What Construction Trends Mean for the Building Materials Sector

By Rodny Nacier

The past few years have been a whirlwind for building material suppliers. New home construction, home repair and renovation, and commercial construction set the bar for what the building materials sector can expect to see in terms of performance. While talk of high interest rates continues, a key leading indicator — the housing market — is possibly starting to stabilize, which could mean better news ahead for building materials. Here’s what’s happening across the construction industry right now and what it means for building materials companies and their investors.

Pandemic Housing Boom Followed by Slowdown

The COVID-19 pandemic led to a short-term housing boom, but this was followed by a subsequent slowdown with new home construction falling significantly early this year. New housing starts peaked at 1.8 million (seasonally adjusted) in April 2022 but fell to 1.35 million a year later, according to U.S. Census data.

A big factor in the slowdown, of course, has been rising interest rates. The benchmark 30-year mortgage rate rose from 3.05 percent in October 2021 to 7.49 percent two years later. Those higher interest rates have stifled housing starts through this year.

Higher interest rates also mean less resale activity, resulting in an unfavorable impact on the repair and renovation market. In August, Home Depot told investors that trends appear to be normalizing but they’re still seeing pressure in certain big-ticket discretionary categories and smaller projects replacing larger ones. That said, recent trends and indicators in home improvement indicate that we may have seen a trough in home improvement activity.

Near Term Housing Market Noise Overshadows Longer-Term Growth Opportunities

Mortgage rates remain elevated, housing turnover and starts are falling, labor is short, and there are pockets of softening prices across the country. However, there are also bright spots, such as new home sales rising in absence of existing home inventory. Looking at the bigger picture, the primary positive macro catalyst for the longer-term housing outlook remains the significant “underbuild” of housing from 2008-2017, when the slow pace of housing starts fell dramatically lower than the pace of prior decades. Simultaneously, America’s housing stock is aging and millennials are finally forming households.

Recent commentary from homebuilders indicates that trends are improving sequentially off the troughs as the market continues to recover. It appears that homebuyers are starting to accept the new normal of higher interest rates after such a prolonged period of low rates, which is resulting in stabilizing  demand.

Macro new housing forecasts remain mixed heading into the second half of the year. However, several sources have increased their forecasts for housing starts significantly while several large homebuilders say they expect to see improving demand, better pricing on orders and favorable margin outlooks.

As home prices began to rise again, some builders stopped promoting interest rate buy-down programs, instead opting to use incentives on an as-needed basis although this recent trend may change as some pockets of pricing have started to flatten into the fall. Builders are adapting by constructing smaller homes and changing the floorplans to make homes more affordable for first-time buyers, who continue to be the main driver of new home demand.

Repair and Renovation Segment is Softening

During the pandemic, many locked-down homeowners decided to invest heavily in repairs and renovations. According to historical LIRA benchmark data, the moving rate of change for homeowner improvement and repair activity started rising in the fourth quarter of 2020 and peaked at 17.4 percent in the third quarter of 2022. Since then, it has steadily fallen to 5 percent in the third quarter of this year.

The NAHB/Westlake Royal Remodeling Market Index (RMI) stood at 68 in the second quarter of this year, down from 70 in the first quarter. This is markedly lower than when it peaked at 86 and 87 during the second and third quarters of 2021. The future indicators index, meanwhile, stood at 60 in the second quarter of this year, down from 64 in the first quarter and 83 in the third quarter of 2021.

All of this points to an overall softening for the repair and renovation segment. Not surprisingly, the RMI is markedly higher for small projects (81) than it is for medium-sized projects (77) or large projects (72). Medium-sized and large projects are often financed using a home equity loan or line of credit that now come with higher interest rates than they did a year or two ago.

A Mixed Outlook for Commercial Construction

Many large commercial construction projects were put on hold during the pandemic as uncertainty gripped the markets. After a period of normalization in project timelines as evidenced by an expansionary Architectural Building Index (ABI) in much of 2021 and 2022, the commercial environment has softened and the outlook has become a bit more uncertain into the back half of 2023.

In August, the ABI stood at 48.1, marking the eleventh consecutive month where billings have been essentially flat at architecture firms. There are also signs that the pipeline of future work may be starting to slow. While inquiries into new projects remained relatively strong in August, the value of newly signed design contracts declined for the first time since April, meaning that fewer clients signed contracts for new projects than in the prior three months.

On the other hand, infrastructure spending remains a potential bright spot. According to an analysis of the legislation from the Brookings Institute, the Infrastructure Investment and Jobs Act will lead to roughly $864 billion in spending on infrastructure programs over the next five years.

Light at the End of the Tunnel?

In conclusion, while overall sentiment in the building materials and construction space remains mixed, there are several bright spots that investors can get excited about: input cost inflation trends appear to have peaked, waning demand in new residential and repair and remodel markets appears to have troughed, underbuilt and aging housing stock remains a long-term tailwind, and positive regulatory catalysts for infrastructure spending are likely to become a boon for non-residential spending. After a rough few years, there may finally be a light at the end of the tunnel for building material suppliers. Now is the time to start thinking about how trends in new home construction, home repair and renovation, and commercial construction could impact building material suppliers in 2024 and beyond.