Preparing for Eventual Construction Downturn

By Rebekah Morris for AZBEX 

Business as usual will not last long. As Arizona construction projects continue for the most part, a near total economic shutdown is happening all around us. The abrupt economic shock is resulting in dramatic increases in unemployment and simultaneous record-setting federal government stimulus spending. At some point, economic contraction translates into less demand for construction.  

The BEX Leading Market Series discussion on Wednesday, April 29th, attempted to unpack some of the issues in tracking the real impacts of COVID-19 on the Arizona economy and how those translate into local real estate development and construction.  

Director and Professor of Research at the University of Arizona, Dr. George Hammond described the impacts to the Arizona economy due to the health epidemic caused by COVID-19 as unprecedented and an “outside force acting on the economy”, not something coming from an imbalance within the economy such as the financial crisis of the Great Recession. He, along with Mark Stapp, Executive Director of the Arizona State University MRED Program, and Anthony Jeffers, Director of Project Development for Hensel Phelps Construction participated in the second virtual LMS event discussing how local A/E/C and commercial real estate firms can understand the impacts and prepare for the upcoming slowdown in construction. 

Construction is different than other sectors of the economy, in part because construction was deemed an essential activity by Governor Doug Ducey, and the nature of the business – construction projects last months if not years from initial contract signing through closeout.  

Magnitude of Impacts Unknown, Focus Turns to Less Common Metrics 

Economic data in general is only available in hindsight: population reports are released only once per year, common commercial real estate (CRE) vacancy reports are issued quarterly, and monthly statistics include the detailed statewide employment report. Given that significant delay, Hammond indicated economists have started paying attention to more frequent metrics such as the weekly new claims for unemployment.  

Stapp similarly indicated some of the most critical metrics for the local real estate market include landlord’s ability to collect rent. He says May, June and July will be crucial to understanding the impacts on the local market.  

Jeffers stated that a metric he is most concerned about is the burn rate: how fast companies are burning through their revenue or cash reserves. He went on to state that is a little bit of a blind spot for most firms; everyone was so confident coming into 2020, they had a great year in 2019 and were looking at an even better 2020. They may have made commitments a few months ago, and now given this shock to the overall economy; they may not be able to deliver on these obligations.  

Recovery will be Rooted in Behavior and Confidence 

The panelists repeatedly discussed how behavior and confidence will be the basis of an economic recovery. When individuals and businesses feel confident that their personal and professional risk is at an acceptable level, the recovery, especially for the state of Arizona, will be strong. Hammond described the state of the Arizona economy “Pre-COVID-19” as very strong. He stated that job growth, population, every traditional metric he measures, was doing very well. Stapp also echoed that, adding that coming into this recession there is virtually ‘no overhang’; we have not overbuilt in any real estate sector. Jeffers went even further detailing how everyone is interpreting the data and information in a slightly different way, and that collective response is really going to show in how individuals and families make decisions on how to handle education in the fall, summer family vacations and more.  

Future Real Estate and Construction Opportunities 

In past economic downturns, public spending generally became a source of construction contract opportunities. This recession will be different in that the public sector is going to contract quickly with the dramatic reduction in Transaction Privilege Tax, or sales tax. From BEX’s annual research of Capital Improvement Plans (CIP), a trend over the last few years has been to turn away from bond debt to finance capital projects. Instead municipalities have relied on general fund monies, which are predominantly funded by sales tax collections. That does not bode well for this recession; public spending on capital projects is very likely to decline. In the last State Transportation Board meeting, the ADOT CFO even stated that there may be as much as $540M cut from the 5-year State Transportation Improvement Plan (STIP), ADOT’s version of a 5-year CIP. 

Jeffers predicted that future construction opportunities will be fewer and have more competition in the coming months and into 2021. He described the range of how construction companies will be impacted by the recession – smaller firms will likely see a slowdown sooner as billings and pipeline opportunities dry up, and larger firms will take longer to see an impact since their contract volumes are likely much larger. Conversely, larger firms’ reality might be much deeper and more pronounced if there are fewer large projects coming available and the larger overhead they sustain needs to trim even further. 

Stapp predicted that because the economy was doing so well coming into this, “there is a lot of capital sitting on the sidelines.” He predicted certain sectors including self-storage, data centers, industrial, and even new single-family detached residential construction and single-family for rent product will do very well. Stapp also noted that Arizona is poised to recover very well since we have the amenity of great outdoor spaces – we can offer spacious outdoor spaces that many dense urban locations cannot.  

As for overall segments of the economy that will come out of this fairly well, Hammond predicted that sectors that were already online should come out well, anything related to delivery services as well. He predicted the tougher sectors will be related to tourism and travel, but if they get creative and offer ways to make people feel comfortable and safe to gather, they will do well.