July 2023 AIA Consensus Construction Forecast

A surge in 2023, followed by slower gains in 2024

Spending on nonresidential buildings has been growing at a torrid pace so far this year. Even with the expected moderation during the second half of the year, the AIA Consensus Construction Forecast Panel is projecting that spending will increase by just under 20% for the year. That pace of growth hasn’t been seen since the construction boom years leading up to the Great Recession. Leading the charge is the manufacturing sector, where spending is projected to increase more than 50% this year on top of an exceptional performance last year. And while industrial construction spending is expected to be the bright light, healthy gains are expected across the board, with both the commercial and institutional construction categories projected to increase at a double-digit pace.

However, after the surge this year, market spending growth is expected to come back to earth in 2024. Forecast panelists are calling for a modest 2% increase in overall building spending next year, with a projected modest decline in the commercial sector, a 4% increase in spending on institutional facilities and even just a 5% increase in the currently red-hot industrial sector.

View interactive data from the Consensus Construction Forecast

The inflation fight continues

Though spending on nonresidential buildings increased by more than 10% last year, once inflation in the inputs to construction are factored in, the real increase in construction activity was much lower. Inflation in construction costs continues to be an issue, though it has moderated significantly in recent months. Overall inflation in the economy has dropped dramatically over the past year, from over 9% compared to year-ago levels in mid-2022 to around 4% at present. However, the Federal Reserve Board’s battle on the inflation front is far from over as further declines will be much more difficult to realize.

The same is true for construction costs. Though following a similar pattern to overall consumer price inflation, they have been even more extreme. While the annual increase in the CPI never hit double digits this cycle, the increase in producer prices for construction inputs was in excess of 20% from mid-2021 through the spring of 2022. Recently, year-over-year changes in prices of key construction inputs have turned negative, due to the volatility of some construction commodities and the elevated comparisons from a year ago. Prices for lumber and plywood as well as steel mill products are below where they were a year ago. Both had seen dramatic spikes in prices earlier in the pandemic. While construction commodity prices are likely to remain volatile moving forward, some will fall while others rise, keeping overall commodity input costs to construction in a much narrower range.

Salaries and services costs are a different story. While commodity pricing has been volatile, construction wages have been slowly creeping up, and are now about 6% above year-ago level. The same is true for architecture and engineering services provided to the construction sector, but to a lesser degree. The prices of all of these inputs will be harder to reverse since compensation and other costs of service providers tend to change only very slowly.

Manufacturing sets the pace for the commercial/industrial sector

Within the expected strong performance in building activity in 2023 lies an unusual amount of projected variability by construction sector. Stronger future commercial/industrial categories are expected to include manufacturing, distribution, and hotels. On the institutional side, healthcare and education are expected to perform well.

The strong growth in spending on manufacturing facilities is largely attributed to the reshoring of production resulting from supply chain nightmares during the pandemic. Indeed, the pandemic did encourage many producers to shift some of their activity to domestic sources, but much of the growth

was due to other motivations. Last year, a third of industrial construction was related to computer, electrical and electronic equipment, while over a quarter was for chemical facilities.

There are emerging concerns that outsourcing the manufacturing of high-tech products leaves our economy and national defense more vulnerable. The $280 billion in funding provided by the 2022 federal CHIPS and Science Act is designed to advance domestic research and manufacturing of semiconductors in the United States. These funds will boost spending for these facilities for much of the coming decade.

The growth in chemical manufacturing facilities likewise is only marginally related to reshoring activities. Pharmaceuticals account for a sizeable share of production in this sector, but plastics have recently come to dominate this category. Growth in manufacturing facilities here has more to do with the recent growth in domestic gas and oil production in the U.S., and the competitive advantage of producing plastics from these inputs domestically rather than shipping the oil and gas to foreign markets for the production of these products.

Distribution facilities have helped generate growth in an otherwise weak retail sector. Last year, warehouses accounted for 58% of construction spending in the broader retail and other commercial category. Retail facilities accounted for only 12%, while food and beverage facilities accounted for 9%. Spending on warehouses increased 26% last year, pulling up the broader sector.

However, moving forward, growth in spending on distribution facilities is expected to moderate. The growth in e-commerce activity has slowed since the pandemic, and spending will increasingly be focused on automating existing facilities rather than building new ones.

Due to a dramatic reduction in both business and leisure travel during the pandemic, the hotel construction market was one of the most decimated sectors. Construction spending on hotels declined 15% nationally in 2020, and another 33% in 2021 before making a modest recovery of just under 4% in 2022. The Smith Travel Group reports that key metrics for the hotel industry have steadied and are beginning to improve. The daily average occupancy rate has stabilized at just under 65%, while the revenue per available room has increased almost 4% over the past year. As a result, the AIA Consensus Forecast panel is projecting a 24% increase in construction spending on hotels this year, and an additional 7% in 2024.

Institutional markets exhibit traditional stability

Institutional construction sectors tend to be more stable across the construction cycle, with smaller losses during downturns and smaller gains during expansionary periods. Within this broader pattern, however, the two largest institutional building sectors have seen surprisingly strong growth so far in 2023. Through May, spending on healthcare facilities has increased almost 14% from year-ago levels, while spending on educational facilities is up over 6%.

Healthcare has been one of the few building sectors that continued to see gains during the pandemic. While utilization rates increased during the pandemic, more fundamentally, national demographics point to continued gains in health care spending as the aging baby boom generation will ensure a continued increase in spending on health care services. The AIA Consensus Forecast Panel is projecting spending growth in excess of 10% for healthcare facilities this year, and an additional 3% in 2024.

Unlike healthcare, spending on education facilities declined during the pandemic as remote education reduced the need for the expected renovation and expansion of educational facilities. ConstructConnect reports that the value of construction starts for junior high and high school facilities increased 20% through the first five months of this year, college and university facilities starts are up 14%, while preschool and elementary facilities have increased 9%. While the pace of growth in this sector is expected to slow just a bit over the remainder of the year, the AIA Consensus Forecast panel expects spending in the educational construction sector to increase 10.5% for the year, and another 4.3% next year.

The impending slowdown

The first half of this year has seen gains in construction spending on nonresidential buildings approaching 20%. However, this scorching growth rate is expected to moderate a bit moving into the 3rd and 4th quarters. Even with the easing in supply chain issues and the improved pricing of many construction materials and products, elevated interest rates, more restrictive lending on the part of banks, nervousness over the direction of the economy, and construction labor constraints are expected to slow the pace of growth.

We have already seen design work at architecture firms ease over the past year. In the first half of 2022, the AIA/Deltek Architecture Billings Index averaged an impressive 53.6, suggesting strong growth in design activity. By the third quarter the average index score declined to 51.7, and for the fourth quarter it dropped to 48.1, pointing to a modest decline in design activity nationally. So far in 2023, monthly scores have remained below 50 on average, pointing to continued softness in design activity. Given its normal 9–12-month lead over construction spending, that suggests that spending gains should begin to moderate around now and begin to decline monthly in the third or fourth quarter of this year.