By KERMIT BAKER, PhD, Chief Economist, American Institute of Architects
As recently as the 2020 mid-year update of the AIA Consensus Construction Forecast, the panel members were calling for a high single-digit decline in construction spending on nonresidential building in 2020. However, the construction market held up surprisingly well in the second half of last year, and the 2020 figures will likely show only 2% to 3% fall once the final figures are reported.
Still, both design activity at architecture firms and contracts for new building construction projects were much weaker for the year, pointing to a more significant decline in spending this year. Nevertheless, a recovery is expected to be on the way, as virtually all major building sectors are projected to increase in 2022.
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These are some of the major takeaways from the nation’s leading construction forecasters who comprise the AIA Consensus Construction Forecast Panel. The decline in construction spending this year is projected to be just under 6%, with a steeper 7% decline for commercial facilities, 4.5% for industrial buildings, and 4% for the institutional sector. Next year is projected to return to growth, with 3% gains in the overall building market in 2022 matched by both the commercial and institutional sectors.
This year, the steepest declines are expected to come from office buildings (down over 9%), hotels (down 20%), and amusement and recreation (down almost 13%). Healthcare and public safety are the only major sectors that are slated to produce gains this year. Next year, the recovery is expected to be paced by strong growth in hotel construction (up almost 9%), and amusement and recreation (up 11%), in both cases offsetting some of the losses from this year.
Repairing an underperforming economy
The December jobs report confirmed that the economy needs additional support in order to move to a sustainable economic expansion. Even though there are about ten million fewer payroll positions than there were before the COVID-19 pandemic hit, progress has stalled in recovering them. Of particular concern were the 500,000 payroll positions lost in the leisure and hospitality sector. That means that this sector has lost almost 25% of payroll positions since February 2020, matching losses in the airline industry. However, movie theaters (-42%), spectator sports (-39%) and amusement and recreation (-31%) are among the sectors that have seen even greater losses. Continuing the trend of a dual economy during this pandemic, several sectors of the economy have seen a growth in payrolls since early 2020. These include supermarkets (+2%), product distribution (+7%), and building material retailers (also up 7%).
There is some cause for optimism given the late December passage of $900 billion of additional federal stimulus funding. Key elements of this package include another $600 in direct payments to qualifying individuals, $300 per week in supplemental unemployment insurance for up to 11 weeks, and $280 billion designated for the Paycheck Protection Program, which provided incentives for small businesses to keep employees on their payrolls. These initiatives were generally very effective in providing a safety net for impacted households and small businesses last spring. However, they weren’t designed to provide sufficient support for an extended period of economic weakness, and the December jobs report suggests that we may already be heading into another down cycle. Even this additional funding is unlikely to provide sufficient financial support for economic growth through the entire vaccination period, suggesting that even more stimulus will be needed in the coming months or else our economy likely will be in for an extended period of stagnant growth or modest declines.
With the two Georgia senate seats now in the democratic column, there are a new set of policy options for the Biden administration. Still, given the razor thin margins in both the House and the Senate, programs likely to be enacted will need to have at least modest levels of bipartisan support. An infrastructure program is likely near the top of the list of programs that both parties could support, and the Biden Administration seems ready to make this a priority, in part because it would be viewed as a stimulus program, but also because borrowing costs are near historical lows.
Biden has historically been a strong advocate of infrastructure investment. He has promoted a $2 trillion investment package that encompasses a broad definition of infrastructure including renewable energy projects, public school construction, and broadband as well as more traditional public works programs, with a particular focus on green transportation.
Even with the recent stimulus funding, the Biden Administration is likely to push for another round, which is likely to include more direct payments to individuals as well as provide state and local government aid. This was a point of contention in the last bill, but with the severe economic losses that the pandemic has placed on municipal governments, coupled with the future cost associated with distribution and administration of the COVID-19 vaccine, there is likely to be more support for this effort.
Income inequality also could be addressed, at least marginally, through an increase in the tax rate for upper-income households. Additionally, there may be an effort to raise the federal minimum hourly wage to $15. Healthcare reform may come in the form of adding a public insurance option to Obamacare, expanding eligibility for Medicare, and/or allowing Medicare to negotiate drug prices. Finally, there may be a renewed interest in immigration reform.
Leading industry indicators don’t point to optimism
Business conditions at architecture firms also underscore the view that 2021 will be a challenging year for the construction industry. The AIA’s Architecture Billings Index (ABI), which measures revenue trends at US architecture firms, recorded a decline starting last March and has seen additional declines in every subsequent month. Given that AIA research has demonstrated that the ABI leads nonresidential construction spending by an average of 9-12 months, construction activity in 2021 is projected to be weak.
The steepest declines in the ABI occurred in March through May, at which point the downturn began to moderate. However, in recent months the movement toward recovery has lost momentum, suggesting that architecture firms are entering 2021 facing a continued sluggish design market. Fortunately, there are some signs that conditions may improve in the coming months. Project inquiries from prospective and former clients have been strong recently, suggesting that new work may be picking up. More concretely, new design work coming into architecture firms has generally been more positive than billings in recent months, suggesting that firms are bringing in more project activity than they are completing. However, firms are seeing different business conditions regionally. Firms in the northeast saw the steepest downturns as the pandemic hit, and conditions remained the weakest for the remainder of the year. Business conditions at firms in the other three regions – all modestly declining – are fairly comparable.
Construction contractors share similar concerns regarding the outlook for the industry this year. The recently released 2021 AGC-Sage Construction Hiring and Business Outlook Survey also points to a challenging year for construction. Contractors were asked to provide their projections for growth or decline in up to sixteen construction sectors that they serve, and on net they expect thirteen to see decreased spending. The major commercial sectors – retail, lodging, and offices – are expected to fare the worst, with two-thirds or more of respondents expecting revenue declines in these sectors this year. Other sectors that are expected to fare poorly are education (K-12 and higher ed.), public building, and transportation. The sectors expected to see at least modest growth are healthcare facilities (non-hospital), warehouses, and municipal water and sewer systems.
This same survey identifies the major problems for contractors that the pandemic had on their projects last year. Impacts mentioned by at least a quarter were “projects have taken longer than we anticipated” (64%), “costs have been higher than we anticipated” (54%), “we have put higher prices into our bids or contracts” (33%), “we have won new projects or add-ons to existing projects” (25%), and “we have put longer completion time into our bids or contracts” (25%). Major concerns for 2021 include “continuing impact of pandemic on projects, workers, or supply chain” (84%), “material costs” (58%), and “increased competition for projects” (55%).
A recovery in the distance?
In spite of a potentially challenging year for the nonresidential construction market, there are a few potential silver linings. The first is a healthy residential construction market. Home building and home improvement activity in the 2020 pandemic year both exceeded their 2019 levels and are both on pace for healthy growth in 2021. A healthy housing market is traditionally a harbinger for a healthy nonresidential market, so strength in residential activity should help cushion the projected building downturn.
Secondly, while the new construction market for buildings is expected to be weak this year, the retrofit market should be a good deal stronger. Many existing commercial and institutional facilities need significant modifications to accommodate a post-pandemic staff and client base, and much of this activity is not included in the construction spending figures.
Finally, as pandemic concerns begin to wane and economic activity begins to pick up, there is likely to be considerable pent-up demand for nonresidential space. We can expect, for example, a short-term burst in travel that will generate demand for lodging and related leisure and hospitality activity. Personal services, amusement and recreation activities, and cultural events can be expected to see a surge to begin to compensate for an extended period of underspending on these activities.