Construction starts continue to boom across the country, but economic headwinds soon could put a damper on the industry, according to Richard Branch, chief economist at Dodge Construction Network.

In fact, Branch said starts are “likely to erode” as the year progresses due to heightened lending standards caused by banking uncertainty. But while this recent uncertainty among lenders could make projects fail to pencil, construction start data has yet to show a pullback.

Instead, total construction starts jumped 19% in March, according to Dodge. The reading has now posted two consecutive months of growth, predominantly due to a boom in manufacturing construction.

Here, Branch talks with Construction Dive about the effects of banking uncertainty on construction, the bifurcation of the market and specific standout sectors in 2023.

Editor’s note: This interview has been edited for clarity and brevity.

CONSTRUCTION DIVE: Signs point to decreased construction activity as financing costs become too high even though starts still show growth. Do you share concern that banking uncertainty can eat into construction’s momentum?

RICHARD BRANCH: I think it's far too early to see. Over time, tighter lending standards are going to eat away at momentum seen in the construction industry. I think though it's too early to see it in the starts data.

We are, though, seeing it in our leading indicator of construction, the Dodge Momentum Index. That tracks nonresidential building projects when they first enter the planning queue. That's been down the past couple of months.

Part of why that is down is owners and developers are realizing that financing projects is going to be much tougher as the year progresses. So, they're just putting fewer and fewer projects into the planning queue. The translation there for starts is there's a lag. So, over time as the year progresses, that's just going to be another weight pushing construction starts lower throughout the year.

It's a tough nut to crack because overall the U.S. financial system is in very solid shape. But lending standards are getting tighter as the economy starts to slow down and the Fed raises interest rates. But this is exactly what the Fed wants to happen. They want lending standards to get tightened. That will slow down the economy. That will start to eat into inflation. So from the Fed’s perspective, that's exactly what they want.

What sectors do you think will grow despite economic concerns?

The impact on construction is not going to be felt everywhere. It's easily and quickly splitting into a market of haves and have-nots. I don't think there's going to be a lot of flat markets in 2023.

Where I think the offset happens to make the total market flat is in manufacturing, infrastructure, healthcare, life science buildings and data centers. That's the positive side of the market offsetting the declines that we're expecting to see in commercial and residential.

We're not going to see an impact on manufacturing and infrastructure just because there's so many public dollars sitting in the queue from the CHIPS Act, the Inflation Reduction Act and the Infrastructure Investment and Jobs Act. That should keep that momentum very positive in those verticals.

You mention that construction activity in certain real estate sectors such as retail, warehouses, offices and hotels, is set to decrease. What are some specific verticals there you’re keeping an eye on?

The first one would be traditional office buildings. They were already at risk of a downturn because of increased work-from-home and hybrid relationships. Now you add increased lending standards, that's just going to weigh more and more on traditional office construction.

Warehouse construction is also headed lower, although I would view that more as a structural decline as opposed to a cyclical decline. What I mean with a structural decline is because one major player is getting out of the industry — that's Amazon saying that we're not building warehouses anymore. They're a significant chunk of that sector. So when they step away, warehouse construction will move quite a bit lower.

Third would be multifamily construction. The multifamily sector will feel a bit of pain this year, mostly because of a weakening employment picture, then we add in tightening financial standards for potentially less investment into the multifamily market. That should weigh heavily on multifamily starts this year.

Those are the most at risk, those are going to be down. There's no doubt about it.

Goldman Sachs and J.P. Morgan recently asked their employees to return to the office for a full five days a week. A panel discussion during the 2023 New York Build Conference indicated the office sector is beginning to show signs of life. Is that recovery in the office sector something you’re expecting?

I think office construction is going to continue to struggle. If you look at data sources like Kastle Systems, they do those keycard access readings, in the top 10 markets, they're reporting that only 50% of workers are back in the office. That hasn't moved up or down. It's been flatlined.

So, while companies may be well intentioned in wanting to bring workers back to the office for either perceived productivity gains or for work culture improvements and whatnot, I think they're going to struggle. More and more workers want remote and hybrid work and if we think about how tight the labor market is not just in the construction sector, but economy-wide, employees tend to have a bit more power in this relationship.

Employees continue to want more hybrid and remote options, so while employers may be wanting to pull people back into the office, I think it's going to be a struggle to get them to do so.

Are there any other trends you think are important to mention?

I'll cycle back to the idea about the market becoming really bifurcated in 2023. As I look back on my career, this has the potential to be the most split market I've ever seen. Split not just in verticals, but split in terms of geography and areas where you're seeing strong demographic growth.

These are in places like Texas or South Atlantic communities that are seeing these big manufacturing projects break ground. That manufacturing will bring housing, will bring schools and healthcare down the road, as opposed to communities where the demographic growth is lower, where they're not seeing a big boost in manufacturing.

I think this, on a whole, is a fairly flat market in 2023, but potentially one of the most split markets we've seen in quite some time.