Industrial Warehousing, Single- and Multi-Family Homes Sustain Economy as Signs of a Recession Continue to Mount
By LOUIS BEDIGIAN
“A recession is coming! A recession is coming!” That was the economic assessment at the end of 2022. It wasn’t a dire warning; many economists predicted that this recession would be far less intense than the Great Recession (2007-2009). But the general belief was that a recession was coming and that it would be felt in 2023.
Fast-forward 12 months and developers and contractors may be having a bit of déjà vu. Little has changed in the outlook – all indications still point to a degree of economic decline in the foreseeable future. For example, the Conference Board Leading Economic Index (LEI) for the United States declined by 3.4% between March and September 2023[1]. The declines are not yet significant enough to pinpoint when the recession will arrive, but economists are still confident that one is on the horizon.
“When you raise rates, historically you hit housing, automobiles, and construction, yet all three are all good right now,” said GraphsandLaughs, LLC Chief Economist Elliot Eisenberg, Ph.D. “That’s why our economy is holding up in the face of the high rates, for a bunch of odd reasons. Housing because people are locked into their mortgages, so no one [is selling] their house. There’s no inventory, so builders build houses. Car making because we couldn’t get chips, we were underbuilt. Now they’re catching up, but there’s strong demand. And construction because of the government incentives.”
Incentives include funds from the $280 billion CHIPS and Science Act of 2022, which has earmarked capital for projects that are equal to or exceed $300 million[2]. In September 2023, the U.S. Department of Commerce announced that funds would also be available to projects that are below that threshold[3].
“Construction is doing pretty well,” said Eisenberg, who also founded Econ70.com (a daily 70-word blog on the economy). “Residential construction is picking up a little bit, [but] non-residential and public are doing better. Public because there’s public money out there. Roughly half of the private construction is being generated by manufacturing, which is the CHIPS bill. It’s okay so far. But housing will weaken at some point [and] the CHIPS bill is going to run its course, so the leading economic indicators in construction are not so hot.”
Ups and Downs Continue to Rattle the Economy
The American Institute of Architects (AIA) Consensus Construction Forecast Panel, which includes forecasts from Dodge Construction Network, Moody’s Analytics, and Associated Builders and Contractors, predicts a 2% gain in nonresidential construction in 2024[4]. That's a significant drop from the 19.7% increase projected for 2023. Industrial construction is expected to rise by just 5.4% in 2024 versus 55.1% this year.
While future gains may soften, Plante Moran Financial Advisors Chief Investment Officer Jim Baird noted that homebuilders have gone through a “15-year period of significant underinvestment in our housing stock.” He sees this as a “favorable backdrop for homebuilders” over the long-term.
“I would be optimistic, once you get through this soft spot, that demand – not just in Michigan but across the country – has the potential to be pretty good,” Baird affirmed. “I would say probably more so in areas of the country that are benefiting from demographic trends and migration and immigration.”
In the short-term, Baird is concerned that high home prices and high interest rates will negatively impact demand for new construction homes.
According to the November 2023 ICE Mortgage Monitor Report, the principal and interest (P&I) payment for a median-priced home reached $2,500 for the first time in October, costing homeowners an additional $144 per month[5]. For more than three decades, P&I expenses – which do not include taxes, insurance, or HOA fees – were less than 25% of the median household income. But with prices so high, the report estimated that P&I costs were 40.6% of the median household income, creating the least affordable housing market since 1984.
“Certainly, residential builders felt the impact of higher interest rates and higher home prices, which really has taken affordability back a couple decades,” said Baird.
This is all part of the tug-of-war going on between the Federal Reserve and the economy, which includes measures to quell inflation.
“On the flip side of that tug-of-war is the U.S. consumer, which has continued to spend at a pretty good pace, fueled by three things,” Baird continued. “One, the strength of the labor market and strong wage growth. Two, this stockpile of cash that was accumulated during the pandemic. Three, the rapid growth in credit card debt outstanding. That’s what has kept the economy growing.”
Job Growth, Cash, and Too Much Debt
Job growth has continued in a number of areas, including construction. Data from the U.S. Bureau of Labor Statistics show that the construction industry added 23,000 jobs in October –5,000 more than the 12-month average of 18,000 jobs[6]. All told, 150,000 jobs were added across all sectors in October, a number that Eisenberg said was “not bad” but showed signs of “continued weaking in the labor market.”
“Most of the jobs being created are backfilling jobs in healthcare, transportation, hospitality, leisure, and so on,” Eisenberg explained. “But it’s been steadily slowing for a couple of years, and it continues to slow. The high rates are going to continue to weaken our economy.”
Cash savings have also helped to keep the economy afloat. The Economic Research Department of the Federal Reserve Bank of Kansas City reported that savings as a percentage of disposable income reached a record high of 33.7% in April 2020[7]. And according to the Board of Governors of the Federal Reserve System, U.S. households accumulated roughly $2.3 trillion in savings from the start of the pandemic through the summer of 2021[8].
Despite the massive amount of capital retained by consumers, many individuals have taken on additional debt. This decision may not have been by choice, however. While the monthly jobs report paints a rosy picture of the economy, LinkedIn's Global Talent Trends report suggests that, between August 2022 and August 2023, U.S. hiring rates declined by 24%[9]. If people are struggling to find a job, they may have been forced to take on debt just to pay for their mortgage and other essentials.
Regardless, Baird still expects the upcoming recession to have the “look and feel of a run-of-the-mill business-cycle recession,” similar to the recessions of 1990 and 2001.
“Frankly, we’re a good chunk of it through before you realize you’re in a recession,” said Baird, alluding to the fact that declines have already begun in some areas. “That doesn’t mean there aren’t job losses. That doesn’t mean there’s not a soft spot in the economy. It just means it doesn’t have the same degree of severity that we’ve seen in either of the last two [recessions].”
The next recession may not as memorable, but it could usher in a set of new records that aren’t easily forgotten. Consumer debt is just one example. The Quarterly Report on Household Debt and Credit, published by the Federal Reserve Bank of New York's Center for Microeconomic Data, shows that aggregate household debt balances reached $17.29 trillion in Q3 2023[10]. This represents a $228 billion increase in the third quarter alone and a $3.1 trillion increase since the end of 2019.
Aside from the meteoric rise in debt, mortgage rates have also reached levels not seen in more than 20 years. Data from Freddie Mac's Primary Mortgage Market Survey show that mortgage rates are starting to decline but are still higher than the year ago period. As of November 9, 2023, the 30-year fixed-rate mortgage fell by 26 basis points to 7.5% – the largest one-week decrease since November 2022[11]. That said, mortgage rates remain the highest since 2000, when the year’s average reached 8%[12].
“Mortgage rates have come down as long-term treasury rates have come down,” said Baird. “But it’s still a modest yield curve, and it still tells us we’re in that window of potential recession risk.”
Planning for Tomorrow While Embracing Growth at Every Turn
University of Michigan researchers expect that single-family starts in Michigan will be nearly 5% above their pre-pandemic levels by the end of Q4 2025[13]. This is a positive step in the right direction that is likely to be spurred by lower interest rates over the next two years. Even now, researchers found that single-family construction rebounded in Q2 2023, rising 11.2% in Michigan after enduring declines for four consecutive quarters.
That’s not the only good news. In a September 2023 analysis of data from the U.S. Bureau of Labor Statistics’ Job Openings and Labor Turnover Survey (JOLTS), Associated Builders and Contractors found that construction job openings increased by 56,000[14]. With high demand for new talent within the construction space, unemployment remains under 10% in every state[15]. Better still, construction wages have been outpacing economy-wide wages by more than 2X[16].
However, the increases won’t last forever. University of Michigan researchers estimate that, by the end of the 2023, 6,600 construction jobs will have been added in Michigan. The following year will be much less rewarding, with just 500 new construction jobs added, and only a modest pickup in 2025 with 2,400 new employment opportunities.
If there’s a silver lining here, it’s that growth may slow to a crawl but will not diminish entirely. Baird said that some municipalities may have leftover stimulus money that was reserved for construction projects that have been planned for some time but not have not yet begun. This, Baird said, could give the industry “a little bit of a boost” ahead of or during the recession.
“Construction [is a] mixed bag,” he said. “Commercial real estate, you’ve got this bifurcation between sectors that have been doing well and sectors that have been doing poorly. Obviously one of the biggest lingering effects of the pandemic is the significant reduction in demand for office space, so that particular sector remains under pressure. Retail, perhaps, to a lesser extent.”
Industrial warehousing and multi-family housing have held up better, Baird said, high interest rates notwithstanding. “There’s still a lot of pent-up demand there and under investment,” he added. “On the warehousing and industrial side, I think it’s a combination of this push to bring back, to a degree, more manufacturing capabilities and capacities here in the United States. But even more so, the change in the way commerce takes place [with] a lot more online shopping. [There’s] less demand for traditional bricks-and-mortar space and more demand for distribution centers.”
Eisenberg believes there is growth potential in office spaces, but only for organizations that are willing to pay for a quality building that appeals to employees and prospective hires alike.
“Office is interesting because the C-quality office space, you can kiss that off,” said Eisenberg. “That’s history, no one wants that. Who wants to go to work in a building full of COVID, right? B-quality buildings are problematic. But if you build a new building, it’ll rent. In the past, you’d get a nice building to impress your clients. Now you’re getting a nice building to impress your employees.”
In a world where remote work is possible, some employees may need an incentive to go back to the old way of doing things. Eisenberg joked that an environmentally friendly, LEED-certified building that’s made with sauerkraut and runs off old French fry oil should do the trick.
“You’re essentially telling your workers, ‘We care about you, we love you, and we’re going to give you a very good workspace,’” said Eisenberg. “That’s the important thing. You build an A+ building next to a subway station, it’ll rent up. And that’s what’s happening. You’re seeing construction in offices [even though] vacancy rates are pretty high. Ten years ago, we had all those office parks that were empty and people were moving downtown. This is a similar sort of process. It isn’t office parks moving downtown creating vacancies in suburbia. Now you’ve got vacancies in B- and C-quality buildings and new construction with the A’s.”
Whatever comes in 2024, Eisenberg said it’s important for builders to stay focused on projects they can complete and sell as quickly as possible. They should not, however, overextend themselves.
“If you’re a single-family builder, build a few at a time,” he said. “Don’t build too many so you can get rid of them. Build it and sell it, build it and sell it. That’s the key.”
THIS ARTICLE WAS PUBLISHED IN THE DECEMBER 2023 ISSUE OF CAM MAGAZINE.
References
1 https://www.conference-board.org/topics/us-leading-indicators
4 https://www.aia.org/articles/6648150-after-potential-record-growth-in-2023-cons
5 https://www.blackknightinc.com/data-reports/november-2023-mortgage-monitor
6 https://www.bls.gov/news.release/pdf/empsit.pdf
9 https://business.linkedin.com/talent-solutions/global-talent-trends
10 https://www.newyorkfed.org/medialibrary/interactives/householdcredit/data/pdf/HHDC_2023Q3
12 https://www.bankrate.com/mortgages/historical-mortgage-rates
13 https://lsa.umich.edu/content/dam/econ-assets/Econdocs/RSQE%20PDFs/MI_Forecast_(2023.09).pdf