Keeping the Hardhats On
It should come as no surprise that 2020 was a unique year in the construction industry. With strict lockdown mandates, remote working, and fear of virus infection, the country experienced a shock that rippled through the economy. News of the pandemic and realization of its potential impacts arrived at the end of the first quarter. Examining construction expectations following the news may give insight into the reaction and recovery of the industry.
How much of an impact did the pandemic have on each of the major construction sectors? Which asset classes, if any, were resilient? How long will the recovery process take? What does the future look like in a post-COVID world across all asset classes? These are the questions that many investors and developers continue to face as the industry emerges from this remarkable challenge. This article will review sector performance and examine the construction perception changes throughout the evolution of the pandemic.
Construction Starts Forecasts
The following five sections examine the construction expectations as they changed each quarter through 2020. ConstructConnect is a pre-construction project management platform that reports US Construction Starts Forecasts quarterly. From only a hint of the pandemic to the peak restrictive mandates, construction expectations adjusted.
Each column of the upcoming charts represents the full-year construction expectation as of the specified quarter. The expected level in the first quarter indicates the general market conditions coming from the previous year. The year 2020 started with a general expectation of a slight increase in construction from the previous year — the construction industry was expanding. Second-quarter shows full uncertainty of the market immediately following the announced restrictions. The patterns show the nature of the sector during a market shock combined with the response time required to alter construction. These reactions may give some insight into each sector’s resilience as markets face future challenges.
- High initial projection for the year with $88.5 billion in anticipated construction starts
- Projections fell sharply by $33 billion due to the COVID-19 shock
- Projections rebounded quickly by $14.9 during 3Q 2020
- Little changed after midyear with actual starts falling between the 3Q and 4Q forecasts
Multi-family apartments gained significant popularity over the past couple of years and 2020 was projected to slightly outperform the previous year in construction starts. The first quarter projection of $88.5 billion was $700 million higher than the actual 2019 starts. However, this expectation quickly changed when the pandemic was announced in March. The 2Q 2020 forecast set the multi-family sector’s total construction starts for the year to decline to $55.4 billion. This is the lowest projection of multi-family starts since the Global Financial Crisis. Several factors led to this low projection including remote working restrictions, the shutdown of public amenities, and the desire for more living space.
The growing trend of small living spaces combined with elaborate common areas completely reversed. Work-from-home restrictions also reduced demand for multi-family housing since the restrictions allowed many residents to move further away from the urban offices. Additionally, with the shutdown of “non-essential” businesses, such as restaurants, bars, sports arenas, concert venues, etc., many tenants lost their desire to live in the heart of downtown. Tenants realized the opportunity to move out of expensive major metro areas to take advantage of lower rental rates and additional space in less dense locations. Ultimately, these factors caused a troubling uncertainty as investors were skeptical about the recovery of multi-family property and the economy overall.
As the year progressed into 3Q 2020, fear began to fade as businesses, offices, and amenities reopened with limited access and under specific protocols. ConstructConnect’s data reflects this response with construction start projections increasing to $73.1 billion by the 4Q forecast. Furthermore, a Multi-family outlook by CBRE suggests the trend of outmigration to other less dense metros is temporary and that the multi-family sector will recover to pre-COVID levels by mid-2022. However, since 30-60% of offices are transitioning to remote work and suburban living becomes increasingly available, CBRE expects the urban market will experience a longer recovery process than the less expensive, lower-density suburban market.
- Low projection from the start of the year at $14.8 billion
- Gradual decrease in expectations over 2Q, 3Q, and 4Q
- Actual starts of $11.6 billion were lower than any projection
At the beginning of the year, retail building starts were projected at $14.8 billion, the lowest level among all sectors according to ConstructConnect. This seemed to be a reasonable projection since, during the past three years, retail construction activity had been on a gradual decline due to the rising popularity of online shopping. In response to this trend, retail companies began to adopt new strategies by creating a more innovative and convenient shopping experience including combining online and physical store shopping.
The shift from physical to digital shopping disrupted the brick-and-mortar retail business model for a couple of years prior to 2020. Construction starts declined from 2018 to 2019 and were projected to decline further during 2020. The onset of the COVID-19 pandemic in 2Q 2020 exacerbated this trend.
Stay-at-home restrictions, stringent business restrictions, and customer anxiety caused retail stores across the country to close. Although there was a surge in e-commerce sales, annual total retail sales grew by only 0.4%. This was the lowest growth rate since the Global Financial Crisis, according to a Retail Outlook by CBRE. Additionally, S&P Global Market Intelligence recorded 52 retail companies filing for bankruptcy last year, which was the highest number since 2009. Accordingly, investors and developers seem to remain cautious about retail investments as revealed by the continued decline in construction projections throughout 2020. The actual recorded construction starts for 2020 totaled $11.6 billion, lower than any of the quarterly expectations.
- 1Q 2020 projection was $19.6 billion
- Steep decline to $10.5 billion (lowest projection among all sectors) in 2Q 2020
- Slight increase in projections to $12.8 in 3Q 2020
- Actual starts of $10.2 billion (lowest among all sectors)
The hotel sector was the most dramatically affected sector by the 2020 pandemic. In 1Q, hotel construction activity was projected to be $19.6 billion for the year. The onset of the pandemic at the end of the second quarter drove forecasted construction starts down by more than 46% to $10.5 billion. There seemed to be a slight increase in construction start projections in 3Q but expectations dropped to $10.2 Billion in 4Q.
According to a Hotel Outlook by CBRE, COVID-related factors including fear of infection, lockdown mandates, and reduced business travel caused the dramatic downturn in demand for the hotel industry. Occupancy rates ranged between 50% and 70% during February prior to the widespread acknowledgment of the virus in March. By April, occupancy rates fell to 15%, according to CBRE. Gradually throughout the year occupancy partially recovered to a range of 30% to 50%. Construction recovery is expected to be a slow process for the hotel sector. According to ConstructConnect, it is not expected to reach pre-COVID levels until 2024. CBRE suggests that the hotel industry will not make a full recovery until group and business travel resumes their previous levels.
- High projection of $34.3 billion starts at the beginning of the year
- Dramatic drop in expectations to $23 billion in 2Q 2020
- Projections continue to decline in 3Q 2020
- Actual annual starts recover to 2Q 2020 projection of $23 billion
Office buildings experienced a sharp decline in construction activity during 2020. Forecasted office starts fell from $34.2 billion in 1Q to $20.1 Billion in 3Q. Actual construction starts of $23.1 billion exceeded the most conservative 3Q expectation but only by $3 billion. Data suggests that there is likely to be considerable office market scarring over the medium term from the pandemic. According to ConstructConnect, office starts are expected to decline again in 2021 and new construction is not expected to reach its pre-COVID projections ($34 billion) until 2025. Furthermore, CBRE research expects that office will be the slowest sector to recover to pre-pandemic investment volumes.
Investors are still uncertain about the space demand for tenants in a post-COVID world as the new trend of hybrid remote working continues to gain popularity. CBRE suggests that remote working could cut the overall need for office spaces by 15%. Compounding the effect, some popular CEOs are publicly stating that they expect more flexible work arrangements for the near future. Consequently, expected demand for office space is highly uncertain as firms are currently able to operate with less physical space.
Despite the uncertainty around office usage, Class A office space could see increasing demand as tenants consider employee health. According to CBRE, “Occupiers are increasingly demanding flexible space options, shared meeting space, indoor air quality, connected building apps, and touchless technology when considering new leases.”
- Surprisingly, warehouse starts were on a declining trend since 2018
- Unlike all other sectors, its lowest forecast for construction starts was in the first quarter
- Projections increased in 2Q 2020, the only sector to do so
- 3Q 2020 and 4Q 2020 experienced elevating projections
- Actual starts equaled $22.9 billion, an increase of $5 billion from the 1Q 2020 projection
The warehouse sector had very different expectations from all other sectors during 2020. It was the only sector to show continuous increases in forecasts from quarter to quarter. In 1Q, 2020 warehouse project starts were forecasted to be $17.9 billion. Warehouse buildings did not experience a decline in projected construction activity in 2Q but rather an increase in projected activity. Projections continued to rise as 2020 progressed and finished with actual starts reaching $22.9 billion.
Measures taken to deal with the pandemic, including forcing people to isolate, negatively affected most commercial property. However, these actions brought about a spike in demand for delivered goods and food. The resulting increase in e-commerce accelerated the move from retail space to warehouse space. Warehouse construction activity accelerated in response. CBRE research suggests that new industrial completions will increase by 29% during 2021. ConstructConnect data also shows increased completions in the future.