Falling home-construction spending offers scant clarity on industry trajectory

Data: U.S. Department of Commerce; Graphic: CONEXPO-CON/AGG 365

In a generally softening U.S. economic environment, the construction industry is producing indicators that maintain the mystery about where this economy is headed and how fast.

Total construction spending dipped 0.7% in August. Growth in spending during July was revised slightly lower and now shows a 0.6% drop. But year-to-date spending is 10.9% greater than the first eight months of 2021.

August’s slip was broad-based, but total residential spending fell 1.0% and total nonresidential slid 0.4% during the month.

It appears rising interest rates are hitting home construction hardest and fastest. Spending on new single-family homes dropped for the fourth month in a row, falling 2.9% from July. Spending on other residential segments rose, by 0.4% for multifamily construction and 1.0% for improvements to owner-occupied housing.

Data: U.S. Department of Commerce; Table: CONEXPO-CON/AGG 365

“The construction market is in a transition that is likely to accelerate in the months ahead,” said Ken Simonson, the Associated General Contractors of America’s chief economist. “Steeply rising interest rates have crushed demand for single-family housing and threaten developer-financed projects, while newly enacted federal legislation will soon boost investment in power, manufacturing, and infrastructure construction.”

There’s more good news for nonresidential contractors.

“Building material costs appear to be moderating, with the Producer Price Index for inputs into construction cooling to 12.2% year-over-year in August,” said Charlie Dougherty, economist at Wells Fargo. “In particular, lumber prices have come down markedly in recent months and are now back to levels on par with those seen pre-pandemic.

“Higher financing costs are likely to further weigh on construction activity moving forward. That noted, the pipeline of new nonresidential projects looks to be holding up amid heightened economic uncertainty. The Architecture Billings Index improved to 53.3 in August, the 19th straight month above the 50 mark which indicates expansion in billings at architecture firms.”

Nonresidential contractors optimistic

The annual rate of spending on all private nonresidential construction edged down 0.1% in August. Private nonresidential spending was down 0.1%, its second monthly decline in a row, and for 2022. Public nonresidential construction spending was down 0.8%, its second decline this year.

“The disparity between high contractor confidence and worrisome macroeconomic outcomes persists,” said Associated Builders and Contractors’ National Chief Economist Anirban Basu. “According to ABC’s Construction Confidence Index and Backlog Indicator, many contractors remain in expansion mode and expect to experience rising sales and profit margins going forward. Many also expect their employment levels to be higher in six months.”

Indeed the Backlog Indicator remained unchanged at 8.7 months in August, according to ABC’s monthly member survey. Backlog is down from the peak of the second quarter of 2022 but remains higher than at any point from March 2020 to March 2022. The August reading is a full month longer than in August 2021.

ABC’s Construction Confidence Index for profit margins bounced back into positive territory while the sales and staffing level indices remained above 50, indicating expectations of growth in the next six months.

“Despite the high risk of recession, contractors collectively expect sales, employment and profit margins to grow over the next six months,” said Basu.

“Reconciling strong microeconomic perspective with weak macroeconomic outcomes involves looking at segment-specific data.”

Spending in what is currently the biggest single private nonresidential category, commercial spending, was unchanged in August, with a 0.5% rise in retail construction spending offsetting a 0.8% drop in warehouse.

The power segment – comprising electric, oil, and gas projects – slipped 0.9%. Manufacturing construction declined by 0.5%, but year-to-date spending soared 23.6% above the first eight months of 2021. When you add up commercial, power and manufacturing spending, they make up roughly 69% of private nonresidential expenditures.

Of the five largest private nonresidential categories, only office (0.3%) and healthcare (0.1%) managed spending increases in August. Communication (0.4%), lodging (1.7%) and transportation (1.2%) also logged improved spending.

Public construction expenditures retreated 0.8% during August. Public residential spending fell 2.7%, while the nonresidential category declined 0.8%. Nine of the 12 major public nonresidential categories declined during the month, most notably highway & street (-1.4%), educational (-0.4%) and transportation (-0.4%).

Builder confidence tracks the slide

Private residential construction spending declined 0.9% to an annual pace of $912.9 billion in August, as rising mortgage rates pushed single-family construction spending off a peak higher than that reached during the housing bubble of 2006. But year-to-date spending in the category was 19.6% greater than the same period of last year.

The pain is coming to single-family construction. Spending on single-family home building dropped 2.9% in August after a 4.3% decline in July. The National Association of Home Builders suggests rising mortgage rates and supply chain disruptions put a damper on housing. Nevertheless, spending on single-family home construction year-to-date is 12.4% above a year ago.

Multifamily construction spending edged up by 0.4% in August, after a decrease of 0.4% in July. Year-to-date multifamily spending was 0.4% below the August 2021 estimates.

Spending on private residential improvements rose by 1% in August and was 37.2% higher over a year ago.

Builder confidence in the market for newly built single-family homes fell three points in September to 46, the lowest level since May 2014 with the exception of the spring of 2020, according to the monthly NAHB/Wells Fargo Housing Market Index (HMI). The HMI is projecting ongoing decline for the volume of single-family housing starts. Twenty-four percent of builders reported falling home prices, up from 19% last month.

Don’t let August’s 28.8% jump in new home sales throw you off track. The increase interrupted two consecutive months of decline. Year-to-date, new home sales are running 14.1% slower than the same period last year.

Mortgage rates trended lower in the second half of July and first weeks of August, and builders offering incentives spurred buyers to move quickly. The upside surprise is also a reminder that underlying home buying demand remains strong and worsening affordability is the major factor holding back prospective buyers.

Mortgage rates have spiked back up and are currently close to 7%, however. The move threatens to significantly reduce home buying activity in the months ahead.

Builder sentiment has declined every month in 2022. More than half of the builders in the most-recent survey reported using incentives to bolster sales, including mortgage-rate buydowns, free amenities and price reductions.

All three HMI components posted declines in September:

1. Current sales conditions dropped three points to 54
2. Sales expectations in the next six months declined one point to 46
3. Traffic of prospective buyers fell one point to 31

Increased building material availability has allowed builders to complete more homes. The monthly count of sold, completed homes rose to 201,000 in August, its highest pace this year. The monthly count of unsold completed homes also increased to 49,000, a post-pandemic high.

The median new home price fell 6.3% during the month to $436,800. This equates to an 8.0% year-over-year gain, the softest annual rise since November 2020.

“Despite August’s unexpected surge in new home sales, higher mortgage rates are likely to continue to slow home buying and take the air out home price appreciation, a process that already appears underway,” said Dougherty.

The S&P CoreLogic Case-Shiller 20-City Composite Home Price Index (HPI) fell 0.4% in July, the first monthly decline in over a decade. On balance, home prices are still well above prior-year levels, with the national HPI 15.8% above this month last year. The elements are all in place – shifting demand, increasing supply and worsening affordability – for further selling-price decline.

Sharply higher financing costs in September increases the risk home prices moderate more quickly. That noted, higher rates may serve to dissuade sellers from trading to a higher cost mortgage. Reduced turnover as buyer demand remains strong could limit the extent home prices cool.