIC nations) would eventually supplant the United States as the primary driver of global economic expansion. It hasn’t happened yet. China is set to sustain its lowest rate of annual economic expansion in at least 20 years. Brazil is in recession, and Russia’s situation is even worse. Among the BRIC nations, only India, the world’s largest democracy, is having a solid year economically. Unlike Russia and Brazil, oil production is not a primary source of growth in that country. India’s primary resource is a large and growing population of talented, educated young people—the ultimate renewable resource.
In addition to weakness in emerging countries, much of the developed world continues to be sluggish. Europe’s malaise is well known, and the emerging refugee crisis will place additional pressure on labor markets with already high unemployment and strained central government budgets. The Canadian economy, to which America exports more goods than any other nation, actually recessed during the first half of the year, weighed down in large measure by the collapse in commodity prices. The Japanese economy also continues to perform erratically.
On top of global economic weakness is the fact that the U.S. dollar is much stronger than it was a year ago. As of this writing, one dollar can purchase 120 Japanese yen. Roughly a year earlier, the dollar could buy around 100 yen. Today, one euro can purchase $1.12. It wasn’t that long ago that a single euro could purchase $1.38. Several years ago, one Canadian dollar could purchase more than one U.S. dollar. Today, the Canadian dollar purchases only about three-quarters of a U.S. dollar.
The strong American dollar has stifled U.S. exports. Exports are on track to decline in 2015 for the first time since the financial crisis despite a national push to expand shipments abroad. According to the U.S. Commerce Department, exports of goods and services were down 3.5 percent in July compared to the same period one year ago.
In addition to strains coming from the global economy, the public sector continues to be a relative drag on U.S. economic growth. The inability of Congress to extend the nation’s Highway Transit Fund in meaningful ways has delayed project starts. Recent fears regarding another federal government shutdown also have contributed to a “not yet” economy. On top of that, a lack of transparency remains regarding tax treatment of equipment and related purchases, which is further undermining current growth.
To the extent that the economy is performing, it is largely in interest rate-sensitive areas. At the top of the list is consumer spending. Despite soft wage growth, consumers continue to lead the way, spending more on restaurants, automobiles, electronics and lodging. Low interest rates represent an inducement, particularly with respect to the purchase of new cars, which are back to pre-recession levels or better.
Residential construction continues to represent another important economic driver. Both multifamily and single-family segments have been on the mend. Borrowing costs are low for developers and purchasers alike, helping fuel an uptick of spending on housing.
According to a recent report from Trulia
, a real estate listing and analytics company, multifamily construction activity is elevated relative to historic averages in more than one quarter of the nation’s largest metropolitan housing markets. In red-hot markets like New York, activity is four times the normal average; in Boston, it has tripled. As reported by CNBC, Dallas, Houston, Seattle, Los Angeles and San Francisco are all experiencing above-average apartment construction while experiencing below-average supplies of homes available for sale. These and other markets are known for their capacity to attract young college graduates in large numbers, and the in-migration of young knowledge workers is helping propel multifamily development booms.
U.S. housing starts expanded to a near eight-year high in July. Through that month, housing starts have exceeded a one-million-unit pace for four consecutive months. Interestingly, single-family construction has been at the heart of residential recovery recently. In July, groundbreaking for single-family homes surged by nearly 13 percent to an annualized pace of 782,000 units—the highest level since December 2007, which happened to be the initial month of the Great Recession.
Nonresidential Construction Spending Expands Briskly
If the conventional wisdom is that residential construction leads commercial construction, then it stands to reason that nonresidential construction’s recovery will continue into and through 2016.
Recent data emerging from the industry have been generally upbeat. Despite weak federal government outlays, restrained spending among many state and local governments, and a slowdown in investment in the nation’s energy exploration industries, nonresidential construction managed to expand 12.4 percent year over year through September. According to the U.S. Census Bureau, nonresidential construction spending fell in September for the first time in eight months. With the large year-over-year gains, this is nothing to worry about. For the month, nonresidential spending totaled $696.3 billion on a seasonally adjusted, annualized basis.
Driven in large measure by a boom in auto production-related investment, manufacturing construction was up by more than 40 percent on a year-over-year basis in September. Increases in leisure and business travel have helped drive hotel occupancy rates higher, supporting 33 percent growth in lodging-related spending during the past year. Spending in the amusement and recreation category is up by more than 30 percent.
The expansion of the nation’s health insured population has helped push health care-related construction up by 9 percent, while the continuous growth in demand for data has helped boost communication-related construction by 10.2 percent during the past year.
Signs of life are appearing in certain publicly financed segments. Highway and street-related construction increased 10 percent during the past year, in part because of a need to address deferred maintenance. Environmental Protection Agency mandates coupled with highly publicized water main breaks around the nation have pushed sewage/waste disposal construction up 12.9 percent during the last 12 months and water supply-related construction up 5.6 percent. Education-related construction spending is up 11.5 percent as public school systems strive for better science labs, leak-proof roofs, see-through windows and more efficient energy use.
Rebounding construction volumes help support profit margins by rendering the average worker busier and more productive. But this rebound also has helped produce an expanding skills shortage. In September, the construction industry unemployment rate dipped by another 0.6 percentage points, bringing the rate down to 5.5 percent. Also, 125,000 fewer construction workers were looking for employment. During the past 12 months, the industry has added more than 200,000 positions, making it one of the best performing sectors in the economy, both in absolute and percentage terms. This is consistent with the prevailing belief that wage growth in the industry will continue to ramp up in the future. The unemployment rate for the construction industry is essentially at its lowest point in the past eight years.
Associated Builders and Contractors (ABC
) produces a number of leading indices, each of which suggests that 2016 will be another solid year for the typical U.S. nonresidential construction firm. ABC’s Construction Confidence Index
has been structured to provide decision-makers and managers with a sense of a typical contractor’s outlook during the next six months. It encompasses expectations with respect to hiring, profit margins and projected sales growth. According to the most recent survey, which was conducted in September, overall contractor confidence has increased with respect to both sales (67.3 to 69.4) and profit margins (61 to 62.9). While the pace of hiring is not expected to increase rapidly during the next six months, the rate of new hires will continue at a steady pace. It would be difficult to increase the pace of hiring because finding suitably skilled personnel has become so difficult in much of the nation.
ABC’s Construction Backlog Indicator
also signals strong demand during the months ahead. According to the latest backlog survey, average contractor backlog stood at 8.5 months by mid-year 2015. Average backlog is surging in the western United States, home to many of the nation’s fastest growing technology companies. Backlog in the heavy industrial category also has been rising rapidly recently, consistent with observed increases in construction related to factories and distribution facilities.
The average firm is not only benefiting from more work, but also has the capacity to take advantage of cheaper input prices. Prices for diesel fuel and natural gas have trended lower for much of the past year, as has the price of iron and copper products. While some contractors in commodity-rich states have been negatively impacted by these price declines, others benefit due to the positive impact on commercial and other forms of construction.
A weak global economy and stronger U.S. dollar will prevent the U.S. economy from surging ahead in 2016. Stakeholders can expect a 2.2 percent rate of growth (or similar to that) next year. There are significant risks to the downside, including volatile financial asset prices. The recent softening of job growth may keep the Federal Reserve pinned on the sidelines for the balance of 2015. Under most conceivable scenarios, rate increases will be gradual and intermittent.
Part of the Federal Reserve’s reluctance to begin normalizing monetary policy is attributable to an awareness that the U.S. economy has become addicted to the availability of cheap money. Low interest rates are fueling growth in consumer outlays, construction and auto sales/production. Were interest rates to rise meaningfully, the U.S. economic recovery would be jeopardized. Real estate valuations also would be compromised, which would have a chilling effect on commercial and other forms of construction.
However, construction stakeholders can find reasons for encouragement. The U.S. unemployment rate has fallen, and the nation is roughly a year away from full employment. Wage growth is set to accelerate, which should keep the consumer spending-led recovery in place. The economic weakness in China and greater difficulty accessing capital there could create opportunities for U.S. producers to strategically gain global market share in certain key product categories. America contains most of the world’s signature technology companies, and U.S. demographics are far more promising than in the balance of the developed world.
Anirban Basu is chief economist of Associated Builders and Contractors. For more information, visit abc.org.
Read "Regional Outlook: Moving in the Right Direction
" for more state and regional economic predictions.
Eye on Equipment
Looking ahead to 2016, contractors and equipment specialists alike are interested to know if economic conditions are ripe to invest in equipment—whether via rental or purchase.
Signs are pointing to cautious optimism and slow, steady growth.
According to the Equipment Leasing & Finance Association
’s Monthly Leasing and Finance Index, which reports economic activity from 25 companies representing a cross section of the $903 billion equipment finance sector, overall new business volume for September was $8.4 billion, down 13 percent from new business volume in September 2014. However, volume was up 22 percent from $6.9 billion in August. Year to date, cumulative new business volume increased 4 percent compared to 2014.
Separately, the Equipment Leasing & Finance Foundation
’s Monthly Confidence Index (MCI-EFI) for October was 58.7, easing from the previous month’s index of 61.1.
“We see many of our small business customers delaying purchases or putting the equipment acquisition decision through more evaluation than we had seen in the last year,” says MFI-ECI survey respondent Valerie Hayes Jester, president of Brandywine Capital Associates, Inc.
According to the survey of financial executives:
Lauren Pinch is managing editor of Construction Executive. For more information email firstname.lastname@example.org.
- 14.8 percent believe business conditions will improve during the next four months, 77.8 percent believe business conditions will remain the same during the next four months, and 7.4 percent believe business conditions will worsen.
- 40.7 percent expect to hire more employees during the next four months, 51.9 percent expect no change in headcount, and 7.4 percent expect to hire fewer employees.
- 3.7 percent evaluate the current U.S. economy as “excellent,” 88.9 percent consider it “fair,” and 7.4 percent rate it as “poor.”
- 7.4 percent believe U.S. economic conditions will get “better” during the next six months, 77.8 percent indicate the U.S. economy will “stay the same” and 14.8 percent believe U.S. economic conditions will worsen.
- 40.7 percent believe their company will increase spending on business development activities during the next six months and 59.3 percent believe there will be “no change” in business development spending; none foresee a decrease.