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Pressure Points—What Builders Can Expect

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The persistent labor shortage in the construction industry shows no sign of turning around, but there are some new pressures on builders going into 2019.

Interest rates have started to increase. The Federal Reserve has raised rates three times this year. As of press time, rates are between 2% and 2.25%, but a December increase was widely expected by economists. Dodge Data & Analytics anticipates between three and four rate hikes next year, which could bring interest rates to between 3.25% and 3.5% by the end of 2019.

RELATED: As Interest Rates Rise, Opportunities Abound

In early November, the 30-year fixed mortgage rate reached 5.17%, according to the Mortgage Bankers Association, and the 10-year treasury yield was over 3%, the highest level since 2011.

Materials costs aren’t going down either. As of October, the cost of construction goods inputs was up 7.9% year over year, while services inputs increased 5.2%, according to the producer price index.

The political landscape will bring new uncertainties next year. The governorship will remain in Democratic hands when Governor-elect Jared Polis takes over for John Hickenlooper in January, but several positions held by Republicans went to Democrats in November, including attorney general, secretary of state and state treasurer. Following the midterm elections, Democrats now have single-party control of the legislature, worrying some in the building industry.

“There is pent up demand among Democrats and their core constituencies for legislation and policies impacting the legal system, employment and workplace laws, and environmental regulations,” the Colorado Association of Home Builders noted in a statement following the election. “The CAHB and many of our industry partners have worked successfully over the past few years on bipartisan solutions to critical issues, highlighted by our efforts on construction-litigation reform. We are looking forward to educating new legislators and the Polis administration on the issues critical to home builders across Colorado.”

Slow growing in 2019

Dodge estimates that by the end of 2018, total construction starts will have increased 3% over 2017 to $807 billion, according to Robert Murray, chief economist at Dodge. While construction starts are increasing, they’re decelerating significantly. From 2012 to 2015, starts increased between 11% and 14% each year, Murray noted. Growth slowed to 7% in 2016 and 2017. Dodge predicts that next year, construction starts will be relatively flat at $808 billion.

“An important question going into 2019 is whether deceleration is followed by a period of high-level stability or a period of decline,” Murray said in a statement. “For 2019, it’s expected that growth for the U.S. economy won’t be quite as strong as what’s taking place in 2018, as the benefits of tax cuts begin to wane.”

Some of the stressors that hurt the building industry in the mid-2000s are gone, according to Dodge’s 2019 outlook report. For example, the glut of single-family housing and new retail space has dried up.

“These types of imbalances are not yet present in the current construction expansion, lessening the likelihood that a sharp decline will take place, barring a crisis in the financial markets,” according to the report.

Murray expects to see an increase in short-term interest rates as monetary policy becomes more neutral, while higher inflation expectations in financial markets drive up long-term interest rates. He expects nonresidential construction to hold steady or increase, thanks to increased funding from state and local bond measures, and increased federal funding once appropriations bills for fiscal year 2019 are finalized.

“In this environment, it’s forecast that growth for construction starts will decelerate further, but not yet make the transition to the point where the overall volume of activity declines,” he noted.

There is one area where he expects a dip: residential building. Dodge believes the residential sector will see a 2% dip as single-family and multifamily housing declines with consumer demand.

Dodge predicts a stronger market for single-family homes. In spite of higher mortgage rates, less affordability in housing stock and fewer tax advantages to owning a home, the research company expects only a 3% drop in single-family housing starts.

Multifamily housing starts, on the other hand, may fall as much as 8%. Dodge believes that the erosion in occupancies and rents that started prior to 2018 was put on hold as the economy strengthened this year, but expects it will return next year.

Feeling blue in Colorado

David McLain, partner at Higgins Hopkins McLain & Roswell and a columnist for Colorado Builder, is concerned about the balance of power following the change in Colorado’s leadership.

“With Colorado going from a purple to blue state, those protections aren’t there,” he said in mid-November.

He predicts three issues will rise to the top of legislators’ to-do lists in 2019.

One is arbitration. “We saw a couple of bills last year intended to weaken the ability to get cases into arbitration,” he said. He anticipates “maybe not [a] full-frontal attack but just attacking arbitration across the board.”

He expects calls for prejudgment interest to be reinstated as well. Following a case between Goodyear Tires and Holmes in 2010, the Colorado Supreme Court ruled against allowing interest on claims to accrue from the time of loss.

“If what you’re suing me for is the cost to go fix your house, you don’t get prejudgment interest,” McLain explained. “I’ll be interested to see if the plaintiffs’ attorneys do something to get prejudgment interest back.”

Under the Colorado Consumer Protection Act, builders who violate the act have to pay three times the damages as a punishment. The legislature capped damages at $250,000 in the early 2000s, McLain said. Now “the question is, do the plaintiffs’ attorneys now want to take those caps off?”

One new area to watch, McLain said, is who pays attorneys’ fees. “Right now in Colorado, you only get attorneys’ fees paid if it’s provided for in your contract or if it’s provided for in statute,” he said. “Typically, we advise builders not to put attorneys’ fees clauses in their contracts or in the declaration because you’re going to pay out more than you ever receive in construction defect settlements. That gives the builder the ability to negotiate better deals on the back end when you’re trying to settle if the plaintiff’s attorney knows they’re not going to get their attorney’s fees paid.”

McLain encouraged builders to “get involved with their local associations and be prepared to show up at the legislature and make their voice heard.”

He added, “The last two years at the legislature were a little bit calmer, and I think that it’s going to go into full-blown defense mode.”

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