It may not be fast, but nonresidential construction is likely to bounce back more steadily in 2022, says Mircea “Mig” Dobre, senior research analyst, covering machinery and diversified industrial companies for Robert W. Baird & Co. Dobre has been with Baird for 20 years, and has a master’s degree from The University of Chicago. In an exclusive interview with RER, Dobre talks about the economic and construction landscape as we head into 2022.
RER: Overall, how do you view 2021?
We are at the mercy of the market, if you just look at the headlines, the S&P is up 23 percent for the year 2021 [Editor’s note: The interview was conducted December 15, 2021. In its final figures, the S&P 500 gained 26.9 percent in 2021]. In anybody’s book if the market is up that much, it’s got to be a good year, but it doesn’t feel that way. Probably because there’s been so much volatility. With the various variants, the Delta and the Omicron variant, we’ve been all over the map.
What are your expectations for nonresidential construction in 2022? Let’s talk about some of the categories likely to be most important to RER readers – commercial strip malls, hospitals, manufacturing facilities, warehouses, schools, office buildings, highways/roads, public compared to private.
DOBRE: You’re right, nonresidential has bottomed, it effectively bottomed in October. This was the second year of decline for private nonresidential construction, it declined in 2020 and declined again in 2021. Our view is we are going to see a recovery in 2022. Our forecast is for relatively modest growth, we’re talking a couple of points of growth, there could be upside to that number. Our thinking is momentum might really start to build in 2023.
Last year around this time, when so many people were still working from home, you talked about the future of office construction, that there would be a slowdown in office construction and kind of a “reimagining” of what offices would be like in the future. Any update on those ideas?
There are certain areas that are going to remain under stress in 2022, office construction is one of them, lodging and hotels is another one. Yes, it’s a function of the pandemic, but it’s also a function of the fact that we’re just not seeing a lot of new projects coming into the pipeline. So, it’s going to take a while for those markets to stabilize. And really those are the two markets that are acting as a drag on what otherwise would be a 5- or 6-percent growth environment.
This normalizes in 2023 when our best guess is that lodging actually returns to growth, and I still think office will continue to contract again because of the COVID issues. Coming back to work is a complex issue. I think a lot of employers are discovering that employees need more flexibility, which means part time in the office, so you don’t need as much office space as you previously thought.
The last point I wanted to make on private nonresidential is that there’s a very close relationship between residential activity and private nonresidential activity. We’ve seen over time that residential activity leads private nonresidential activity by about a year and a half to two years so when you think about how strong the residential market has been in 2020 and 2021, it really would make sense that nonresidential, despite office and lodging, would start doing better in 2022 and should accelerate in 2023, which is pretty much how we set up our own forecasting and thinking.
After a long wait we have finally seen infrastructure legislation. What will be the impact – in the short term and the long-term?
In regard to infrastructure there are a couple of things to know here. The funding is available. In terms of what is actually incremental, it’s not a trillion dollars, it’s roughly half that, incremental funding over a five-year period.
So that’s meaningful, don’t get me wrong. But this is not the sole source of funding, the infrastructure bill is not the only one. There have been multiple pools of funding that were passed in the prior bill. There’s the $1 trillion relief bill -- the Infrastructure Investment and Jobs Act – and there was a $1.9 trillion COVID relief bill called the American Rescue Plan. The first one was passed in December 2020, the second was passed in March 2021. In that bill, there are literally tens of billions of dollars that have been allocated for things like education, like increased state and local funding, state and local got $360 billion. State and local entities are essentially in the process of thinking, “Ok we got all this money from the federal government, how can we spend it in our local community?” A good portion of this will find its way towards improving schools, improving local roads because the infrastructure bill targets federal highways, but the street in front of your house is not paid with federal funds. That’s where out of this incremental funding, the $350 billion is going to come in to help those state and local funding pools where the states have discretion about where they want to allocate this money.
As far as the impact goes, there’s going to be a little bit of a lag within our forecast, and your readers are close to this so they can understand this. It’s probably going to be at least 18 months until you go from funding being made available to where projects actually start happening. In our minds, we think the earliest we’re going to see a bump in activity is the back half of 2022, more likely the fourth quarter of 2022 and quite a bit of acceleration into 2023. And if you think about the cadence of how this funding gets dispersed, our analysis really shows that spending is actually going to increase in 2024 versus 2023, and 2025 versus 2024, and peak sometime in 2026. So there are multiple years of spending growth from the bills that passed in 2021 and 2020 and that spending is really not going to peak until 2026.
There are geo-political issues that will affect the world and domestic and international economies. Relationships between the U.S. and China continue to be contentious. Any sense of how this will play out in the foreseeable future and what kinds of impacts on the construction industry and rental?
This is a hard question to answer because the construction industry and rental, they are very domestic in nature. It’s hard to see where geopolitics directly plays into that. I certainly believe that part of the reason why there is urgency with regard to investing in infrastructure, and with regards to investing in key areas of manufacturing in the U.S., a good example would be semi-conductor manufacturing. We’re looking to invest tens of billions of dollars in increasing production capacity in the U.S. – not in Taiwan, not in Asia, but here in the U.S. in order to address these chip shortages.
What should company supply chains really look like? Should we be as reliant on Asian and specifically Chinese imports as we are? I think the short answer is no we should not. And the way we resolve this issue is investing domestically, which carries through to construction activity into rental. Half of United Rentals’ business is industrial. A reinvigoration of the manufacturing base in the U.S. has very meaningful positive implications for that component of the rental industry.
As you predicted, the residential construction would be strong and healthy over the past couple of years with demographic trends playing a significant role in that area. How do you see that segment continuing in the foreseeable future? You spoke about factors such as low interest rates and also a potential forgiveness of student debt as spurring the market, so how are those factors playing out?
Not even I expected to see the kind of growth like we have seen in 2021, because we’ve never seen growth like that ever before as far as my data goes. It’s been an outstanding year, and it goes to explain why it’s so hard to find anybody to work on your house, because everybody is so damn busy. I think residential will continue to grow, but it cannot continue to grow at the pace that we’ve been growing in 2021. I think the growth is going to moderate, but it’s going to remain positive.
My view is that the real potential of the housing market as you look out to 2024, housing starts are going to get up to 2 million units. Right now, everything we talked about in terms of the demographic factors a year ago, two years ago, that’s still in play. Households are forming, more importantly millennials are coming of age where they’re not only getting married and forming households during the prime home-buying age, but the market is short roughly 1.5 to 2 million housing units. That situation won’t get resolved in a year or two years; it’s going to take some time to resolve. And that’s really going to be the factor that’s going to push towards that 2 million figure, which I think implies roughly about 8 percent growth if you think out to 2024.
Interest rates are a risk factor, affordability is a bit of an issue. That’s probably the biggest challenge that we have in the housing market, how do you match the right supply with the right demand? Because if you have new entrants into the housing market, first-time home buyers, supplying them with high-end homes worth $1.5 million is probably not the right thing to do. Being able to find those more affordable entry-level programs is key.
A year ago, I said the student loan forgiveness initiatives that were being kicked around in Washington will have a meaningful impact on the housing market. We haven’t seen that student loan forgiveness happen yet but that’s still a factor that can come into play to further catalyze housing demand.
Bottom line on housing, I still believe we could be looking at high single-digit growth, 2 million units is the target as we look to 2024, but it’s going to be much slower than what we’ve seen this year.
The pandemic is still a big unknown as far as how long it will last and how hard it will hit us, but what are some of the likely affects you can see?
One is re-thinking the office, and the headwind that we think this will continue to pose. That’s one element. The other element also has to do with housing. There are folks that are re-considering whether or not they want to live in cities. And if they do live in cities, do they want a second home with a bit of a yard, where they can have the ability to sort of distance themselves from others? I don’t believe this is just transitory, I don’t think that’s just a 2020 or 2021 phenomenon. This is the sort of thing that re-shapes the way folks think about their living conditions. And this is not unique. We have seen similar things happen before.
If you go back to another traumatic event for all of us – 9/11 -- it very much altered the way we as Americans were thinking about the world. The way we were making decisions about vacations and things we were going to do. In my opinion, it was not at all coincidental that following that traumatic event, we saw massive investment in housing. We saw so many individuals that were looking to nest in a world that was perceived as being less safe.
We have seen the emergence of the home improvement industry from TV shows like HGTV, the fantastic success that Home Depot and Lowe’s and the rest of them have had. The pandemic, which was another traumatic event, fueled this desire that people have had to have a little bit of room, a little bit of space and essentially invest in their homes. Their homes are where they feel safe, where they can separate themselves from others, so they want to make a better living environment for themselves there.
History shows us that when events like this happen, this is not just a one- or two-year thing. There are multiple years worth of demand, that takes time to manifest. I am one of the people that wanted to do a few things to my own home, and I couldn’t because everybody was too busy. I couldn’t find a contractor to do the kind of job that I wanted done. It doesn’t mean I’m not going to do it; it means instead of doing it in 2021, I’ll do it in ‘22 or ’23. I think that’s one of the really important effects of the pandemic.
It looks as though the oil-and-gas market is coming back, doesn’t it? What are your expectations?
It is coming back somewhat. The recovery of oil and gas has lagged meaningfully everything else – construction, industrial, the broader economy. For those who are investing in exploration and production companies, the real concern has been twofold. One of them is regulatory, and it really has to do with uncertainty as to whether or not fracking rules change, drilling rules change -- the environment is very dynamic. And the second thing has to do with the rise of ESG investing (environmental, social and governance investing.) Investors are essentially putting a lot of pressure on companies to improve the impact they have on the environment. And the ones that are viewed as having a very negative impact on the environment oftentimes those companies are having a difficult time raising capital in capital markets.
So there has been great reluctance on the part of these energy companies because of these two factors to invest in additional supply. And many of them are looking to redeploy that capital towards alternative energy whether it’s renewable, hydrogen, or other types of projects. This is creating a situation where demand for oil is increasing but the supply is having a harder time keeping up.
The laws of economics will tell you that higher prices will follow. I think the net effect in 2022 and 2023, especially if the economy continues to grow, we are going to see higher oil prices. But investment eventually is going to start to pick up because prices are a very strong motivator, especially for private companies -- not the public ones that are subject to investor scrutiny. The private companies will start deploying some capital and take advantage of higher prices. Bottom line, I expect oil and gas to grow at a faster clip in 2022 than what we’ve seen in 2021. So, there’s going to be acceleration there. But frankly in any other environment oil and gas would be an absolutely stellar market in 2022. It will be good but not as good as it could have been absent those other concerns.
As it pertains to the rental industry, increased demand from oil and gas, which we’re going to see in 2022, is coming at a time when activity is pretty good and fleet availability is pretty tight to begin with. So this is only going to add more fuel to the fire that we’re seeing in utilization and rental rates.
There is increased demand for electric drive vehicles, solar applications, and alternative fuels, and equipment manufacturers are getting involved and coming out with new products. Do you expect these markets to continue to grow?
The answer is absolutely yes. The implications are twofold: If you’re an OEM, you obviously have to keep up with the times and evolve your technology. If you look at Terex, if you look at Oshkosh (JLG), Caterpillar, Deere, all the big suppliers to the rental industry, they have multiple product streams and work streams that are geared precisely to alternative fuels.
It’s not just electrification, it’s decarbonization. How do you do the work with fewer carbon emissions? For a rental company, it’s just as important, if not more important. Because I think rental finds itself at a critical juncture as far as investing is concerned. From the investors side, investors are looking at the rental industry as an industry that can catalyze and accelerate the adoption of modern electric or hydrogen proportioned vehicles because the rental industry thrives on technological innovation. They can then turn around and offer it to customers. That’s part of the value proposition.
And at the same time, this is not just an investor thing, from a customer standpoint, there are states and local entities that are increasingly focused on whatever they are using, what sort of environmental impact do you have in doing the job? Having the right equipment can make a difference in winning a job or not. So absolutely this is here to stay.
Currently in the rental industry, rental companies have been talking a lot about long lead times and manufacturers are talking about supply chain issues, as well as labor shortages. How do you see those issues playing out in the foreseeable future? And what effect will it have on the used equipment market?
These problems are here to stay for the time being. Our sense from what we are hearing from various manufacturers, maybe things were as bad as they’re going to be in the fourth quarter [of 2021]. And from here on out things get gradually better. One of the things we’re watching for is the supply of chips, especially what’s coming out of the automotive industry, because they’re the first ones to feel it. We’re hearing from those companies that things are starting to get a little bit better. And then the second thing we’re watching is just the transportation supply chain. What is happening in places like Newport and the ability to actually get containers shipped from Asia to the U.S., from Europe to the U.S., and vice versa. Things aren’t great there but it’s starting to look like maybe there’s light at the end of the tunnel.
We expect that it is really the second quarter of ’22 that manufacturers are going to be in a position where they can really increase production rates. Because they have a lot of orders from rental customers that they have to convert on. So about the second quarter of ‘22 they will be able to gear up and start ramping up deliveries.
As far as the effect on the used equipment market, what’s happening right now in used equipment prices is pretty amazing. When folks need equipment and they can’t get anything new, they buy used and as new equipment availability increases, it’s fair to expect moderation in used equipment prices. Frankly I don’t think that’s going to be a bad thing, especially for smaller operators that have to be active in that market.
In regard to labor shortages, we see that all over in the economy. Rental companies have difficulty finding good people. We are seeing that in a lot of industries but in construction, some jobs are not happening because there are not enough workers. How is that going to be addressed or what ideas if any do you have for addressing those problems?
Suffice it to say the construction industry needs people. If we’re going to build more things, there are a few things that have to happen. We have to be more productive and we’re going to need more people. Everything that we talked about here, housing being in good shape, private nonresidential construction looking to re-accelerate, massive funding on the public side, all of this is going to put pressure on contractors that are doing the work to get more productive and be able to find more talent.
How do you do it? That’s a complex question, it involves really having good development programs first and foremost. Do you have a good pipeline into your local technical schools, do you have a good apprenticeship program, and can you retain employees, do you offer them the proper benefits, do you give them the proper pay, do you give them the proper development opportunities within your company? It used to be that big companies would do those things and nobody else would, right? If you’re a small business, you weren’t going to worry about all that. The reality is everybody has to be worried about that now.
And you’ve got to think about building your talent pool and retaining your talent pool as one of the critical success factors for your business. That being said, there has to be a focus on productivity. And this is where I think the rental industry can really come into play even more than it has historically. If you have the right equipment, if you have modern equipment, if you have productive equipment, and every one of these OEMs will be able to tell you that products over the last two, three, four years have meaningful enhancements that are geared towards user productivity, right? That is part of the value proposition that the rental industry can bring, and they can make contractors more efficient in a capital-light scenario where the contractor doesn’t need to invest millions of dollars in equipment, they can rent it from the appropriate provider. And I think that also plays a role in retaining people. Everybody who works on a jobsite wants to work with equipment that is good, that is safe, that helps them be more productive and get the job done fast.
So this is a very important dynamic and is a great opportunity for the industry to be able to capitalize on. In our own math on it, if our construction forecast through 2023 proves correct, the industry is going to need to find another 450,000 people to hire into the construction industry, which is not insurmountable, that’s adding about 4 percent of headcount relative to pre-Covid levels. But in a tight labor environment, that is going to be a real challenge.
Do you expect a big year for the rental industry or more of a measured, cautious growth?
We do expect a good year for the rental industry. I think it is going to be a solid year, but a bit different than 2021 though. When you look at 2021, it was a year in which demand was much better than anybody forecasted. It was very skewed towards residential, and given that everybody cut in 2020, essentially everybody saw utilization skyrocket and rental rates got higher. There is a natural limit to utilization, you can’t expand utilization forever. In 2022, I think the primary drivers of growth are going to be the ability to obtain equipment, do you have enough equipment to put on rent, and rental rates. Utilization is less of a factor now; I think the industry from everything we can tell is pretty close to being fully utilized. So those are the two factors and if manufacturers can indeed ramp up production for new equipment as we expect in the second quarter, then that equipment should arrive just in time as we get into the really busy construction season to be able to be put on rent and put to work.
Our hope is that all of this plays out this way and that the industry is going to have another good year. There is a risk factor that these supply chain disruptions can prevent manufacturers from ramping up production, and it actually gets pushed out, which would be really unfortunate for an industry that is seasonal like rental. If you’re not getting your equipment when you need it and you get it after the season is over or towards the end of the season, that has meaningful implications to one’s business.
Perhaps there needs to be a different attitude towards immigration. Increased immigration could help solve the labor shortage as opposed to hurting it.
I don’t disagree with that. That is something that multiple industries have pointed out, it’s not just construction. The restaurant industry is struggling with it. The agricultural industry is struggling with it, you look at places like California and look at the Central Valley and talk to the farmers over there and they’ll tell you what a huge deal this is for them. This is something that we are collectively struggling with, and we might have to re-think that attitude. Politically these are decisions that are above your pay grade and mine, but a good point nonetheless.
