Recovery in building construction projected to continue into 2023
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Industrial sector seen as strongest, but commercial upturn anticipated to be surprisingly robust
The recovery in the broader economy in 2021 didn’t carry over to the nonresidential building sector. Spending on the construction of these facilities declined about 5%, on top of the 2% decline in 2020. However, the market is expected to see a healthy rebound, with spending increasing by 5.4% this year before accelerating to an additional 6.1% increase next year, according to the AIA’s Consensus Construction Forecast panel.
The construction spending downturn was widespread last year. Only retail and other commercial, industrial, and health care facilities managed to eke out spending increases. This year, only the hotel, religious, and public safety sectors are expected to continue to decline. By 2023, all the major commercial, industrial, and institutional categories are projected to see at least reasonably healthy gains.
Economic challenges abound
The broader economy has seen a solid recovery since the depths of the pandemic-induced recession. It grew by about 5% last year and now has fully recovered from the past recession. There were almost 4 million net new payroll positions added last year, bringing national employment almost back to the level it was at in February 2020 prior to the pandemic. The national unemployment rate was 3.9% at the end of last year, just above the 3.5% rate in February 2020.
In spite of these positive economic indicators, there are several headwinds to future economic growth. The uncertainty surrounding combatting Covid and its variants have added tremendous uncertainty to future building needs. The Biden Administration’s Build Back Better program was slated to add significant support to the construction sector, but its funding is very much in doubt at present (January 2022). Supply chain disruptions are likely to continue slow economic growth well into this year. Inflation accelerated during the second half of last year to its highest rate in almost four decades, which is expected to put upward pressure on interest rates. Finally, the already-serious labor shortages look to become even more severe this year and next.
While moderating, supply chain disruptions continue for many materials and products, and are expected to be problematic throughout most of 2022. The pandemic continues to cause delays for many producers, and this situation is exacerbated due to the growing reliance of the US economy on imports. Imports as a share of US production has more than quadrupled since the post-World War II era. Just as critically, a growing share of US imports come from developing countries where the infrastructure typically is not as robust, and where the pandemic often has had a greater impact on the production and transport of goods. Construction has been particularly hard hit by supply chain delays. Construction input costs overall rose about 20% last year, with some products (steel and oil-based products are examples) rising more than 50%.
The pace of inflation has surged recently. Consumer prices were increasing 7% annually at the end of last year, while producer (wholesale) prices were increasing at an even faster pace. Given the strength of the economy, this high rate of inflation will force up interest rates. Short-term rates are expected to rise about three-quarters of a percentage point by the end of the year, with long-term rates rising by a similar amount.
Adding to inflationary pressures is the surprisingly tight labor market. The economy has added back most of the over 22 million payroll positions lost during the pandemic. Building construction contractors have seen a comparable share recovery in payroll employment. Notably, architecture firms are one of the few sectors of the economy where employment had exceeded it pre-pandemic high by the fourth quarter of last year.
Industries throughout the economy are finding it challenging to retain their current employees and are having difficulty recruiting new ones. Most workers feel that jobs are plentiful, and therefore are increasingly comfortable leaving their current job in favor of searching for a better one. A recent survey of architecture firm leaders found that more than four in ten feel that recruiting architectural staff is a serious problem at present, and that it may create difficulties for the firm over the coming months given anticipated project workloads.
The residential market leads the way
A construction cycle generally starts with the homebuilding and home improvement sector, and then moves to commercial, industrial, and institutional facilities. New housing developments generate demand for office, retail, and lodging space initially, and eventually for institutional facilities like schools, healthcare, and religious facilities. However, over the past decade we haven’t seen traditional construction cycles due to weakness in the residential sector resulting from the collapse in the housing market leading up to the Great Recession.
Quite unexpectedly, the pandemic kick-started the housing market. As households were fleeing urban areas and moving to larger homes in the suburbs and exurbs given their desire for additional space, the housing market flourished. Housing starts nationally increased by about 7% in 2020 even as economic activity crashed in the early days of the pandemic. Last year, housing starts increased another 15% to their strongest level of production since 2006. While the multifamily side was much stronger in the years following the Great Recession, during the pandemic single-family construction has dominated, accounting for almost 80% of the gain in residential construction activity over the past two years.
However, these gains were not evenly spread across the country, suggesting that the rebound in nonresidential construction activity will also have regional dimensions. Population flows last year favored southern and inland western regions of the country where housing tends to be more affordable. The US Census Bureau reported that population growth in the US last year was a minuscule 0.1%. However, eight states (Idaho, Montana, Utah, Arizona, South Carolina, and Texas) saw their population increase by more that 1%, topped by Idaho’s 2.9% increase in population. Nine additional states saw their population grow by at least 0.5%, and five of these nine states were in the South region.
Building activity on the rebound
Challenges to the economy and the construction industry notwithstanding, the outlook for the nonresidential building market looks promising for this year and next. One solid indication of the outlook is the recent upturn in design activity at architecture firms. After a decline in January 2021, architecture firms reported strong growth in billings for the remainder of the year. In fact, last year had the highest average scores for the Architecture Billing Index since 2007. On average, revenue at architecture firms increased almost 6% last year. This year, even more growth in revenue is expected, almost 7% on average.
As a result, the building construction market is projected to see healthy gains this year and next. The commercial construction market was expected to be the hardest hit by the pandemic and to experience the weakest recovery. Remote work meant less need for offices, e-commerce reduced the demand for traditional brick and mortar retail, and travel cutbacks dramatically cut into the lodging market. While the commercial market has been generally lackluster since the pandemic hit, some sectors have done surprisingly well. Retail space, in particular, was one of the few major sectors to see an increase in construction activity last year, reflecting consumer spending on goods given the limited desire to purchase services. Some of the strength in the commercial sector came from repurposing existing space to uses more in demand. Commercial construction activity is projected to see growth of just under 5% this year, and an additional 5.3% in 2023, and as such is one of the biggest surprises in the construction outlook.
The industrial market is expected to pace the building construction upturn this year and next, with projected gains of over 9% this year and more than 8% in 2023. This sector has been one of the few in nonresidential construction to benefit from the pandemic. The strong growth in e-commerce during the pandemic meant increased need for distribution facilities. Additionally, supply chain problems have provided the incentive for companies to increase their domestic production in an effort to avoid the long delays often seen with imported goods.
The institutional sector tends to be the last to recover from a downturn, and that looks to be the case with this cycle. After a fairly steep decline last year, overall growth for these facilities is projected to increase almost 4.5% this year and 5% next. The two largest institutional categories moved in opposite directions last year. Healthcare construction eked out a small gain when almost all other sectors declined, and is projected to see growth of 6% both this year and next. Education, with reduced need for facilities given the widespread reliance on remote learning, saw a decline last year, and is projected to see a rebound of 3.5% this year before benefitting from accelerating growth in 2023.
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For more detailed information on the forecast and economic conditions, join the Quarterly Economic Update on AIAU on February 3, 2022 at 2pm ET.