The Truth Behind Construction Activity Indicators
Deciding to develop a home or commercial building on a plot of land can be a very difficult decision to make. You don’t want to construct the building only to find that the demand for new housing units or apartments in the vicinity is low. One method that’s commonly used to identify the viability of a development project is to assess building activity indicators. These are economic indexes or reports that allow investors and analysts to look at data about the current and projected demand for industrial, residential, and commercial construction.
If you’re not yet confident about the viability of constructing a new building, these indicators should paint a clearer picture of the types of buildings that would do best for the area you’d like to develop in. When you’re trying to identify how healthy the area is for industrial and commercial projects, the building activity indicators to look for include the construction of hospitals, hotels, multi-family residences, schools, and office buildings. As for residential activity, this includes new housing permits for multi-unit dwellings and single-family homes.
Along with the activity of buildings being constructed, these indicators can also take prices of residential and commercial construction into account. If prices have decreased over the past months or years, this may indicate that the real estate market in the vicinity isn’t healthy. Keep in mind that building activity indicators can also track the number of permits that are issued for new construction.
If building permit approvals are increasing at a steady and consistent pace, this may indicate that the market is a healthy and growing one. While the information included in a building activity indicator report is highly beneficial, it’s also important that the developers or projects managers who look at the report understand how to assess the results. For instance, the projected demand can be even more important than the current demand when making decisions on which buildings to develop. This article offers a comprehensive look at building activity indicators and the importance of them.
What to Understand About Construction Activity Indicators
When you’re looking at construction activity indicators, it’s important that you understand what these indicators are telling you about the economy and the local real estate market. If your analysis of the data you receive from these reports is based on faulty logic, you could end up making poor investment decisions. These reports can give you useful insights about the health of the overall economy that you can’t get with other types of data.
It’s important to understand that the amount of construction that occurs in a town or city has always been a strong indicator of how the economy is performing at the time. In most years, construction spending makes up nearly four percent of the U.S. economy when looking at GDP. When businesses and investors are placing their money in new construction, you can be relatively confident that the economy is already strong or is expected to grow in the months and years to come. Low building activity almost always correlates with a poor economy in the city or region.
The building activity indicators that can be measured include everything from construction spending to building permits issued. Each data point offers valuable insights that can help you determine what’s happening with the economy. Keep in mind that different indicators are published by different entities.
Two Most Popular Indicators
Among the most popular indicators comes in the form of the Architecture Billings Index, which directly polls architecture companies about their billing activity in the most recent month. If this activity decreased, increased, or remained flat, the architecture companies would provide the index with this information, which is then collated into data that can be used by developers and investors when assessing the strength of the economy.
Another highly popular indicator comes in the form of the New Residential Sales Index, which has been put together by the U.S. Census Bureau as a part of their New Residential Construction Index. The data that’s included in this index provides regional and national information about the number of single-family homes that have been placed on the market for sale. Once you identify which type of building you’re constructing, you should search for the indicators that best match this building type.
Popular Construction Activity Indicators
Some of the more popular construction activity indicators that can be tracked in one of these reports include:
- Total new-housing starts – This type of activity involves the number of residential homes that begin construction on a monthly basis. If new housing starts are increasing on a monthly basis, this may point towards sustained economic growth, which would make residential construction a wise investment.
- New home sales – Identifies the number of sales that have occurred for newly constructed homes. If homes are being constructed at a regular rate but are remaining on the market for months before being sold, it’s possible that the market isn’t as healthy as other property investors believe.
- Architectural Billings Index – As mentioned previously, this is an important economic indicator that looks at the demand for the construction of non-residential properties. This is considered to be a leading indicator and should be used by every developer and investor.
- Pending home sales – The National Association of Realtors has created a Pending Home Sales Index. This particular index is useful for tracking home sales that involve a signed contract but have yet to close. Even though tracking new home sales is a great indicator of the health of the surrounding market, it doesn’t paint a complete picture. Because of how long the closing process can take, new home sales could be low one month but very high the next, which balances out.
- Total construction spending – This indicator measures how much money is being spent on new construction. Keep in mind that this indicator encompasses all construction types, which include industrial, commercial, and residential.
- New Residential Construction and Sales Indices – Among the most data-heavy indicators include the ones put out by the U.S. Census Bureau. Their residential construction and sales indices are put out on a monthly basis and provide comprehensive data on domestic construction. This data includes the amount of spending activity that has occurred by dollar value. The spending types that are measured in these reports include non-residential spending, residential spending, private spending, and public spending.
Even though the sale of existing homes is useful for identifying the health of the real estate market, it doesn’t give information about new construction activity.
How Construction Spending Affects Activity Indicators
Construction spending is a key factor that affects the activity indicators that are used to identify the viability of a development project. This economic indicator measures how much money is currently being spent on new construction. The Census Bureau for the U.S. Department of Commerce puts out a VIP survey that looks at non-residential and residential construction within the private sector while also taking federal and state construction spending into account. Keep in mind that construction spending encompasses all of the costs that go into a development project, which include materials, labor, and any engineering work that’s needed.
Keep in mind that around 50 percent of construction spending in the country comes directly from the residential housing sector. Even though this data doesn’t have a substantial effect on financial markets, it can help you understand economic growth throughout the country. This growth is determined by the current GDP, which stands for Gross Domestic Product. The metric tracks all services and goods that are produced in the country. If the GDP is increasing at a steady rate, business and consumer spending tends to go up as well.
When the economy starts to grow, construction spending typically increases alongside it. On the other hand, construction spending usually decreases when the economy has slowed down. In the housing sector, construction spending for new homes helps determine the current health of the real estate market. Likely the most important indicator to look at when assessing the health of your local real estate market involves housing starts, which indicate the number of homes that have begun construction in the past month.
As for non-residential construction spending, this form of construction can have a significant impact on the economy. Keep in mind that businesses spend several hundred billion dollars every year on development projects. The impact that commercial construction spending has on the economy extends to adding jobs for contractors and banks. While the role that contractors play in these projects is obvious, banking hires also increase as a result of construction projects needing to be financed.
Data Types Included in Construction Spending
The data types that are included in construction spending figures extend to:
- Total costs of materials and labor
- Costs of engineering and architectural work
- Any overhead costs, which can include marketing, management, and sales costs
- Contractor’s profits
- Loan interest
Most reports of building activity indicators come out in the middle of the month. Once these reports are in hand, you should be able to use the data to determine if your project is economically viable. The economic viability of your project should be measured against the financial costs to determine if construction should continue. Like any major investment, having data to back up your decision-making process helps to minimize risk and make you more confident of the decisions you make.
Jason Somers, President & Founder of Crest Real Estate
With over 15 years of professional experience in the Los Angeles luxury real estate market, Jason Somers has the background, judgement and track record to provide an unparalleled level of real estate services. His widespread knowledge helps clients identify and acquire income producing properties and value-ad development opportunities.
Learn more about Jason Somers or contact us.