First of all, to our loyal subscribers: apologies for the clickbait title. I wish I could say it did not happen on purpose — but yeah, it totally did. In dis/constructed articles, we slice facts and logic into 10 pieces. So, you know, I asked myself: “why not slice ten big coronavirus facts around construction”. The thing is: right now, facts alone don’t seem to sell — folks seem to love a good panicky title. Well, here you go.
With that out of the way: let’s move on to business. What is Covid-19 doing to the AEC sector? When panic and pandemic are used interchangeably — it’s time for facts and logic.
As current events unfold in real-time, getting data on construction and building materials in equal real-time can be challenging. For example: the EU released their trade figures for January 2020 on March 9th, 2020. → 37 days of delay. That doesn’t help much right now.
Better: there are economies whose data we can use as leading indicators (eg. China) for what we should expect to happen to the construction sector in economies lagging behind in the Covid-19 outbreak (eg. United States).
1. What’s true: Western economies are reliant on building material imports from China and Korea. The US imports 10x more building materials than they export. Some American construction firms rely on China for up to 80% of their materials.
2. But: In January 2020 — like they tend every year around Chinese New Year — Western economies stockpiled building materials such as steel from China.
4. It is true: Construction projects on Chinese territory came to a full temporary halt in due to workers delays. 130’000 construction workers in Hong Kong alone had been temporarily laid off or hours cut. And: after lifting the Chinese quarantine measures, construction projects dealt with ramp-up issues as many workers in China were unable to get to their sites in the first hours and days. But: China is recently ramping up its transportation systems. This is increasing the rate at which construction workers get back on site.
5. Meanwhile, in the US: OSHA considers the risk of transmission on construction sites very low. That notwithstanding: anxiety among construction professionals abounds.
6. As evidenced by China, disruptions do not come so much from construction workers being sick — but if they can get to site. We must monitor public quarantine measures and corporate responses (eg. stay-home policies). As of today (March 16), we cannot see a major disruption of construction workforce in the US.
7. In response to Covid-19: the Fed has already lowered rates for the past few weeks, culminating in an effective 0% rate as of March 15. These actions led to high demand in refinancing mortgages from borrowers in past days.
8. The big question weighing on our mind is: “What will lenders in lagging Covid-19 economies do?” Lenders fear construction projects get (a) delayed, leading to bad debt, and (b) force majeure claims and lawsuits with their borrowers to resolve any incurred bad debt. The main point to observe here is how long construction activity comes to a halt due to (1) supply chain disruptions and lack of material and (2) disruptions in worker availability. If construction disruptions continue for several weeks, lenders will likely explore moratoriums for new lending on big construction projects . On the other hand: if construction halts are temporary phenomena — like seen in leading indicators like mainland China and Hong Kong — we should expect construction activity not to produce a ton of bad debt, and lenders retain trust. Our view is backed by lending experts at Fidelity.
9. China is the main leading economy in the Covid-19 outbreak. The Chinese National Bureau of Statistics reported a 20% YoY decrease in retail sales. But: this includes a devastating January, as the main lock-down measures in China had been put in place only January 23. Construction activity had resumed to 40% on February 25. We have no official construction statistic of the past 3 weeks yet — based on our conversations with folks on the ground in China we estimate that 80–90% of the construction activity is back to normal as of today. S&P Global expects Chinese construction activity back at normal growth as of Q2/2020.
Recession kicks in when money stops flowing. And money stops flowing when trust in commercial partners is hurt. When we look at the data, we find no pattern that indicates a fundamental erosion in the trust commercial partners place in each other in the global economies as a result of Covid-19.
The current situation is different than the subprime crisis in 2008/2009, where trust in the quality of mortgages and the ability of banks to sustain the bad debt had been significantly eroded. This created wide-spread ripple effects among market participants not trusting each others’ promises.
Covid-19 — other than subprime mortgages — has an inherent safety switch built in: people get healthy again. The fundamental promise is unshaken so far: “I will show up to work on a construction project”. Once people are cured, it is likely we can again trust their promise automatically.
To illustrate our point, compare the following charts:
In the 2008/2009 financial crisis, China’s QoQ growth decreased to 6%.
During the SARS virus crisis, China’s QoQ growth remained around 9%.
In March 2020: Foreign direct investment into China kept coming (though -8% YoY), even at the height of the Covid-19 outbreak.
And finally, fact is: outbreak centers so far have aligned along an east-west pattern of similar climate and nadir of temperature. Whether there is causality or just correlation, not even the world’s best virologists can say right now. Make of it what you want.
For me as an early-stage investor in ConstructionTech, all these facts mean one thing: I remain optimistic, but I also remain picky about which economy I invest in. I remain quite intrigued of the opportunities that right now get created in Asia, as Asian governments have shown dynamic and decisive responses to Covid-19 (China, India), or are in more economic and climatic environments that might just be more robust to Covid-19 (India).
Also, some of the world’s most valuable ventures were founded during 2007–2009. Part of the reason in B2B was that when competition got swept away, those left standing had an open playing field for a while. The current market environment is an opportunity for companies in Western markets to exploit truly global trends (eg. tech adoption for remote collaboration), build resilience, and be the #1 in an open playing field in AEC.
At Foundamental, we are monitoring what happens in India and a few other lagging economies in the next 10 days, and will use especially the Indian economy as a key indicator how to place our money in the coming weeks and months. History shows previous corona pandemics took roughly seven months to play out. We are currently in month 4.
The bottom line: We remain optimistic global investors.