COVID has spurred the most significant inflection point in the construction and building products sector since the Great Recession, and recent trends have significantly reinvigorated private equity investor and strategic buyer interest in the category. There is opportunity for premium valuations for sellers over the next 12-24 months, especially for scale market leaders, and companies that have demonstrated resilience through this COVID period.
Increased Private Equity and M&A Activity
Growing private equity interest in the industry, combined with compelling public trading levels and a prolonged low interest environment, have driven higher valuations in the sector. Since the beginning of the year, share prices of construction and building products indexed companies have increased by approximately 15% on average. Many private equity firms that in recent years have been cautious towards the industry, are reengaging and picking their spots across specific products and/or end markets. The rise in private equity activity is expected to trigger increased M&A, as these investors seek to augment the organic growth of newly acquired companies with strategic add-on acquisitions. Strategics who shifted focus to cash conservation early in the pandemic are now reemerging as active buyers. Given strategic buyers’ synergies and longer investment horizons, they could be attractive buyers for companies to derive outsized valuations as compared with private equity multiples.
Notable Uptick in Residential, Repair & Remodeling Sectors
In residential end markets, the migration towards work from home (“WFH”) solutions has accelerated interest in products that enhance home functionality and comfort, such as HVAC and insulation/energy efficiency. These trends are also expected to benefit new construction and enhance the attractiveness of the Repair & Remodeling (“R&R”) sector for private equity and strategic buyers in the near term.
R&R markets have seen a significant uptick in activity driven by the increased focus on creating an efficient, comfortable and aesthetic working environment. Such activity has been underpinned by DIY projects, which dramatically increased 2020 home improvement spend. Coming into 2021, the historically high levels of existing home sales in recent months are expected to further stimulate the remodeling market, as homebuyers invest in their newly acquired residences.
Residential new construction outside urban centers, particularly single-family home construction, is also benefitting from a confluence of trends including low mortgage rates, growing household formations, increasing home prices and a COVID-accelerated desire for more space and outdoor exposure. These shifts are expected to sustain strong demand into 2021 and beyond, as historically low housing inventory drives continued construction activity. While less dense, small scale residential construction is increasing, the outlook for large multi-family residential construction has deteriorated as a result of the shift out of urban centers and diminished willingness and ability to pay for amenities and luxury.
Commercial Construction will Follow Residential Market Trends
Commercial and other nonresidential end markets are more of a mixed bag, and buyers and investors will be picking their spots carefully. Significant exposure to retail, hotel and urban center office construction is a concern, as new construction starts levels in these markets are expected to remain below pre-pandemic levels. However, new commercial construction outside of city centers, particularly in areas that have seen meaningful increases in post pandemic residential activity, is a growing focus for investors. Commercial construction typically mirrors residential market trends. As the population migrates further out of the city, commercial construction, albeit of smaller structure, is expected to follow.
In addition, COVID-driven acceleration in ecommerce and climate control is leading to greater focus on advanced air quality and filtration products, as well as warehouse construction exposure for product fulfillment. Similarly, remodeling activity in nonresidential buildings, which decreased during the pandemic as investments in larger ticket repairs and upgrades were pushed back, is expected to resume and include greater investments in improving filtration, air quality and space of existing buildings.
The Long-Term Opportunity
These are challenging but also exciting times for the sector. The market disruption is creating near-term and longer-term opportunities for companies that are able to capitalize on end market and product trends. Companies that are favorably exposed to COVID driven trends will continue to generate meaningful strategic buyer and private equity investor interest. While it is too early to determine whether the construction cycle has truly reset, the changing M&A and capital market dynamics have brought back buyers and investors in force and will continue to offer compelling valuations for the right type companies in the space.