President of Clayco’s Industrial Business Unit and Executive Vice President of Clayco, Inc.
Construction is a driving force behind the U.S. economy, contributing 4% to the GDP. As a leading indicator, the construction industry can offer valuable insights into the economic landscape, helping market observers anticipate trends and forecast future economic activity.
Often one of the first signs of an economic downshift is when capital markets and construction investments dry up, and existing projects are completed before the slowdown in new projects becomes noticeable. When the Federal Reserve announced inflation concerns, construction leaders were already well aware of the growing price of goods and services—having already encountered those increases for months.
Industry participants and experts recognized the turbulence looming on the horizon due to several dynamics: increased demand for building products in the market, growing numbers of remote workers, international supply bottlenecks, population shifts and the ongoing labor shortage.
My insight is garnered from decades of diverse career experience. I’ve worked in roles ranging from building in the field as a carpenter to creating teams and overseeing some of the nation’s most exciting commercial and industrial construction projects.
Assessing Market Shifts
From buying commodities like copper, aluminum and steel, to dealing with domestic and foreign business and labor, construction is impacted by many different factors.
In March 2020, steel prices were trading between $500 and $800, but July 2021 brought trading up 200% to $1,800. Similar increases were seen with wood and other materials, and costs surged 35.7% from January 2020 to July 2022.
While soaring shipping prices helped fuel global inflation and made life challenging for contractors temporarily, they are finally normalizing as projections place global logistics and distribution markets at a 4.9% compound annual growth rate until 2026. A slower economic pace of growth indicates the end of pandemic-era prices with stabilized rates and moderated inflation.
The Current Position
The path to economic recovery is winding and will take perseverance and business savvy to navigate effectively and sustainably.
Escalating construction prices surged over three years. Data shows costs went up by 17.5% year-over-year from 2020 to 2021, the largest spike in this data from year to year since 1970.
Real estate investors face increasing risk due to economic headwinds, making it likely that capital will seek lower levels of investment in certain sectors. This dynamic, along with office vacancies remaining high, has further fueled capital’s flight away from this asset class as various industries switch to hybrid or remote working.
Construction material prices rose 1.3% in January 2023. This will continue to impact the overall cost of commercial real estate developments as prices start to recuperate and industry executives predict a shrinking market throughout 2023.
Despite these obstacles, the escalation rate of construction prices has reconciled. According to my company’s cost index report, pricing through the second quarter of 2023 is now at an annual escalation rate of 6%, an exponential decrease from what we have previously experienced but still far above what economists desire.
What Lies Ahead
The outlook for projects dependent on outside financing is greatly challenged. In July, the Fed announced—again—the raising of its key short-term interest rate by a quarter percentage point.
With pressures on valuations from increased interest rates, high vacancies in assets like office spaces and tenants’ inability to pay rent, equity and debt investors are waiting on the sidelines to see if valuations are significantly affected. Without financing, projects are under a lot of pressure in the office market due to a lack of demand. This newly introduced valuation tension in speculative distribution and multifamily residential projects creates headwinds for the industry to work through.
Despite these challenges in distribution, multifamily and corporate offices, the need for manufacturing, life sciences, food and beverage, and data center spaces remains strong. This underscores the strong demand for construction workers. According to one analysis, contractors will need to hire an estimated 546,000 workers this year in addition to the normal pace of hiring to support demand.
According to J.P. Morgan, “Global consumer price index (CPI) inflation is on track to slow toward 3.5% in early 2023 after approaching 10% in the second half of 2022.” Reports show hopeful news for continuing to solve supply chain issues. The downside is that bottlenecks, labor shortages and increased labor wages are still concerns for the industry to navigate this year. Additionally, the supply of specific building products remains constrained, and demand is set to continue for items such as electrical gear and mechanical equipment.
Despite the noted downturns in certain segments of the construction industry, I believe the demand for craft labor will continue to outweigh the supply. Large-scale mega-projects will sustain the demand for labor to support manufacturing and mission-critical sectors by exceeding any additional labor available by a downturn in other less mechanical and electrical-intensive market segments.
When navigating the tricky waters of inflation, rate hikes and rising labor costs, leaders should focus on building a robust customer portfolio by strengthening relationships with clients that they envision thriving in the “new” economy.
At the same time, leaders need to be aware of the dangers of building an organization that places an excessive amount of focus on markets that are currently experiencing strong demand. They can accomplish this by positioning their company for what will come after current market conditions have stabilized.
Traditionally, when the Fed raises rates, it cools the labor market and allows companies to pay people less. But that’s not the case today. Businesses built on a model consisting of an endless supply of cheap labor and cheap overseas goods will likely struggle or fold in the months ahead unless they pivot toward valuing what truly matters in the fourth “new normal”: hiring for the skills needed to get the job done.
Business leaders should prioritize flexibility and adaptability in the face of an ongoing labor shortage. With the price of labor rising due to a shrinking, more highly skilled and educated labor pool, business leaders can choose to offer pre-pandemic wages and watch as talent flows to their competitors, or be proactive in the face of this challenge and aggressively add (and compensate) that talent where needed.
The time is also right for organizations to develop robust front-end strategies while adopting a project-execution mindset that meets all of their customers’ needs. This involves developing individuals and selecting them for teams that match their skill sets, as well as providing cross-disciplinary strategic training to promote those employees’ long-term growth.
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