Construction spending rose 7.2% on the year in April

Construction spending popped 1.2% in April after upward revisions to March data. Spending is reported in nominal terms; therefore, inflation plays a key role. Compared to a year ago, spending is up 7.2%. There is no specific deflator for the construction sector; the producer price index for construction inputs fell 4% on the year, mostly due to the sharp decline in energy prices. Labor costs for nonsupervisory construction workers have risen 6.7% on the year.

Private residential construction spending edged up 0.5% in April; strength in multifamily construction offset further losses in single-family construction. Although overall single-family construction spending has been falling for the past 12 consecutive months, demand for new housing remains robust. Permits for single-family homes were up 3.3% in April.

A resolution to the debt ceiling debacle is expected to be passed in early June; this will provide some reprieve for mortgage rates, as they tend to follow the path of the 10-year Treasury bond. Spreads between the 10-year bond and 30-year mortgage rate remain higher than pre-pandemic, which is keeping many would-be buyers on the sidelines. The silver lining for builders is that historically low inventory of existing homes is helping push up demand for newly built homes.

Multifamily construction spending grew 0.6% in April and has been growing at a double-digit annual rate since October of 2022. The largest supply of multifamily homes in decades is expected to finish construction this year and next, although it will not be enough to keep up with household formation in many high-net migration states. Permits for new multifamily build were down in April, which signals the pipeline is not infinite. More supply will translate to lower rents in some regions, which will help bring down housing inflation, although that will occur with a lag.

Private nonresidential construction spending surged 2.4% in April and 31.2% from a year ago. Nonresidential construction growth started to outpace residential construction back in the summer of 2022, shortly after the Federal Reserve embarked on its rate hiking regime, which the housing sector is very sensitive to. The commercial real estate sector sees longer term projects and investments and responds to tightening of conditions with a lag.

The return of travel and tourism has pushed up spending for lodging and transportation infrastructure spending, both up 41.6% and 33% from a year ago, respectively. The Memorial Day weekend logged stronger travel numbers compared to the same time in 2019, according to the TSA.

Although consumers have been pivoting their spending from goods into services, commercial infrastructure spending, which consists of restaurants, retail, warehouses and auto dealers, was up 0.7% in April and 23.4% higher than a year ago. Warehouses make up the largest portion of this category, where spending was up 1.7%. Warehouses are expected to remain resilient this year, as demand for e-commerce remains above pre-pandemic levels.

Office spending remains robust, up 14.6% from a year ago. Most of the new office projects are for medical offices, where demand will remain strong as the population continues to age. City center offices are still struggling to bring back workers; vacancy rates remain high. A reset of valuations is expected for office spaces in large city centers and coastal cities. Office spaces in regions that did not have strict Covid regulations have seen a much stronger return to offices. These regions are on better footing than their coastal counterparts.

Manufacturing construction spending, the largest portion of nonresidential construction, surged another 8.7% in April. The bulk of the surge continues to be from computer and electrical manufacturing infrastructure, which is being buoyed by renewed investment from both private and public sectors. A lack of workers in mining, engineering and construction will keep a cap on how much construction activity can grow.

Public construction spending, most of which occurs at the state and local levels, rose 1.1% in April. The largest component, highway and street spending, was up 1.3% for the month. More infrastructure projects have been ramping up in recent months and are expected to continue to contribute to economic growth in 2023.

Bottom Line:

A pivot out of residential into nonresidential construction has kept building activity strong in the face of rising interest rates and tightening credit conditions. Construction and land development bank loans, most of which are issued by small, domestically chartered banks, were still growing annually in mid-May, but at a slowing pace. Another hurdle for builders is finding workers, which will remain a long-term concern for the industry.