High cost: Is lumber worth its weight in gold? Diamonds? Platinum?
Published in Institutional Real Estate, Inc. on August 19, 2021. Written by Denise Moose.
There came a point at the end of 2020 and beginning of 2021 where a joke was told that people should start proposing marriage not with the standard diamond, but with a chip of wood on the ring. If you were in the know about the cost of lumber, that joke was hilarious.
In April 2021, Fortune had a headline that read: “The price of lumber is up over 200 percent — and pre-COVID levels might never return.” It was reported in the article that home builders and do-it-yourselfers just couldn’t catch a break due to the price per thousand board feet of lumber jumping to an all-time high of $1,104, according to Random Lengths — a staggering 208 percent from one year previous.
When the pandemic struck last year, shutdowns caused sawmills to halt production at the same time that quarantining Americans rushed to Home Depot and Lowe’s to buy up materials for do-it-yourself projects. That supply-and-demand mismatch caused lumber inventory to plummet. Aided by recession-induced record-low interest rates, the housing market boomed in summer 2020. As that market got hotter and existing home inventory fell, buyers turned to new construction. Of course, new homes require a lot of lumber, thus exacerbating the shortage.
“We’ve certainly seen significant cost movement in the multifamily space, most obviously driven by the runup in lumber pricing,” says Nathan Schubert, managing director at Crow Holdings Capital. “The good news is, rents have been growing at an accelerated pace over the last six months as well, which helps keep development yields at attractive levels. There isn’t as much of a concern with value-add, as the costs associated with value-add improvements aren’t significant enough to affect the returns in that sector, especially as rents are growing significantly for this product type as well.”
Christopher Bley, co-president and chief investment officer at IHP Capital Partners, said in early July that the high cost of lumber is a concern for their team. “IHP Capital Partners provides equity for residential development throughout the western U.S. and is a tactical partner and trusted fiduciary for well-known institutional investors and a wide range of the industry’s most notable home builders and developers,” says Bley. “Along with our partners, IHP currently has about 32 residential projects in various stages of development in Colorado, Utah, California, Oregon, Nevada, Washington, Texas and Arizona. Lumber prices greatly affect both our ground-up for-sale home-building projects, as well as our build-for-rent projects. As a primary direct cost, lumber makes up roughly 20 percent of the total cost of building a house. While lumber prices have started to decline from their peak in May 2021 — about 67 percent as of June 30 — they are still higher than anytime in pre-COVID history.
“Lumber is one of several important input costs that are fluctuating quite a bit in 2021. The unpredictability of these costs makes underwriting and active management of construction projects much more difficult, like trying to hit a moving target. These factors can make projects inherently riskier as we try to deploy capital based on our rigorous analytical models.”
Richard Whiteley, co-president and COO at IHP Capital Partners, adds that although lumber is the lead actor, they are seeing rising input costs across all residential product types, from townhomes to single-family detached homes, and across all geographies where IHP is active.
“The cost of concrete and pipe have been on the rise, and it is increasingly difficult to source appliances and other important items like garage doors that are needed to complete homes,” says Whiteley. “The home-building industry is experiencing a textbook example of the ‘Bullwhip Effect’ that distorts supply chains across other industries. At the outset of COVID, many in the real estate industry expected the worst and adopted a wait-and-see posture. Little did anyone know at that time that residential home building would be one of the unexpected beneficiaries of the pandemic. While home builders and suppliers largely shut down for periods of time in 2020, homebuyer trends, many that were in motion before the pandemic, greatly accelerated and caught suppliers off guard. Work-from-home requirements and stay-at-home orders caused people to re-evaluate their living situations as homes suddenly became offices, learning centers, gyms and more. Homebuyers began to aggressively seek out more spacious environments, larger homes in suburban communities with recreational amenities outside of the urban core.”
How big of an impact are the rising prices having on bottom lines?
“While inflation may continue to present some hurdles in the near term, the combination of rent growth and cap rate compression continue to make development yields attractive,” says Matt Colter, managing director at Crow Holdings Capital.
Bley adds that during the housing industry’s last bull market run around 2005, building costs increased 2 to 3 percent and prices rose more than 12 percent, leading to huge levels of margin expansion and profitability.
“What we are seeing today is very different, with only a fraction of the profit finding its way to the bottom line,” says Bley. “Rising input costs such as land, concrete and lumber are eroding home-builder profits. This contradicts the misconception that home builders must be ‘minting money’ in today’s environment where the demand for new homes from buyers is historically high. The velocity of sales — or, absorption, in single-family terms — is a key component of generating return-on-equity for capital investors. The faster capital is turned over, the better are the returns. That being said, lumber cost increases are somewhat offset by the faster absorption we are seeing across the industry.”
Luckily, as of early August, Market Insider reported lumber prices look cheaper after a 65 percent plunge, given Americans still want new houses. The article stated prices for lumber futures soared in the early part of the year to a record high of above $1,700 per thousand board feet amid strong demand for new houses and a home-improvement craze. But they have since tumbled around 65 percent to $607 as of Aug. 3, as suppliers have ramped up output and demand has cooled.
Robert Minter, director of investment strategy at Aberdeen, told Market Insider that lumber currently “looks a little cheap.” He said the COVID-19 story is far from over, and many Americans are still keen to move houses if their companies allow them to keep working from home.