Given the current economic climate and the recent debt ceiling crisis avoided, what could happen in the commercial building/construction market? What do general contractors need to do to survive what could be another turbulent year or are there any signs of hope in 2023? According to top management at Kapitus, the following are expectations from now until year-end.
FINANCING APPLICATIONS
We are seeing tightening across the banking sector since at least the spring of 2022, and this tightening accelerated after the failures of SVB and Signature bank. As banks have pulled back from extending credit to small businesses, we have seen an increase in quality applicants who are looking for additional growth capital and are unable to obtain the financing they need from the banking system.
ECONOMY
The Federal reserve seems determined to slow the economy through additional rate hikes until inflation comes under control. As a result, we do expect the economy to continue to slow in the coming months and this slowing could place greater strain on the construction industry. Ultimately, we see the employment rate as the greatest indicator of demand in the construction industry. If unemployment begins to rise, demand for new housing and home renovations is likely to decline.
BUSINESS LOAN INTEREST RATES
The cost of capital to small businesses has risen at a rate this is likely in-line with the rise in the Federal Reserve rate. This has been challenging for businesses which depend on regular financing as a core part of their regular operations. Businesses which consistently fund the purchase of inventory or raw materials are especially impacted. Higher cost of capital also makes the financing of certain new projects and expansion opportunities uneconomic, slowing overall growth.
RESIDENTIAL REAL ESTATE
Higher interest rates are cooling the real estate market across the country, but we continue to see strong credit demand from contractors as a shortage of affordable housing, coupled with low unemployment rates, generate demand for new housing stock. In addition, higher interest rates mean that many homeowners are locked into lower rate mortgages and are choosing to stay in their home rather than selling and repurchasing in a higher rate market. As a result, many of these homeowners are looking to renovate existing housing stock, driving demand for contractors.
While consumer savings has declined significantly from its post-pandemic high, higher earners have by in large maintained their savings while lower earnings have burned through much of theirs. With strong rates of employment across all income levels, consumer spending has remained elevated. This is especially true for high earners who have continued to invest in real estate and home improvement despite a higher interest rate environment. However, we do believe that the failure of SVB and Signature has made high-end consumers more cautious about the overall state of the economy and we would not be surprised to see a further slowdown in high-end real estate purchases, especially if interest rates continue to rise.
EXPECTATIONS FOR OTHER INDUSTRY MARKETS
Overall, we believe the shortage in affordable housing across the country will drive demand for multi-family construction for years to come. However, we are more pessimistic about commercial office space which we expect to suffer in many major metropolitan areas as remote work becomes a permanent fixture in American life and many long-term corporate leases expire. All real estate markets will be susceptible to the negative effects of higher interest rates and constrained bank liquidity which may create significant volatility in real estate prices should another banking shock occur.
CLOSING THOUGHT
We expect the remainder of 2023 to be volatile as Fed rate hikes continue to slow the economy while combatting inflation. We expect increased volatility in the capital markets which will translate into volatility in real estate prices. We do expect unemployment to rise but see higher unemployment disproportionately impacting the lowest wage earners who are already showing signs of weakness through higher credit delinquencies and reduced purchasing power. However, the high-end consumer will remain strong throughout the year, while being more price conscious and looking for bargain investment opportunities. High-end consumers will continue to build and invest in real estate but will be looking for price concessions and better overall terms as the cost of financing these projects continues to rise.
About the Author:
Ben Johnston is COO of Kapitus, a leading provider of financing for small and medium size businesses. For more about equipment financing and other services, visit www.kapitus.com.
Modern Contractor Solutions, June 2023
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