Recession Watch: Why the Next Downturn Will Be Different
Almost all economists and contractors expect some degree of economic slowdown this year, and some have even incorporated a recession into their forecasts. But the key question is: how will this downturn be different? From labor shortages and commodity volatility to rising interest rates, industry leaders shared their observations and response strategies.
Almost all economists and contractors expect some degree of economic slowdown this year. Some have even factored a recession into their current forecasts. But the question on many observers' minds is:How will this downturn be different。
"Our early signs, like most contractors, are that some slowdown is coming, as our projects are being pushed out to later time frames," said George Pfeffer, a member of the management committee at DPR, a commercial general contractor based in Redwood City, California. "We've been through several of these cycles, and I can say there's always something different each time."
Pfeffer pointed to labor shortages and commodity market volatility as key factors. He said,the trajectory of material costsplays a significant role in procurement strategies.
For example, electrical manufacturers and distributors have told DPR that there is currently a $1.5 billion backlog of orders for switchgear—the components needed to power and distribute electricity in projects. As a result, DPR expects shortages of metal receptacles and bus plugs due to high demand, Pfeffer said.
"In terms of new work opportunities, we expect the market to be more challenging," Pfeffer said. "There are a lot of variables now, and we expect these to be clarified in 2023, which may mean clients will delay projects until more certainty emerges."
Learning from history
Looking back at data from past recessions can help understand the current environment.
According to the Associated General Contractors of America (AGC), in the months before the Great Recession, nonresidential construction employment growth averaged 3.3%. This time, in the last seven months of 2022, that figure was about 6.3%.
"In the second half of 2022, nonresidential construction growth was stronger than in the second half of 2007," said Ken Simonson, AGC's chief economist. "At that time, single-family and multifamily construction were both declining, which may have dragged down demand for related retail, street, school, and public safety construction, and other types of nonresidential construction demand were also slowing."
According to the U.S. Bureau of Labor Statistics, the national unemployment rate is also much healthier now than in the months before the Great Recession. In the summer of 2007, unemployment hovered around 4.6%, while just last month, it was about 3.5%.
Construction backlog in November also reached its highest level since the second quarter of 2019,according to Associated Builders and Contractors (ABC), indicating that new projects are still coming online.
"It's hard to imagine the kind of significant unemployment spike seen during the Great Recession," said Jeff Hansen, CEO of Adolfson & Peterson Construction, a general contractor in Minneapolis. "We face labor shortages today, and job creation is still happening. I don't think there will be a major adjustment."
Given these differences, John Fish, CEO of Suffolk, a Boston-based construction contracting firm, said the 2023 recession will have its own unique markers, distinct from past economic downturns.
"Despite rising interest rates and high inflation, the fundamentals of our economy remain strong," Fish said. "We see GDP trending upward, consumer confidence remains high, Americans still have spending power, and employment reports are strong with low unemployment."
The impact of interest rates
Meanwhile, Fish said rate hikes remain a major concern for the construction industry. The Federal Reserve raised its benchmark rate in December to a range of 4.25% to 4.5%, up from 0% to 0.25% at the start of 2022. Additionally, two Fed officials said earlier this month that further hikes could push rates above 5%,Bloomberg reported。
"I often compare our economy to a patient, and the Fed's rate hikes are the medicine given to this patient," Fish said. "From the impact of rates on the housing market, real estate development, and consumer demand, we see signs that the medicine is working. But we must be careful not to overdose."
Too many rate hikes mean fewer construction starts, said Barry Wurzel, president of Wurzel Builders, a general contractor based in Austin, Texas.
"Rates may continue to rise, and there could be some storms over the next six months or more," Wurzel said. "Inflation affects everyone in the chain."
Hansen said the amount of debt in the commercial real estate sector maturing over the next two years, amid rising interest rates, remains a top concern.
"The real impact will be the erosion of investor returns," Hansen said. "The possibility that real estate returns are significantly lower than current interest rates will create a negative leverage effect and affect investors' willingness to hold."
Similarly, the availability of new debt in capital markets will be a primary issue for commercial development, said Turner Burton, president of Hoar Construction, a construction firm headquartered in Birmingham, Alabama.
This makesfinancing for commercial real estate projects more challenging, said Anirban Basu, ABC's chief economist.
Prepare for more supply chain shortages and price increases
Analysts expect material prices to continue rising in the coming years, said Michael Hardman, a vice president at Turner & Townsend, a UK-based global real estate and infrastructure consultancy. Nonresidential construction input prices are still 11.5% higher than a year ago and up 40% since February 2020,according to ABC's analysis。
"What we're seeing today is the continued impact of inflation over the past few years, and it's starting to affect the market," said Derek Cunz, executive vice president at Mortenson, a construction firm based in Minneapolis. "Costs have risen significantly over the past few years, making some deals harder to close."
According to the U.S. Bureau of Labor Statistics, the average inflation rate in 2007 was about 2.8%. In 2022, the average inflation rate was 8%, although the rate has been declining in recent months.
This has also led to higher price tags and uncertainty around accurate budgeting, Burton said. For example, Madison Square Garden Entertainmentraised the price tag for the MSG Sphere project in Las Vegasto nearly $2.18 billion, up from a previous estimate of $2 billion.
Meanwhile, according to ABC's analysis, nonresidential construction input prices fell slightly in November compared to the previous month.
That bodes well for supply chain recovery, said Bert Brandt, managing director of construction for the Americas at Lendlease, an Australian contractor and developer. Still, supply chain markets show signs of different materials moving in different directions, said Richard Kennedy, president and CEO of Skanska USA.
"We're seeing improvements in the supply chain, with improvements in building and structural product lines, while lead times for key mechanical, electrical, and plumbing equipment remain at unprecedented levels," Kennedy said. "Overall price levels remain high, and many major construction indices reported flat fourth quarters, which will be a welcome relief for the industry."
Lessons learned from past recessions
Contractors say the key to staying ahead in 2023 is diversification.
Although some commercial sectors, such as retail and hospitality, will feel the effects of a recession more quickly, this still leaves ample resources for more institutional projects, helping to maintain balance, Burton said. Pfeffer agreed, pointing to healthcare, life sciences, and manufacturing as potential safe havens.
"We need to seek out work that allows us to best overcome skilled labor shortages and commodity market volatility that affects procurement," Pfeffer said. "We're looking at what helped us weather past storms."
Other areas expected to perform well in 2023 include life sciences, data centers, and manufacturing projects, Fish said. Brandt agreed that the life sciences sector should withstand an economic slowdown over the next 12 months. Kennedy also added that infrastructure projects tend to be executed during economic slowdowns.
"A recession is a good reminder to stick to your business strategy and focus on winning work in your core geographic areas and markets," Kennedy said. "Otherwise, you might find yourself taking on projects that are not financially suitable for the business or do not align with the organization's risk appetite."