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Construction Industry Overview

What’s ahead for Construction in 2020?

This Year’s 2% Growth Will Feel Better Than Last Year’s 2%

After slowing from nearly 3% growth in 2018, real GDP looks to have risen just slightly more than 2% this past year. Most of the moderation has come from capital spending, with reduced oil and gas exploration accounting for a large proportion of the slowing in nonresidential construction outlays and the lingering uncertainty about tariffs stifling outlays on capital equipment. With Phase 1 of a trade deal with China signed as well as a revamped NAFTA (which is now the USMCA), we expect the fog of uncertainty surrounding international trade to gradually lift over the course of 2020. Global growth looks set to accelerate this year, although the coronavirus and Boeing’s production cuts of 737 MAX assemblies will likely weigh heavily on first quarter growth.

While 2020 is likely to get off to a slow start, we expect momentum to gradually build over the course of the year. The Federal Reserve cut interest rates three times this past year by a total of 75 basis points. Long-term yields also declined, with the yield on the 10-year Treasury falling 77 basis points. Yields have fallen further at the start of 2020, mostly on fears that efforts to contain the coronavirus will lead to a sharp slowing in global economic growth. Even if yields rebound from current levels, as we expect them
to, the drop in rates that we saw last year will likely boost economic growth this spring and summer. Monetary policy works with a long and variable lag, with the bulk of the lift from a drop in interest rates boosting the economy somewhere between 12 and 18 months later.

Lower interest rates should provide construction a much needed boost. While parts of commercial construction have been strong for some time — primarily luxury/lifestyle apartments, warehouse and distribution space, hotels, and Central Business District (CBD) office space in a handful of rapidly growing cities — the overall volume of commercial construction has lagged considerably behind prior cycles. The weakness has mostly been in the suburbs — particularly retail space and office parks that tend to cluster around shopping malls and interstate highways. The past decade saw a move back toward the center cities, particularly by younger workers.

A Shift Back to the Suburbs

The urban migration fueled a building boom in mid-rise and high-rise luxury/lifestyle apartments and also drove redevelopment of neighborhoods that were closer to the key employment markets. Tear downs and rebuilds accounted for a substantial proportion of single-family construction during the past decade and that process required much less additional infrastructure investment. The renewed interest in downtown areas also sparked the redevelopment of former retail and industrial spaces into new office space. Both trends are expected to continue in the coming decade but we are also seeing momentum building for more greenfield development in the suburbs.

The shift back to the suburbs is likely to build over the course of the decade, as more and more millennials reach their forties and begin to focus on raising a family. The move back to the suburbs is not likely to mimic what was seen in the post-World War II era, however, which was driven by an affordability migration that followed the ever-expanding highway network further and further out into the suburbs and exurbs. We expect a larger proportion of millennials to remain closer to the center cities than prior generations did and look for the suburbs to increasingly urbanize, adding entertainment, healthcare, and other amenities found closer to downtown areas.

Suburban residential development is set for stronger growth. We see single-family homebuilding gradually gaining momentum over the course of the decade, as the preference for single-family living  reverts back to its long-term norm. Single-family housing starts totaled 888,200 units this past year and we expect starts to gradually rise to around 1.1 million units by the end of the decade. Multi-family starts are expected to remain near their recent pace, although we expect to see a shift toward more condominium development over the course of the decade. In addition, many of the luxury and lifestyle apartments were built with the idea that they might one day be converted to for-sale housing, which would fuel growth in renovations.

For the near-term, we are looking for homebuilding to be a key source of strength in 2020. Sales of new homes rose 10.3% this past year and likely would have risen even more if not for the lack of supply in rapidly growing markets in the South and West. The strength in sales has bolstered builder confidence and we are seeing increased residential development in rapidly growing areas in the South and West. The South has accounted for close to 56% of singlefamily starts, with the bulk of the activity occurring in Texas and Florida.

Demand for homes in the South continues to be driven by population and employment growth, as well as the region’s greater affordability. Eight of the nation’s 10 fastest growing major metropolitan areas from 2010 to 2018 were in the South. The median price of a new home is about 10% less in the South than it is nationwide, more than 28% less than it is in the West and whopping 39% less than the Northeast. We look for single-family housing starts to rise 7% in 2020 and 2.1% in 2021. Multi-family starts will likely remain near recent levels, although a late-year surge in starts in 2019 may set the stage for a slightly smaller number of starts this year.

The revival in suburban residential development should provide some relief to retail development, with most of the growth in neighborhood centers and a handful of regional shopping centers. On an overall basis, however, the U.S. is still considerably overstored and we expect retail construction to decline 3.5% in 2020, following a larger 6.4% drop in 2019. We have a small 1.3% rise projected for 2021. Retailers continue to struggle with competition from online sales, which are capturing close to half the growth in retail sales each year. While overall retail development will remain soft, redevelopment activity remains a growth area, with former retail space being repurposed into mixeduse projects, healthcare facilities, fulfillment centers, and educational facilities.

The flip side of the weakness in retail development has been persistent strong growth in industrial development. Growth is being fueled by three overriding trends: The growing need for fulfillment centers that provide the last mile of e-commerce, the development of larger regional distribution centers, and growing volumes of international trade. The latter influence is being felt at all of the nation’s major ports but is most apparent in rapidly growing ports in the Southeast, which have seen a growing share of container traffic shift from the West Coast following the widening of the Panama Canal. Southern ports have also added key infrastructure to move containers rapidly onto trucks and, increasingly, trains which link the ports to key inland areas. The Southeast has also seen considerable foreign direct investment in manufacturing facilities, many of which serve as key export platforms.

Office development rose solidly this past year, with office construction outlays rising 7.9% following an 8.4% gain the prior year. Much of the growth has been in markets where the tech sector is growing rapidly, such as San Francisco, Seattle, Los Angeles, Dallas-Fort Worth, Austin, and Denver. Growth has also picked up along the East Coast, particularly in rapidly growing areas such as Atlanta, Nashville, Charlotte, Raleigh, and Northern Virginia. Most new office projects continue to be in the CBD or near-in urban submarkets. Returns on suburban office space have generally lagged, which has opened up fairly sizable gap in rental rates between downtown areas and the suburbs. We look for demand to revive in the suburbs over the course of the decade and look for office development to gradually increase as more suburban areas seek ways to urbanize and capture some of the energy prevalent in many
downtown areas.

Hotel development is one of the great mysteries of this past decade. New hotel construction has soared past expectations, as demand has proven strong. Hotel operators are struggling with slow revenue per available room (RevPAR) growth, which is expected to eventually slow construction. We do not think the slowdown will be this year, however, and look for hotel construction to rise 4.5%, following an 8.2% rise the prior year.

Growth in institutional projects is expected to remain strong, reflecting stronger state and local government revenue growth and the demands of an aging population. Spending for healthcare, education, and public safety will account for the bulk of the 4.2% rise in outlays we are expecting in 2020. Amusement and recreation is another growth area, although construction is expected to slow from the double-digit gains seen this past decade. While the category is relatively small, it benefits from the rising
number of Baby Boomers retiring each year, as well as the strong preference of Millennials to live near key entertainment hubs.

Overall, we look for nonresidential construction spending to rise 2.8% in 2020, which would be a slight improvement over the 2.3% gain posted this past year. With more greenfield development, we should see more spending on road work and water and sewer projects as well. The bulk of new construction will continue to be in the Sun Belt. We are seeing a shift away from some of the larger markets on the West Coast toward midsized and smaller markets in the West, as well as an out-migration to Texas and the Southeast. The Northeast is also seeing an accelerated migration, fueled by Baby Boomers and prime working-age individuals seeking lower taxes and more affordable housing.

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