This analysis attempts to develop the resulting impact of a construction recession scenario caused by the current Covid-19 pandemic. The scenario presented does not assume a catastrophic failure of the U.S. economy, but does assume a large drop in construction activity in 2020 and 2021.
This analysis generates spending cash flows from current and assumed reduced new construction starts to then determine how spending may affect future construction activity.
Impact of Pandemic on Construction
Analysis of a Recession Scenario 2020-2022
by Ed Zarenski 3-20-20
The change around us is happening so fast, in my opinion, no one is ready for what comes next.
The world is struggling to get the upper hand in a pandemic, travel is coming to a near halt, stock markets are down 30% in a month, universities have sent students home, schools and businesses are closed until further notice, events all around the country are being canceled and people are being instructed to stay home and limit social contact.
We won’t get the first hard data of Coronavirus impacts on the construction industry spending and jobs until reports released in first week in May which will cover jobs mid-March thru mid-Apr and spending for March. The first hint at what we might expect regarding slowdown could be the Dodge construction starts for March which comes out around Apr 20. But spending and jobs from work in backlog coming out in the May reports could be better 1st indicator.
Firms that manufacture goods used in construction may be closed temporarily, so they are producing less. Shipping of products on world markets has slowed or stopped completely. Materials supplies will soon be affected. Construction projects will most likely experience delays. Product shortages, delivery delays and shutdowns will drive up costs and extend project schedules.
Projects in planning may be canceled due to drop in demand, decline in capital or slowdown in economy. Retail stores may cancel expansion, educational facilities may delay starting new construction, transportation facilities may postpone later phases of long planned growth.
As I sit here writing this, the city of Boston this morning announced that ALL non-essential construction projects are to shut down today. That’s nearly all projects. Boston accounts for $22 billion/year in construction spending, 80% of all construction in the state of Massachusetts, 60% of all work in MA-CT-RI, 50% of all New England. This affects well over 100,000 jobs.
Also, the San Francisco Bay area has been directed to shelter-in-place, essentially shutting down all nonessential construction work. This impacts approximately 200,000 construction jobs and amounts to about double the volume of work as Boston.
We can expect more locations to issue directives such as these in the near future.
How Can We Measure the Effects Due to Covid-19 Impacts?
Let’s first establish the baseline. The starting baseline is my current construction spending and backlog forecast for 2020-2021 which includes 2019 total spending and new construction starts through February. There is considerable strength in Nonresidential Buildings and Non-building Infrastructure starts and spending. There is weakness in residential.
The best indicator of future construction activity is the sum of the projected monthly cash flows generated by all the construction starts that have been recorded.
This plot shows the correlation between projected cash flow from starts and actual spending.
Recession What If? Starting Baseline
To begin, we can look at the current forecast of new starts, backlog and spending.
Construction Starts in 2018 were up 4% and prior to that were up 10%/yr. 2019 starts including revisions are up 4%. 2020 starts are forecast down 4%. Current Backlog is up 30% in the last 4 years, at all-time high. Although spending is forecast up only 4%/yr. the next two years, spending is at an all-time high.
Residential construction starts peaked in 2018. Starts in 2019 are level yoy, but have been flat or in moderate decline since mid-2018. Spending is forecast up 5% in 2020 but down 1% in 2021.
Nonresidential Buildings starting backlog increased 10%/year for the 4 years 2017-2020. Starts have moved sideways or in slight decline since mid-2018. 2019 starts are down 9% from 2018. Spending is forecast up 3% in 2020 and 2021.
Infrastructure starting backlog, by far the most robust, has increased 15%/year for the 3 years 2018-2020. Spending is forecast up 6% in 2020 and up 8% in 2021.
It is important to understand when spending from backlog occurs. Average cash flow curves for nonresidential work show about 15%-20% of spending from new starts occurs in the year started and about 40%-50% occurs the following year. 80% of all nonresidential spending in any given year is from backlog. If new starts drop by 10%, that has only a 1.5% to 2% impact on total spending in the first year. The following year spending would be down 4% to 5%.
Residential spending is far more dependent on new starts than backlog. Only about 30% of residential spending comes from backlog and 70% from new starts. If residential new starts drop 10% that impacts total spending by 7% in that year.
When a recession occurs, new construction starts would be substantially reduced. Although some projects will be canceled or delayed mid-schedule, most projects already in construction would move on to completion. Most of the cut back comes from a reduction in new starts.
In the great recession, residential starts dropped 70% from 2005 to 2009, down from $400 billion to $110 billion. Nonresidential Buildings starts dropped 35% from 2008 to 2010. Nonbuilding starts fell only 6% in 2009. Total All Spending declined 30% from $1.160 trillion in 2006 to $788 billion in 2011.
Regardless what may lead to a construction recession, in this case a global pandemic, it is the current high amount of work in backlog that will work hard to mute its effect.
No analyst had been indicating huge declines in new construction starts within the next few years. At worst, some suggested a moderate slowdown. Prior to today, data seemed to agree with a moderate slowdown.
Although Dodge is forecasting the $ value of housing starts down 6% in 2020, Housing Starts # of units as reported by US Census in Q4 2019 are at a post-recession high, reducing the likelihood of such a decline.
Dodge 2020 forecast for new nonresidential buildings starts is down 2.5%.
This recession scenario does not assume a catastrophic failure of the economy.
It is unknown how much existing or new work might get canceled. To get an idea how a recession might impact construction spending, this analysis reduces new construction starts by 20% in 2020 and 10% in 2021 from the baseline. That’s about the average of what occurred in the great recession, although then it was far greater in residential and much less in non-building infrastructure. Only once in the last 20 years, other than the great recession, did new construction starts drop more than 5% in any sector in a year.
So initially, compared to the baseline forecast, there would be 20% less work to bid on in 2020 and 10% less in 2021. But that is not how spending, or revenues, would react. Backlog and spending schedule curves determine the impact on spending, or revenues.
Here’s the resulting change in the spending plots. Only the estimated spending to the right of the dateline changes.
Residential construction spending would drop about 14% in 2020 and then drop 13% in 2021 below the baseline scenario. Residential is far more dependent on new starts within the year for spending than on backlog. That’s why residential spending drops quicker than all other work.
Nonresidential Buildings spending ends 2020 4% lower than it would have under the baseline scenario but then drops 12% in 2021 and 10% in 2022. Backlog going into 2020 in this sector is strong and therefore, even though spending is 4% lower than baseline, 2020 still posts a spending gain of 1.5%. 2021 declines 8% and 2022 gains 1%.
Non-building Infrastructure spending ends 2020 3% lower than it would have under the baseline scenario but then drops 9% in 2021 and 10% in 2022. Non-building Infrastructure has so much work in backlog that this sector still posts a spending gain of 6% in 2020 and 1% in 2021. It declines by 2% in 2022.
The major declines in 2020 are residential since most residential spending comes from new starts within the year, but for all other work, the strength of backlog going into 2020 pushes most of the declines out to 2021 and 2022.
Total all spending would drop from the current 2020 forecast of $1.365 trillion to $1.260 trillion. In 2021 and 2022, instead of baseline spending of $1,370 trillion, it would drop to $1.230, back to the level of 2016. The losses in the Great Recession, a total drop of almost $400 billion, set construction spending growth back 12 years.
Not only did Boston shut down non-essential construction projects but also New York and California have done the same. Boston accounts for about $20 billion/year in construction spending, but NY and CA together account for about $280 billion. Let’s assume CA and NY and Boston shut down all but critically essential construction for 1 month. Let’s say that is 80% of all construction. That represents a shutdown of $20 billion of construction in one month’s time.
The difference with temporary shutdowns vs a reduction in new starts is that work shut down is delayed. It will reduce total spending in that month in 2020 but will shift the entire schedule of spending out by some number of months. Upon resuming, some will still occur in 2020, and some very likely gets pushed into 2021 or later, but eventually all of the delayed work will get completed. If 20% of all U.S. construction shut down for one month it would delay $25 billion worth of work by one month. If 20% of all 2020 U.S. construction new starts get canceled, it would reduce future workload by $250 billion, spread over the next three years.
The magnitude of spending declines would impact the jobs situation. History shows that job declines of the same magnitude do not follow immediately with volume declines, therefore we would not see an equivalent reduction in workforce in 2020. But spending declines in 2021 and 2022 could lead to a loss of about 500,000 to 750,000 jobs. Over the course of the great recession we lost 2.3 million jobs.
This is a WHAT IF? Analysis.
Assumption that new construction starts drop 20% in 2020 and 10% in 2021 lower than the baseline forecast.
This would cause total construction spending to drop 8% in 2020, 12% in 2021 and 7% in 2022 from the previously established baseline forecast.
The spending declines measured in dollars, measured from the previously established baseline forecast, are: down $100 billion in 2020, down $140 billion in 2021 and down $100 billion in 2022.
This could lead to a loss of about 500,000 to 750,000 jobs for three years.
What this will do to the construction inflation rate is hard to predict. Typically when work volume decreases the bidding environment gets more competitive and prices go down. However, if materials shortages develop, that would cause prices to increase. Add to these issues the fact that almost every project currently under construction may be halted for a period of time, the delays may add several weeks to perhaps a month or two to the overall schedule. I think in this case the materials availability issues and schedule delays will outweigh any decline in work available for bid. I would add a minimum of 1% to all baseline inflation rates for 2020 and 2021.
“None of us have much of a sense what the economy will be in 2021.” Fed Chair Jerome Powell 12-11-19