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Why Construction Spending Is So Important to the Economy

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Jan. 5 2016, Updated 6:51 a.m. ET

Construction spending: Critical component of economic performance

Each month, the US Census Bureau releases its Value of Construction Put in Place survey. It measures the total dollar value of construction work in the United States.

In the quarter ending September 30, construction spending as a percentage of GDP (gross domestic product) rose to 6.1%. This was a big rise from a year ago when it stood at 5.4%. Over the past 50 years, the average has been closer to 8.4%, so we are still well below historical averages. Take a look at the chart above and note the fall in construction spending as a percentage of GDP. You can clearly see the drop-off after the housing bubble burst.

In many ways, this represents pent-up demand, not only from the private sector, through commercial and residential construction, but also public construction. You’ll hear the “crumbling infrastructure” argument a lot from politicians.

The other issue that politicians are discussing is the need for affordable housing. Tight inventory makes it difficult for people to afford rentals, and rental inflation has been moving up steadily.

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Homebuilders may be changing their demographic focus

Homebuilders like Lennar (LEN) and CalAtlantic (CAA) have largely under-built after the housing bubble burst. Many were afraid of being caught with inventory and land, so they have held back, only building what they’re reasonably confident they can sell. We have yet to see builders take more risk, but the inventory problem is becoming so acute that the risk-to-reward ratio may be too good to ignore.

Given the well-known problems with the first-time homebuyer—student loan debt, a tight job market—builders have focused more on the move-up and luxury buyer. Toll Brothers (TOL) has been focusing more on luxury urban apartments, as the Millennial generation eschews the single family residences of the suburbs for upscale urban locations.

The builders with more of an entry level focus, such as PulteGroup (PHM) and D.R. Horton (DHI), are beginning to focus more on the lower price points in anticipation of the return of the first-time homebuyer. Investors who want to bet on the sector as a whole could look at the SPDR S&P Homebuilders ETF (XHB).

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