Higher mortgage rates weigh on single-family home construction plans.
Construction spending grew 0.3% in March from February’s downwardly revised figures. Total spending is up 3.8% compared to a year ago and is captured in nominal dollars. According to the producer price index, input costs for construction are down 4.4% compared to a year ago; the comparisons start to work in the deflationary direction starting in March because when Russia invaded Ukraine a year ago, it sent energy and other input costs soaring. There are still some inflationary pressures for the construction industry, including cement, gypsum, plastics, coatings and glass. Workers are still in short supply, especially as more public projects are in the works.
Construction employment has remained steady, even in the face of rising rates and slowing economic growth. Traditionally, construction employment tends to be one of the first areas to show weakness prior to a recession. We saw employment fall compared to the prior year in February of 2007, while the recession didn’t officially begin until December of 2007.
This time is different. A lack of existing housing inventory is pushing up demand for newly built single-family homes. Homeowners who are staying in place instead of trading up are turning to more home improvement projects. A large pipeline of multifamily and nonresidential projects, which respond to rising rates with a lag and take longer to complete, are still in the works. Additionally, increased government spending on infrastructure will keep a floor on demand for workers for the next few years.
This creates a difficult environment for the Federal Reserve, which is counting on a cooling in employment to help bring down inflation and eventually open the door for it to start cutting rates. The expectation is that this won’t occur until early 2024, barring any sort of financial crisis.
Private residential construction spending fell 0.2% in March, pulled down entirely by a drop in single-family construction activity. Mortgage rates climbed in March, which brought down mortgage applications in the month; applications were about half of what they were in March of 2022. The silver lining for builders is that as inventory remains tight in the resale market, those who are still looking to buy are more likely to turn to newly built homes due to more supply. This does not help first-time or lower income buyers who cannot afford the premium on the cost of a newly built home, especially in a rising rate environment.
Multifamily construction spending grew 0.4% in March, but momentum has been slowing. Multifamily starts were down 5.9% on the month in March, while permits were down 20% on the month. As much needed multifamily supply comes on line this year and next, rents are expected to continue to cool. Builders have been pivoting to nonresidential and nonbuilding projects as they finish up the multifamily ones.
Private nonresidential construction spending popped 1% in March after being revised higher in February. A 4.6% surge in manufacturing construction led the gains; spending on computer and electrical manufacturing skyrocketed by 10.8% in the month and is almost three times greater than a year ago. The second and third largest components of nonresidential construction, commercial and power, respectively, were down in March. Financing for construction has been harder to come by, especially since these loans tend to be for a shorter maturity. The level of loans is still higher than a year ago, but the momentum has been flattening.
Demand for nonresidential and public infrastructure remains strong.
Public construction spending grew 0.2% in March, while February data were revised higher. Most of the spending occurs at the state and local government levels, which grew 0.3% in the month. Governments still have funding from the pandemic to help boost spending on public projects. Additionally, as home values have risen over the past few years, property taxes have gone up as well.
The construction sector continues to chug along, even as headwinds mount. Tighter financial conditions that translate to lower loan activity for construction projects are likely to take some steam out of the industry, but demand for nonresidential and public infrastructure remains strong for now. Spending on nonresidential projects could outpace spending on residential ones; the last time this happened (for longer than a month) was in 2012.