The wheels of construction turn slowly.
There is plenty of talk these days of whether or not we may slip into another recession. On any given day you can read several articles pointing to why or why not we are headed into another recession. I’m not trying to take a position here. I would like to get a rough idea what would happen to this current construction recovery if we do slip into recession.
A starting baseline for this discussion is my forecast for 2016; total spending up 10%. nonresidential buildings up 14% after a 17% increase in 2016, residential up 12% following 13% in 2015 and non-building infrastructure up 1% for a total less than 2% in 2015-2016. So, you can see I’m not predicting a recession.
If you think of a recession as having an immediate affect on total construction, like a quick drop in materials prices or cost of buildings, think again. Construction is sort of like an aircraft carrier, it takes a long time to turn around.
The best indicator of future construction activity is the projected cash flow generated by all the construction starts that have been recorded. Construction starts represent the beginning of spending on new projects. Projects can take many months to reach completion. Some portion of the total project spending occurs in every month over the full duration of the project from start to completion.
We start 2016 with a backlog of projects that will generate about 70% of all the cash flow in 2016. It’s likely that most if not all of the projects already started would move on to completion. But new starts will be cut back.
To get an idea how another recession might affect construction spending, I kept all backlog as is but I reduced future new construction starts for the next two years (2016 and 2017) by 30% for residential and nonresidential buildings, and 15% for infrastructure projects. This mimics the declines we experienced from 2006 to 2009. I then allowed for a 5% increase across all sectors in 2018.
The result is a 5% drop in construction spending in 2016, still higher than 2014, but then a 10-15% drop in 2017 setting us back to near the same level as 2013.
These spending declines would cause a temporary loss of about 400,000 to 500,000 jobs.
Nonresidential buildings could still eke out a slight gain in 2016 but would drop 20% in 2017. Residential construction would drop about 5% in 2016 and then drop another 10-15% in 2017. Nonresidential infrastructure work would decline 10% in 2016, but then rebound to no change in 2017.
After two years of declines, in 2018 nonresidential buildings would climb back to near even with 2017, residential would grow 5% and infrastructure would remain flat. Total 2018 spending would climb only 2% over 2017 and would still only reach spending in 2013.
So, a 30% decline in activity for two consecutive years starting today would set us back four to five years, but the major affect would not be felt until 2017. If that were to happen, obviously spending would be revised, but also I would have much different predictions for inflation and jobs.
There’s a reason we see the dips and rises on the chart in both 2016 and 2017. It reflects the decline in the rate of new starts plus the remainder of old backlog finishing at varying end-dates. Also, given a constant amount of seasonally adjusted new starts, there is a difference in the actual amount of starts in winter months vs summer months. This plays out over time as dips and rises in spending. Spending activity will not be smooth in a recession.