Dodge Data and Analytics Chief Economist Richard Branch joined the Engineering Influence podcast to discuss his 2021 economic and construction market forecast.
Host: Welcome to the Engineering Influence podcast sponsored by the ACC Life/Health Trust. With us today is Richard Branch, chief economist for Dodge Data and Analytics. A couple of weeks ago, Richard released Dodge's 2021 economic and construction market forecast. And he's joined us to delve into the numbers. Richard, welcome to the podcast. Click here to purchase the Dodge Construction Outlook 2021.
Branch: Thanks. Great to be here.
Host: To start, can you give us a broad sense of what the engineering industry can expect in 2021?
Branch: Sure. I think the simplest thing to say is that we do expect construction activity to improve next year. We do expect it to grow, but that pace of growth is going to be fairly modest. It's going to be fairly moderate. Of course, given everything that the industry and we as individuals have been through in 2020, that is certainly good news. But we need to keep in mind here that there are significant headwinds at play as we move into 2021 that make this recovery much more tenuous.
Host: In your forecast, you mentioned several times that it depends on the widespread adoption of a vaccine by the middle of the year and the passage of a substantial stimulus package in the range of $1.5 trillion in the first quarter of the year. Have you ever had a forecast that faced such stark deal-breakers and how stark are they?
Branch: Pretty unique, I'll say that. I think the closest parallel that I can think of is if we go back to 2009 during the Great Recession as Congress was weighing passage of the American Recovery and Reinvestment Act. If we think back to that time, it passed both the House and the Senate pretty much along party lines, but getting it to that point, it was touch and go and it was unclear right up until the last couple of days of how much sacrifice would need to be made in terms of the overall amount in the ARRA funding to get the support needed to get through Congress. Obviously, it ended up passing and it had a tremendously positive influence on the economy in the wake of passage.
Branch: So now we've got not only the uncertainty regarding the passage of further fiscal stimulus, but I would offer it's happening in a much more sensitive political environment. We're currently in a transition period between two administrations and between two congresses because there will be changes in the house and the Senate as well,. Then we need to layer on top of that when we can expect not just the vaccine to be ready, but when we see it adopted widely across the country. Of course, there's been a lot of good news recently with regards to efficacy rates of the vaccines as they make their way through trials. So that certainly good news. And I think at least that knowledge does or should provide a sense of stability in terms of the underpinning of the forecast.
Host: What are your thoughts on that stimulus package? Do you see it going through in the first part of the year?
Branch: So when we did our forecast, we assumed that $1.5 trillion would be adopted in the first quarter. And we were using that 1.5 trillion as I'll call it a median. It could have been a little bit higher, could have been a little bit lower depending upon what the final makeup of Congress was going to be. The Democrats lost a good chunk of their majority in the House. It looks like they're on track to lose about 10 seats of their majority, if not more--there are still a few races where they're counting--and the Senate is still up for grabs. We've got those two run-offs in Georgia to get through, but if you look at just how much split-ticket voting there was in this election, it's probably reasonable to assume that the Republicans will maintain control of the Senate, but it could go either way. Short story long, given that reduced majority in the House, though, I think we can probably expect that $1.5 trillion is a maximum dollar amount instead of a median. That's good news and bad news, right? The good news is a lower dollar value means it's probably going to get through Congress much quicker. So we might see it sooner rather than later. The bad side is the reduced dollar value means less support for individuals for businesses and of course, state and local governments.
Host: Looking at the specific sectors, the warehouse sector is thriving. You mentioned in your forecast that there were 38 warehouses over 1-million-square-feet built in the first nine months of 2020. And then looking at 2021, you forecast a strong market for this sector. How resilient is the warehouse sector?
Branch: Backing up to 2019 in terms of warehouse construction, it set a record in terms of our data, both in dollar value and square footage, and our data goes back to 1967. We do expect it to break a record again this year and next. So over the short term, through 2021and even into 2022, I think this market's fairly resilient. Online shopping is going to continue to gain market share over bricks-and-mortar. And then we layer onto that consumer behavior and consumer attitudes towards shopping and our expectations on delivery--I don't want to wait a week, I want my stuff now. So we're seeing the build-out of these large facilities, and there have been several this year that have been in the 3 to 4 million-square-foot range.
Branch: But I think you get to a point where, within the next handful of years, the market gets a little bit saturated in the sense that you're going to get to a point where the buildup of those large facilities has occurred along most major transportation routes and within a short drive to the major metropolitan areas in the country. So what happens after that? I think the market starts to shift into a more spoke-and-hub approach and you get more suburban/urban development of warehouses. These are smaller facilities, for Amazon and these other distributors, to help them satisfy that last mile of delivery.
Host: Is the data center market a similar type of market or does it have more long-term potential?
Branch: We capture data centers under the office market, so they're not part of the warehouse market, but it's a very similar dynamic except the upside potential in terms of longevity is more powerful on that data center side. As companies and as individuals, our data use increases exponentially, with virtually no limit on the amount we want to stream and the amount of data that gets transferred on a minute-by-minute basis across the U.S. economy. So over the longer term, the data center market is much more resilient.
Host: The situation for public construction is dire in your forecast. You quoted a Kroll Bond Ratings Agency report that projects $690 billion in state and local government revenue losses in the coming fiscal year. Yet you only project a 1% drop in the value of public building starts. So how do those jive?
Branch: Our public building category includes prisons, courthouses, local police and fire stations, armories and military buildings, and whatnot. So as part of our forecast process, we include large projects that we expect to break ground. We include those explicitly in the forecast years, and as we look into 2021, there are several that we expect to break ground. There's a $300 million courthouse that we expect to break ground in Norristown, Pennsylvania, and a handful of similarly sized projects across the country. And when you look at the entire category of all the 22 that we forecast, this is on the smaller side. It's around a $9 to $11 billion per year market. So those large projects have much more of an outsized influence in terms of the direction of the forecast.
Host: I noticed that also in airports. I don't remember the numbers, but there was the projection for the entire market, and the work at JFK was going to account for about 60% of that.
Branch: That's pretty much it. If you look at our transportation building forecast in 2021, it's an 11% gain, which is a pretty bold prediction to make given where transportation is headed currently. But as you said, we do expect those early stages of JFK to break ground in New York City in 2021. That's going to be a multi-year multi-billion dollar project. But it goes without saying that if that project were to be delayed or canceled or scaled back, that could very easily take that 11% gain and shift it to the negative. It's a very similar story with the public construction in that it's about a $10 to $11 billion per year market. So if you take out a billion or two from JFK, if that were to be delayed, scaled back or, or canceled, that would shift that entire market to the negative.
Host: The streets and bridges construction sector is looking at a slight increase in activity. I think it was about 1% or so. How much of that is due to the FAST Act extension and how important is getting a five-year transportation program in place to the resilience of the sector.
Branch: In a word critical. If we recall the FAST Act expired at the end of September 2020,. As part of the continuing resolution that's keeping the government open through December 11th, they extended the FAST Act through the end of September 2021. So that's good news. It did keep however funding flat, so the funding level for fiscal year 2021 is the same as the funding level for fiscal year 2020. That's why our forecast for streets and bridges is showing a fairly tepid gain. In terms of the importance of getting that reauthorized, it's critical given that the dire need of infrastructure in this country in terms of road and bridge work.
Branch: The good news, though, is we're optimistic that the reauthorization of the FAST Act will occur in the summer of 2021. Congress made good progress on it before the election. the Senate Public Works Committee released a plan in the spring or summer that was unanimously... Let me say that again, the Senate Public Works Committee unanimously approved their plan to reauthorize it at around $320 billion. The House, as part of HR-2, or the Moving Forward Act also authorized a five-year plan that would have been an excess of the FAST Act. So the good news is the underlying support for an increase in transportation funding is there and once we get into the new Congressional year, the inauguration takes place, and everybody has a chance to sit back and breathe, we think that goes forward. In our forecast, we've built in $300 billion for the core highway portion or highway bridge portion. That's more than what's under the FAST Act, but that's not going to help us until we get into 2022.
Host: Not surprisingly given the state of the nation's water and wastewater infrastructure, you project a healthy increase in this sector. How do you see that being funded?
Branch: I don't know if I'd use the word healthy. When we look at our environmental public works category--that's the summation of sewer systems, water systems, as well as dams and reclamation projects--we're looking at a 1% gain for that entire sector. In terms of what drives that funding, it's usually through that the Corps of Engineers, the EPA construction budget, as well as state revolving funds. And in general, the appropriation process has been fairly positive to those budgets. And when we look at what the House and the Senate were saying just before the election, we're looking at funding being fairly flat to a slight positive overall for the EPA, for the Corps, and for the State Revolving Funds budget. So that gives us that just a little bit of an increase. We're also looking at the two-year update to the Water Resource Development Act. Again, there was broad bipartisan support for that before the election in both the House and the Senate, so we think that in short order, once we get into 2021, that we'll get that authorized by Congress. And that's likely to be an $8 to $9 billion program over two years.
Host: The power market is remarkably volatile. Going back a few years, the value of starts was up 123% in 2019, then down 48% in 2020, and you forecast a 35% jump in 2021. Why is it so volatile?
Branch: It's essentially the presence, or the absence, of these large LNG import and export facilities. Those projects are measured in the billions of dollars, between $1 and $5 billion per project. So having one of those start in a year, skews the data, because it's not there the next year and pushes it down. When we look at the forecast for 2021, the Federal Energy Regulatory Committee has approved 15 LNG facilities all in the Gulf coast, except for one that's up in Portland, Oregon. Again, multi-billion dollar facilities. So they've approved 15, we're expecting one or two of those will break ground in 2021. And again, at a billion or a couple billion dollars, they certainly will cause that 35% gain.
Branch: But I think if you go broader than just that LNG import and export facility, renewables is also a growth market in the electric power sector. If you look at all electric generation starts over the past 10 years--coal, natural gas, nuclear, utility-grade solar, and utility-grade wind--wind and solar combined have accounted for about 60% of the total. As those technologies come closer and closer to grid parity, where a kilowatt-hour from one is the same as a kilowatt-hour from the other, they're just going to keep ramping up.
Host: What about the transmission line market within the power market? What do you see there?
Branch: I think they go in lockstep. If you think about where these wind and solar projects are, they're not in midtown Manhattan or downtown Boston. They're in Wyoming and Texas and out Wes and generally not in populated areas. As part of building up that renewable infrastructure, you need to build the high-speed transmission lines to get them from Wyoming or Texas into the major markets across the country. So they absolutely move in lockstep.
Host: Finally, you reported in your forecast that the office vacancy rate moved higher in 55 of the 63 metropolitan markets in the third quarter, yet you expect the market to grow in 2021. What's behind your optimism.
Branch: I think there are three reasons here. Despite the fact that vacancy rates are moving higher, and despite the fact that COVID has pushed us all out of our offices and into our living rooms and whatnot, there will still be projects that move forward. I'm not 100% on board with the office-market-is-dead storyline. I think companies will continue to invest in office space. Amazon has been very upfront about that. There is actually a $2 billion office project that broke ground in New York just within the last couple of weeks. So those projects will continue to move ahead, not to the same pace as they've done in previous years, but the office market will continue to move forward. Second, we include renovation dollars in our office data. So if you think about maybe an open space office, cubes and whatnot and converting that back to traditional offices and improving air handling and HVAC that boosts the dollar value as well. And as we previously discussed, we include data centers in our office market. Over the past couple of years, it's ranged between 15% to 20% of total office construction. And I think that's an incredible growth market over the next several years,
Host: If I may just tag onto that. One of the other things besides the death of the office that people have talked about has been the movement of people from living in cities to moving to the suburbs. Do you see that as a continuing trend?
Branch: Absolutely. When you look at our residential data by county and you look outside of the large central metros, like downtown Phoenix and downtown New York, and out in the fringe metro or fringe areas, which are basically the suburbs or even beyond that into micropolitan areas or rural areas, we are starting to see residential activity pick up significantly there. Of course, that creates incredible spinoffs. It'll pull some commercial construction with it, although it'll be a different kind of commercial construction than we've seen, with fewer urban towers and maybe more flat flexible space. It'll pull institutional construction with it, schools and healthcare, and it'll pull infrastructure construction with it. You need roads, you need bridges, and new water. So I think that movement is definitely a silver lining for the construction sector in 2021.
Host: Great. Well, thanks so much for sharing your expertise with us today.
Branch: Happy to do it. Anytime.