What slowdown? Pace of construction activity projected to accelerate through 2019
Strength in industrial and institutional sectors offsetting projected easing in commercial construction activity
Construction spending for nonresidential buildings is projected to increase 4 percent this year and continue at that pace of growth through 2019. While the commercial construction sectors will generate much of the expected gains this year, by 2019 the industrial and institutional sectors will dominate the projected construction growth. Construction labor shortages and rising materials costs continue to be headwinds to future growth. However, rebuilding after the record-breaking losses from natural disasters last year, the recently enacted tax reform bill, and the prospects of an infrastructure package are expected to provide opportunities for even more robust levels of activity within the industry. AIA’s Architecture Billings Index (ABI) and other major leading indicators for the industry also point to an upturn in construction activity over the coming year.
Economy able to support further growth in construction
Even eight and a half years into this current national economic cycle, the US economy remains on solid footings. Given the strong levels of business investment, economic growth is estimated to have been 2.2 to 2.3 percent range last year, easily topping the 1.5 percent growth from 2016. Over two million new payroll positions on net were added to the economy last year, the seventh straight year that payroll growth exceeded that level. The national unemployment rate ended the year at 4.1 percent, its lowest level since 2000. And while low interest rates have helped to fuel this growth, rising stock prices have ensured that public companies have had access to capital to expand their operations. The Dow Jones industrial average increased almost 25 percent during the year.
However, in the face of a supportive economy, construction spending on nonresidential buildings disappointed last year. Overall spending on these facilities grew by only about 2.5 percent, with spending on manufacturing facilities seeing a steep double-digit decline. The only sector achieving healthy growth was retail and other commercial facilities, an odd result given the numerous reports of failing shopping centers due to strong growth in e-commerce sales. However, much of the spending reported in the retail and other commercial facilities category was for distribution facilities and related logistic operations to support a more efficient e-commerce system.
Still, the slowdown in spending last year was sharper than expected. Annual 2015 increases were almost 16 percent across the entire nonresidential building category, with the office and lodging categories realizing strong gains, and the institutional categories posting increases of almost 8 percent overall. Growth in activity eased in 2016, with overall spending on nonresidential buildings increasing by only 6 percent even though the office and lodging categories posted gains of nearly 25 percent. Spending on institutional facilities was disappointing, with increases totaling less than 2 percent in this category.
Signs of an impending upturn
The relatively steep slowdown in the growth in construction spending in recent years might suggest that this year might result in a decline in overall spending. However, quite the contrary, the AIA Consensus Construction Forecast panel is projecting a modest pick-up in the growth rate, and another solid performance in 2019. There appear to be several factors behind this optimism:
- Rebuilding and repairs from natural disasters: The National Oceanographic and Atmospheric Administration recently reported its 2017 estimate of losses from major natural disasters like hurricanes, wildfires, and flooding. At $306 billion, it easily shattered the previous record of $215 billion (adjusted for inflation) set in 2005 from the impacts of Katrina, Rita, Wilma, and Dennis. While the totality of these loss figures won’t be directly translated into rebuilding and repair activity, they will produce significant opportunities for the construction sector. Existing research suggests that the duration of rebuilding activity after natural disasters is significant, with the peak in spending generally occurring two to three years after the event.
- Tax reform implications for construction: The recently enacted tax reform package dramatically reduced the nominal tax rates for businesses, and some of these savings will likely be reinvested back into the businesses. With capital expenditures able to be expensed rather than depreciated under the tax act, businesses have even more incentive to invest in their businesses. The impact of tax reform on business profitability will vary by industry, with more capital intensive industries (e.g. utilities, real estate, and transportation) and those with higher effective tax rates (e.g. agriculture, financial services) potentially benefiting the most. In contrast, the single-family housing market recovery is likely to be slowed by the tax package. The lower limits for the deductibility of mortgage interest, as well as the cap set on state and local tax deductions (including property taxes) reduce the tax preferences for homeownership, and likely will moderate growth in house prices, particularly for upper-end homes in areas with high state and local tax rates.
- Possibility of an infrastructure package: A priority of the Trump administration has been an infrastructure investment program. There have been several versions floated, with the current iteration calling for a $200-billion federal investment over the coming decade leveraging and additional $800 billion in state, local, and private investment. The details of such a program, and the likelihood of its being implemented, should unfold over the coming weeks.
- Strong consumer and business confidence levels: Consumer sentiment—as measured by the University of Michigan consumer sentiment index—turned up in the latter part of 2017, with fourth-quarter figures at their highest levels in almost two decades. Likewise, business confidence levels in 2017, as measured by the Conference Board’s CEO business confidence survey, were at their highest point since before the last recession. These indicators suggest broad confidence in economic conditions across both households and businesses, and a willingness to spend and invest.
- Leading economic indicators for the construction sector: While there are several “special circumstances” that may provide growth opportunities for the construction sector this year, there are other more basic indicators that point to growth. AIA’s ABI has been signaling growth in design activity for most of the past year, which would point to a comparable upturn in construction activity throughout 2018. Even more significant, the AIA’s index for new design projects coming into architecture firms saw an even sharper upturn than the overall ABI in 2017, demonstrating a growing pipeline for design activity. Additionally, both Dodge Data and Analytics and ConstructConnect reported strong gains in nonresidential building starts in 2017, demonstrating considerable building activity currently underway.
Growth on the horizon
After a somewhat disappointing performance last year, 2018 and 2019 are projected to see healthy levels of growth in nonresidential building spending. Even this late in the construction cycle, that AIA Consensus Construction Forecast panel sees opportunities for future expansion. This year, the strongest growth is expected to come from the commercial sectors, with spending on office, retail and other commercial, and lodging facilities all expected to see gains in excess of 4 percent. By 2019, the major commercial sectors will likely see slower growth, while industrial, healthcare, and education facilities are projected to see spending gains of 4 percent or more.
The extent to which the major institutional construction categories can continue to generate healthy growth will largely determine the eventual duration of this construction cycle. Having reached levels comparable to prior construction cycles, commercial construction activity is unlikely to grow faster than our overall economy in coming years. The institutional categories largely have not reached the level of previous cycles, and therefore favorable business conditions could generate above-trend growth for the next few years for these building types.
Kermit Baker, Hon. AIA, is AIA’s Chief Economist and part of the AIA Economics and Market Research Group, which provides AIA members with insights and analysis of the economic factors that shape the business of architecture.