Outlook has improved for construction spending with upturn in the economy

CCF July 2021

Screenshot from the Consensus Construction Forecast, July 2021. Click the link below to view individual forecast details.

View the interactive Consensus Construction Forecast >

Pent-up demand from the pandemic is creating a general spending surge, and construction looks to get its share of the benefits in the next two years.

Our economy grew by 6.4% in the first quarter of this year, and the expectations for the second quarter are that growth will accelerate even more. This strength is creating optimism in the outlook for construction spending this year and next. After declining about 2% last year, the AIA Consensus Construction Forecast Panel in its mid-year update is projecting that spending on nonresidential buildings will decline an additional 3.9% this year – an upgrade from the 5.7% decline forecast at the beginning of the year – and that 2022 will see a 4.6% increase in spending. The strongest performers this year are expected to be health care facilities (up 1.4%), and a few others that should see only modest declines (retail, -1.3%; religious, -0.9%; education, -2.1%). However, in 2022 virtually all the nonresidential building sectors are expected to see healthy growth, paced by lodging, as well as amusement and recreation, both of which saw steep declines during the pandemic.

Challenges from a strengthening market

Even while momentum is developing behind most of the nonresidential building sectors, there are several potential potholes on the road to a construction recovery. Inflation is suddenly back on the radar screen given the surge in consumer spending, as well as the growing federal debt levels. The global supply chain continues to face problems, even though a global economic recession in 2020 severely dampened demand for many products. House prices have been surging, leading to fears of a house price bubble, much like the concerns over a stock market bubble last year. Finally, labor shortages are developing throughout the economy, and the construction industry often fares poorly in the competition for new workers.

Emerging inflation. After years of inflation below targeted levels—including the fear of deflation as the pandemic shut down much of the economy—rising prices have re-appeared as a major concern for our economy. Consumer price inflation had been running below 2% for most of the past four years, and even dropped to around 1% or below for the final three quarters of 2020. However, as the pandemic fears have eased, consumers have begun tapping into their substantial savings and making up for deferred spending. As of the second quarter of this year, consumer prices are growing at a 4% pace compared to the prior year.  Producer prices have accelerated even faster, increasing almost 6% in the second quarter.

Economists are increasingly divided as to whether we are in a temporary inflation bubble or the beginning of a new period of structural inflation. The temporary proponents argue that current price spikes reflect unique circumstances often brought on by production disruptions from the pandemic. Additionally, they argue that inflation is determined by comparing current prices to those of a year ago, and a year ago prices were depressed due to the pandemic. The structural adherents argue that inflationary pressures are becoming more pervasive and are beginning to be built into labor contracts, rents, and areas that reinforce expectations that prices are moving permanently higher. Once producers and consumers begin to assume that prices will continue to increase, it is more difficult to reverse them.

Global supply chain disruptions and rising commodity prices. Related to the inflation debate is the ongoing disruption in global supply chains that is simultaneously creating prices spikes for many commodities and dramatically increasing lead times for others. While not all commodities have been impacted equally, there have been substantial disruptions for many construction materials, including softwood lumber products, metals, and energy products. Additionally, supply chain disruptions have caused delays in the production and distribution of other products that rely on multiple inputs, such as appliances.  

Other than general pandemic-related disruptions, there seems to be no single reason for the myriad of issues affecting global supply chains. The suddenness of the lockdowns when the pandemic hit convinced many manufacturers that demand would be depressed for an extended period of time. In those industries where demand came back sooner and stronger than expected, often it was difficult to bring back workers who were worried for their own safety, or had family issues that affected their willingness to return to work.

Generally, high prices reduce consumer demand and encourage producers to increase supply, so the hope is that normal market processes will eventually fix supply chain challenges. However, many companies have witnessed the inherent liabilities of global supply and may restructure their production processes to bring at least some output closer to home where they have more control and are less vulnerable to global disruptions.

Potential house price bubble. As the stock market increased 40% from the onset of the pandemic through the end of the year, there were mounting concerns of a potential bubble bursting. With additional strong growth in stock prices since the beginning of the year, this concern has not subsided, but is starting to be displaced by surging house prices. House prices nationally have been growing at a double-digit percentage pace since late last year, and the pace of growth has been accelerating recently. The recently reported S&P CoreLogic Case-Shiller index of house prices for April of this year showed an 14.6% annual increase, the highest annual rate of price growth in the almost 35 years that the index has been reported. Until the Great Recession proved otherwise, many thought that a significant national house price decline was most unlikely. While market conditions are certainly different now—underwriting standards are much tighter and households on average have much higher levels of home equity—there are limits to how much house prices can grow relative to household incomes before a correction occurs.

A vulnerable labor market.  Despite healthy growth in the number of payroll positions recently, there are still 6.5 million fewer payroll positions now, and the national unemployment rate is almost 2.5 percentage points higher than before the pandemic. That should point to a labor market with significant excess supply. However, recent figures suggest otherwise. The most recent Job Openings and Labor Turnover report from the U.S. Department of Labor indicated the even with almost six million new hires in May, there were over nine million open jobs out of a total employment base of over 150 million workers. The construction sector is following a similar pattern. There are about 7.5 million workers in the industry, and the unemployment rate is 7.5%. Still, after hiring over 300,000 workers in May, there were still almost as many unfilled job openings in the industry.

Many employers are so desperate for workers that they are offering financial incentives for new recruits. ZipRecruiter, an online job search site, recently reported that almost 20% of all jobs posted on their site are offering a sign-on bonus, a share that has exploded in recent months. The leisure and hospitality sector best exemplifies this unusual labor situation. As a result of layoffs during the pandemic, this industry currently has about 13% fewer workers than it had prior to the recession. However, employers are desperately searching to fill open positions. Wages are rapidly rising, with average pay for the restaurant industry now above $15 per hour for the first time. The construction industry competes with many of these other sectors that are experiencing labor shortages, ensuring that labor issues and higher wages will be an issue for construction for the foreseeable future.

Emerging opportunities for stronger growth

In spite of the emerging headwinds to a stronger design and construction recovery, there are other factors that potentially could produce growth beyond what might be expected from the underlying strength of a rebounding economy. As well as the need for additional building space, architecture firms are already reporting growing demand for retrofitting existing buildings, particularly in light of post-pandemic concerns. Also, the bipartisan negotiations for an infrastructure program may well supplement the existing strong demand for building activity.

Retrofitting existing buildings. Even prior to the pandemic, architecture firms were reporting that almost half of their billings on average resulted from renovations, rehabilitations, retrofits, additions, and historic preservation projects on the existing building stock. This was before concerns developed regarding how buildings could be made safer for employees and customers with heightened health concerns. From this base, a June 2021 AIA survey of architecture firms reported that almost a third of firms indicate that work on existing buildings increased at their firm as compared to pre-pandemic levels, and well over half indicated that these projects remained at about the same level. Only 13% for firms reported a declining share. Somewhat surprisingly, building sectors where firms had seen the greatest gains in retrofitting were manufacturing and distribution, multifamily residential, and many of the key institutional building types (healthcare, education, corrections, government). Facilities that had seen declines in retrofit activity were largely concentrated in the commercial category (retail, lodging, travel and tourism).

Potential infrastructure package. While it still has a long way to go, there appears to be growing bipartisan interest in Congress in passing an infrastructure program. According to a White House fact sheet, “the Plan makes transformational and historic investments in clean transportation infrastructure, clean water infrastructure, universal broadband infrastructure, clean power infrastructure, remediation of legacy pollution, and resilience to the changing climate.” Touted as a $1.2 trillion program over a five-to-eight-year horizon, about half of this figure comes from expiring existing programs that are expected to be renewed, and the other half from new spending.

Just over half of the proposed new spending is earmarked for transportation projects, with the largest pieces for roads and bridges, and passenger and freight rail. The remainder is for other infrastructure programs including power grids, broadband, water, and resilience. The construction industry would be a major beneficiary if such a program is enacted. However, most of the funding would go to engineering and public works construction firms, with a likely modest impact for architecture firms.

An overall improved outlook

While it will take a while for the recent burst in design activity to translate into construction spending, the coming years look to generate health growth in construction activity. According to real estate professionals, market conditions are improving in the major commercial, industrial, and multifamily residential sectors. A semi-annual forecast survey conducted by the Urban Land Institute this past May reported that the consensus is that over the coming years vacancy rates will decline and rents will increase for multifamily rentals, offices, retail facilities, lodging, and industrial/warehouse facilities. A difference is that these two metrics are already better than their 20-year average for multifamily rentals and industrial/warehouse facilities. For the commercial categories of offices, retail, and lodging, there needs to be significant catch-up before these metrics return to pre-pandemic levels. However, this is expected to happen by the end of 2023.

View the interactive Consensus Construction Forecast >

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CCF July 2021

AIA

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