Lower gross domestic product and a shaky global economy have not yet put a damper on employment. February’s job growth was 242,000, stronger than January and slightly better than expected. Within the Bureau of Labor Statistics’ March 4 report were several bits of encouraging data for the economic outlook. Unemployment held steady at 4.9 percent, an indication that more job seekers were entering the market. Along those same lines, the workforce participation rate climbed to 62.9 percent and the broadest measure of unemployment – the U6 rate – fell to 9.7%. Private payrolls swelled by 245,000 jobs and private payroll wages grew more than 2.5 percent year-over-year. Within the employment sectors, construction employment grew at the highest rate, more than doubling the rate of total non-farm job growth.
Construction data and sentiment appear to be moving in diverging directions after the first two months of 2016. Government data released on March 1 estimated that total construction spending in January 2016 was $1,140.8 billion, and increase of 1.5 percent compared to the upwardly revised $1,123.5 billion total in December. January’s volume was ten percent higher than the previous January. The report, which also showed permits for construction trending higher than starts, supports the forecast from most construction economists of growth between five and ten percent for the full year. Public construction spending grew 4.5 percent over December, a continuation of a much stronger upward trend, while private investment was up modestly. The data portrays a market that may reflect the sentiment of mid-2015, however, as corporate profits, business investment forecasts and other economic metrics are less robust than construction.
The government’s report on the housing market two weeks earlier showed continued strength, with construction of multi-family remaining in an upward trend. But, in the context of data on new and existing home sales and builders’ sentiment, it’s also clear that the uncertainty about the economy is sapping momentum.
On February 17, the Census Bureau reported that total housing starts rose 1.8 percent from January 2015 to January 2016 despite a 3.8 percent decline from December to January and a 2.8 percent drop the month before. Single-family starts increased 3.5 percent but multi-family starts fell 3.8 percent. Building permits, however, rose 14 percent year-over-year, with single-family permits up 9.6 percent and multi-family permits increasing by18 percent. There were permits for more than 90,000 more multifamily units in January than starts, suggesting more projects may begin soon.
Also on February 17, the American Institute of Architects reported that the January Architectural Billings Index (ABI) slipped to 49.6, down from 51.3 in December. While barely negative – a reading below 50 merely indicates that more architects reported a decline in billings than an increase – the January decline is the third dip below 50 in the past six surveys. New project inquiries also fell significantly in January, although remaining positive at 50.3, a level that was ten points below the December reading.
To the extent that inquiries indicate the future billings, January’s survey raises concerns because the 12-month trend in inquiries has turned slightly downward. If the declining trend continues, it will lead to declining billings and eventually, declining construction activity. The modest downward dip in inquiries trending may also just reflect the growing slowdown in planning of multi-family and lodging development.
The hotel construction market continues to thrive but investor concern about overbuilding appears to be rising. According to data tracked by industry resource STR Inc., hotel occupancy rates hit an all-time high of 66 percent in 2015 and revenues and room rates climbed near record levels. Construction of hotels soared 31 percent in 2015 but slowed by 1.2 percent in the second half of the year. Hotel stocks, meanwhile, have been hit by investor selling. While strong performance is an incentive to develop more rooms, lenders are showing a diminished appetite for hotel deals, meaning developers proceeding with projects will see higher lending costs. STR nonetheless expects growth in room inventory in line with the industry’s 1.9 percent rate in both 2016 and 2017.
Concern about multi-family development is also rising, although several of the major financing conduits for apartment projects have added to their allocations for multi-family deals again in 2016. Analyses of the housing markets defy conventional or historical trends. For example, while the multi-family market has been seen as booming since the beginning of the recovery in 2010, the volume of actual starts only rose above the 50-year average of 359,000 units in 2015. Moreover, the peak of two earlier boom cycles – in 1985 and 1972 – reached 576,000 units and 902,000 units respectively. Construction of multi-family units appears to be peaking in early 2016 at somewhere above 425,000 units, but a slowdown below the average is more likely for the full year.
Even more inexplicable is the protracted sluggishness in the single-family market. Starts in this category of housing peaked in 1972, 1978 and again in 2005, when 2.068 million units were started. In the 48 years prior to 2005, the average number of single-family units started was above 1,546 units. Construction dropped off dramatically from 2006 to 2009, when only 554,000 single-family houses were started. The overextension of mortgages during the housing bubble created an excess inventory that had to be sold prior to the resurgence of new construction. By all measures that overhanging inventory has been absorbed for two years or more, yet new construction only recovered to the one million-unit level in 2014 and the average number of starts in the intervening eight years has been 809,400.
There have been a number of explanations for the housing market performance since the mortgage crisis: tight credit, enormous foreclosure inventory, low household formation, shifting housing preferences, changing social demands of the Millennial generation and the urbanization of the retiring Baby Boomers. All of these trends could have had minor and/or short-term impacts on housing activity, but the magnitude of the decline goes well beyond such influences. Even if any or all of these trends could have depressed demand for single-family homes, the reality is that a proportional boom in apartments has not occurred. New construction of single-family homes has slightly greater than half the 50-year average over the past eight years, but new construction of apartments remained below the 50-year average for seven of those eight years.
One possible explanation for the protracted decline in starts is that the overhang of excess and troubled inventory was much greater than estimated. Still, the number of units built from 2008-2015 was almost 5.9 million units than the average for half a century prior. The more likely explanation for the state of housing construction is that the severity of the Great Recession allowed for an extended deferral of household formation for an unusual number of Americans. That suggests pent-up demand that should drive another housing boom within a few years, regardless of the economic conditions.
Dodd Frank regulatory burdens have limited mortgage lending well past the time that lenders were anxious to renew higher volumes. Subdivision development also suffered from the effects of the recession and the heightened oversight that doing land acquisition and development loans would bring. There is no measure of the level to which these issues have suppressed construction but the data suggests that demand cannot be held back much longer.
Demand for commercial construction, on the other hand, has been less constrained by factors other than economic health. After suffering losses in value in excess of 50 percent following the financial crisis, commercial property values have recovered completely, reaching record levels per square foot in many markets and categories. As would be expected, commercial real estate saw steady gains in occupancy as employment gained strength. Stronger performance and property values allowed the large number of commercial loans written during the frothy days of 2005 to 2007 to refinance as they matured five and ten years after origination.
The closer correlation to the overall economy means that commercial development is getting long in the tooth as the economy is in 2016. In addition to the dynamics of the apartment and hospitality segments, growth in retail and industrial development is also slowing. The office market is seeing above-average levels of construction in the first quarter of 2016, with demand still outstripping supply in a number of U.S. cities – including Tampa, Raleigh, Atlanta, Miami, San Diego, Phoenix, Washington DC and Pittsburgh. Development in some of the hot spots in the U.S. – Houston, Dallas, San Francisco, Seattle and San Jose for example – remains very active, but evidence is growing that the party is winding down in those cities.
Integra Realty Resources (IRR) looked at the commercial real estate property types in its 2016 Viewpoint report. One of its evaluations looks at the major U.S. markets and judges where those cities are in the lifecycle of recession to recovery to expansion and oversupply. Its findings concluded:
- Nearly half the office markets are still in expansion mode, with 41 percent more than two years away from supply/demand balance.
- All multi-family markets except one (Jackson MI) were in expansion, with 83 percent of suburban and 70 percent of urban markets in balance.
- Retail markets were still in an expansion phase, with 63 percent of the cities recovering or expanding. The central and western regions of the country had more cities in recovery than other regions.
- Expansion was still underway in 46 of 61 industrial markets, with no markets in the oversupply phase.
Like multi-family, most hospitality markets were expanding, with 75 percent in that phase. IRR forecasts that hospitality will begin to decline in 2017.
The consensus forecast from these commercial real estate observers, along with the economists for Dodge Data & Analytics and Construction Market Data, is that commercial construction should see another five-to-seven percent more growth in 2016. Even if a softer economy dampens demand earlier than expected, investors will continue to push supply higher. Yield from other investment vehicles simply won’t offer sufficient risk-adjusted returns and pressure to place cash in real estate will encourage development, even if demand for the space isn’t as robust.
Public construction has begun to emerge from an extended funk. Spending on public construction rose again in 2015, following an uptick in 2014. Long-term demographic trends are still unsupportive of revenues, at least until the next generation makes its move into home ownership, but the improved economy and labor market have given a boost to sales and income taxes that support state and local construction. And at the federal level, the long-overdue highway bill – known as FAST Act – will provide a reliable funding stream for repairs to highways and bridges through 2020.
In addition to the surface transportation funding, federal construction spending will also be driven by the extended period of deferred spending on government facilities that followed the expiration of the American Recovery and Reinvestment Act of 2009. Spending by the General Services Administration has increased during the past two years and more projects are in the pipeline to address obsolescence and space needs at federal offices and courthouses.
Beyond 2016, forecasts of greater public construction are built upon the assumption of continued economic growth of more than two percent, an assumption that looks less certain than it did six months ago. Political ideology battles will likely have a bigger impact on public construction than economic expansion, however. The growth of government debt and pension obligations have choked out room for capital spending without increasing revenues, which is at the heart of most ideological debates between the two major parties. There is inevitability to the ravages of time on the built environment, so maintenance and repairs cannot be deferred indefinitely.
One glimmer of hope on the revenue piece of the equation is the public response to referendum. The sample size is very limited but voters in a number of states have approved borrowing or revenue increases to support needed construction. In California, where referendum is the rule for major public bond programs, voters have said yes to as many as 80 percent of the projects on the ballot in recent years. That suggests that while Americans may be split on the concept of higher taxes, fees or debt, they are generally agreeable to such measures in practice in their own backyards.