The U.S. construction market is steady and growing slightly amid the second longest period of sustained economic expansion since 1964. Despite fears of an impending slowdown, FMI Research projects that construction put-in-place will increase year-over-year by slightly less than 1 percent in 2019 (down from 3 percent in 2018).

The industry is weighed down by the residential and multi-family construction segment, but bolstered by near-full employment, wage improvement and strong non-building structure growth. Infrastructure construction spending — particularly related to transportation (e.g., airport, mass transit, railroad, water ports) and nonbuilding structure construction (e.g., power, highway, water, sewer) — has also contributed to 2019 growth.

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Significant investment across the power, water and sewer segments is necessitated by the demands of a growing population. The Census Bureau projects that the population will reach ~350 million by 2030.1 Positive macroeconomic trends also reinforce the need for such investment to support the corresponding growth in commercial and industrial sectors. The demand for utility services (i.e., electric, natural gas and water) has outpaced current capacity, and the aging infrastructure already in place has become increasingly unreliable. Going forward, significant opportunity exists for industry operators specializing in underground pipeline construction services to replace existing infrastructure amid heightened regulatory scrutiny. Conversely, those contractors with significant exposure to the new-build markets may need to look internally to ensure they are prepared with a variable cost structure and strong backlog to weather a slowdown in the growth of single-family homes.

Economists are citing two major reasons for the potential decline in residential construction. The Fannie Mae Economic and Strategic Research Group has suggested that rising federal funds rate by the Federal Reserve is having a detrimental impact on willingness to buy. As the cost of borrowing increases, it is more difficult for a buyer to meet the expectations of a seller for the value of a home. While the Federal Reserve is executing relatively conservative rate hikes, the increased cost of debt is nonetheless impactful to the housing market. The second primary concern is the population growth in the United States. According to Bill Conerly, a Forbes contributor, housing is built to accommodate new residents and, in particular, new families. The United States population growth in 2018 was the lowest since 1937 and a “new normal” of average housing starts is likely between 1.1 to 1.2 million versus the 1.5 million that the market grew accustomed to. FMI Research projects that single family put-in-place will slow growth in 2019 and that both multifamily and residential improvements will experience a decline resulting in a stagnant residential construction market.

The communication construction segment (up 3 percent year-over-year) is experiencing tailwinds as 5G implementation moves from engineering into the field. Deloitte estimates that $130 billion to $150 billion of fiber infrastructure investment will be needed over the next five to seven years to “support broadband competition, rural coverage and wireless densification.”2 The emergence of 5G wireless technologies marks the next great shift in telecom infrastructure (i.e., from wireline to fiber). Without the far-reaching densification of deep fiber, “carriers will be unable to support the projected four-fold increase in mobile data traffic between 2016-2021.”3 Multi-year initiatives led by telecom service providers will create fiber installation, small cell deployment and on-going maintenance contract opportunities for those operators with the requisite fiber construction capabilities.

Even with these pressures, a slowdown is all that is expected in the current market. Income and hours continue to rise, U.S. home prices are up almost 5 percent over the year prior and the supply and demand appear to be close to neutral. For those with significant residential exposure, we view this as a period to take a breath and make some important decisions within one’s organization to improve through any pause in the market. That includes making hard performance and personnel decisions, refining strategy for long-term success and, most importantly, maintaining a healthy balance sheet by avoiding overextension on new or larger projects.

The impact of the current administration on the construction industry is also worth mentioning. Pro-business policies and reduced regulatory requirements have increased speed to build in some areas of the economy, but tariffs have increased the cost of materials and little is expected to be done with a divided White House and Congress.

Industry Spotlight — Water/Wastewater

The water and wastewater segments will play a critical role in growing utility-related construction through the forecast period. FMI Research projects that both segments, taken together, will grow at an annualized rate of ~5 percent from 2019E-2023F. While water and wastewater construction spend is not expected to rise to the level of industry highs recorded in 2008 (just prior to the residential construction collapse), it is expected to come close by the end of the forecast period. Demand in both segments will be driven by the replacement of aging infrastructure, population growth, residential and utility construction and state and local government spending. In addition, the opportunity for on-going, lower-margin (but less cyclical) maintenance work will grow as additional capacity is installed.

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While per capita water consumption is expected to decrease as a result of greater conservation measures taken in response to higher usage rates (approved by Public Utility Commissions to fund infrastructure improvements), any corresponding decrease in water supply demand will be offset by the incremental downstream needs of a growing population and increasing commercial and industrial activity. In addition, the adverse effects of numerous natural disasters — including hurricanes and wildfires — continue to place additional stress on an already-strained water supply.

Reliability risks associated with aging water and sewer pipeline infrastructure are the primary reasons for investment. The renewal rate for water utilities is expected to increase sharply in response to recent EPA guidance. They will implement section 401 of the Clean Water Act to promote the building of pipelines to ensure Americans have clean water for drinking. In addition, guidance related to accelerated replacement of asbestos cement pipe will encourage spending at the state and local level. The EPA is providing billions in funding for some of these projects and combining them with WIFIA loans to create powerful financing solutions for major infrastructure projects.

The Water Infrastructure Act of 2018 provided some much-needed federal support in the near-term. The new law authorizes $3.7 billion for new Army Corps of Engineers projects and $4.4 billion for drinking-water projects. It also reauthorizes the Water Infrastructure Finance and Innovation Act (the WIFIA) at $50 million and the Drinking Water State Revolving Fund (DWSR) at ~$4.4 billion. These funds can be utilized for loans, loan guarantees, bond insurance and project refinancing.

While this is certainly a positive development for the industry on its face, it remains a far cry from the influx of capital that organizations like the American Water Works Association believe is needed — especially considering the current administration’s expectation that local water utilities become self-sufficient over time as a result of increasing deregulation. Information from the American Society of Civil Engineers suggests that by 2020 44 percent of U.S. water pipe will be classified as poor, very poor or life elapsed. Because of this, 20 percent of treated water is lost each year. There is a critical need for multi-decade investment and improvement of the U.S. water system.

Sewage and Waste Disposal

Sewage and Waste Diposal

  • Passage of America’s Water Infrastructure Act in late 2018 and reauthorization of the Water Infrastructure Finance and

  • Innovation Act (WIFIA) provide a substantial boost in funding

    Residental needs and technology advancements will drive overall demand

Drivers: Population, industrial production, government spending

Water Supply

Water Supply

  • Passage of America’s Water Infrastructure Act in late 2018 and reauthorization of the Water Infrastructure Finance and

  • Innovation Act (WIFIA) provide a substantial boost in funding

    Recent introduction of the Water Quality Protection and Jobs Creation Act of 2019 further supports ongoing clean water supply infrastructure spending

Drivers: Population, industrial production, government spending

Dan Shumate is a managing director and Jay Bowman is a principal at FMI Capital Advisors.