Slowing Down

Mounting headwinds threaten to undermine construction growth

Lead economists in the construction industry project continued modest growth in 2019, but caution that rising interest rates among other factors will threaten overall growth in the long term. “Despite month-to-month fluctuations, the outlook remains positive for modest to moderate increases in most [construction] spending categories at least through the first part of 2019. However, damaging trade policies, labor shortages and rising interest rates pose growing challenges to contractors and their clients,” says Ken Simonson, chief economist for Associated General Contractors of America.

Dodge forecasts single-family home starts sliding 3 percent.

Total U.S. construction starts are projected to reach $808 billion, essentially even with the $807 billion estimated for 2018, according to the 2019 Dodge Construction Outlook. By major sector in dollar terms, residential building will be down 2 percent, nonresidential building will match its 2018 amount, and non-building construction will increase 3 percent.

“Over the past three years, the expansion for the U.S. construction industry has shown deceleration in its rate of growth, a pattern that typically takes place as an expansion matures,” Dodge Data & Analytics Chief Economist Robert Murray told attendees of the 80th annual Outlook Executive Conference in National Harbor, Md. “After advancing 11 percent to 14 percent each year from 2012 through 2015, total construction starts climbed 7 percent in both 2016 and 2017, and a 3 percent increase is estimated for 2018.

“There are mounting headwinds affecting construction, namely rising interest rates and higher material costs, but for now these have been balanced by the stronger growth for the U.S. economy, some easing of bank lending standards, still healthy market fundamentals for commercial real estate, and greater state financing for school construction and enhanced federal funding for public works.”

“An important question going into 2019 is whether deceleration is followed by a period of high level stability or a period of decline,” Murray observed. “For 2019, it’s expected that growth for the U.S. economy won’t be quite as strong as what’s taking place in 2018, as the benefits of tax cuts begin to wane. Short term interest rates will rise, as the Federal Reserve continues to move monetary policy towards a more neutral stance. Long-term interest rates will also rise, reflecting higher inflationary expectations by the financial markets. At the same time, any erosion in market fundamentals for commercial real estate will stay modest. In addition, the greater funding from state and local bond measures passed in recent years will still be present, and it’s likely that federal spending for construction programs will increase once all the federal appropriations bills for fiscal 2019 are finalized. In this environment, it’s forecast that growth for construction starts will decelerate further, but not yet make the transition to the point where the overall volume of activity declines.”

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2019 vacancy rates are expected to rise as the economy slows, slightly dampening construction for offices and warehouses.

Among key segments measured in year-over-year terms, the 2019 Dodge Construction Outlook predicts construction starts for single-family housing to be 815,000, down 3 percent; multifamily housing, 465,000, down 8 percent; and, commercial building, down 3 percent. On a positive note, institutional building, manufacturing plant construction and public works construction will see positive gains of 3 percent, 2 percent and 4 percent, respectively.

The slight decline in homebuyer demand, notes the Dodge forecast, is the result of higher mortgage rates, diminished affordability, and reduced tax advantages for home ownership from tax reform. In fact, sales of newly built, single-family homes fell to a seasonally adjusted annual rate of 544,000 units in October—the lowest sales pace since December 2016—according to newly released data by the U.S. Department of Housing and Urban Development and the U.S. Census Bureau.

“This decrease in single-family starts isn’t a surprise given the drop in our builder confidence index,” says National Association of Home Builders Chairman Randy Noel, a custom home builder from LaPlace, La. “Builders are showing caution as mounting housing affordability concerns are forcing some consumers to delay making a home purchase.”

“Single-family starts were strong at the beginning of the year, but weakened this summer and have remained soft,” adds NAHB Chief Economist Robert Dietz. “Despite this softness, 2018 construction volume is set to be the best since the downturn. A growing economy and positive demographic tailwinds are supporting housing demand as interest rates rise. However, policymakers should take note of the November decline in builder confidence as a sign that housing affordability conditions will weigh on the housing market going forward.”

Limited Cement Gains

Corresponding to the deceleration in construction starts, the Portland Cement Association Market Intelligence Group cement consumption forecast paints a limited growth pattern from 2017 levels, with this year trending a 2.9 percent gain, followed by 2.6 percent and 1.6 percent bumps in 2019-2020.

“We are expecting relatively modest but sustained interest rate increases after 10 years of low and stable rates,” says PCA Senior Vice President and Chief Economist Ed Sullivan. “The Federal Reserve’s actions will gradually slow the construction sector’s growth due to higher mortgage rates for residential buildings and higher borrowing costs for nonresidential buildings. While the tax cuts passed at the end of 2017 have helped to boost the overall economy, rising debt will frame the discussion of future federal public infrastructure spending.”

PCA’s overall projection for the U.S. economy suggests considerable strength that will take time to unravel. The seeds of a gradual softening will surface from rising interest rates; emergence of state-level fiscal difficulties at a time of relative prosperity; and, aging of the recovery. PCA forecasts the GDP growth rate to be 3.1 percent this year, 2.7 percent in 2019, and 2.2 percent in 2020. The unemployment rate now below 4 percent is expected to trend down—intensifying labor shortages and leading to stronger wage gains.

“America’s economy is unquestionably strong and resilient,” Sullivan affirms. “The real GDP growth is healthy, wage growth is up, and both the unemployment rate and consumer household debt are at near record lows. While interest rates are rising, they have not reached a threshold that would cause a significant adjustment to the positive overall growth projections.”

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The omnibus federal appropriations bill passed in March provided greater funding for transportation projects that will carry into 2019.

Against this year’s volume, Dodge Construction Outlook predicts 2019 multifamily housing activity will slide 6 percent in dollars and 8 percent in units.
2018 Reflection

Thanks to the strong economy, producers saw modest growth this year despite severe weather impacting key markets in the third quarter, and hope to continue that momentum in 2019. Martin Marietta Materials Inc. reported record results for the third quarter ended September 30, with total revenues of just over $1.2 billion versus just under $1.1 billion for the prior-year period.

“Our record third-quarter results demonstrate Martin Marietta’s strong execution as we capitalized on the improving strength of the current construction cycle while successfully managing through near-term challenges,” says Ward Nye, chairman, president and CEO of Martin Marietta. “In September, extraordinary weather challenges, including record Texas rainfall and devastation from Hurricane Florence, mostly in the Carolinas, adversely impacted our third quarter. As a result, Texas, our largest state by revenues, and North Carolina, our third-largest state by revenues and leading state by unit profitability, were disproportionately negatively affected during the industry’s busiest and most profitable period.”

“Despite these short-term disruptions, we remain on track to once again deliver record revenues and EBITDA for the full year, and we are well-positioned to continue our growth trajectory in 2019,” Nye affirms. “We believe the ongoing construction cycle will continue to promote sustainable and steady growth for the foreseeable future, fueled by strong underlying demand and the long-awaited arrival of increased public-sector activity.”

U.S. Concrete, Inc. also reported record results for the third quarter, including a consolidated revenue increase of 14 percent to $404.3 million. “While the September 2018 weather presented a major obstacle for the quarter, we continue to be excited about the opportunities available to us for growth and margin expansion,” says William J. Sandbrook, chairman, president and chief executive officer of U.S. Concrete. “We are well-positioned to benefit from our increased vertical integration and aggregates exposure and the steady multi-year cyclical recovery that we believe has substantial remaining runway in our vibrant markets.”

Vulcan Materials Co. Chairman and CEO Tom Hill states, “Our execution in the third quarter overcame weather challenges in key markets and delivered strong incremental earnings. We are focused on finishing 2018 strong and carrying that momentum forward.”

“Looking ahead to 2019, our business is positioned for continued shipment growth, compounding pricing improvements, and further gains in unit profitability in 2019,” Hill says. “Vulcan-served markets are benefitting disproportionally from both growing public construction demand and continued growth in private demand, led by residential demand growth in our markets. We expect our aggregates shipment and price momentum to continue in 2019 leading to mid-single-digit growth in both.”


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