Non-Residential Construction Soft in the Pandemic Economy
Jacob Hess
February 02, 2021
Construction spending is an important economic indicator that is especially sensitive to fluctuations in the business cycle. Since construction projects typically take time, the decision about whether or not to move forward with one incorporates a firm's view of future prospects of economic growth. Construction spending is typically broken down into residential and non-residential construction, the latter including pretty much anything that is not a home or an apartment. As one would expect, the COVID-19 pandemic has had its unique impact on the indicator in 2020.
The Census Bureau released its report on construction spending for December 2020 on the first day of the new month. Overall, spending grew in the month, up 1.0% to $1.490 billion. That makes for an annual increase of 5.7% in 2020. The growth breaks down into two diverging trends in residential and non-residential construction with residential up 3.1% on the month and 20.7% year over year and non-residential down -0.8% on the month and -4.8% year over year. As pointed out in a previous article, the real estate market has been surprisingly strong throughout the COVID-19 pandemic, and it shows in this report. The need for new homes is the primary driver of construction spending at the moment.
Non-residential spending, on the other hand, has lagged quite significantly. The dip has been strongest in manufacturing (-17.5%), lodging (-24.0%), amusement and recreation (-15.6%), and power (-11.1%). As expected, several of these industries have been impacted by lockdowns. Year over year growth has slowed to the largest decline since May 2011. It's not a surprise. Capacity utilization has barely returned to pre-COVID-19 levels, and millions of people are still unemployed or on a prolonged furlough.
ConstructionConnect documents the decline in its report on construction starts. In 2020, the organization found a -31.9% drop in non-residential construction starts much lower than the drop of -18.3% in total construction starts. The report acknowledges the effects of lockdowns closing down construction sites but insists that "economic uncertainty leading to cuts to capital expenditures and tight state and local budgets" was the primary driver. In particular, the report points out steep declines in industrial and commercial sectors.
Despite an end to the pandemic in view, ConstructionConnect does not forecast a V-shaped recovery in non-residential construction. In 2021, its projection sits at 8.6% "a tepid decline given the depth of the decline in 2020." For certain industries, its projections are highly pessimistic. Retail construction starts are not forecasted to return to pre-pandemic levels until 2023, and office construction starts not until 2025. Estimates for manufacturing starts, a bit more optimistically, are expected to rebound at a faster pace to 2021 but not to pre-pandemic levels
It's interesting to note that this contraction has occurred while interest rates are at the lowest they've ever been, suggesting the downturn is being exacerbated by demand rather than capital availability. From an ROI perspective, many firms likely do not see investments in new buildings as an effective way to make enough return to cover the cost of capital even if the cost of capital is very low. There are several trends across different industries causing this (teleworking, eCommerce, etc.), but most find a commonality in digitization and the power of the internet.
At the moment, it appears that non-residential construction spending is set for a soft 2021 coming off of a steep decline in 2020. The structural changes in the economy brought on by the pandemic are likely to embed themselves more permanently especially for the industries most affected like retail and office construction. These unique changes might turn out to be pretty lasting if that is the case.
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