EMMALEE_SCHAUMBURG
Vineyard Church, Kansas City, Mo., image by Emmalee Schaumburg
In a Jan. 16, 2019, report the Washington, D.C.-based American Institute of Architects (AIA) shared the report that follows, by Kermit Baker, Hon. AIA.
Growth should continue through 2020, but a number of emerging red flags suggest a cautious outlook.
Spending on nonresidential buildings nationally is projected to grow by 4.4 percent this year, paced by healthy gains in the industrial and institutional building sectors. For 2020, growth is projected to slow to 2.4 percent, with essentially no increase in spending on commercial facilities but gains in the 3 percent range in the industrial and institutional categories. Still, there is growing concern inside and outside of the industry that a broader economic downturn may be materializing over the next 12 to 24 months.
Continued healthy gains in construction activity in the near-term is the projection of the AIA Consensus Construction Forecast Panel, composed of leading national construction forecasting firms. As a group, they see the 2018 growth rate remaining essentially unchanged for this year. However, the composition will change significantly. Last year, spending on commercial facilities increased around 7 percent while advancing by about half that rate for institutional buildings and declining for the industrial sector. This year, gains in each of the major building sectors are expected to be in the 3 percent to 5 percent range.
These projections are consistent with business conditions at US architecture firms as measured by AIA’s Architecture Billings Index (ABI). The average ABI score for 2018 was essentially unchanged from 2017. Since the ABI has been shown to lead construction spending by an average of 9-12 months, this would suggest that the growth in spending on nonresidential buildings in 2019 should be close to the growth rate of 2018. Additionally, new design contracts coming into architecture firms grew at a healthy pace in 2018, underscoring the robust level of backlogs currently enjoyed by most firms.
Overall economy performing well
While nervousness persists, the economy has been performing very well recently. Growth in GDP is estimated to be close to 3 percent for this past year. The jobs market continues to be very healthy. Over 2.6 million net new payroll jobs were added in 2018, far exceeding the less than 2.2 million added in 2017. As a result, the national unemployment rate was below 4 percent for most of the year. Consumer sentiment levels remained strong, with 2018 recording their highest readings in almost two decades. The nation’s factories also were humming, with industrial output achieving its strongest growth in almost a decade.
However, there are several signals that are pointing to an emerging slowdown in the broader economy, and therefore in the construction sector. These include declines in leading economic indicators, weakness in some key sectors of the economy, and softness in the markets of our major trading partners. These signals may be temporary responses to negative short-term conditions, but historically they have preceded a more widespread downturn.
Declines in leading economic indicators: Financial measures such as stock prices, interest rates, and corporate profits—which are often are more forward-looking—frequently turn down before actual economic activity softens. Stock prices have been exceedingly volatile for several months, somewhat obscuring the downward trend of about 15 percent in the fourth quarter of 2018.
Long-term interest rates have been easing somewhat recently, while short-term rates have been rising as a result of actions by the Federal Reserve Board. This has caused a flattening in the yield curve, where returns from long-term rates move closer to those of short-term rates. If the yield curve were to invert—meaning that long-term yields moved below short-term yields—that would be an historically strong indication of an impending recession.
Weakness in some key sectors of the economy: Despite overall economic strength, there are signs that cracks are emerging in some of the leading sectors of the economy. Of particular vulnerability are major consumer purchases like homes and cars, as well as major business investments in plant and equipment.
After dropping sharply during the Great Recession, housing starts have seen a very disappointing recovery. It appears that housing starts have peaked for this cycle, having declined steadily from their first-quarter 2018 levels. Auto sales fall in the same category of major consumer purchases that often are financed; likewise, this sector has seen softness recently, having declined in 2017 and remained at this same lower level last year.
Business investments often reflect what corporate leaders feel is the growth potential for their companies. Investment nationally in new plants and equipment saw healthy growth in 2017 and through the first half of 2018, but slowed significantly beginning in the third quarter of last year. Given the recent trends in business confidence scores, investment is unlikely to accelerate anytime soon. Business confidence fell sharply through 2018, with the fourth quarter showing the lowest levels in six years.
International slowdown: Given the reliance of the US economy on worldwide trade, our future growth is increasingly dependent on economic conditions across the globe. The economies of many of our trading partners have not been performing as well as our own, which suggests that our export volumes will be declining in the future.
Recent forecasts from the International Monetary Fund suggest that world economic growth will be slowing in the coming years. The slowdown is expected to be the greatest in advanced economies, such as those in the eurozone as well as the UK, Japan, and Canada. Additionally, some emerging economies—most notably China—are expected to see slower growth moving forward. The recently enacted—as well as threatened—tariffs that may expand into trade wars have discouraged global investment while simultaneously slowing exports, particularly to China due in large part to the retaliatory tariffs that China has placed on key US products.
Commercial construction soft; institutional activity firming
For the first time in many years, growth in institutional construction activity is projected to exceed its commercial counterparts. The major commercial sectors are feeling the headwinds of a softening economy, while demographic forces are still propelling the key institutional sectors.
Retail activity continues to suffer from the growth on online shopping. While only about 10 percent of total sales, e-commerce has been growing at about three times the rate of traditional brick-and-mortar sales. The slowdown in housing hasn’t helped, as new residential development often spurs new retail construction activity. Instead, larger shares of investment in these facilities is going to the renovation of existing buildings. The panel is projecting less than 2 percent growth in retail construction spending this year, and essentially flat levels next year.
Office construction looks to be the strongest commercial sector, with 5 percent growth projected for this year and 1 percent in 2020. This sector has benefited from strong job growth, and the apparent bottoming out of the years-long decline in office space per employee. Much of the increase has come from the booming technology sector, so the outlook is dependent on continued growth in this industry sector.
Education facilities are the largest nonresidential building sector, accounting for over 20 percent of overall spending. While demographic trends are generally favorable to the education construction outlook, fiscal developments are the real growth engine. Rising house values have finally given local governments a boost in property tax revenue to undertake new projects and renovate older buildings. The rising stock market in recent years had built up endowments for private schools and colleges to expand their facilities. The consensus is for 5.5 percent growth in the education sector this year, and an additional 4 percent in 2020.
Healthcare building spending is benefiting from extremely favorable underlying demographics, but growth has been tempered by uncertain implementation and modifications to the federal Affordable Care Act. The outlook looks a bit brighter now, and the panel is calling for 4 percent growth this year, and an additional 3.6 percent next.
The nonresidential building construction outlook can best be described as benefiting from solid current conditions but tempered by growing uncertainty over how broader economic trends will play out. The fact that architecture firms had a strong 2018 bodes well for healthy growth continuing in construction activity through this year. However, AIA recently surveyed architecture firms about their expectations for revenue growth in 2019, which are more tempered. While 2018 gains averaged over 7 percent, their expectations are for less than 3 percent growth in 2019.
Kermit Baker, Hon. AIA, is AIA’s Chief Economist and part of the AIA Economics and Market Research Group, which provides AIA members with insights and analysis of the economic factors that shape the business of architecture. Learn more at www.aia.org.
