Why Construction Spending Matters

Did you hear the news about construction spending?  If so, were you surprised? 

The recent report by the Commerce Department did come as a surprise to many who have been eagerly watching for signs of a sustained recovery in the real estate industry. Construction spending dropped 0.9 percent to an annual rate of $834.4 billion; this was the biggest decline in a while. In an earlier survey by Reuters, economists expected construction spending to rise by 0.4% again.

The July construction report, released on Tuesday, showed total private residential construction spending fell by 1.6%, even though new single- and multi-family home building increased by 1.5% and 2.8%, respectively.  According to the Wall Street Journal, spending to fix up existing structures fell 5.5% in July. On the other hand, spending on public sector construction fell by 0.4 percent while expenditure on federal government projects fell 1.3 percent. This was a drop for a second straight month.

Why does construction spending matter?  The construction industry is one of the first to go into a recession when the economy declines and likewise it is the first to recover as conditions improve.   Hence, it is considered a ‘leading indicator’ in the world of economic data.  Think groundhog day, and the notion of whether the groundhog sees a shadow or not.  So, construction spending provides insights or clues, for the sleuths in the bunch, about what is coming ahead….like coming attractions when you go to the movie theatre.  Unlike the simplicity of groundhog day, construction data is not immediately reported and it is best to view the data over a period of time, aka trend or moving average, than as a point in time.  Therefore, a three to six month moving average is best suited to determine trends.

Additionally, construction spending represents approximately 20 percent of the gross domestic product (GDP) of The United States of America, making it an important source of information about the economic health of our country.   In short, real estate matters!  You could think about GDP roughly similar to taking your temperature.  There is a number or range of numbers which indicate your temperature is in the ‘healthy range’ and then there are numbers that are outside of that temperature range which indicate you’re not healthy.  Right now, GDP is outside of the healthy range but consistently moving back towards the healthy range.

The most important question to ask: “Is there spending on construction?”  The emphatic answer is YES.  Yes, there is spending on construction.  The close behind follow up questions then are: “How much construction spending is there?” And “is that amount of spending the same amount, more or less than the prior month, prior three months?”  The amount of spending is currently at more than $800 billion on an annual basis.  That is not a shabby number by any stretch.

Nonetheless, there are worries that the ‘trend’ of construction spending could dampen recent optimism that the economy is improving.  The good news is that spending on new residential construction continued to go up in July, which is echoes other signals that the housing sector could be improving.

 Michael Hobbs, PahRoo Appraisal & Consultancy

 Twitter @Pahroo

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