The United States has been experiencing an ongoing construction expansion cycle over the past decade. The national economy remains buoyed by confident consumers, rising household incomes and the lowest unemployment rate in 18 years. The expectation is that in the near term, the industry will remain strong as tax cuts, the promise of a boost in investment in infrastructure and relaxation of regulatory burdens lead to stronger demand. However, many in the industry believe that the current construction spending cycle will be upended at some point in the next three years, with the Construction Executive magazine warning of a potential downturn in 2020 in their recent mid-year economic outlook.
While construction project backlog and contractor confidence remain high, there are a number of challenges facing the industry that can impact future demand and contractor margins. The most notable challenges being skilled labor shortage, rising prices for construction materials and rising interest rates.
Skilled Labor Shortage
The construction sector is experiencing a shortage in labor, particularly skilled workers. It is expected that it will either become harder or remain difficult to recruit and hire qualified skilled workers. Contractors are using strategies which include:
- Increasing base pay rates,
- providing incentives and/or bonuses,
- offering improved employee benefits,
- and training and development.
The Rise of Rates and Materials
Inflationary pressures are building throughout the economy and manifesting in rising material prices. In particular, lumber and metals have seen dramatic price increases, in part due to international trade issues. According to Anriban Basu, Chief Economist for the Associated Builders and Contractors (ABC), “Contractors are becoming more and more concerned about surging materials prices—especially metals. On a year-over-year basis, iron and steel prices are up 13.5 percent, which not only impacts a contractor’s margins but could potentially diminish demand for construction services overall.”
The Prime Rate has been increased five times over the past eighteen months from 3.75% in December 2016 to the current level of 5.0%. The Federal Reserve has indicated that it is expecting to raise interest rates twice more in 2018. Rising interest rates could cause the construction sector to slow and hamper the expansion of the commercial real estate market.
The immediate outlook remains bright for the construction sector, with elevated backlogs and demand. However, the future will be challenged with skilled labor shortage, rising prices for construction materials and rising interest rates. Construction companies can prepare by evaluating how the economic forecast will affect their current overhead structure and consider developing an economic downturn plan.
For more information about the future of construction and real estate or for help evaluating your business, please contact your Sikich Advisor.