Building and construction will, like other industries, experience decreased demand during the COVID-19 crisis. However, the decline is not expected to be evenly spread, and there will be sectors experiencing relative resiliency.
- New construction is expected to drop considerably in 2020, but given the shortage of residential units going into the crisis, the decline is not expected to be a sustained period of low activity.
- Repair and remodeling (R&R) is expected to outperform new construction, and within R&R, “small ticket” items are expected to outperform the “big ticket” items, leading to some benefit for channels that focus on those items (e.g., retail and ecommerce).
- Commercial construction is experiencing disruption and a downturn. However, performance is expected to vary between sectors that experience little impact beyond 2020 (e.g., data centers) and sectors that experience high short-term impact and uncertain recovery beyond 2020 (e.g., retail).
As in other industries, stakeholders in the building and construction value chain have felt the effects of COVID-19. Although construction activity has been allowed to continue in many areas of the U.S., industry participants are adjusting their expectations for 2020 as the economic uncertainty takes a toll on future demand. This year is set to be a challenging one for building and construction; however, certain market segments and product categories may be in a better position than others to weather the storm. While many states, if not all, have deemed construction as an essential business, the level of construction activity has still significantly declined. States that have deemed construction nonessential have not always clearly indicated when it might resume. Figure 1 shows how COVID-19-related construction restrictions evolved across the U.S. from March 16 to April 7, 2020.
US construction restrictions by state
The residential construction market has seen steady growth in recent years, with strong demand during the first two months of 2020, before COVID-19 cases began to accelerate in the U.S.
Demand for new homes is expected to drop considerably in 2020 as consumers delay plans to move and as they grapple with economic uncertainty. Leading residential homebuilders have seen contracts decline in recent weeks and have started to slow land purchases and development to preserve cash. As a result, IHS Markit estimates that new housing starts (single family and multifamily combined) will be around 900,000 in 2020, which implies a decline of about 30% from 2019 housing start levels and is below the past decade’s average annual household formations of about 1 million.1 Building material companies have started to make adjustments based on reduced demand, with several lumber mills announcing operating capacity reductions of 20%-40% for April.
While the decline in new housing in 2020 is forecast to be severe, it is not expected to be a sustained period of low activity. The U.S. is currently estimated to have a housing shortage of about 3.5 million units; even with the recovery after the Great Recession, new housing starts have remained below the long-term average (see Figure 2). Therefore, barring a severe depression, new home construction will be needed to fill the gap in available housing, particularly in areas where the shortage is particularly great, such as California, Florida, Texas and North Carolina. Some states (e.g., Texas) also have a housing shortage that might be mitigated by the fall in the price of oil and correspondingly lower level of economic activity.
In the coming weeks, L.E.K. Consulting will be tracking a number of key metrics to understand the severity of the slowdown in new home construction and the potential rate of recovery, including building permits, housing starts, housing completions and builder contracts, among others. This dashboard will be used to assess the health of the market and will serve as a key input into our outlook for new home construction.
Home improvement spend in the U.S. has historically been less volatile than new home construction and therefore tends to perform better during recessionary periods as homeowners continue to make repairs and improvements to their homes. However, large discretionary projects (e.g., a kitchen remodel) are often financed with home equity loans and tend to perform poorly in downturns.2 With the recent stock market decline and economic uncertainty, these big-ticket home improvement projects are expected to suffer as they are less urgent and easier for homeowners to postpone.
Smaller projects are expected to fare better, especially in product categories such as paint, door hardware and plumbing fixtures that are well suited for “do it yourself” (DIY) efforts (see Figure 3). Additionally, lawn and garden projects should fare better not only due to the relative affordability and simplicity for a DIYer, but also because U.S. homeowners are spending more time at home this spring due to the pandemic. While the situation is still evolving, early signs of a shift can be seen in the data, with Home Depot foot traffic up 26% since March 1, and Google search volume for “DIY” projects is up 10%-20% from levels seen in February.3
The expected increase in smaller home improvement projects also has implications for purchase channels. During periods of slower new construction activity and macroeconomic downturn, as was seen in the Great Recession, the home improvement channel (e.g., Home Depot, Lowe’s) typically gains share from the pro channel. This trend is expected to occur in light of the COVID-19 downturn, though a higher portion of home improvement purchases may be made online, whether through brick-and-mortar retailers or online-only sites.
L.E.K.’s real-time market pulse dashboard will also track several indicators for R&R activity, including existing home sales, home values, mortgage applications, web search activity and home improvement channel foot traffic.
Product category outlook
The coming slowdown in new home construction will have an outsize impact on certain product categories (see Figure 4) that have a high portion of demand generated from new homes (e.g., lumber, insulation). On the other hand, certain product categories that tend to over-index in home improvement appear well positioned to weather the overall slowdown in construction activity, especially those products that are relatively affordable (e.g., paint, plumbing fixtures) and easy to purchase online (e.g., lighting, hardware). Additionally, shifting digital engagement efforts in categories that have historically lagged in online penetration may represent an opportunity for manufacturers to capture value and protect share during the downturn.
Over the past few weeks, COVID-19 has generated an unprecedented disruption in business activity, and the extent to which different industries are impacted is still being determined. Almost all industries are facing significant near-term challenges. For most, this is a downturn from which they will recover, though others face a more uncertain future based on potential long-term changes driven by the COVID-19 crisis.
While construction on existing projects has continued in most regions, many projects in the design or planning stages are being delayed or canceled. A recent survey by the Associated General Contractors of America indicated that 45% of respondents have had current or future commercial building projects canceled by owners.
Several industries were examined to understand how commercial segments are being impacted by COVID-19, as well as the factors determining the rate of recovery (see Figure 5). The impact of COVID-19 is such that most sectors will experience a decline in 2020, but their speed and rate of recovery will vary considerably.
In the wake of travel restrictions and shelter-in-place guidelines, the U.S. hotel industry has all but shut down in recent weeks. Hotel occupancy rates for the week ending March 21 were about 30% versus about 87% for the same week in 2019. While the duration of the COVID-19 crisis is unclear, 2020 is expected to be the worst year on record for hotels, with revenue per available room estimated to be down 40% for the full year versus 2019. That being said, an L.E.K. survey found consumers expect that most travel activity will return to normal once the COVID-19 crisis has passed, though it may not happen immediately.
The retail industry has similarly been hit hard by COVID-19, as nonessential stores have been closed in most areas for weeks. During this time, many consumers have shifted more of their purchases online and have expanded the range of products they purchase online. These factors have some experts predicting that COVID-19 has accelerated the shift toward ecommerce for a segment of the population that otherwise would not have been pushed to purchase so much online. For that reason, the retail industry may not fully recover from COVID-19, particularly those specialty retailers that do not sell food (e.g., department stores, apparel).
The office market is expected to struggle in the near term as owners face pressure from tenants that are struggling to meet lease obligations or asking for concessions. Additionally, COVID-19 has forced almost all office tenants to become more comfortable with remote working arrangements. According to the 2019 National Compensation Survey by the Bureau of Labor Statistics, only 7% of civilian U.S. workers have access to a flexible workplace benefit or the ability to work remotely. For many office tenants, these past few weeks have been the first real test of what will happen when a large portion of the staff work remotely. The longer the COVID-19-related shutdowns last, the higher the risk that more companies will adopt flexible remote working policies, which could drive a decrease in demand for traditional office space and buildouts. However, co-working providers with sustainable business models could derive benefits from the increase in remote working models
The picture on manufacturing is likely to be positive in places but with a high degree of variance between sectors. Manufacturers focused on less discretionary items or in sectors experiencing higher levels of relative growth, such as warehousing or certain types of consumer staples, are expected to perform relatively well. Manufacturers relying on highly discretionary and higher-ticket consumer items are expected to experience a longer path to recovery, as are those manufacturers highly exposed to the oil and energy sectors. Manufacturers with a high proportion of sales in exports will be affected by the relative strength of recovery in foreign markets, as well as the exchange rate; both of these indicators are still emerging.
Warehouses and distribution centers are in the rare situation of being fairly well insulated from the challenges of COVID-19. Last-mile delivery warehouses are particularly well positioned due to their support of ecommerce. Additionally, warehouse construction may benefit as businesses look to build regional supply chain models in order to minimize potential overseas supply disruptions and expedite delivery times. So, unlike other segments, warehouses are not expected to see much of a near-term impact and may actually benefit from the potential step change increase in ecommerce penetration that is predicted to occur over the next three to five years.
Data centers are also expected to perform relatively well. Data center growth prior to COVID-19 has been driven by the desire of companies to reduce the large capital and operational costs of maintaining and running an in-house system, as well as by the improved performance that data centers provide in latency, performance and coverage. Growth in data consumption and 5G adoption also indicates a positive future outlook. These drivers are expected to continue, as COVID-19 disruption has meant that businesses place even greater value on seamless and more extensive data services, together with the growing reliance on cloud and network services as more people work from home and utilize ecommerce platforms. In addition, the flexibility and breadth of data center offerings (e.g., modular data centers that are containerized solutions, often serving edge/last-mile needs) mean that the industry is relatively well positioned to adapt its offerings.
The COVID-19 crisis will undoubtedly have a significant impact on the building and construction market in the U.S. While there are certainly challenging times ahead for the industry, there are also a number of market segments and product categories that are expected to demonstrate resiliency and that present opportunities for growth. L.E.K. is actively analyzing a range of indicators to understand real-time changes in the market and will continue to share our outlook for 2020 and beyond.
Tim O’Neil, Managing Director in L.E.K.’s Building & Construction practice, co-authored this report.
1Home Improvement Research Institute/IHS Markit presentation on March 31, 2020
2Big vs. small R&R spend from John Burns Real Estate Consulting data
3John Burns Real Estate Consulting webinar on March 31 (pages 60 and 62)
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