By Daniel LoBue, Tego Systems Corp.
U.S. Construction Overview
With quite a tumultuous year on the inflation and interest rate front, the U.S. construction industry, in particular the residential markets, have continued to respond accordingly. If you remember, in November 2022 due to the fast-changing environment we decided to use current instead of the revised data we typically use. This has been the most sensible approach as the Federal Reserve’s interest rates have continued to rise to 5.5% and inflation has started to cool significantly to 3.2% in July, down from the previous 6.5% at the end of 2022. We will discuss below the current situation and outlook for each of the U.S. construction segments.
a. Residential Housing Construction
revised residential chart market study
Single-family housing completions have grown to 1,321 million units, a 26% increase compared to year end 2022 that closed at 1,047 million units. This seems to be a big jump, but builders struggled to get inventory to market in a high inflationary environment, and compared to 2021 completed inventory has increased only by 7% based on a multiyear comparison. Total construction spending in residential housing has risen to $839 billion representing a decrease of 1.5%, and with construction inflation having slowed to 2.4% it has actually lowered by 4.9%. Residential building permits have inched up 7% compared to 1,441 million in 2022 where it dropped off by 23%, down from 1,737 million units in 2021 to 1,342 million units in 2022.
From the start of the pandemic, building permits started to reflect what the U.S. housing market would need on an annualized basis to satisfy the actual demand. Significantly higher mortgage rates, which almost doubled from midyear 2022 to currently around 7%, have impacted activity substantially. This is also reflected in the tremendous drop of existing homes sale inventory that decreased from 5 million units earlier this year to 4 million units currently. Naturally everybody that does not absolutely have to sell their house will hold on to their homes as a vast majority of homeowners are locked in at below 4% interest rates on their 30-year mortgages. We expect owner-occupied renovation activity to pick up as most U.S. households are in a very good financial position. We further expect wage growth to continue, which by the end of 2024 will have offset the impact of the last two years’ spike in inflation.
After the tremendous run up in 2021 and 2022 for multifamily permits, which peaked at 600,000 units in 2022, they have rebalanced to more sustainable levels at 460,000 units. The National Low Income Housing Coalition (NLIHC) estimates the U.S. has a national shortage of 7.3 million affordable rental homes, which will keep multifamily development at robust levels into the foreseeable future.
At the end of last year, we anticipated the residential housing market would fair strongly going into 2023/24, contingent on how mortgage rates would fare. We have since revised our outlook from moderately strong to cautious as construction and resale activity cannot fully accelerate until the Federal Reserve starts to lower interest rates, which we do not expect to happen until the second half of 2024. When the time comes, pent-up demand from current headwinds—and the still existing shortfall of residential homes due to the Great Recession starting in 2008 (estimated still to be 2-4 million units)—will have become substantial and will deliver very strong growth in the residential housing market.
b. Non-Residential (Commercial) Construction
revised public non-residential chart market study
Pent-up demand from the pandemic is still delivering strong growth rates at 12% for the commercial construction market. With this growth rate, we continue to maintain our robust rating even though it may cool off into single-digit percentage growth in 2024. It has grown from $590 billion in 2022 to $658 billion, which is the highest ever recorded. As recession fears have started to abate, we will maintain our current outlook.
c. Public Construction
The $550 billion infrastructure bill from November 2021 is still contributing to strong growth albeit in the high single digit percentage points at 7%. We maintain that this growth will continue for years to come. Public construction spending has grown from $348 billion in 2021 to $412 billion in 2023 – a whopping increase of 19%. As less than 10% of the infrastructure bill funds have been deployed so far and another $185 billion of funding has been committed to projects that will take years to complete, we remain very optimistic. Based on the current rate of distribution we estimate it will take a decade to exhaust all the funds from the bill, which will bode well for the public construction sector.
To recap, the U.S. construction market is in the middle of the interest rate storm that will not stop raging until the Federal Reserve starts to lower rates. Despite the headwinds and the residential housing slowdown, the baseline remains solid as the base economy of the U.S. is still to be rivaled by no other. As multifamily, commercial and public construction still continue to grow, they will in part offset the slowdown in the single-family home sector. Total construction spending in the U.S. increased from $1,827 billion in 2022 to $1,909 billion in 2023, which after adjusting for inflation is a small nominal increase.
Inflation, Geopolitical & Supply Chain
Our position remains that, despite the Federal Reserve’s efforts to rein in inflation with its current quantitative tightening policy, it will not reach target levels of 2% in the short-to-midterm. The Consumer Price Index still shows stubbornly high levels of inflation at 6.8% even though overall inflation has dropped to 3.2%. We expect overall inflation to hover around 3.5-4.5% into the foreseeable future and to gradually ease off to 2%, but not until 2028-30. Federal Reserve Chair Jerome Powell’s Goldilocks speech at Jackson Hole, Wy., on Aug. 25, gives us some assurance that immediate rate increases might be tabled for now, but are still a weapon in the Federal Reserve’s repertoire if needed to rein in a potential rebound of inflation.
As we move into the 2024 presidential elections, we do not expect any changes to the U.S. economy until the new/existing administration is in office. The economy depends on its existing fundamentals and an election year rarely has had an influence one way or the other. Economic policy continuation or change of direction during the first term of the 2025 administration will set the tone for the coming years. At this point we see no changes in fundamentals to make any revisions to our current outlook.
The world has become politically fractured over the last several years and uncertainties about territorial and economic disputes will persist for the remaining decade and beyond, which at times will be impacting supply chains negatively. Supply chains have returned for the most part to their status quo and have normalized after a very volatile three years.
Outlook 2023-2024
The U.S. GDP is estimated to grow 2.4% in 2023 to $26.9 trillion, which adjusted for inflation will contract by around 0.5% but will account for the largest year ever on record. To put things in perspective, this represents 26% of the world’s total GDP.
I may quote James Diamon of JP Morgan Chase who called the recent U.S. credit rating downgrade by Fitch “ridiculous” in light of the sheer size of the U.S. economy. Despite the chatter of other countries trying to develop their own reserve currency system, daily worldwide foreign exchange volume tells quite a different story. Daily turnover of all currencies traded stands at nearly $8 trillion, of which 88% are settled against the U.S. dollar, which paints an indisputable picture.
We do not expect the residential housing market to improve from current levels until the Federal Reserve starts to lower interest rates. Pent-up demand will continue to sell in the meantime and when time comes will drive significant growth and activity in this sector. Multifamily construction will continue strong due to the underlying needs for people to live in more affordable accommodations.
Commercial construction has been contributing to its 2023 growth and will remain solid going into 2024 as there is still pent-up demand from the pandemic. The public construction sector will continue to benefit significantly from the massive Infrastructure bill going into 2024 and beyond as previously explained.
We remain very optimistic for the U.S. economy and are cautiously optimistic for the overall U.S. construction market for the remainder of 2023 and maintain our positive outlook beginning in the second half of 2024.
