Cost of Capital Increases for Construction Industry

Happy 2025! For my first post of the new year, I want to discuss the cost of capital.

From January 2024 to 2025, the weighted average cost of capital (WACC) increased from 7.71% to 8.17% for engineering-construction companies, and 9% to 9.46% for building material companies.
Why it matters:

• The WACC is determined by the costs of equity and debt for a company. The data above is the average WACC for 42 publicly-traded engineering-construction companies and 46 publicly-traded building supply companies.
• The WACC is the hurdle rate for companies in that investments they make in their businesses need to be in excess of the WACC. If the WACC increases, so does the required return on investment in order for it to be profitable.
• With a higher WACC, the more expensive it is to finance capital expenditures. So if a companies like Granite, Tutor Perini or Shimmick want to upgrade their excavators or companies like Carrier, Zurn Elkay or JELD-WEN want to invest in more factories to manufacture air handling units, drinking fountains or window systems, respectively, then the cost of those investments is greater if they are being financed. Put another way, the return those investments need to provide must be greater if they are to be profitable.
  
• Higher WACC tends to stymie capital investments.

The cost of capital for publicly-traded companies that compete in the construction industry has increased over the past year. This will make it more difficult for companies to justify, or benefit from, capital investments in equipment, facilities, or acquiring other businesses. Before hitting the panic button, the increases were not huge, relatively speaking. Also, the data is for publicly-traded companies in the United States. That is, the sample size does not represent the entire construction industry (data on privately-held companies is difficult to find; private company WACC could be better or worse than publicly-traded companies) or any one company. However, using the average WACC for publicly-traded companies as a proxy WACC for the entire industry allows us to assume that financing major investments will be more difficult this year than it was last year. 
I included the Federal Funds Rate in the graph above for reference. Typically, when the the Federal Open Market Committee decreases the Fed Rate, as they did at their November 2024 meeting, they do so to stimulate the economy by making it less expensive to borrow money. Yet the construction industry saw the opposite happen. This seems to indicate that, in spite of the Fed Rate reduction, investors are seeking higher rates of return for capital invested in the construction industry. If the people you are borrowing from want greater returns, then you tend to borrow less.
On another note, if you are a construction economic data nerd like I am (diagnostic test: if you are still reading, you are a suspect), then check out the data provided by NYU finance professor Aswath Damodaran. The data in the graph above is from his dataset and he has a lot of useful financial and economic data.