Spending Stabilizes at Elevated Level; Supply Constraints Become More Apparent

While nonresidential construction spending growth struggles to maintain momentum, the balance of 2016 should prove a rewarding period for many construction companies. America’s consumer-led economic recovery remains in place, and construction backlog remains at elevated levels. 

Overall, the amount of nonresidential construction value put in place has expanded just 1.2 percent during the past year, suggesting that nonresidential construction activity has plateaued. Nonresidential construction spending dipped 1.3 percent in May to a total of $684.9 billion on a seasonally adjusted, annualized rate, according to analysis of U.S. Census Bureau data. 
April’s nonresidential spending figure was revised upwards from $688.2 billion to $694.1 billion. The previous three months of data—January, February, and March—all received slight downward revisions. 

In April, private spending was up 3.4 percent and public spending was up 1.4 percent. 

While many will attribute these modest numbers to a lack of dynamic economic growth in the United States, other factors are at work to constrain the level of observed growth in nonresidential construction spending. 

For instance, lower materials prices are embodied in the value of completed work. Though commodity prices have been firming recently, they had been in decline for more than a year (see page 12). Additionally, in many communities, nonresidential construction is facing severe constraints given an insufficient number of qualified workers. That effectively results in a ceiling on the amount of construction value that can be delivered over any given period. 

Several years ago, many specialty trade contractors were not nearly as busy—labor supply was accordingly plentiful. Circumstances have changed. Despite a broader U.S. labor market rebound in June, the construction industry failed to add jobs for a third consecutive month, according to analysis of U.S. Bureau of Labor Statistics data. 

While nonresidential specialty trade contractors collectively added 3,700 net new positions, nonresidential builders shed 1,300 positions, and heavy and civil engineering contractors reduced staffing levels by another 3,900. Residential builders trimmed their employment total by 2,400 in June, while residential specialty trade contractors added 4,700 positions. 

Despite recent job loss, the industry’s unemployment rate has fallen to its lowest level since October 2006. The construction industry unemployment rate declined to 4.6 percent in June from 5.2 percent in May, indicating tight labor supplies as a growing number of construction workers and jobseekers are shifting to other industries, such as leisure, health care, professional/business services, retail and finance, which continue to add jobs. 

Both residential and nonresidential subcontractors report lengthy backlogs and have begun to hike up prices. Some are turning away work for the first time in years. According to Associated Builders and Contractors’ Construction Backlog Indicator, backlog among the nation’s largest contractors now stands above 12 months, a record for the series. The biggest firms with the greatest capacity to attract talent have been able to accept work that others have to turn away in a market that has stabilized at a comfortable level but still faces a skilled worker shortage. 

Another factor in sluggish nonresidential construction growth may be growing skittishness among private developers, who have become increasingly concerned by possible overbuilding in commercial, office and lodging markets. Both lodging and commercial construction spending dipped in April. This hesitancy is reflected in many ways, including in the Architectural Billings Index, which has struggled to consistently stand meaningfully above its threshold value of 50. Public spending also remains lackluster as many states deal with underfunded pensions and ballooning Medicaid costs. 

Given labor supply constraints, the industry’s capacity to deliver additional services has become strained. 

Bright Spots 
Despite the recent slowdown, most segments report meaningfully higher activity relative to one year ago. Only four of 16 nonresidential construction segments have experienced spending declines during the past year. Three of these segments— water supply, conservation and development, and public safety— rank among the four smallest and largely depend on public spending. 

 The level of construction work in certain markets is simply stunning—from Seattle, Portland, Ore., and Silicon Valley to Greenville, S.C., Sarasota, Fla., and Atlanta’s suburbs. Based on survey data, most contractors appear satisfied with this state of affairs. 

While U.S. economic growth continues to be tepid, some sectors of the economy have experienced enormous progress over time. Low interest rates have been critical in many instances, and this is certainly true with respect to the U.S. auto sector. Several years ago, major U.S. auto producers were struggling to avoid bankruptcy. Now, these companies are once again profitable and are currently expanding their global footprints. Foreign auto manufacturers, including Subaru, Toyota, Honda, BMW, Mercedes and Volkswagen, have expanded production in North America. Greenville is now home to the largest BMW factory in the world, and that plant has expanded on numerous occasions. 

In mid-2015, Tesla began construction of its $5 billion Gigafactory in Sparks, Nev. That project alone would have accounted for more than one-fifth of the manufacturing-related construction spending in 2004. Boeing’s ongoing expansion is also helping the industrial sector of the economy retain momentum. 

Meanwhile, the spread of e-commerce is expanding demand for warehouses and fulfillment centers. Accordingly, commercial construction remains one of the nonresidential sector’s bright spots. 

The power sector also has been associated with large construction spending increases during the past decade. Between 2004 and 2016, the annualized rate of spending increased from $36 billion to nearly $87 billion. In recent months, spending has stagnated, but the overall rate of investment in U.S. power plants and other energy-related facilities remains higher now than it was pre-recession. 

Looking Ahead 
The question on virtually every construction leader’s mind is: How long will this last? While every cycle has a beginning and an end, this time is different in part because of ongoing caution among lenders. For instance, previous commercial real estate cycles were associated with steadily loosening credit standards. However, because the Great Recession was so devastating to bank capital and liquidity, cautious lending standards are expected to help significantly extend the current cycle. 

However, there are other sources of excess financing, including foreign money. Economies in much of the emerging world (China, Brazil, Russia, Turkey and South Africa) have been unusually weak. Data indicate each of these nations is associated with significant capital outflows and much of that money is coming to America, often used to purchase or develop commercial real estate. A significant fraction of these funds flows to America’s major cities, including New York, Boston and San Francisco. With so much foreign equity flowing into the United States, it is conceivable that certain segments, including the U.S. hotel sector, are presently being overbuilt. 

Other concerning forces are at work. For a third consecutive month, construction input prices expanded (increasing by 0.5 percent) according to the June 15 Producer Price Index released by the U.S. Bureau of Labor Statistics. This follows eight consecutive months during which construction input prices fell. 

Rising prices are part of a broader emerging inflationary story that could, among other things, lift interest rates and real estate cap rates. With fuel prices now rising and the nation approaching full employment, inflation is likely to become much more of a factor than it has been in recent years. All things being equal, rising interest rates are not good for the nation’s nonresidential construction industry. 

A number of key Federal Reserve policymakers have signaled that higher rates are coming. In a recent New York Times article, New York Federal Reserve Bank President Chris Dudley stated, “We should continue to see tightening of the U.S. labor market, probably a gradual acceleration in wages as the labor market gets tighter. And if that’s how the economy plays out, then I think we’re going to see further moves by the Fed to gradually normalize interest rates.” 

However, the weak jobs number will impact Federal Reserve policy, and what had been a likely interest rate increase in June or July may be off the table for now. 


Construction Prices Tick Upward 
Nonresidential construction input prices expanded 0.9 percent in May, but are still 3.5 percent below their year-ago level. Price gains were largely driven by iron and steel prices and steel mill product prices, which expanded 5.8 percent and 4.6 percent for the month, respectively. 

The global economy continues to disappoint relative to expectations established coming into the year. Higher prices may stimulate new rounds of production, including in energy markets, but the implication is that prices are unlikely to rise dramatically going forward. 

Analysts’ views regarding the direction of commodity prices diverge wildly. While supply and demand play a role in fashioning commodity prices, so too does the value of the U.S. dollar. U.S. interest rates continue to remain low and in many cases have been declining. The dollar has correspondingly weakened in recent weeks. Should that continue, commodity price increases could be sharper than presently anticipated. 

Nine key input prices rose in May on a monthly basis: 
  • Crude petroleum prices expanded 0.6 percent from April 2016, but are down 32.5 percent from May 2015. 
  • Unprocessed energy material prices expanded 0.9 percent on a monthly basis, but have fallen 23.1 percent on a year-ago basis. 
  • Prices for steel mill products expanded 4.6 percent on a monthly basis, but are down 5.2 percent on a yearly basis. 
  • Iron and steel prices expanded 5.8 percent month over month, but are down 2 percent year over year. 
  • Softwood lumber prices expanded 2.2 percent for the month and 6.3 percent for the year. 
  • Fabricated structural metal prices remained unchanged month over month and are down 1.9 percent year over year. 
  • Prices for plumbing fixtures and fittings expanded 0.2 percent for the month and are up 0.3 percent from the same time last year. 
  • Prices for prepared asphalt and tar and roofing and siding products expanded by 0.4 percent month over month and 0.7 percent year over year. 
  • Natural gas prices rose 2.9 percent for the month, but are down 23.5 percent from the same period one year ago. 
Two key input prices declined on a monthly basis:  Nonferrous wire and cable prices fell 1.3 percent on a monthly basis and have fallen 9.2 percent on a yearly basis.  Concrete product prices inched down by 0.1 percent month over month, but are up 3 percent year over year. 


Anirban Basu is chief economist for Associated Builders and Contractors. For more information, visit abc.org/economics