U.S. Construction Sector: Navigating Rate Risks and Finding Shelter in Infrastructure

The U.S. construction sector stands at a crossroads in mid-2025, grappling with headwinds from elevated interest rates, supply chain disruptions, and diverging trends in public and private spending. While private construction faces slowing momentum due to financing costs and material price pressures, public infrastructure projects are gaining traction, buoyed by federal funding and bipartisan support. For investors, the path forward requires discernment: avoiding sectors sensitive to rate hikes while capitalizing on resilient niches like transportation, utilities, and education.

Interest Rate Sensitivity: A Double-Edged Sword for Private Projects

The Federal Reserve's cautious stance—keeping the federal funds rate at 4.25-4.5% with gradual cuts expected by year-end—has created a precarious balance for private construction.

High borrowing costs have tightened lending standards, with lenders demanding stricter debt service coverage ratios and lower loan-to-value thresholds. For instance, multifamily developers now face terms like 65% LTV compared to 75% just two years ago, reducing leverage flexibility. Meanwhile, residential construction has stagnated, with single-family starts down 4% year-over-year due to affordability strains.

Investors should avoid overexposure to residential developers like Beazer Homes (BZH), which faces margin pressure from rising mortgage rates. Instead, focus on sectors with inflation-hedging properties. For example, industrial developers (e.g., Prologis (PLD)) benefit from e-commerce demand, though their projects face delays due to material shortages.

Supply Chain Constraints: Tariffs and Trade Policy Upend Cost Predictions

Trade policy uncertainties are exacerbating construction's pain points. Tariffs on steel, aluminum, and potential new levies on copper and lumber have driven material costs higher.

The impact is uneven. Public projects like highways and bridges, often insulated by federal funding, can absorb cost increases through budget adjustments. In contrast, private-sector projects—especially residential and commercial—face margin squeezes. For example, Beazer Homes reported a 14% year-over-year drop in gross margins in Q1 2025 due to lumber costs exceeding $700 per thousand board feet.

Investors should favor companies with diversified revenue streams. Caterpillar (CAT), which supplies heavy equipment to both public and private clients, benefits from infrastructure spending while mitigating sector-specific risks.

Public vs. Private Spending: A Divergence with Long-Term Implications

While private construction spending fell 0.3% in May 2025 (to $1.65 trillion), public projects surged 0.5% to $487.6 billion, driven by federal funding.

Public Sector Strengths:
- Infrastructure Investment: The $136 billion allocated under the Infrastructure Investment and Jobs Act (IIJA) for 2025 is fueling projects like the Port of Tacoma terminal expansion and broadband upgrades in tribal areas. Companies like Fluor (FLR) and AECOM (ACM), which specialize in public-sector contracts, are poised to benefit.
- Megaprojects: Over $120 billion in projects exceeding $1 billion are in planning stages, including high-speed rail and urban transit systems. These projects are less sensitive to rate hikes due to fixed-price contracts and government guarantees.

Private Sector Challenges:
- Residential Lag: Single-family starts have declined as mortgage rates remain above 6%, and homebuilders face excess inventory in Sun Belt markets.
- Commercial Volatility: Office construction continues to shrink amid hybrid work trends, but data centers—a subset of "office" projects—remain robust, with demand from cloud providers.

Investment Strategy: Focus on Resilience and Public Contracts

1. Infrastructure Plays:
2. ETFs: The iShares U.S. Infrastructure ETF (IGF) offers exposure to companies like Quanta Services (PWR) and Granite Construction (GVA), which are core to public projects.

3. Utilities: Regulated utilities (e.g., NextEra Energy (NEE)) are beneficiaries of energy grid upgrades funded by the IIJA, offering stable dividends and inflation protection.

4. Sector-Specific Picks:

5. Transportation: Companies involved in rail and transit systems, such as Brookfield Infrastructure Partners (BIP), should thrive as states prioritize mobility projects.

6. Education and Healthcare: Public spending on schools and hospitals is growing. For example, Shawmut Design and Construction, which handles institutional projects, reported 22% revenue growth in Q1 2025.

7. Avoid Rate-Sensitive Sectors:

8. Steer clear of pure-play residential developers until mortgage rates stabilize below 5.5%. Monitor Beazer Homes' stock price closely—its decline in 2025 mirrors broader sector weakness.

Conclusion: Navigate with Caution, Invest in Certainty

The construction sector's 2025 landscape demands a disciplined approach. While private projects face headwinds from rates and supply chain bottlenecks, public infrastructure offers a reliable growth vector. Investors should prioritize companies with federal contract exposure and avoid sectors reliant on volatile private demand. The next critical data point—September's Fed meeting—could determine whether rate cuts materialize, potentially easing financing constraints. Until then, shelter in infrastructure and think long-term.

Multifamily REITs like EQR, which benefit from steady rental demand, may offer a middle ground for investors seeking yield without overexposure to rate risk.

Final Take: Public infrastructure is the safe harbor in a choppy construction market. Ride the wave of federal funding while waiting for private-sector clarity.