Interest rates, supply chain, buyer preference shaping construction

For the past two-and-a-half years, many conversations have centered around COVID.

While COVID guidelines and regulations may be waning, it's longer-term effect on business sectors still is very much part of the discussion. This is especially true when it comes to the uncertain economic climate for the rest of 2022 and beyond.

One of the biggest sectors in flux is the construction market. With supply chain issues, increased interest rates and a shift in buyer preferences, all segments of the construction industry are tackling substantial issues.

Housing vs. commercial

Both the housing and commercial construction markets are shifting, in large part because of the wants and needs of a post-COVID environment.

"The housing market has grown far more rapidly since the pandemic—remote work has decreased need for office space," said Ed Hudson, director of the Market Research Division of Home Innovation Research Labs. "Construction of homes continues to push further away from urban and high-density suburbs and into outlying, less-populated areas—this was already occurring before COVID, but the pandemic accelerated the movement."

When comparing the Census construction spending figures for June 2022 and June 2021, Kenneth Simonson, chief economist for the Associated General Contractors of America, said that single-family construction was up 8 percent, but that was a big slowdown from the 20 percent or larger year-over-year gains of a few months ago.

Simonson noted that commercial construction is defined in a variety of ways. The monthly Census report on construction spending on projects underway includes retail, warehouse and farm construction, while others count office, hotel, and some include rental housing. The broadest definition treats commercial as synonymous with all nonresidential building or even public works.

"Private nonresidential construction was up 2 percent and multifamily and public construction were flat," he added.

Among the commercial categories, Simonson said growth ranged from 14 percent for warehouse to 6 percent for retail, with office down 1 percent and lodging off 7 percent.

"Going forward, I expect single-family will decline. Infrastructure, manufacturing and power/energy construction will grow strongly," he said, "and various 'commercial' or income-producing categories will hold more or less steady."

The commercial market, in particular, is affected by purchasing habits.

"In commercial construction, we are seeing more conversions from certain types of uses (including office space) to other uses that have grown since the pandemic," Hudson said. "For example, the shift from retail to online buying is causing conversions that add to warehouse/transportation hub space."

Single family vs. multifamily housing

Breaking down the housing construction market even further shows varying segments are fairing differently.

"Monthly data on housing starts, building permits and new-home sales (Census Bureau), existing-home sales (National Association of Realtors), and homebuilders' sentiment (NAHB) all indicate a rapidly cooling market for single-family housing," Simonson said.

Hudson shared a similar sentiment.

"Single-family housing starts and permits have begun to fall due to the higher interest rates, but multifamily remains strong," Hudson said. "Also, the time cycle for multifamily project planning, permitting and construction is much longer than single family, so we should expect some stability here."

Yet, while there can be more stability in the multifamily sector, it still is susceptible to economic conditions.

"At the moment, demand for multifamily construction is holding up better, but that market is also vulnerable to a downturn as the costs of construction and financing risk rising faster than rents," Simonson said.

Post-COVID building trends

In a post-COVID world, buyer preferences have changed substantially on what they are looking for in new construction. There are different requirements home buyers are looking for than they were pre-COVID.

"The COVID-19 pandemic has had three major effects on home buyer preferences, namely increased interest for a home office, a suburban location and exterior amenities such as porches, decks and patios," said Rose Quint, assistant vice president of survey research for the National Association of Home Builders.

Home buyers also are considering where they are living more, with trends of being closer to natural elements a bigger priority than in past years.

"Population has tended to move toward geographic areas that are highly desirable (near shoreline, national parks, etc.) and retirement areas (COVID pushed some into retirement) that may not have been able to sustain employment had remote work not become more common practice," Hudson said.

Hudson shared that Home Innovation Research Labs ran a study in December 2021 that found that 30 percent of builders increased the number of homes with dedicated offices due to the pandemic, and 25 percent said they will continue after the pandemic.

Yet they found home offices and outdoor spaces are not the only factors that go into new construction. Hudson said in that same study, 14 percent of builders said they increased the number of home gyms/workout rooms and 10 percent said they will continue after the pandemic.

"There has been a giant movement in recent years toward tightening the building envelope to improve energy efficiency—which use sealants to achieve," Hudson said.

The interest rate factor

While home buyers are looking for different features for new projects, they also are looking for alternatives to new construction.

"Interest rates have caused new home starts to decline," Hudson said. "As higher rates push people out of buying new homes, these will add to the demand for rental housing until interest rates fall again."

Interest rates are minimizing affordability.

"High interest rates and strong growth in home prices have reduced housing affordability to its lowest level since the Great Recession," Quint said. "As a result, home construction and sales, as well as builder sentiment, have deteriorated significantly in 2022."

Home buyers are not the only ones looking at alternatives.

"Remodeling still remains strong since a much higher share of remodeling is paid from savings," Hudson said. "Many builders and providers of products and services are beginning to look toward home remodeling as a way to sustain business growth."

Simonson said the effect of more remote workers and the use of shared workspaces is in flux.

"More companies are demanding workers return to the office, at least part time, but many workers are refusing," he said.

"Some companies are imposing layoffs, yet overall employment still is rising strongly, and job openings remain high. These cross-cutting trends mean there is a lot of uncertainty about demand for office construction in the future. But for now, there appears to be more spending on renovations than new office construction."

Supply chain

Beyond interest rates and buyer preferences, there is another significant factor affecting construction: the supply chain.

"This is a big topic (that is) impacting construction on so many levels," Hudson said. "Imported goods slowing due to COVID protocols at import facilities, factory closures due to COVID slowed production, and an overall increase in demand for construction materials—and contractors—all played roles in shaping the industry over the past couple of years."

An example of this would be how the slowdown of steel imports caused a shortage of truss plates, Hudson said, which caused floor and roof truss orders to delay for up to six months.

"Builders looked for alternatives, learned to order far in advance, or just build fewer houses," he added. "High cost of materials has builders seeking alternative materials, alternative suppliers which includes looking outside the U.S. for sources."

The supply chain factor continues on, as it is still experiencing disruptions.

"While some items are arriving in a more timely fashion, such as lumber, delivery times continue to worsen for other items," Simonson said. "Still more potential delays are possible as extreme heat and drought in China, the U.S. disrupt power, factory production and river transportation. Strikes among transport workers in the United Kingdom and potentially among rail and West Coast dockworkers in the U.S. add to the uncertainty."

Supply chain disruptions can wreak havoc for a production schedule.

"Double-digit growth in home prices in the last two years is directly linked to increases in building material costs, which have surged over 35 percent since January 2020," Quint said.

Hudson shared that it's not just the cost of materials that are causing issues, but the wait times.

"Cost of materials has not had much impact on rate of home construction—however, lack of availability of materials (long wait times for delivery) has lengthened out average home construction time by two or three months, and caused some builders to reduce number of homes built and definitely increased the cost of housing," according to Hudson.

The overall construction market is facing challenging times ahead as it continues to adapt to higher interest rates, supply chain disruptions and customer preferences for new buildings.

Quint concluded that between the COVID-19 pandemic's effect on home buyer preferences, high interest rates and strong growth in home prices, as well as that growth's effect on building material costs, the housing market has tough times ahead.

"Combined, these signs point to a recession in the housing industry," Quint said. "NAHB is forecasting single-family production will shrink in 2022 for the first time since 2011."