The economy started out the first quarter of 2016 in good shape, as energy and commodity prices stabilized at reduced levels. This led to more construction activity nationwide, with average prices coming in at an annual escalation rate of around 6 percent, depending on location. Construction job growth and dollar volume both continued upward trends as non-residential construction spending rebounded 48 percent from its most recent bottom in 2011. On balance, current indicators support stable construction growth over the short-term.
Construction costs have trended toward a 3.1 percent annually compounded escalation rate for the past 30 years. Year-over-year CPI inflation is now trending below the Federal Reserve’s long-term targets, due to the extended decline in energy prices.
According to 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 entered a self-sustaining phase of expansion.
Robust job gains and other indicators point to a strengthening labor market. And, while inflation ticked up slightly in recent months, it continues to run below the 2 percent long-term goal, due to declines in energy prices and non-energy imports.
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 rebounded 48 percent from its bottom, while residential dollar volume has recovered and is currently 95 percent higher than its bottom in July 2011.
Through the first quarter of this year, construction spending increased 11 percent compared to the same quarter a year ago. Existing home inventories have continued a decline and are now at 4.7 months as eased credit conditions, low vacancy rates, stable long-term employment, and income growth combine to increase household formation.
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 average ABI score in the first quarter of 2016 was 50.6, as architecture firms across the country reported modest overall growth in billings despite a somewhat volatile three months. Residential firms continued to report the highest activity (53.7), with commercial/industrial design firms also experiencing steady growth (52.0); while institutional firms are in a small decline (49.0).
Continued growth in construction activity has increased construction employment by 1.2 million workers since 2011. The construction unemployment rate is returning to its long-term average, with seasonal fluctuations between 5 and 12 percent. The slowdown in 2015 construction job growth is expected to drive wage and productivity increases, as construction dollar volumes continue to expand.
Total job growth in the US economy continues at a healthy rate, averaging around 246,000 jobs per-month for the last year. Job growth can continue at 250,000 jobs per month for 27 months before reaching the upper end of the target range. The economy must produce at least 100,000 jobs per-month to remain neutral.
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.
Regional imbalances in capacity utilization leveled off in the first quarter of 2016. Currently, 47 percent of states are categorized as having either a yellow or orange Labor Utilization Rate, as have 60 percent of the top 20 U.S. Cities (by GDP).
Markets continue to show signs of strength, with capital construction prices in 2016 trending to an annual rate of 4 percent to 9 percent, depending on location, with an average 6 percent. The New York Stock Exchange has continued performing at levels consistent with a plateau in financial market prices.
Construction prices are now firm and increasing above the long-term trend line. Nationally, construction prices are expected to escalate above the trend line in 2016, as construction volume increases, and labor capacity narrows.
By Johnathon Allen
This report is based on the Vermeulens Q1 2016 Market Outlook report.