AIA: Steady Construction Growth in the Forecast

Click for a graphical overview of the Consensus Construction Forecast

Last year finished stronger than expected for the nonresidential building construction market. While severe weather conditions in many part of the country got construction activity off to a slow start, a strong finish pushed spending on buildings up an estimated 6 percent in 2014. Commercial construction spending increased by nearly 15 percent, and growth in industrial construction increased by almost as much. However, the institutional sector continued to disappoint, as spending declined again for the year, although it appeared to be nearing a bottom.

For the coming year, prospects look to continue to improve, with overall growth projected to increase almost 8 percent. Commercial and industrial activity will again pace the upturn, with both sectors projected to grow at a double-digit pace. However, institutional activity is expected to return to the positive column, with spending gains of 5 percent. Next year is projected to be almost a carbon copy of 2015, with overall spending gains around 8 percent, commercial/industrial growth again in double digits, and institutional activity improving by another 5 percent.

           

These are some of the key findings from the American Institute of Architect Consensus Construction Forecast conducted in December 2014. Based on projections from some of the country’s leading nonresidential construction forecasters, the consensus is that this will be the year that the construction recovery finally reaches all of the major building sectors.

Uncertainty Clouds the Economic Outlook

The economy is strong enough at present to support additional construction activity, and lenders seem less hesitant to provide capital to the nonresidential construction sector than they did a few years ago. Gross domestic product, the broadest measure of our economy, has been growing at around the 4 percent rate for the past three quarters. This level of growth encouraged companies to hire, as there was a net increase of almost three million payroll positions in 2014, the largest yearly increase since before the dot.com recession last decade. This growth has pulled the national unemployment rate down to 5.6 percent, its lowest level since before this past recession, while pushing up consumer sentiment scores. Rising corporate profits have lifted stock prices to near record levels, which in turn have lifted business confidence scores. And, finally, rising home values had helped boost local property taxes for many local governments, making them more willing to undertake expansion programs for schools and other municipal facilities.

In spite of this impressive list of recent positive developments that should enhance the construction outlook, there is a comparable list of emerging concerns—issues that are still unfolding and that in all likelihood will influence the construction outlook over the next few years:

    • Uncertainties in international economies;

    • Potential labor shortages;

    • Lower energy costs;

    • Rising interest rates;

    • Outlook for the residential sector; and

    • Rising construction costs—materials and construction labor.

Uncertainties in international economies. While the U.S. economy has outperformed expectations in recent quarters, economies in much of the rest of the world have not. One reason for this is falling oil prices, which are ultimately very helpful for oil-importing countries but in the short run are detrimental to exporters. Additionally, weak international growth has helped push up the dollar relative to other currencies, which makes U.S. products more expensive abroad, thereby reducing U.S. exports.

The International Monetary Fund recently released its World Economic Outlook update, which lowered projected international growth by 0.3 percentage points both this year and next from its outlook of just three months ago. Still, international economic growth is forecast at 3.5 percent this year and 3.7 percent next year, up from an estimated 3.3 percent in 2014. However, the U.S. is in the unusual position of having one of the brightest economic outlooks, while recent growth centers like Russia (projected GDP of -3.0 percent this year) and Brazil (a measly 0.3 percent growth projected for this year) are underperforming. The entire Euro Area is expected to see another disappointing year of 1.2 percent growth, after a gain of just 0.8 percent last year and a 0.5 percent decline in 2013.

Potential labor shortages. The pool of construction workers declined substantially during the downturn, as construction workers moved to other industries or simply dropped out of the labor force. As the construction industry has recovered, it has had difficulty attracting younger, more highly educated workers as well as immigrants, who traditionally account for a large share of construction workers.

Recent surveys by both the National Association of Home Builders and the Associated General Contractors of America point to an emerging serious labor problem. The NAHB 2014 survey found that almost half of builders nationally reported a shortage in labor availability, matching the share of builders reporting problems in 2004 and 2005 at the peak of the last cycle’s home building boom. The 2014 AGC survey found that 83 percent of construction firms were having difficulty filling on-site craft worker positions, such as carpenters, equipment operators, and laborers, while 61 percent were having difficulty filling professional positions, such as project supervisors, estimators, and engineers.

Lower energy costs. The recent sharp drop in oil prices will help some economies and some industries, while hurting others. Large oil exporters such as Russia and Saudi Arabia will see significant declines in revenue, while major importers such as China and the U.S. will see a boost through lower energy costs. Within the U.S. economy, industries and local economies dependent on oil production will suffer, while energy-intensive manufacturers and virtually all consumers will benefit from lower energy costs.

Within the construction sector, building materials with a large energy component (e.g., concrete) will benefit from lower costs—as will products and materials that are transported long distances—due to lower transportation costs. Construction projects related to oil extraction, one of the fastest-growing nonresidential construction categories in recent years, will slow as lower energy costs limit the economic viability of many projects.

Rising interest rates. With the Federal Reserve having ceased its purchases of long-term bonds and securities for this cycle, and sending signals that it will begin raising short-term rates later this year, higher interest rates in the near future are almost a certainty. Higher interest rates mean higher borrowing costs, which would—absent stronger growth in the economy—no doubt slow the construction recovery.

However, interest rate increases look to be moderate in the near term. Long-term rates have headed back down recently in spite of the Fed’s actions, as nervous investors look to less risky alternatives to the volatile stock market. Lower energy costs will continue to moderate inflation throughout our economy, giving the Fed more discretion in dealing with the timing of raising short-term rates.

Outlook for the residential sector. In addition to being an important construction sector, the residential market generally provides important insights as to the future path of nonresidential building activity. Home building, fortunately, is in the midst of a healthy recovery. Housing starts nationally exceeded a million units in 2014, the first time they have been at this level since 2007.

In spite of the progress to date, the housing market does point to some shortcomings in the construction sector. Over the past several decades, the U.S. has averaged between 1.6 million and 1.7 million housing starts a year—we have a long way to go to get back to anything approaching these levels. Secondly, the recovery to date has been heavily concentrated on the multifamily side. Multifamily starts have more than tripled from their 2009 low, while single-family starts are up less than 50 percent. To achieve a full recovery requires more growth on the single-family side of the market, and rising house prices, tight credit, high debt levels, low income growth, and general nervousness about owning a home have held back this side of the market.

Rising construction costs: materials and construction labor. With a recovering construction market comes the risk of volatility in construction material prices. Recently, the Bureau of Labor Statistics has reported jumps in prices for aluminum (up 11 percent over the past year), cement (6 percent), and gypsum products (5 percent). A national construction cost index developed by Rider Levett Bucknall reports that construction costs increased 5.2 percent for the year ending October 2014, up from 3.6 percent for the year ending in October 2013 and 1.7 percent for the year ending in October 2012.

Construction material costs, with the possible exception of petroleum-based products, are likely to continue to be volatile but generally drift upward in the coming quarters. However, inflation in construction labor costs is a greater concern because it is more difficult to reverse once it gains momentum. So far, there is little evidence of rising labor costs in the construction industry, but it is still early in the nonresidential recovery cycle. Generally, the path to labor cost inflation is an increase in hours worked for payroll workers (which have been creeping up for construction workers over the past few years), followed by increases in payrolls (which also have been growing since the end of 2011), and then, finally, an increase in salaries. Average hourly earnings in the construction industry increased an estimated 3.1 percent in 2014 after a 2.8 percent increase in 2013, according to Department of Labor data, so labor costs have been largely contained to date. However, given the concern over future labor shortages, labor costs could easily begin to accelerate.

Optimism Prevails for the Construction Outlook

On balance, the construction outlook is buffeting between positive industry fundamentals like a healthy economy, strong job growth, and healthy levels of consumer and business confidence, and the cautionary conditions discussed above. However, with relatively strong year-end results in 2014, the AIA Consensus Forecast Panel seems to be leaning toward optimism.

The recent Architecture Billings Index scores would support this optimism. Since May of last year, ABI scores have been very positive, so the growth in design activity in 2014 can be expected to produce strong growth in construction activity this year. The recent upturn in the institutional ABI reading also suggests that the construction market should be more balanced this year, with all of the major sectors participating in the recovery.

Additionally, design activity at architecture firms should continue to remain strong in the coming quarters. The AIA has been collecting information on new design projects coming into architecture firms, and most months in 2014 saw healthy growth. This is also reflected in the growing backlogs at architecture firms—the length of time for which current project activity would keep the staff at a firm fully employed—which averaged 5.3 months on average in 2014, up from 4.9 months in 2013 and 4.5 months in 2012.

So, after a strong finish to 2014 in terms of construction spending, the momentum should continue through this year and next. The almost 8 percent projected growth this year, and the slightly above 8 percent growth projected for next year, come from the same sources. The commercial market is projected to increase almost 12 percent this year, with double-digit growth anticipated in the office, retail, and hotel sectors. In 2015, growth is projected to continue at almost the same pace, with another year of strong gains in all the major commercial sectors.

Additionally, though, this year is expected to be the beginning of a recovery in the institutional sector. Overall gains are expected to average around 5 percent both this year and next, with all the major institutional sectors participating. The largest component, education facilities, should see around 5 percent growth this year and next, after recording a modest 1 percent estimated gain last year. The expectations are similar for the other major institutional sector, healthcare, which saw a high-single-digit decline in spending in 2014. Spending for religious and public safety facilities should see more modest gains this year and next, while the amusement and recreation sector is expected to see some of the strongest growth within the institutional category.

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. Learn more at aia.org/econ.

Source: AIA