After a soft May, second quarter data indicates that job gains were stronger in June 2016, while economic activity has been expanding at a moderate rate. Overall job growth in the first two quarters of 2016 declined from an average of 245,000 per month to 172,000 per month. The slowing trend could be part of a cycle witnessed in previous expansions. Commodity prices appear to have stabilized at a reduced level, which increases room for inflation in construction and other sectors. While construction dollar volume has dropped 3 percent in the past three months, 2016 construction price increases are trending toward 6 percent, depending on location.
Construction Costs
Construction costs have trended toward a 3.1 percent annually compounded escalation rate for the past 30 years. Year-over-year CPI inflation is now trending below the Federal Reserve’s long-term targets, due to the extended decline in energy and commodity prices.
According to Vermeulens, the rate of construction cost escalation is related to the federal goal of achieving an annual inflation rate of 2 to 3 percent, and the monetary policies used to achieve this. With the removal of quantitative easing by the Federal Reserve, the economy has entered a self-sustaining phase of expansion.
On balance, payroll data and other labor market indicators point to an increase in labor utilization over the past three months, with household spending growing strongly, and inflation continuing to run below the 2 percent long-term goal.
Construction Volumes
Construction dollar volume is the number one factor for construction costs, because bids increase as contractor opportunities and project backlogs grow. After rebounding considerably since the most recent bottom in July 2011, overall construction dollar volume finally dropped by 3 percent in the second quarter of 2016, driven mostly by a reduction in residential activity.
Existing home inventories currently remain stable at 4.6 months. Non-residential construction spending is also holding stable after a 16 percent volume growth in 2015.
AIA Billings
The Architectural Billings Index (ABI) is a key indicator of expected construction volumes nine to 12 months in advance. A score greater than 50 indicates growth. A majority of architecture firms nationwide reported improved business conditions in June. The overall ABI score for the month was 52.6, indicating moderate billings growth at firms, depending on regional location.
The Midwest (48.2) was the only region reporting a June decline in billings. Billings continued to improve at firms in the West (54.1) and Northeast (51.8), while firms located in the South (55.5) experienced the strongest growth.
Architecture firms specializing in residential projects (57.9) reported the most growth in June, while institutional firms (52.7) saw a refreshing uptick after an extended period of decline that started in late 2015. Growth at firms specializing in commercial/industrial (50.3) sectors remained essentially flat.
Labor Market
Job growth in the first two quarters of 2016 declined from an average of 245,000 per month to 172,000 per month, while total job growth in the U.S. economy has grown at a relatively healthy rate over the past year, averaging roughly 206,000 jobs per month since July 2015.
Construction job growth dropped by 22,000 in the second quarter of 2016, echoing the decline of construction dollar volume over the same period.
Sustained growth in construction activity has increased construction employment by 1.2 million workers since 2011. Simultaneously, the construction unemployment rate has been trending downward and appears to be stabilizing near the benchmark levels established in the mid 2000s. Unemployment rates fluctuating between 4 and 6 percent will likely cause an uptick in labor costs similar to increases experienced between 2004 and 2007.
Labor Capacity Utilization
Labor capacity utilization is calculated by comparing the ratio of current construction employment to peak employment, and allowing for a sustainable rate of growth. A utilization rate of greater than 85 percent (yellow) puts upward pressure on construction labor costs.
Regional imbalances in capacity utilization reduced in the first two quarters of 2016. Currently, 47 percent of states are categorized as having either a yellow or orange Labor Utilization Rate, as have 60 percent of the top 20 U.S. Cities (by GDP).
Forecast
The New York Stock Exchange (blue line) is a strong parallel of construction prices, as improving equity markets provide capital and investment spending for construction. The last four years have shown continued improvements in equity markets.
Capital construction prices in 2016 are trending at an annual rate of 4 percent to 9 percent—depending on location—with an average 6 percent nationally. Current construction prices are firm and stabilizing above the long-term trend line, and construction employment is at capacity.
Assuming a continued stability in construction volume, costs are expected to remain above the construction cost trend line for the near to medium term.
By Johnathon Allen
This report is based on the Vermeulens Q2 Market Outlook report.
