Mid-Year Forecast: Where Does the Construction Economy Go from Here?

Bryan Furnace (00:00):

Today we're back at you with another economic update. As many of you guys, especially in the residential side may have noticed, things are starting to taper down and we're not quite seeing the big boom that we were. And I don't know about you guys, but I would like an economist's opinion on what's going on and what to expect over these next six to eight months. So without further ado, we're going to talk to our... Well kind of resident economist now, Ken Simonson.

Ken Simonson (00:35):

Well, the whole economy is in a state of flux at the moment. There are still signs that things are slowing down, but economists and investment analysts who had been predicting recession sometime soon for over a year, they haven't seen it. I won't say they're disappointed, but anyway, those forecasts are kind of going away or being pushed further out. It's sort of like the prediction of a thunderstorm that doesn't materialize. There's still clouds out there, but at the moment, no rain is falling for most of the economy. Certainly in terms of construction, we are seeing scattered showers. Certainly home building on the single family side went into a deep dive for over a year. But interestingly, that seems like it's drying up in the positive sense that we may have hit bottom. And the home builders say that they're more optimistic, they're taking out more permits, starting more single family homes. On the multifamily side, it's the opposite. There's a record number or a 50-year high in the number of housing units being constructed at the moment, but starts and permits are way down by almost 50% compared to that.

Bryan Furnace (01:43):

Interesting.

Ken Simonson (01:44):

And I think that reflects the fact that interest costs keep going up. Financing is getting more difficult as banks are tightening their lending standards. Some construction costs are still rising, but rents have topped out in many markets. In fact seem to have dropped off a little bit because so much supply is coming into the market. So I do think that we're going to see a reversal in single family versus multifamily and the multifamily will drop off. On the non-residential side, again, there are mixed stories. The office market looks bad and looks like it's only going to get worse. Yet within that as defined by the Census Bureau is data centers. That's really a totally different kind of product. Unfortunately, we don't get separate data on it. So when you look at the overall office spending numbers, construction spending numbers from census, it sounds like things are good, but I think it's only because the data center market is extremely strong.

(02:42):

There may still be some remodeling going on within office buildings, but by and large new office starts your way down. And I think there's worry about other income producing properties also like warehouse. Yes, you have some markets, some market segments like cold storage seem to be doing very well. But overall, we see a pullback by retailers not wanting to hold as much inventory. And I think the warehouse market, which has been very strong, is going to drop off.

(03:11):

Offsetting those declines, though you have just incredible growth in manufacturing plants. For over a year now we've seen these enormous fabs for semiconductor wafers going up outside of Phoenix and Austin, more recently, Columbus, Ohio. But there are many other kinds of manufacturing that are also going strong. For instance, auto, electric vehicle and battery plants. And then more companies are deciding that they need to shorten their supply chains, and so they're building or adding the manufacturing capacity in the US.

(03:44):

Finally, we have the public markets, and I know there's been an expectation for over a year and a half that we'd see huge amounts of money being awarded and turned into contracts for highways, for transit, for broadband communication, and then also from the so-called Inflation Reduction Act, huge tax credits to support power projects for renewable energy. All of that though has been held back by a lack of clarity on regulations, whether it's for what components have to be US made, what sort of apprenticeship programs have to be in place, or what kinds of projects qualify for tax credits. So I think we will still see a boom in power and in infrastructure projects, but it hasn't really hit yet.

Bryan Furnace (04:31):

It is interesting to hear kind of the official side of the story because just on this side, the anecdotal side, it very much feels like residential has really started to slow, but it seems like all of the heavy civil stuff is still booming pretty strong, and that kind of mirrors exactly what you're saying here that that's indeed happening. So do you have any prospects for the next six months? What can we expect coming down the pipeline for us?

Ken Simonson (06:14):

Well, I'm keeping my fingers crossed that we will see more of this federal money turning into actual contracts. You're right that the heavy civil side has done well, not just because of manufacturing, but state and local governments came through the pandemic period in much better fiscal shape than in previous recessions or slowdowns. That was because of these trillions of dollars of federal aid that went to individuals, to businesses and directly to state and local governments. So the money that went to individuals and businesses helped keep them afloat, hired, earning paychecks, paying taxes, and those things helped the state and local revenue side and then the direct federal aid help them keep up spending. So some of that has shown up in state and local spending on highways and water and sewer and school projects.

(07:05):

But I think that's likely to taper off, that federal money has mostly been used up or at least committed, but the money under the Infrastructure Investment in Jobs Act from November of 2021, the Inflation Reduction Act and the CHIPS and Science Act, a lot of that is yet to come. So that's why I'm hopeful that we'll start seeing that turn into actual projects in the next few months. Meanwhile, I think there's still good growth ahead for manufacturing plants and seems to be unlimited demand for data centers that every few months there's some new reason to think that we're going to use the internet more. And the latest of course, is this ChatGPT or other forms of so-called generative AI adds still more demand to sending electrons through these data centers.

Bryan Furnace (07:55):

Sure. So my final question for you is next year's going to be an election year and when do we need to start thinking about how the politics might play into the economy? And do you have any thoughts on what direction that might go? I know that's a lot of speculative stuff, but just kind of any initial thoughts for us?

Ken Simonson (08:15):

Well, it does seem like every year is an election year or preparing for the election year in Washington. And as we saw with the debt ceiling showdown, things do get resolved, at least either resolved or pushed back in terms of having to deal with the doomsday scenario usually at the last minute. And I think that's going to continue to be the story. That particular issue looks as if it's been postponed to 2025, but there's still a lot of other spending bills that have to get through Congress. So I think anybody who depends on federally funded projects such as Corps of Engineers or general services administration projects, they need to keep an eye on what goes on Capitol Hill and with the White House. But more broadly, there are all these regulations that are still pending in terms of defining what kinds of materials qualify for the Build America, Buy America Act, or alternatively, how do you get a waiver if you can't find a product that's made in America that you have to have.

(09:23):

And then there are also questions about what sorts of alternative energy projects qualify for tax credits. The IRS has no experience writing rules for tax credits for these things, and yet they're not going to go ahead unless investors know that they will qualify. So I think these are not so much congressional decisions right now, but there will be things that are going to come up over the course of the election. And then finally we have the question of what's happening to prices and the costs of materials. Fortunately, that story has gotten a lot better for the most part, the supply chain has generally improved, but there are still worries about transformers and electrical switch gear, certain other materials. Right now it seems like concrete is available, but last fall it was in short supply or the cement was in almost every state, and that could pop up again.

Bryan Furnace (10:19):

What was the cause? I know locally we had a lot of kind of speculation on, oh, it was because of this, oh, it was because of this. What was kind of the overall root cause of the concrete shortage last fall?

Ken Simonson (10:29):

I think like many things, it has its origins going back a long ways. Nobody wants a cement plant near them. Investment is very expensive. And now with tighter CO2 emissions rules, this is a big contributor to carbon and I think it becomes even dicier whether to invest in a cement plant. At the same time, our demand for concrete products, particularly ready-mix, but also concrete pipe and pre-stressed and pre-cast concrete that keeps growing as we build ever bigger manufacturing plants and some infrastructure a lot more likely to come. So I do think this is going to be a problem that will crop up, at least in some regions. Anytime you have a cement plant that goes down for maintenance or unexpected repair needs that can really stress the system in the region, there just aren't a lot of duplicate sources in many parts of the country.

Bryan Furnace (11:28):

It is always fascinating to learn just the small things that can make such a big impact in industries like that. And then another thing that kind of occurred to me is how in the blue collar world, we have our heads down just thinking about the blue collar world, and yet the white collar industry is directly impacting the demand that we see. And in particular, when you talk about office space, the big debate right now is should we go back to working in the office or continue to work from home? And on the blue collar side with our heads down, we don't really realize that's directly impacting the amount of demand for new office space or office space being renovated. And so that's having an immediate impact on some of the contractors that really specialize in that industry.

Ken Simonson (12:09):

Oh, absolutely. And if I had to pick a category of construction projects that I think is going to remain weak for several years, office would be at the top of that list.

Bryan Furnace (12:21):

Agreed, agreed. Well, Ken, thank you so much for all the wisdom as always. We appreciate it.