Here’s a headline published recently.
“Construction spending rose year-over-year during first 9 months of 2015”
What they really meant to say
“Construction STARTS rose year-over-year during first 9 months of 2015”
Why make a big deal out of this. Well, here’s an example. The brief states “nonbuilding work climbed 35%” during the first nine months of 2015 compared to same months 2014. TRUE, if we look at new construction STARTS, but construction spending for non building work is down 2.5% during the first 8 months of 2015 vs 2014 (Sept spending won’t be available until November 2nd).
Construction starts help us understand where future spending is headed. Construction spending is based on how much is occurring this month from all the projects that started in the previous 12 to 30 months.
Let’s use an example to understand new construction starts vs construction spending:
All the nonresidential building projects that start in a given month have a schedule duration of 20 months.
The total starts in this month is $60 billion.
Over a duration of 20 months they will average a put-in-place construction spending of 60/20 = $3 billion a month. Spending follows a typical bell curve, starts out slow, gets real strong in the middle and finishes slow. The spending cash flow from these new starts will begin slowly at a rate of perhaps $1 to $2 billion/month, it will peak in about 10 to 12 months at perhaps $4-5 bil/mo, and then will taper to the finish again at about $1-2bil/mo. It will take 20 months to spend this $60 billion in new starts from this single month.
The point here is this: Current spending is based on the last 2 to 3 years of starts. New starts will generate the next 2 to 3 years of spending. Don’t get the two confused. Big increases in new starts is not telling us how much spending is going on right now, it’s telling us how much spending to expect in the future. And to get the real picture of what to expect in the future we need to look at the cumulative cash flow that occurs in any given future month from all the previous starts that are still ongoing. Furthermore, the construction starts values that are published every month represent a sampling of new construction activity, approximately 50% to 60% of total construction activity. While the total reported construction starts for a year might be $500 to $600 billion, the total spending in that year will be more like $1.0 to $1.1 trillion.