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Residential Activity Supports Construction

RFP
Construction spending came in at a seasonally adjusted annualized rate of $1.4 trillion in September, about flat compared to August. Gains were led by private residential construction for the fourth month in a row; private residential construction is now 3% higher than February levels and 10% higher than September 2019. Private nonresidential and public construction spending have not regained their pre-pandemic pace and are currently down 6.4% and down 3.8% compared to February levels, respectively.

Private residential construction, supported by both single-family and multifamily construction spending in September, is up 3% compared to August levels. Single-family construction has been on a tear, with strong demand from low mortgage rates; the supply of existing homes is nowhere near what is needed. This activity is being driven by those with higher wage jobs who didn’t suffer employment or wage losses due to COVID. We could see a slowdown as the year comes to a close and the recession metastasizes into a prolonged recession.

Pending home sales came in 2.2% below August levels; all regions except the Northeast recorded lower sales. Momentum is slowing, even though pending sales are still higher for 2020 compared to 2019.

Multifamily construction has been trailing the single-family market but multifamily permits started to climb in September, signaling that some regions of the country, mainly the suburban markets orbiting big cities, are experiencing increased activity in the rental sector. With many workers continuing to work from home well into 2021, the constraints of a long commute are negligible so people are searching for space and quiet. It is too soon to tell if this trend will become permanent as long as the appeal of a big city remains muted, with theaters, restaurants and bars closed into 2021.

Private nonresidential construction, down 1.5% in September and off 6% compared to a year ago, has fallen for two straight months. Almost every component of nonresidential construction posted losses in September, with the exception of religious structures and offices. Some workers started to return to the office around Labor Day but the return has been slow and not without setbacks. The latest wave of the virus threatens further return to office spaces at least for the rest of the year. With only about a quarter of the workforce that initially worked from home back in the office in October, many office spaces and the business districts around them will continue to suffer steep revenue drops in the fourth quarter. That in turn will translate into large tax revenue losses for those cities.

According to the Federal Reserve’s Beige Book, commercial construction activity remained weak in October, with the exception of warehouse and industrial space construction (especially cold storage). Many regions noted supply shortages and climbing costs for materials and labor contributing to the slowdown. Lead times have been rising, while some costs have been passed onto customers.

Retail bankruptcies have slowed slightly since their summer peak, but many retailers are still on the brink. As we enter the holiday season with another wave of the virus threatening to slow retail activity and celebrations, many are bracing for another wave of bankruptcies. Others are hanging on to see if one more holiday season can help them; look for another wave of bankruptcies come January when returns start flooding in. Two mall owners have already filed for bankruptcy; rent relief provided to their tenants did not include mortgage or tax relief for them. According to one report, up to 17% of existing malls may need to be redeveloped.

Public spending, down 1.7% compared to the previous month, recorded losses in almost all categories. State and local government spending, the largest component of public spending, was down 1.2%; states have begun to cut spending due to significant budget gaps caused by COVID-19. Spending on highways and streets, hospitals, public parks, transportation, power, water, conservation and development were all down.

Spending on primary and secondary education (K-12) was up 4.5% as kids returned to school and additional investment was needed to make schools safe. Spending on higher education was down 2.2% on the month and down almost 23% compared to a year ago. Higher education investment may be depressed for years to come; enrollment for undergraduate programs is down 4% compared to last year and graduate enrollment down 2.7%. International student enrollment has been falling since 2016; in 2019 the number of student visas issued was down 43% compared to the peak in 2015. According to the National Association of International Educators, U.S. private and public colleges and universities are set to lose around $3 billion from the loss of international students alone. Many of those students have decided to forego their American education altogether, rather than just deferring a year like many American freshmen.

Bottom Line
The economy is still in a COVID-sized hole. The outlook for the fourth quarter looks bleak as the prospect of fiscal aid has plummeted. The bright spots of single-family housing added to warehouse and industrial construction can only carry the economy so far into the fourth quarter. There is a risk that growth in the fourth quarter could be flat or even go negative.

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