REACHING A PEAK?

Investment in some sectors of construction, such as manufacturing, have greatly increased but the cost of borrowing remains an issue, reports Scott Hazelton

US real Gross Domestic Product (GDP) advanced at a 1.6% annual rate in the first quarter, according to the ‘advance’ estimate issued at the end of April. This is down sharply from quarterly growth averaging 4.1% over the final two quarters of 2023. While the deceleration overstates the weakening of the economy, we expect GDP growth to average 1.8% per quarter for all of 2024.

The narrative behind this slowing is familiar: past monetary tightening continues to weigh on business fixed investment, tightening bank lending standards and a flat profile for equity values weigh on consumer spending, a strong dollar weighs on net exports, and past tailwinds diminish.

The most important development for our construction outlook is a reassessment of Federal Reserve interest-rate policy. At the beginning of April, futures markets were pricing in better-than-even odds of at least one rate cut by the June meeting of the Federal Open Market Committee. As of early May, market expectations for the first rate cut shifted to September.

This led to sharp increases in both term Treasury and private yields. Moreover, we think the Fed will not begin cutting rates until December and will ease only gradually over the first half of 2025. These developments led us to raise our projection of private borrowing costs for several quarters, implying more drag on business fixed investment than in prior forecasts.

While the residential housing market is tight, construction will be impeded by poor affordability. The homeowner vacancy rate, the proportion of the homeowner inventory that is vacant for sale, remains at a record low of 0.8%.

Tight inventories may explain why home prices have suddenly reaccelerated. The Federal Housing Finance Agency (FHFA) House Price Index popped up 1.2% in February, the most substantial gain in 22 months. Record home prices and over 7% mortgage rates are pricing a growing segment of US households out of owning a home.

It also took longer than ever to build a home last year. The time from authorisation to start for a single-family home increased from 1.1 months to a record 1.5 months in 2023 – in 2013, it took 0.7 months. Once started, a single-family home took a record 8.6 months to complete, up from 7.0 months in 2019 and 6.0 months in 2013. Housing starts fell 4.7% to a 1.415 million rate in the first quarter. In the forecast, housing starts rise to 1.43 million this year, 1.38 million in 2025, and 1.39 million in 2026.

Computer, electronic and electrical

We expect nonresidential structures construction to decelerate this year and contract in 2025. We are beginning to see this in the monthly data, especially in the manufacturing sector.

Most of the recent strength is in a category of manufacturing structures called computer, electronic, and electrical structures. This sector was boosted by generous incentives in the Inflation Reduction and CHIPS and Science Acts but is now approaching a peak. When deflated with an appropriate price index, construction spending in this sector has slowed sharply over the last couple of months. Bank lending standards have tightened over the last year, potentially reducing the flow of credit to businesses that cannot raise capital by issuing debt. In the coming years, real borrowing costs back off from a current peak but only partially reverse the recent increase, remaining above pre-pandemic levels for many years. We expect this to suspend the prior trend of rising capital intensity, slowing the rate of growth of investment relative to output.

Construction of office space may offer growth in 2024, but this will come from the booming data centre market which is recorded in the office segment. Construction of actual office space will remain in decline into 2025 as real estate markets continue to rationalise post-Covid. Lodging construction offered double digit growth in 2023, but 2024 will see growth at reduced levels.

Retail may eke out growth, but this will be largely renovation spend as existing stores are re-purposed. After three strong years over 2020-22, warehouse construction growth moderated last year, and is set to decline in 2024 and 2025 as most shippers have completed their footprint expansions. Indeed, we are even seeing some warehouse projects being canceled as consumer spending cools.

The best opportunities for nonresidential structures growth will come from the institutional segment with health care, education and government office structures all offering double digit growth.

However, much of this is state and local government spending of Investment in Infrastructure and Jobs (IIJA) funds, which have an expiry date. As we look to 2025 and beyond, growth slows sharply into the low single digits.

There is a bit more optimism for infrastructure, although even here, the peak is approaching.

The IIJA provided impetus across the infrastructure spectrum, including highways and streets, water/sewer and communications. IIJA spending ramped up in 2023 and is expected to peak in 2025, although the tenyear plan implies that even when growth plateaus, spending will remain significant. Looking at spending by segment, most highway and street funding has been allocated, and that may peak in 2024. However, funding for water and public transit projects has taken longer to roll out and they will peak later. Water treatment is an area to watch. The Environmental Protection Agency (EPA) is rolling out new regulations that significantly reduce synthetic chemical levels in the public water supply. Current plant filtration cannot meet these standards, so regions of the US with high exposure may see an even longer run of water treatment plant construction growth.