Lumber Price Surge Sends Shockwaves Through Construction-Related Industries
Throughout late 2020 and the first half of 2021, lumber prices skyrocketed as lumber mills around the world shut down due to the pandemic. In the short term, the impact wasn’t readily apparent because no one could foresee how long the shutdowns would be in place, or what the lasting effects might look like.
The lumber mills surely didn’t realize they would halt production for as long as they did, and couldn’t have planned for the impact lowered production would have on global supply. Compounding the issues caused by low supply, employers allowed their employees to work from home, giving homeowners more time and energy to put towards home improvement projects. In 2020, home improvement spending was up 8.7% from where it was a year before and 2021 didn’t see much of a change in the number of projects undertaken by homeowners (both DIY and projects where contractors are involved).
The lumber industry is not insulated and fluctuations in pricing can have widespread effects on several industries. In this case, the increased lumber prices have disproportionately affected the construction industry and many industries that rely on construction for growth.
A Deep Dive Into The Lumber Price Rollercoaster
Going into the pandemic no one was sure what the future would hold. Companies across every business sector were hurled into planning for something they’d never experienced before, without any indication of how long it might take to get back to normal.
In the lumber industry, companies decided to stop production in their sawmills to keep their employees safe and because they thought demand for lumber would plummet. Instead, demand for lumber grew in a way no one expected. All of a sudden, people were spending time at home and had the time to take on projects they may have been putting off.
Simultaneously, historically low-interest rates encouraged more people to buy houses, severely reducing inventory and driving real estate prices in most markets to new heights. To keep up with the housing supply crunch, while also taking advantage of a low cost of capital, homebuilders ramped up production, furthering the lumber supply and demand gap.
Through this perfect storm of events, lumber output rose by only 3.3%, while new home construction rose by 12% and home renovations rose by 7%, according to the National Association of Homebuilders. As a result, 1,000 board feet of lumber went from $349 in April 2020 to $1,514 in May of 2021, a 334% increase in just over a year.
As the saying goes, whatever goes up, must come down, so too has the demand for lumber cooled since reaching its peak in May 2021. 1,000 board feet of lumber reached an annual low of $442.7 in August and is going for $634.80, still 82% higher than in April of 2020. Partially fueled by difficulties finding employees, lumber mills are increasing production but are still unable to fully meet demand. However, as lumber supply and demand fluctuate for the rest of the year, this indicator will surely continue changing.
How Have Fluctuating Lumber Prices Affected Multifamily Development
In a typical multifamily development project, lumber accounts for 10% – 15% of the total ground-up cost to build, while the remaining 85% – 90% of development costs come from everything else, including concrete for foundations and parking decks, asphalt for parking lots, design and engineering fees, landscaping, etc…. Therefore, fluctuations in lumber costs after a project has been underwritten can have a major impact on the profitability of the project. Developers were faced with an interesting set of circumstances – demand for multifamily housing is rising at a quick pace and construction costs rose making it more difficult to get a new project off the ground.
Either as a reaction to a challenging single-family market to buy in or as a trend more indicative of what the future holds, demand for multifamily units has risen substantially in the last decade. Developers have been doing what they can to meet the demand while still hitting their projected returns for investors.
According to an article written by Parcel Pending in 2020, multifamily supply growth slowed in 2019 but was expected to pick back up in 2020. Correctly, Freddie Mac also predicted that supply would start outpacing demand through 2020, and vacancy rates would rise slightly. However, through 2021, vacancy rates have dropped signaling either an increased demand or lowered supply, or both.
As developers are delaying projects, either by choice or necessity (developers were waiting for lumber prices to drop or were unable to get the materials they need), the number of new units coming to market remained low through the first half of 2021. With lumber prices falling, the supply of new units will likely turn the corner and begin catching up to demand.
In addition to the rising cost of materials, construction companies are also facing a shortage of skilled labor and increased wages to keep the employees they already have. Construction jobs have historically paid well, as much as double what hospitality jobs pay on an hourly basis, but with a severe shortage of skilled labor (there is a need for more than 1 million construction workers in the next two years), employers are having to raise wages to keep their talent from being poached by other companies.
Going into the pandemic there was already a shortage of a couple hundred thousand workers. When projects came to a halt during the mandatory shutdowns, employees, needing a way to support themselves, moved around the country to find work, some leaving the construction industry altogether. In some cases, even with higher wages, construction companies are unable to find employees to fill the roles they have available, limiting the number of projects they can take on and the time it takes to complete ongoing projects.
Conclusion
Fluctuating construction costs (major swings in lumber prices more specifically) is one of the most significant factors in the challenges developers have faced in underwriting new projects. Lumber has not been the sole culprit in increased construction costs and extended timelines, however. All materials from concrete to drywall have seen inflated prices thanks to decreased supply as manufacturers are still trying to catch up from when they slowed, or stopped, production during the first several months of the pandemic. Thankfully, rental rates have also risen significantly in the year and a half COVID has been around, keeping projects attractive to investors.
