What the Rise in Commercial Construction Spending Means to REITs

The data from the Commerce Department shows that the total private commercial construction spending increased year-over-year by 12.7% to a seasonally adjusted annual rate of $696 billion in July. The month-over-month comparison shows that the construction spending increased marginally by 0.5% in July over June.

The construction spending mainly includes expenses incurred on new structures and improvements to existing structures in the private sectors. Here are some examples of these costs:

• labor
• materials
• architectural design
• engineering work
• contractor payments
• overhead
• interest and tax payments for the construction period

Spending on manufacturing was up year-over-year by 72.9% to $94.2 billion in July 2015. On a monthly basis, spending on manufacturing reported a growth of 4.8% over the previous month. The lodging segment, which is the smallest of the lot, experienced a YoY growth of 40.3% in construction spending to $22.4 billion in July 2015.

The office segment, which is in the midst of strong growth, reported higher construction spending of 26.1% to $57.4 billion in July 2015 over the previous year. On the other hand, commercial spending witnessed a modest YoY growth of 5.5% to $65.3 billion in July, though the spending was down by 1.5% over June.

Higher construction spending indicates higher future supply of commercial properties in the market. As long as there is a consistent demand for this incremental supply, equilibrium is maintained. On the flip side, a sharp rise in supply may create a glut in the market, thereby putting downward pressure on the prices.

The fundamentally strong REITs such as Simon Property Group (SPG), ProLogis (PLD), DCT Industrial Trust (DCT), and Boston Property (BXP) are continuously looking for property acquisitions. Boston Property (BXP) forms 2.22% of the iShares U.S. Real Estate ETF (IYR).

In the next part of this series, we’ll discuss the rise of commercial property prices.