Non-residential construction spending has dropped 6 percent since the beginning of 2016. This reduction was offset by a nearly equal increase in infrastructure spending and steady residential construction. Increases in construction prices for 2016 are now trending towards 6 percent annually, depending on location, while job growth saw a slight up-tick with an average of 192,000 jobs added per month in the third quarter of 2016 versus the 171,000 jobs per month averaged in the first half of the year. Energy and commodity prices have seen a slight rebound but remain well below previous levels due to the sustained strength of U.S. dollar.
Some signs of labor shortage in local markets are driving construction prices above the projected construction cost trendline. Market activity and cost escalation continue to vary by region and project type.
Construction Costs
Construction costs have trended toward a 3.1 percent annually compounded escalation rate for the past 30 years. But, six consecutive years of above-average growth have now pushed the construction cost trendline from 3.1 percent to 3.3 percent.
The end of quantitative easing by the Federal Reserve has created a plateau in financial asset prices. According to Vermeulens, the committee expects economic conditions to evolve in a way that will warrant only gradual increases in the federal funds rate. This means the near- to mid-term federal funds rate is likely to remain below levels expected to prevail in the long run. Continued low interest rates are good for stability in the rate-sensitive construction sector.
Construction Volumes
Construction dollar volume is the number one factor for construction costs, because bids increase as contractor opportunities and project backlogs grow. In 2011, Vermeulens saw an average selling price increase of 3 percent. This was followed by a 6 percent increase in 2012, 8 percent in 2013, 6 percent in 2014, and 8 percent in 2015. Annual price increases for 2016 are now trending towards 6 percent nationally.
Construction dollar volume remained flat in the third quarter of the year, and remains at annual rates last seen in late 2015.
Non-residential construction spending has experienced a 6 percent decline since the beginning of 2016. Continued weakness in non-residential construction spending may reduce cost escalation in this sector. Infrastructure spending has offset the non-residential decline to hold the total essentially even.
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. For the first time since the summer of 2012, the ABI posted consecutive months of decline nationally—dropping to 48.4, down from 49.7 the previous month. The new projects inquiry index was 59.4, down from a score of 61.8 the previous month.
Soft billings were led by weak performance in the Northeast, which dropped to 44.0. The South posted the highest score at 53.4—down from 55.5 at the end of the second quarter, while firms in the West came up slightly to 49.5 and firms in the Midwest slid to a score of 50.1.
Growth at architecture firms specializing in commercial and industrial (50.4) projects was essentially flat, while institutional (49.0), multi-family residential (48.8), and mixed practice (49.8) firms all softened.
Labor Market
Job growth in the third quarter of 2016 increased to 192,000 jobs per month—up from an average of 171,000 per month in the first two quarters. Total job growth in the U.S. economy has progressed at a healthy rate for the past year, averaging approximately 200,000 jobs per month. Total job growth in Q3 was on par with this rate, coming in at approximately 192,000 new jobs per month.
The construction industry added 34,000 jobs nationwide in the third quarter. Wage increases in the sector are expected to continue drawing employment from new entrants and other sectors.
Sustained construction activity has increased industry employment by 1.2 million workers since 2011. Simultaneously, the construction unemployment rate has trended downward and is stabilizing near benchmark levels established in the mid-2000s. Unemployment rates between 4 and 6 percent will likely cause an increase in labor costs similar to the increases experienced between 2004 and 2007.
Labor Capacity Utilization
Labor capacity utilization is calculated by comparing the ratio of current construction employment to peak employment, and allowing for a sustainable rate of growth. A utilization rate of greater than 85 percent (yellow) puts upward pressure on construction labor costs. While regional imbalances in capacity utilization are starting to level out, inflation in local urban markets will be driven by supply and demand in each location.
Construction Labor Growth Rate is calculated by comparing the current 12-month average for construction employment relative to the previous 12-month average. Currently, all top 20 U.S. cities (by GDP) are at or above average construction labor growth.
Forecast
The New York Stock Exchange (blue line) is a strong parallel indicator of construction prices, as improving equity markets provide capital and investment spending for construction. The stock market continues to trade in a range consistent with the previous three years. And the Federal Reserve will continue to support strong employment growth with low interest rates over the medium term.
Capital construction prices in 2016 are now trending at an annual rate of 4 percent to 9 percent—depending on region—with an average of 6 percent nationally. Current construction prices are firm and stabilizing above the long-term trend line, and construction employment is at capacity. This means that construction costs will continue to remain above the Construction Cost trendline for the medium term.
By Johnathon Allen
This report is based on the Vermeulens Q3 Market Outlook report.
