Between June and December of 2008, steel prices fell 40 percent. In fact, throughout what would be the worst economic decline since the Great Depression, the cost of construction materials generally fell across the board. Will we see a similar situation with the pandemic-induced recession? And if so, who are the opportunists that will be able to benefit?
Fast forward to this year, where the prices for raw steel have been increasing since April as China—the producer of nearly two-thirds of the world’s steel—reopened and committed to more construction jobs. Thus far, those increases have not been passed on to manufactured steel products such as steel pipe, which are still trending down. Plummeting oil prices have also driven down construction materials costs—both in terms of shipping and manufacturing of petroleum-based materials such as asphalt and plastic fasteners.
Labor costs are another story. In a union town like Chicago, collectively bargained wages are really one of the only increases that contractors should expect to see in the near term. However, Steve Wiley, senior vice president, preconstruction at McHugh Construction Co., believes that even those increases will be offset and absorbed by hyper-competitive contractors and subcontractors.
“I think it’s definitely going to be a buyer’s market for owners and developers,” Wiley said, “assuming that they are able to either fund their project out of CapEx or secure financing for it.”
Many owners and developers will be closely gauging both the effects of dropping materials costs on pro formas as well as the capital markets to see if they’re able to make a play. Some will opt to just sit out the next few months until the economy levels off. While Wiley is aware of some projects that have seen their funding commitments put on hold, there are a number of developers out there that remain confident they can secure financing—or that already have capital reserves—and are ready to deploy those funds while material costs are low.
“Pre-construction activity has been unaffected. In fact, it’s probably accelerated,” said Wiley. “We’re seeing a tremendous amount of budget requests come through our pre-con department, and not just one time. Developers are recycling the same project through pre-construction and watching for reductions in pricing.”
One counterintuitive sector to watch for construction activity in the coming quarters is hospitality. It’s true that hotels have been absolutely walloped by the pandemic’s effects on travel, but that reduced foot traffic can have one upside. Because of the costs associated with business interruption, necessary site improvements are often deferred. Right now, as there is no business to interrupt, some hotels may take on renovation projects.
A lot of this is speculation, however, as 2020 is not the same as 2008. Both years saw economic crashes following unforeseen events, but the horizon for recovery is a lot foggier now than it was 12 years ago.
“The previous slowdown had different driving forces,” Wiley said. “There was more of a predictable behavior to that downturn and therefore more of a predictable recovery.”
The genesis for the 2008-2009 recession was the U.S. housing market; when that bubble burst, it had diminishing impacts radiating out to financial institutions, multinational firms, and the global economy. This current crisis—which is still in its infancy—also has global impacts, but financial experts are trying to gauge the damage in real time.
Their error bars could be far apart, however, as there are just too many unknowns right now. One near certainty is that there will be future, hyper-local outbreaks. Until we have a better understanding of COVID-19 and how to treat it, the duration of this particular recession cannot be predicted.
That said, once construction activity does pick back up, it will occur at different rates in different markets.
“I think the Chicago construction market is going to be affected more negatively than some of the higher growth cities,” said Wiley. “For example, Austin, Nashville and other very hot construction markets will be affected, but not as significantly as Chicago will.”
For general contractors and subcontractors, the next year will be fraught with uncertain opportunities. The increased competition for work will lead to slimmer margins and many firms taking on a project at minimal or zero profit, just to keep their people going and maintain resources. This type of gamble is unsustainable, however; many firms, subcontractors in particular, are likely to see failures and defaults in the next year.
The inscrutability of the coming months does not necessarily lend to more bad news. A vaccine or other therapeutic treatments for COVID-19 might materialize sooner than anyone expected. If that were to happen, shovel-ready projects would break ground almost immediately and, oddly enough, those that were banking on reduced construction costs could see those futures evaporate.