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Construction Industry Insight | Winter 2018


This document focuses on a number of topics that affect the construction industry as a whole, including President Trump’s influence on the industry, the impact of the president’s tariffs on infrastructure costs, expectations for the construction industry in 2019, and prospects for green building over the next 3 years. It also includes a brief summary of trends in used equipment values.

Trump Reaches Midterm: Where are We and What’s Next for the Construction Industry: Donald Trump has been in office a little over two years and his election has had a pronounced effect on the economy. The Dow Jones broke 26,000 points for the first time, the U.S. gross domestic product grew at a hearty 3.5% rate during the third quarter of 2018, and the jobless rate in September was 3.7%, the lowest in almost 50 years. Americans are optimistic that this job growth and economic expansion will continue, as the consumer confidence index is at its highest level since September 2000. With this optimism comes robust demand for construction. However, a number of signs are emerging to suggest that an economic slowdown may be coming. Recent losses across U.S. markets have been prompted by concerns about impending interest rate hikes by the Federal Reserve, U.S.-China trade tensions, and other factors. Several forecasts actually anticipate a recession coming in 2020. Some of the policies with the greatest impact on the construction industry, and the risks that could add to current business and labor challenges are as follows:

Tax cuts and deregulation. The recent economic expansion has been fueled in part by President Trump’s Tax Cuts and Jobs Act, which includes a decrease in the federal corporate income tax rate from 35% to 21%. This has been particularly impactful for small companies as 98% of all construction companies employ less than 100 people. The change in tax structure allows more companies to hire additional people, give them more rewards, and purchase new equipment, thereby investing in the growth of their business.

Infrastructure. Following the midterm elections, both Democrats and Republicans expressed optimism that a bipartisan agreement on infrastructure could be reached. While it appears that infrastructure is something that both parties want to get done, the question is how are we going to find the trillion dollars needed and who will determine how it gets spent? Nobody wants to see other programs they care about cut and there hasn’t been enough sentiment for a new revenue source to back Trump’s proposed $1.5 trillion in infrastructure improvements. The president’s plan calls for $200 billion in direct federal investment, with state and local governments partnering with the private sector to make up the rest of the balance. Some lawmakers have also suggested a federal gas tax, but as yet, there has been no consensus on a funding source.

Spending and trade. Federal stimulus in the form of infrastructure investment may become critical as other forms of fiscal stimulus fizzle out. Although the $1.3 trillion omnibus spending bill passed in March may be enough to drive the economy for another eight months, the longer the expansion, the more exposed we become to existing risks. A primary risk involves the trade tensions between the U.S. and China. Contractors have been feeling the pain of tariffs in the way of higher material costs, and even if tariffs remain at the same levels, this pain will likely worsen. Another risk is the growing federal budget deficit. The government is expected to borrow about $1 trillion next year to make up for the decrease in tax revenue that came with the tax cuts. The rising deficit and debt, now up to $21.8 trillion dollars, will inevitably lead to higher interest rates. We can only hope that both parties will pay attention to holding down the deficit.

Labor. During the past year, U.S. employers added an average of 210,000 jobs a month, but even with unemployment at a 3.7% low, labor shortages in the construction industry are not letting up. In a recent survey of 2,500 construction professionals conducted by Associated General Contractors, 80% of respondents said they are struggling to fill hourly craft positions, while 56% reported difficulty filling salaried positions. To address the shortage, the construction and manufacturing industries have been working with the president to “rebrand” these careers. The president signed the Strengthening Career and Technical Education for the 21st Century Act in July, providing $1.2 billion to states to promote secondary and post-secondary training for jobs that do not require a four-year degree. Considering that the vast majority of construction firms employ less than 100 and account for 67% of all construction, individuals entering the trades could be looking at a pathway to business ownership.

Infrastructure Construction Costs Being Driven Up by Tariffs: Bloomberg Businessweek recently reported that the price tag for a potential $1 trillion-plus U.S. infrastructure program could increase by millions when adding in the extra costs of President Trump’s tariffs. For example, in an analysis of the Environmental Protection Agency’s (EPA) cleanup of the Lower Rouge River in Detroit, Michigan, Bloomberg found that the cost of the $10 million bulkhead wall component of the $63.6 million project had increased by $1.3 million because of the president’s 25% tariff on steel imports from China. While the EPA and its project partner Honeywell International are absorbing about half of the increase, taxpayers will ultimately pay for the government’s share, which could come out of the budgets for other projects. This scenario could also play out among future projects, limiting the scope of a possible nationwide infrastructure program. Other projects that have reportedly been affected by the tariffs include the $3.6 billion Hampton roads bridge and tunnel expansion, the $1.5 billion to $2.1 billion Los Angeles-area Metro Gold light-rail project, and a $135 million wastewater treatment plant in Utah.

The Wall Street Journal recently reported that the Trump administration might be willing to make some compromises in order to seal a deal with Democrats for the type of massive infrastructure program that failed to get off the ground last year. Some insiders believe the president would even reconsider requiring local governments to foot 80% of the cost of their projects, and would be willing to increase the $200 billion limit he had placed on the federal share. The president might also be willing to reconsider his position on the $13 billion Hudson River tunnel project between New Jersey and New York City, part of Amtrak’s $30 billion Gateway program of upgrades to the Northeast megalopolis’ rail infrastructure. After a recent meeting with the president and Transportation Secretary Elaine Chao, New York Governor Andrew Cuomo said the president was considering “next steps” toward funding after seeing how damaged the aging tunnel is, particularly after Superstorm Sandy. Cuomo said he and the president discussed the possibility of tackling the project using a public-private partnership, a turnaround from the president’s resistance to honor a reported deal President Obama’s administration had made with Amtrak, New York and New Jersey to pay for half the cost of a new tunnel.

Construction Momentum Expected to Remain Strong in 2019: Anirban Basu, chief economist for Associated Builders and Contractors (ABC), believes the construction industry can expect another strong year in 2019. However, beyond that it is uncertain how factors like inflation, the labor shortage, tariffs and immigration policy will affect momentum. In addition to job growth, favorable tax laws and increased infrastructure spending, another plus for contractors is the Conference Board’s Leading Economic Index, which has continued to climb, meaning that the market’s current upward trajectory is expected to continue for at least two or three more quarters. In addition, the American Institute of Architects’ Architecture Billings Index recently registered a reading of more than 50, indicating increased future construction activity, and the ABC’s Construction Backlog Indicator, which points to the amount of work that commercial and industrial contractors have lined up, has seen record levels in 2018. Looking ahead, potential obstacles for contractors include rising interest rates, increasing material prices, a shortage of skilled workers as evidenced by record low construction unemployment, and a volatile stock market. While these factors do not necessarily point to a recession after next year, contractors should be wary as the outlook for conditions beyond 2019 remain cloudy.

The continued labor shortage, along with President Trump’s steel and aluminum tariffs, have been the two issues this year with the most potential to affect contractors. According to a report from the Wall Street Journal, the 25% tariff that the president imposed this year on foreign steel imported into the U.S. has resulted in higher prices overall but has not reduced the level of imports. Domestic steel producers have raised their prices to narrow the gap between themselves and duty-heavy foreign manufacturers, and U.S. companies are planning to spend some of that extra cash on expansion. Currently, domestic steel companies meet a little less than 80% of the U.S. demand. In addition, while contractors have managed to complete projects with a limited pool of craft workers, the supply of skilled labor is expected to continue to thin out in 2019. At a recent Dodge & Data Analytics conference, Ken Simonson, chief economist for the Associated General Contractors of America, told those in attendance that contractors would have to learn to live with it because it will continue to get more difficult to find workers in 2019.

Half of Construction Industry Expects Majority of Projects to be Green in 3 Years: Dodge Data & Analytics recently conducted a survey of more than 2,000 industry professionals in 86 countries and found that 47% expect more than 60% of their projects to be green by the year 2021. In the U.S., those anticipating a shift to mostly green projects increased from a current 32% to 45%. The top reasons given for going green were to meet client demands (34%), comply with environmental regulations (33%), and social reasons, such as the drive to “do what’s right” by producing healthier buildings (27%). Of all the social factors presented in the survey, the improved health and wellbeing of building occupants was by far the most important. Although green building activity is expected to increase, not all professionals who plan to go mostly green intend to pursue certification through a third-party program. Even so, more than 66% of those that do certify their projects believe that the process results in better-performing buildings. On a global basis, new commercial construction, followed by new institutional construction, was the top sector for green building. Those surveyed also noted that the top obstacles to green building are actual and perceived first costs, lack of political support or incentives, affordability, lack of public awareness, and lack of market demand.

Trends in Used Equipment Values
Although the financial recovery has been steady, it has recently slowed and a final bill related to the President’s infrastructure plan has yet to materialize. As a result, contractors continue to be reluctant to make large capital expenditures for new equipment designed to meet updated emissions regulations or to lock into long-term leases. In Irontrax opinion, this has had a positive impact on both the rental and used construction equipment markets.

Increasing construction activities coupled with rising government initiatives on infrastructure spending are boosting the growth of the construction equipment rental market, and furthering the consolidation of equipment rental companies. According to a 2018 report issued by Grand View Research, Inc., from 2017 to 2025 the global construction equipment rental market is expected to exhibit a 4.8% compound annual growth rate and reach $230 billion. On the consolidation front, United Rentals, the largest equipment rental company in the world, recently completed its previously announced acquisition of BlueLine Rental for approximately $2.1 billion in cash. The current preference to rent rather than own construction equipment reflects certain advantages, including reduced costs associated with operation, transportation, and servicing requirements. In addition, renting construction equipment is a feasible option for businesses with limited budgets, and is preferred by construction companies that require the equipment for only a specified period of time. Lastly, rental companies perform appropriate tests and inspections on rental equipment, thus improving the safety aspect.

Notwithstanding the current popularity of the equipment rental market, Irontrax believes the market for sales of used heavy equipment continues to be stable. In some cases, equipment in good condition and with lower hours of service is being priced at a premium, while prices for equipment in lessor condition with higher service hours are falling off. In either case, the age of the equipment is not always a critical factor in determining its value. Assuming the economy continues to be stable, it is also our opinion that the overall pricing of new equipment will continue to increase as a result of escalating production costs. Other factors that could contribute to the strength of the used equipment market include the continued increase in lead times for new equipment, additional spending that comes about in connection with President Trump’s Infrastructure Plan, and the anticipated number of energy projects coming back on line. At the same time, we realize that the recent collapse in oil prices could adversely impact the prices of equipment such as cranes used in energy sector.