The construction business can be a bit like sailing – sometimes you have the wind at your back and moving forward is effortless, but conditions can shift suddenly.

Such is the July 2024 AIA Consensus Construction Forecast which shows construction projects “running before the wind” for the remainder of the year, but then beware the doldrums with a slowdown projected in 2025.

“Spending on nonresidential buildings is projected to increase over 7 percent this year, but then slow to only 2 percent growth next year. Commercial facilities activity effectively will be flat this year and next, manufacturing construction will increase almost 14 percent this year before stabilizing in 2025, and institutional construction will see a more than 10% gain this year before slowing to 4 percent in 2025,” says the American Institute of Architects (AIA) midyear projects construction spending update.

Performance Has Varied Greatly by Sector This Year

Despite the healthy nonresidential building market growth in 2024, the AIA says that performance has varied greatly by sector.

“The commercial sector has seen declines year-to-date as compared to the same period a year ago, while spending on manufacturing facilities has seen strong growth and most institutional sectors have seen reasonably healthy gains,” says the AIA.

The following sectors had positive news, according to the AIA report:

• On the commercial/industrial side, a few key sectors have been generating strong growth while others are stagnating. For example, manufacturing construction currently accounts for well over a quarter of all spending in the nonresidential building sector, a share that has doubled since 2019.
  
  
• Embedded in the generally weak retail and other commercial sector is warehouses, which account for over 9 percent of spending in the broader nonresidential building category (up from 6 percent in 2019).
  
  
• Data centers are categorized within the broader office sector. While traditional office spending has been declining, spending on data centers has been rapidly increasing. Commerce Department figures peg data center spending as accounting for over 3 percent of the overall nonresidential building market, and its share has doubled since 2019.
  
  

“In total, these three niche commercial/industrial construction sectors currently account for over 40 percent of the nonresidential building market, up modestly from their 39 percent share last year,” said the AIA report. “In 2019, these three sectors accounted for less than 23% of overall nonresidential building activity. As a result, these construction sectors that typically have a different design focus, materials composition, and contractor specialization now account for much of the gain that the industry has seen recently. That would suggest that some segments of the industry have benefited from the strong growth in these sectors, while others have been passed over.”

Three Market Challenges that Could Lead to a Slowdown

The AIA report highlighted three market challenges that may lead to the projected slowdown next year in construction.

“Indications of a continued slowdown include a challenging lending market for construction projects, continued weakness in commercial property values, and ongoing softness in billings at architecture firms,” said the AIA report.

Here’s a close look at all three:

• Challenging Lending Market for Construction Projects: When the lending market for construction projects becomes challenging, it means that banks and other financial institutions are more hesitant to provide loans for new construction or renovation projects. This can be due to various factors such as higher interest rates, stricter lending criteria, or economic uncertainty. As a result:
  • Developers and construction companies may find it harder to secure financing for new projects.
  • Existing projects might face delays or cancellations due to funding issues.
  • The overall number of new construction projects may decrease.

• Continued Weakness in Commercial Property Values: When commercial property values are weak, it suggests that the demand for commercial real estate is low or declining. This can have several implications:
  • Investors may be less likely to fund new commercial construction projects due to lower expected returns.
  • Existing commercial property owners might postpone renovations or expansions.
  • There may be less incentive to develop new commercial properties.

• Ongoing Softness in Billings at Architecture Firms: Architectural billings are often seen as a leading indicator for construction activity. When architectural firms experience soft or declining billings, it suggests:
  • Fewer new projects are being designed and planned.
  • There's less demand for architectural services, which typically precedes actual construction work.
  • The pipeline of future construction projects may be smaller than usual.

Reading the Tea Leaves: 10-Year T-Bills, MSCI Commercial Property Price Index & ABI

The AIA says all three "market challenges" boxes above are being checked heading into 2025 including:

• Yields on 10-year treasury bills, typically used as a proxy for construction financing costs, are currently running between 4.25 percent and 4.5 percent. While not dramatically different from the levels of the past few decades, they have risen significantly from levels seen in recent years. During the summer of 2020, yields hit a low for this cycle at just over 0.5 percent. They stayed below 1 percent through early 2021, and below 2 percent through early 2022.
  
  
• MSCI’s Commercial Property Price Index indicates a 13.5 percent overall decline in commercial property values since its most recent high in midyear 2022.
  
  
• Architecture firm revenue is a very accurate leading indicator of construction spending with a 9-to-12-month lead. Quarterly billings at architecture firms have been declining since the fourth quarter of 2022, according to the AIA/Deltek Architecture Billings Index (ABI).
  
  

Institutional Sectors to Help Offset Weak Commercial Markets

The AIA report says that double-digit spending growth in industrial facilities this year will help offset a weak commercial market which shows very modest growth going forward and possible declines in spending next year.

Most of the institutional sectors offer more potential in terms of growth in the near term according to the AIA Consensus Forecast panelists:

• The overall sector is projected to increase almost 11 percent this year, and then record another 4 percent increase next year.
  
  
• Healthcare construction, a significant institutional sector, has seen growth throughout the pandemic, and is poised for a 7 percent gain this year, and an additional 4 percent next.
  
  
• Amusement and recreation, a sector that understandably saw little activity during the pandemic, is now poised for a double-digit percentage rebound this year, and an additional 4 percent increase in 2025. 
  
  

“However, expectations are that much of the projected growth in the overall institutional sector will be generated by the education market. Education is the largest institutional component, and accounts for almost one in every five dollars spent on nonresidential building construction,” said the AIA.

Finally, it should be noted that half of the billings at architecture firms come from work on existing buildings, including additions to existing facilities.

“The current economic environment of declining values of existing buildings coupled with the elevated cost of building new facilities often tilts the scales toward reconstruction over new construction. The expectation is that the reconstruction share of total construction activity will continue to increase in the years ahead,” concluded the report.