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Outlook: Construction to ‘Disappoint’

Friday, May 15, 2015

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CHICAGO—The good news: Roads and bridges will see greater investment than other nonresidential sectors in the years ahead.

The bad news: That's not saying much. And it will still be far less than roads and bridges need.

Overall, nonresidential construction spending in the next decade is "likely to disappoint," with a "diminished need for new construction in many key sectors" and significantly lower growth than other reports have forecast, according to a new analysis by investment research firm Morningstar.

construction spending forecast
© / levkr

"While we see pockets of strength, we expect far lower total growth than most and a permanently lower nonresidential construction share of GDP. This might sound negative for the economy overall, but we view it as a positive," the report says.

Recent outlooks, mostly from the construction industry, have forecast nonresidential growth in the high single digits or low double digits.

Not Morningstar, whose independent research informs fund investing.

Its new 132-page U.S. Nonresidential Construction Outlook foresees just seven percent overall growth this year, as post-recession pent-up demand is unleashed, and only four percent annually after that through 2024.

'Pockets of Strength'

"While we see pockets of strength, we expect far lower total growth than most and a permanently lower nonresidential construction share of GDP," the report says.

The strongest growth is expected in manufacturing, commercial, highway and street and health care. Modest contributions will come from the education, office and power sectors.

The firm sees five themes defining nonresidential construction for the next decade:

  • Doing more with less;
  • Building for more seniors and fewer children;
  • Residential recovery begetting nonresidential recovery;
  • Final absorption of pre-recession overbuild; and
  • Slower, but continuing, shale construction boom.
Ruhrfisch / CC BY-SA 3.0

The shale boom from Pennsylvania's Marcellus and other shale formations is expected to continue, but slow, over the next decade, according to Morningstar.

Report co-author Kristoffer Inton says the admittedly "bearish outlook" is not all bad news. "This might sound negative for the economy overall, but we view it as a positive," Inton wrote in Morningstar's Stock Analyst Notes.

That is because the efficiencies that must emerge in tighter times will ultimately better serve the industry and the economy, he says.

Funding Roads and Bridges

The report is relatively upbeat on road and bridge spending, which is forecast to grow by about five percent per year, to $136 billion, through 2024.

"Our bullish outlook for highway and street construction spending is anchored in our belief that the government will increase spending to stem the tide of deteriorating conditions," the report said. The year 2014 represented peak spending levels for the sector.


While the analysts expect seven percent spending growth this year as pent-up demand is released, followed by four percent average annual growth through 2024.

"Yet," the report adds, "spending has clearly remained below adequate levels, as road quality across the entire system has deteriorated over the past decade.

Moreover, "looking at spending levels alone hides the meaningful underinvestment for road and bridges that led to deteriorating systemwide conditions."

Beyond 'Low-Hanging Fruit'

Recent road and bridge spending has been targeted at the most critical projects, "minimizing the impact of the overall decay in the average citizen’s view," Morningstar says.

"However, we think this strategy is unsustainable. With the lowest-hanging fruit addressed, we expect future projects to have diminishing returns in terms of overall system improvement."

Any increased spending in the years ahead will go "for only the maintenance, not the improvement, of current road conditions."

A government commitment to "improve systemwide quality" would improve the spending forecast, but that is unlikely, "given the difficulty in finding enough funding to even maintain current conditions," the report says.

Morningstart pavement and bridge building

"[W]e believe the government will find a way to stabilize funding, given continued road decay and strong bipartisan support," Morningstar analysts say.

Based on 2012 data, the report estimates that just 14 percent of pavement dollars and six percent of bridge dollars are spent on new construction.

Seeking Stable Funding

Given the uncertainty of long-term funding, "true improvement" is unlikely. "However, we believe the government will find a way to stabilize funding, given continued road decay and strong bipartisan support," the analysts say.

Current funding methods could provide $327 billion of net tax receipts for the Highway Trust Fund, but it would face a "significant" shortfall and would require $267 billion in total additional funds from 2015 to 2024.

The report offered these outlooks in other sectors.

Rail & Transit: Slower Growth

Transportation construction is forecast to grow at about four percent per year through 2024, to $62.8 billion—a "modest" deceleration from the last decade's five percent growth. Most growth will be driven by rail and mass transit, following urbanization trends.

© / jmoor17

Construction and maintenance of railroads, airports and mass transit systems make up about 70 percent of the total construction spending for the transportation segment.

Transportation spending accounted for about seven percent of U.S. nonresidential construction spending last year. About 70 percent of that involved railroads, airports and mass transit systems.

Power: Steady Course

"Unlike most other sectors, construction spending for power felt no ill effects from the Great Recession" and reached an all-time high of $101 billion in 2014, Morningstar reports. Power plant construction has been pushed by low natural-gas prices and environmental regulation.

However, spending is expected to slow after 2015, growing only about 2 percent per year through 2024.

Manufacturing: Renaissance AWOL

After growing nine percent annually over the last decade, manufacturing construction will slow to about six percent annual growth through 2024, reaching $103 billion, the report says.

Spending on chemical plants, using cheap U.S. shale, will be the primary driver. Nevertheless, the "long-awaited U.S. manufacturing renaissance continues to be elusive and a relatively insignificant driver of our outlook," the report said.

Water: Replacement Time

Water infrastructure spending will need to increase by five percent annually over the decade, to $60 billlion in 2024, to replace old pipes that are operating beyond design and to accomodate population growth, the report estimates.

With many of residential water systems nearing 100 years old, it said, unscheduled maintenance and emergency repairs are proving more costly than replacements.


Tagged categories: Bridges; Chemical Plants; Construction; Funding; Government contracts; Market forecasts; Mass transit; North America; Power; Program/Project Management; Rail; Roads/Highways

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