Any attempt at an economic forecast should always start with this caveat: Large-scale economies are fantastically complicated systems, and complicated systems are inherently unpredictable. By example, for all the satellites and computer models available to meteorologists a weather forecast can still be very wrong about the weather on a given day.
What looks very clear in hindsight may be perfectly opaque to the people at the time. Very few people saw the Great Depression or the Great Recession coming. We may right now be in an economic bubble — a student loans bubble, a health insurance bubble, an equities bubble — and never know it until the bubble pops.
The extent of the devastation caused by hurricanes and wildfires in 2017 was essentially unexpected and will be affecting the construction market for years to come. The new GOP tax reform package has its advocates and its critics, but no one knows for sure what its mid- and long-term effects on the economy will be. The unknown is always right around the corner.
All of that said, most economic indicators say that the U.S. economy in general and the building construction market in particular are still on track to make gains in 2018. Let’s take a deeper dive into the numbers.
Residential construction starts continue the upward climb we’ve seen since the official end of the Great Recession in 2009 (see figure 1). It is worth noting that residential construction routinely goes through cycles of expansion and contraction; construction ramps up when new home buyers enter the market, eventually leading to overstock and a resulting draw-down in new starts. Even the huge slide beginning in 2006 at the start of the Great Recession can be interpreted as a natural — albeit extreme — part of this cycle.
The conventional wisdom had it that housing starts needed to be about 1.44 million (represented by the orange line) in order to house the growing U.S. population (which went from from 178 million in 1959 to 326 million today). Then came the housing bubble, the Great Recession, and seven years where housing starts dipped well below 1.05 million, long considered the lower threshold for housing starts.
The downturn has led to a significant deficit in housing starts (see figure 2). Between 1998 and 2017 2.181 million homes that in normal times would have been built simply weren’t. This means that, barring some sudden economic downturn, builders should have plenty of work to do in 2018 and beyond.
And, in fact, builders are optimistic. Check out figure 3 which compares housing start data from the U.S. Census Bureau (the blue line) with an annual market optimism survey (the Housing Market Index or HMI) conducted by the National Association of Home Builders (the green line). While the optimism or pessimism of builders has sometimes gotten the better of them, the HMI is seen as a leading indicator of housing starts, and right now confidence is very high, approaching 70 percent.
Another reason for optimism can be found in new household formations, a statistic tracked by Zelman & Associates, a private market research firm. When times are tough people move back in with their parents, delay getting married, put off having kids. But when times are good people feel more comfortable starting a family, and that usually leads to buying a home. Household formations were at 0.955 million in 2014, but climbed to 1.325 million in 2015 and 1.4 million in 2016. (Projections for 2017 are lower at 1.27 million, but those numbers are not definite.)
But tastes are changing in residential market. Fewer first-time homeowners are opting for single-family homes (see figure 4), and the homes they are buying are smaller. After seeing a 59% increase in the average square footage of a new home since 1974, over the past three years that average seems to have leveled off at just over 2,500 sq. ft.
Also, today’s homeowners are more likely to repair, renovate and improve their existing homes. The amount Americans spent on home improvement was $165.9 billion in 2016, will be close to $190 billion in 2017, and is projected to be $201 billion in 2018.
All new construction expenditures in 2016 totaled approximately $780 billion. The market broke 39 percent residential, 61 percent non-residential. Of that roughly $470 billion, no single segment dominates (see figure 5).
While dollars spent on private, non-residential construction returned to pre-Great Recession levels in 2015, growth has stalled, with only a modest 3.6 percent growth anticipated for 2018 according to the American Architecture Institute’s Consensus Forecast (see figure 6 for a breakdown by market segment).
The AIA is a good place to go for insight on the future of the non-residential market. It does an annual Architectural Billing Index with data from its members that has proven to be a good nine- to 12-month leading indicator for non-residential construction. Unfortunately, the index has hovered in the high 40s/low 50s for almost six years now, meaning the people planning these types of buildings are neither glutted nor starved for work.
But one thing almost all economists agree on is that gains in the overall economy can work as the rising tide that lifts the non-residential sector.
The macro outlook
According to the U.S. Bureau of Economic Analysis, the U.S. economy saw a 2.3 percent growth in GDP year-over-year from 2016 to 2017. That’s better than 2016’s 1.5 percent, worse than 2015’s 2.9 percent, but downright spectacular compared to 2009, the height of the Great Recession, when the economy contracted a -2.8 percent.
That growth is reflected in the job market. Unemployment now stands at 4.1 percent, the lowest level in 17 years. Since 2010, the U.S. has seen 17 million jobs added, an unprecedented 85 consecutive months of growth.
But construction jobs are lagging. According to the U.S. Bureau of Labor Statistics in that same period, since 2010, the U.S. has seen only 1.5 million construction jobs added to the economy. A good reason for this may be the “skills crunch” affecting so many of the building trades.
For too many decades the parents and teachers of the middle class — many of whom made it to the middle class via the trades — have encouraged their children to pursue a college degree and white-collar employment rather than seek a career in the building trades. The result is not enough people in the job pool with the necessary skills for construction work.
But unemployment has been in steady decline since 2009 and participation has barely ticked up. It’s a mystery to economists and sociologists alike — where did those workers go?
Another factor is participation. Look at figure 7, the orange line represents the unemployment rate, the green line is the participation rate. During the recession participation dropped as unemployment increased, most probably from people becoming discouraged in their job searches and dropping out of the employment pool.
But unemployment has been in steady decline since 2009 and participation has barely ticked up. It’s a mystery to economists and sociologists alike — where did those workers go? Some may have aged out of the job market, and some may be working in various underground economies, or making a living in ways the government has difficulty tracking, but not enough to account for all of them.
One last piece of the macro-economic puzzle is consumer confidence. According to the Consumer Confidence Index (released monthly by The Conference Board, an independent economic research organization) the index reached 129.5 — anything over 100 is considered optimistic — in November of 2017, a 17 year high (it hit 132.6 in November of 2000).
To summarize, confidence among both builders and consumers is high. Unemployment is low, although construction employment is lagging. No one segment of the non-residential market is dominant, and the residential market has a backlog of nearly three million homes needing to be built. 2018 has the makings of a good — maybe even a great — year.