Guessing games

Features - Construction Industry Update

Mixed economic signals for the construction industry make the year ahead difficult to predict.

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March 8, 2016

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Has construction gone into neutral while waiting for a green light, or is the industry about to reverse direction? That question has gained urgency as the broader economy experiences increasing turmoil while doubts spread regarding the sustainability of recent construction growth.

Construction spending figures from the U.S. Census Bureau illustrate the ambiguous evidence. For 2015 in its entirety, value put in place—spending on projects that already were under way or that broke ground during the year—topped 2014 totals by a healthy 10.5 percent. The upturn was well-distributed among major segments, with private residential spending up 12.6 percent, private nonresidential spending up 12 percent and public construction up 5.6 percent.

However, recent numbers are much less impressive. Private nonresidential spending has fluctuated in a narrow range since May 2015; the December 2015 total was the lowest since April 2015 at a seasonally adjusted annual rate. (Seasonal adjustment is a statistical technique for removing the influence of recurring patterns, such as holiday- or weather-related variations. Annual rate means the monthly total has been multiplied by 12 to allow easy comparison to full-year totals.) Similarly, the December 2015 total for public construction was virtually the same as in May 2015 and was nearly 3 percent below the peak reached in August 2015. Private multifamily construction shrank 8 percent from its all-time high in September 2015 to December 2015. Only new single-family construction has expanded consistently, rising for the ninth consecutive month in December 2015.

DIM MANUFACTURING OUTLOOK

The most notable downturn occurred in manufacturing construction. Spending skyrocketed 44 percent for 2015 as a whole. But after setting records in each of the first five months of the year, spending plunged 13 percent from May to December. The growth was propelled by huge petrochemical and fertilizer projects, natural gas liquefaction and export facilities and assembly and parts plants for cars, trucks, aircraft and other transportation equipment. Many of those projects will continue to be built in 2016, but no new plant have been announced in the last several months.

Meanwhile, many categories of manufacturers are struggling with weak foreign demand or stronger import competition as the dollar appreciates against trading partners’ currencies.

Additionally, domestic demand for oilfield, mining, agricultural and other equipment has shriveled, further dimming the outlook for manufacturing construction.

Warehouse construction is another niche with doubtful prospects. Spending on “general commercial” warehouses, as distinguished from self-storage units, more than doubled from December 2012 to December 2014 but has been nearly flat since then. It appears the massive building program undertaken by Amazon and other Internet retailers largely has been completed, with fewer new warehouses being built in the near future. (One exception may be in Colorado, where marijuana growers reportedly have snapped up all available space.)

SILVER LINING

The retail sector continues to struggle. In January 2016, Wal-Mart announced it would close 154 U.S. stores; Macy’s and several other chains also shut stores or closed completely. Nevertheless, the sector offers some opportunities for demolition and recycling as new tenants take over—and remodel—space abandoned by earlier occupants. More so than in the past, retailers—notably grocery stores—are locating on the first or second floor of multistory apartment, office and hotel buildings rather than in standalone structures.

One of the fastest-growing categories for the past several years was lodging. Hotel and motel construction increased 31 percent in 2015. But this segment also flattened out in second half of the year. Reportedly large numbers of projects and rooms still are expected to break ground or to be renovated in the next 12 months. But the key metric for many hotel investors, called revenue per available room, or RevPAR, recently has turned negative compared with a year ago after steady 5 percent to 10 percent annual growth. That change suggests that many markets may have reached saturation.

On a more positive note, private office construction climbed 26 percent in 2015 to the highest level since 2008. Numerous skyscrapers and corporate office complexes are underway or soon will break ground in a number of locations, including Seattle, San Francisco, Silicon Valley, Los Angeles, suburban Dallas, New York and Boston.

Many companies are replacing or adapting older buildings in city centers, generating considerable demand for demolition and recycling. Suburban office parks, formerly the heart of new office construction, are generally languishing with high vacancy rates, but some of these are being repurposed to add hotels, shopping and entertaining and sometimes housing.

POSITIVE DIRECTION

Private hospital construction turned positive in 2015 after years of decline. Hospitals now face competition from independent urgent care centers, outpatient surgical facilities and primary care clinics in retail locations. Uncertainty over the implications of the Affordable Care Act for hospital use and reimbursement rates also might have held down construction spending.

Compared with a few years ago, hospitals admit fewer patients overnight and discharge them earlier to their own homes or to separate rehabilitation facilities. Thus, new hospitals likely will have fewer patient recovery rooms and more space devoted to treatment and diagnostic facilities.

The outlook appears at least moderately favorable for the three categories that account for nearly two-thirds of public construction: highway and street, educational and other transportation (transit, airports, ports and passenger rail facilities). Highways, transit and Amtrak received a boost in December 2015 when President Obama signed the first long-term (five-year) federal-aid funding bill in more than a decade.

The retail sector offers some opportunities for demolition and recycling as new tenants take over—and remodel—space abandoned by earlier occupants.

The legislation provides much-needed continuity for the programs and modestly increases federal money for all three types of transportation construction. Also, in the past few years, more than a dozen states have passed fuel-tax increases or other measures to fund highway construction.

Several major airports are undergoing modernization and expansion, among them Dallas-Fort Worth, Los Angeles, Salt Lake City and Tampa, Florida, with plans for projects at O’Hare International Airport and LaGuardia Airport. All of these will entail demolition recycling. However, ongoing congressional refusal to raise or replace the gas tax as the mainstay of federal funding means increases in highway and transit dollars likely are to be small at best.

A MIXED BAG

Both public and private spending on higher-education construction reached record levels in 2015, aided more by capital campaigns than by any restoration of public funding. But college enrollment has been falling for three years in a row as the pool of high school graduates shrinks and an improved job market leads high school seniors and older workers to seek employment instead of more schooling. Some colleges are closing their doors or curbing investment in facilities as a consequence.

Enrollment also has been slipping or has remained level in prekindergarten through high school in many parts of the country as the birth rate and immigration have declined. Furthermore, more children are enrolling in urban traditional and charter public schools that may have spare capacity or may be in converted buildings. These locations generate more demand for renovation and temporary construction than the past model of “more children equal more housing in new suburbs equal new schools.”

The most promising sector for construction in 2016 appears to be residential. Multifamily construction (almost entirely rental units, with few condos or coops outside of Florida and New York) has increased at double-digit year-over-year rates since September 2011, though growth decelerated in 2015. Rental growth and occupancy rates still seem to be holding up enough to spur more construction in 2016.

Single-family homebuilding and new and existing home sales have been trending upward. Existing-home sales and new multi- and single-family construction generate demand for residential remodeling and additions.

Putting all the pieces back together, it is likely that 2016 will be another positive year for all three construction segments. Residential construction spending should record spending growth of 8 percent to 10 percent. Private nonresidential spending will do nearly as well overall, with strength in office, electric power, pipeline and hospital construction offsetting weakness in manufacturing, retail, warehouse and lodging segments. Public construction will grow moderately. These numbers augur well for new construction and for demolition recycling. However, if U.S. economic growth stalls, all categories of construction may cool rapidly as well.

Ken Simonson is chief economist, Associated General Contractors of America (AGCA), Arlington, Virginia.