Decreases in energy and commodity prices have driven growth and pricing increases in the non-residential construction market and other sectors of the economy. Year-over-year non-residential construction growth is currently at 25 percent. Combined with a total volume growth of 17 percent in 2014, the sector is approaching a 52 percent rebound in spending from its most recent bottom. Price increases for 2015 are trending toward 8 percent, depending on location.
While commodity prices have decreased, the construction sector is nearing full employment, which is expected to drive significant wage increases.
Construction Costs
Year-over-year CPI inflation is now trending below the Federal Reserve’s long-term targets following the recent decline in energy prices. Construction costs have trended toward a 3.1 percent annually compounded escalation rate for the past 29 years.
According to Blair Tennant, a project manager and cost engineer for Vermeulens, the rate of construction cost escalation is related to the federal goal of achieving an annual inflation rate of 2 to 3 percent, and the monetary policies used to achieve this. With the removal of quantitative easing by the Federal Reserve, the economy has reached a self-sustaining phase of expansion.
Regional labor shortages will push construction prices above the construction cost trend line in local markets. While inflation is expected to remain near its current low level for the short term, the Federal Reserve expects it to rise gradually toward 2 percent over the medium term, as labor markets improve and recent cost reductions in energy and import prices disappear.
Construction Volumes
Construction dollar volume is the number one factor for construction costs, because bids increase as contractor opportunities and project backlogs grow.
Non-residential construction spending has rebounded nearly 52 percent from its bottom, while residential dollar volume has recovered and is currently 66 percent higher than its bottom in July 2011. Existing home inventories have climbed to 5.2 months as eased credit conditions, low vacancy rates, and income growth are expected to increase household formation.
AIA Billings
The Architectural Billings Index (ABI) is a key indicator of expected construction volumes nine to 12 months in advance. A score greater than 50 indicates growth.
The August ABI score of 49.1 dropped from a mark of 54.7 in July. The softening was led by weak commercial and residential billings in the Northeast (46.8). The Midwest (56.1) and South (53.8) continued to have the strongest performance, while the West (50.2) maintained a steady pace. Institutional billings are the strongest sector (53.7), followed by mixed practice (52.8), commercial/industrial (49.7) and multi-family residential (49.5).
Labor Market
The construction unemployment rate is returning to the long-term average with seasonal fluctuations between 5 and 12 percent, but 2015 has seen a significant slowdown in construction job growth. This is expected to result in wage and productivity increases, as construction dollar volume continues to expand.
Total job growth in the U.S. economy continues to growth at a healthy rate, averaging roughly 229,000 per month for the last year.
Job growth can continue at 250,000 jobs per month for three years before reaching the upper end of the target range. At 350,000 jobs per month, the upper range will be met in two years.
Labor capacity utilization is calculated by comparing the ratio of current construction employment to peak construction employment, and allowing for a sustainable rate of growth. A utilization rate of greater than 85 percent (yellow) will begin to put upward pressure on construction labor costs.
Regional imbalances in capacity utilization are leveling off. Currently, 50 percent of states have warmed to either a yellow or orange Labor Utilization Rate, as have 60 percent of the top 20 U.S. cities (by GDP).
Forecast
Regionally, inflation is expected to increase at greater rates in urban centers like Denver, where labor utilization now represents 105 percent of the state’s available construction labor force, which has the result of also pushing Wyoming construction costs up.
Due to strong growth in 2013 and 2014, construction prices moved above the long-term trend line, repeating long-term cyclical patterns. Nationally, construction prices are firm and expected to increase past the trend line for the near- to mid-term, as construction volume increases, and labor capacity narrows.
By Johnathon Allen
This report is based on the Vermeulens Q3 2015 Market Outlook report.
