Healthy advances forecast for nonresidential building market through 2017

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Mid-year update projects somewhat slower gains in construction activity for both this year and next

The national economy seems to be on a slower growth path so far in 2016, in part due to the growing list of national and international vulnerabilities that continue to appear. This slower growth in the broader economy is beginning to put downward pressure on the construction industry. After a solid performance last year, where most commercial and industrial construction sectors grew by 20 percent or more, 2016 was viewed as a year where activity was expected to moderate.

The year has gotten off to a solid start, but the American Institute of Architects’ Consensus Construction Forecast Panel expects growth to begin to moderate as the year progresses. Overall building construction spending is expected to grow around 6 percent this year, and stay in that range for 2017. Commercial construction sectors are projected to be the strongest performers this year, with the institutional categories moving back a bit from their pace of last year. Next year, the commercial sectors are expected to see slower yet still healthy levels of growth, while most institutional sectors will see a somewhat accelerated pace of activity.

US economic progress facing roadblocks

There are many positive signs in the economy at present. Job growth continues to be healthy, the national unemployment rate is below 5 percent, consumer confidence levels are strong, the rate of inflation is extremely low, energy costs remain well below their average of the past several decades, interest rates are near record-low levels, stock prices remain high in spite of unusual volatility, and the single-family housing market is poised for very strong growth.

Still, there is a growing list of issues that threaten to unhinge this economic expansion, both national and international:

• Our manufacturing sector remains weak. The output of our nation’s factories has declined in 13 of the past 17 months, dating back to the beginning of 2015. As a result, business investment has dropped sharply since the third quarter of last year. Business confidence levels are suffering, with the Conference Board’s CEO Business Confidence Index in negative territory since the middle of last year.
• International economies are a drag on the US This sense of gloom in our manufacturing sector is reinforced by several emerging international economic trends that are likely to diminish US exports. Key international economies—including China, Brazil, and Russia—continue to face difficulties. The recent decision by the UK to exit the European Union won’t directly have much effect on our exports, but it may set off a new round of restrictive trade policies. Regardless, the strong dollar, which has gotten stronger as international economies have faltered, provides incentives for increasing imports, which further undermines our manufacturing sector.
• The upcoming presidential election is increasing uncertainty. Presidential elections tend to depress economic growth in the six months leading up to an election, because many investors are reluctant to move ahead with projects given that policies may change. This time, the level of uncertainty regarding post-election policies is unusually high, which likely will depress investment even more.

This rising unrest can already be seen in Federal Reserve actions, which has postponed short-term interest rate hikes so far in 2016. While low interest rates have many positive benefits, they underscore the weak demand that we are seeing throughout our economy. They also have inflated the value of real assets like stocks and real estate, which leaves our economy more vulnerable to a downturn should a negative event materialize.

Construction outlook remains generally positive

In spite of a growing list of threats to the US economy, and therefore the construction sector, the outlook remains reasonably favorable overall. For example, the AIA’s Architecture Billings Index (ABI)—an accurate indicator of construction activity that leads spending in the nonresidential sector by nine to 12 months—continues to send off positive signals. It has remained in the growth range since mid-2012, and in spite of recent volatility, the ABI still documents increases in design activity at US architecture firms. There are signs that progress in design activity may be slowing: the average ABI score of 51.8 for the first half of 2015 dipped to 51.3 for the second half of last year, and continued to ease to closer to 51 for the first half of this year. Still, the new design contracts index introduced by the American Institute of Architects, which measures new project activity coming into architecture firms, remains above the billings index. This suggests that architecture firms are increasing their backlog of project activity.

There is evidence that gains in construction activity will continue to slow in the coming quarters. A consensus forecast of real estate trends conducted by the Urban Land Institute suggests that we are in the latter stages of this current real estate cycle. Their forecast panelists see vacancy rates increasing and rent increases slowing for the multifamily housing and hotel market through 2017 and 2018. The office and retail sectors are projected to see more stable vacancies with slower rent gains, so they too seem to be in the latter stages of this current cycle.

Commercial property values are a vulnerability to future growth in this sector. Commercial property values nationally are currently about 10 percent above their prerecession high, according to data from CoreLogic. International economic concerns—particularly with emerging weakness in Europe following the UK vote—may drive more capital to U.S. real estate markets, coaxing prices even higher in the coming months.

The AIA Consensus Construction Forecast Panel sees healthy but slower growth in the nonresidential building sector. After an estimated 17 percent growth in 2015, the consensus for this panel of experts is for 5.8 percent growth in overall building construction activity this year, declining very modestly to 5.6 percent in 2017. The commercial sectors are expected to be the strongest performers, with an 11.7 percent gain this year and 6.5 percent next, paced by continued strong performance in the office and retail sectors. Industrial construction, which saw growth last year in excess of 40 percent, is projected to see essentially flat levels of construction this year and next.

Healthy single-digit growth is expected from the institutional sector in 2016 and 2017. An optimistic outlook remains for education facilities, with gains in excess of 6 percent projected for both this year and next. The outlook for the health care sector has dimmed a bit, with forecast growth falling to just over 2 percent this year before ramping up to 5 percent in 2017.

Kermit Baker, Hon. AIA, is the 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.

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