When will the music stop for building construction?

As reported in Issue: FCW Global August 2016, Posted Date: 8/12/2016; Author: economist Kermit Baker:

Last year, spending on nonresidential building in the U.S. increased by more than 13 percent. That was on top of an almost 9 percent increase in 2014. Some building categories have seen truly spectacular growth over this period: lodging facilities — up 54 percent in 2014-2015; manufacturing — up 49 percent; office buildings — up 41 percent. Such strong construction numbers might generate concern that we are overbuilding our commercial sector; that we may be seeing a bubble forming, if not nationally, then at least in many of the hotter metro areas across the country. In fact, in this artificially low interest rate environment, over-investing in things like buildings and homes is a concern. For skittish foreign investors in particular, parking money in U.S. real estate is an attractive option, which can lead to building activity that make short-term investment sense, but is not supported by market fundamentals.

However, we’re not there yet in the building sector; the music should continue playing for at least another two to three years. First, the recovery party began late for the construction sector. While our overall economy started its recovery midyear 2009, the building recovery didn’t begin until 2012. And even then, the recovery in this sector was surprisingly weak, with growth of building construction spending averaging only 3.5 percent per year for the first two years. Second, and related to the first, our building levels remain well below what our economy can support. Over the past 35 years, the construction industry has averaged 1.3 billion square feet of building activity annually, according to Dodge Data & Analytics. This year we’re expected to add less than 1 billion square feet, which will be the eighth straight year that construction levels have been below 1 billion square feet.

Not only has the supply of new building been in a historical slump, but we’re generating a lot of demand for additional space. Our economy created almost 2.8 million net new payroll jobs last year, and we’re on a pace to create another 2.2 million this year. This will create a lot of demand for office space, retail facilities, and new hotels and restaurants. And these facilities are already performing quite well. Commercial property values are currently 10 percent above their high point prior to the downturn (before adjusting for inflation) according to Moody’s estimates. Office rents, retail rents, and hotel revenue are all projected to continue to increase through at least 2018, and office and retail vacancy rates are projected to continue to slowly decline over the same period.

The American Institute of Architects recently released its Consensus Construction Forecast for nonresidential activity, which compiles results from the leading national construction forecasters to create a consensus outlook for the remainder of 2016 and 2017. This panel of experts projects nonresidential construction spending to grow by almost 6 percent this year, and essentially maintain this pace of growth through 2017. Strong performers are expected to be hotel construction (more than a 25 percent increase for this two year period), office construction (22 percent), and even some growth from institutional categories like education (a 13 percent gain) and amusement and recreation (16 percent).

It would seem that an advantage of coming late to the economic recovery party is that you can stay longer and continue to celebrate after the others have left. And unless there is a major international meltdown, the music of this current economic expansion will not be stopping anytime soon. For the floor covering industry, this forecast points to several more years of healthy business conditions.

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