Every year brings new challenges in the construction industry, and 2022 is no exception. COVID-19 has been with us for over two years, and decisions made by governments and businesses in the early stages of the pandemic are still affecting markets today – and will be for some time.
When we talk to companies in the industry, including OEMs, distributors and contractors, we hear from each sector what excites them about the industry as well as what keeps them awake at night. Many industry executives are optimistic and expect further growth in non-residential space for the remainder of 2022. However, with so much economic uncertainty, there is still a certain level of caution. Below is a current industry overview and common themes that companies will continue to see through 2022.
The state of the industry in 2022
The passing of the $1 trillion infrastructure legislation in November will provide a generous boost for increased spending in the non-residential business sector in 2022 and beyond. Although the legislation spells out the funds for the works, most of them are not ‘ready-made’ and it takes a considerable amount of time to plan, tender and prepare for the start of the works. Prior to its passage, many states had drawn up project lists with their respective transportation departments, but lacked the funds to complete much of the necessary work; this bill will contribute to that. Larger projects, such as rail, will take much more time and planning and this work will span many years.
The Architectural Billings Index (ABI), an economic indicator of non-residential construction activity, has been used in the construction industry for over 20 years and has a 9-12 month lag time. The ABI ended 2021 at 52, which generally signifies a positive exit as any reading above 50 indicates growth. At the start of 2022, we saw a slight decline to 51, but it rebounded in March and April with improved scores of 58 and 56. There is speculation that these increases may reflect an urgency to beat the continued rises in interest rate from the Federal Reserve.
Another metric used by industry experts is the Dodge Momentum Index.1, a monthly report on non-residential construction projects being planned, which showed that construction spending topped non-residential buildings for a full year. The index had an exceptional year 2021, increasing by 23% compared to 2020 and reaching levels not seen for almost 14 years. The index fell 7% in January 2022, then rebounded with increases of 4% in February and March, followed by a 6% increase in April. Rising interest rates and continued increases in material prices may have an effect on possible uptrends throughout 2022 – this is something to watch.
According to an analysis of government data completed by the Associated General Contractors of America (AGC), prices for building materials jumped 20.3% from January 2021 to January 2022. The Construction Producer Price Index new non-residential, which is defined as prices charged by producers of goods and providers of services, also rose 20.8% over the past 12 months. Steel, timber, cement and copper prices continue to rise in 2022, and many expect them to continue to rise throughout the year due to construction activities and of the Russian-Ukrainian conflict.
Although the effects of COVID-19 have been difficult for businesses, there have been some positive changes. To support the growing demand for projects, companies are building new warehouses and distribution centers. Additionally, more and more businesses are turning to e-commerce, resulting in the construction of data centers to provide the appropriate bandwidth for online business activity.
Supply chain issues will persist for some time, as many still depend on foreign products, but this challenge has sparked multiple discussions about increasing production of goods and products in the United States.
Rising interest rates
The markets have benefited from extremely low interest rates for many years. The Federal Reserve’s monetary policy is now in focus, with most financial institutions expecting four more rate hikes in 2022; three have already taken place in March, May and June. After the recent June meeting and the 75 basis point hike, the Fed said it would use all the tools at its disposal to bring inflation down. In a report to Congress this week, the Fed said it would launch a full effort to bring down inflationary pressures that are unfolding at their fastest pace in 40 years. A tool used by the Fed, the Dot Plot, shows the midpoint, which now stands at 3.375%, indicates that the Fed expects a total of 175 basis points of additional rate hikes to be appropriate over the four meetings. balances of the FOMC in 2022.
WF Securities expects the FOMC to raise rates an additional 275 basis points by the start of 2023. Specifically, it expects the committee to raise rates an additional 225 basis points by the end of the year. (ie 75 basis points in July and 50 basis points at each meeting in September, November and December). They are also looking for 50 basis points of additional rate hikes in early 2023, which would bring the upper end of the target range for the fed funds rate to 4.50%.
The sharp rise in inflation made these multiple rate increases necessary. It’s important for the Fed to watch rates so that inflation doesn’t get too wild, while also not raising rates too quickly, to avoid pushing the economy into a recession. It is a delicate balance, but very essential. President Powell recently said he believes the Fed can control inflation and prevent the United States from entering a recession, although many analysts believe the United States is heading for a mild recession in 2023.
Higher interest rates have a huge effect on the construction industry, as contractors are capital-intensive businesses and can own 20 to several hundred pieces of equipment, depending on the size of the business. The cost of a piece of construction equipment can range from $150,000 to $1 million for larger, more complex units. The overall cost of financing the equipment they need can have a major effect on the profitability of the business. In these circumstances, most will seek to pass on increased costs in future tenders and in other areas of their business.
Distributors often use a combination of variable rate lines of credit and fixed rate loans to finance their inventory and rental fleets. These rate increases will make it more expensive for them to run their business and they will seek to pass on these increased costs in the form of higher rental rates and higher selling prices, which we have seen happen this year.
OEMs often offer grant dollars to lower interest rates for both their distributors and contract customers, which helps sell their equipment faster and competes with OEMs that have a captive finance company. With the higher rates, their cost to redeem those interest rates will also increase, and they will have to decide if they want to continue to offer the same dollars as before the increase (and be less profitable), or pay the same amount. subsidy and offer a slightly higher rate to their customers. It’s never an easy decision and market competition can impact decisions.
Supply chain disruptions
Supply chain disruptions created by COVID-19 are making it difficult for OEMs to manufacture the equipment their distributors need to sell, and difficult for their distributors to get the equipment their contract customers want. to buy. Recent discussions and guidance from OEMs indicate that supply chain challenges, labor issues, chip shortages and rising raw material prices could take nine to 12 months to resolve. This could delay OEM manufacturing output until late 2022 or early 2023, and they may not meet current market needs. As some health experts warn of a new surge of COVID-19, OEMs will also have to decide how quickly and by how much to ramp up production, as a downturn in the future could negatively affect them.
Distributors must be creative in meeting their customers’ needs, such as selling units from their rental fleets that they might never have considered, taking advantage of full equipment depreciation rental fleet as part of the 2017 tax law changes. However, this could create tax issues at a later date.
In addition to selling equipment from their rental fleets, many distributors also buy equipment from contractors, negotiate with other dealers, and go to auctions. Most try to do whatever it takes to keep their customers from having to travel to another dealership for their contractor‘s needs.
Many contractors find that due to the lack of availability of new and used construction equipment, they need to reassess current inventory to ensure they have the equipment needed for the job and to limit costs. We’ve seen a shift in contractors choosing to buy equipment rather than lease it because their monthly payments are similar to, or even lower than, their monthly lease payments. As rates begin to rise, the cost of financing equipment will once again become more expensive than leasing, and you will see it come down.
As we have seen so far in 2022, this has brought both opportunities and challenges to the construction industry. Despite the above, the industry is in the midst of another year of strong growth and is essential to the foundation of our country.
Wells Fargo Equipment Finance produces a 46-year-old annual construction industry forecast. To download the full report, you can go here.
About the Author: Peter Gregory is senior vice president of Wells Fargo Equipment Finance, the equipment financing and leasing arm of Wells Fargo Bank. Based in Atlanta, Georgia, he is the National Director of the Builder and Construction Dealer Services Group. His team provides manufacturers and their distributors with loan and lease solutions for their inventory and rental equipment fleet financing needs in the United States. Gregory has held a variety of positions during his 33 year career in construction equipment financing. Prior to Wells Fargo, he held increasingly senior leadership roles at CitiCapital Commercial and GE Capital Solutions.
1Dodge Data & Analytics, by Dodge Construction Network, https://www.construction.com/news//DMI-April-2022