The Perfect Storm - Part 3
Part 3: Evaluating The Demand-Side of the Equation
Housing Rebound Puts Pressure On Fragile Supply Chain
The housing rebound, modest as it is, has put considerable pressure on the lumber production capacity throughout North America and the result has been a surge in lumber pricing and lumber availability that has thrown the building community into a sideways skid. Anytime you get an aggressive run-up in pricing like we have had over the last year, especially in the last three months, you have tremendous anxiety in the marketplace as everyone scrambles to deal with the discrepancies in what they budgeted they could buy lumber materials for, verses the reality of pricing at the time of purchase. Now, buyers are trying to digest this new reality while trying to project just where this market is heading. In our third installment of The Perfect Storm, we will isolate the demand side of the supply-demand equation to better understand the critical factors that drive lumber consumption.
The U.S. averaged 1.74 million starts per year from 2000 to 2004. Last year’s gain represents an increase of 28 percent over 2011, the biggest annual gain since 1983.
We all know that housing activity is the central component that drives lumber consumption. This past year, U.S. housing starts surged to their highest level since June, 2008, propelling the lumber market to levels it had not seen in over six years. Starts jumped to a current level of 954,000 units per annual rate in December, up from 851,000 in November and 697,000 one year ago. Housing start data from the Commerce Department can be subject to large revisions from month to month but it is clear that the market is finally gaining traction and forecasts for 2013 show continued recovery with starts projected to eclipse the million unit mark. For perspective, U.S. housing starts peaked at 2.07 million units in 2005 before hitting bottom in 2009 at 554,000 starts. The U.S. averaged 1.74 million starts per year from 2000 to 2004. Last year’s gain represents an increase of 28 percent over 2011, the biggest annual gain since 1983. U.S. lumber consumption was tracking at a 6 percent gain over 2011 with projections of a 10-percent increase in 2013 to over 40 billion board feet, certainly a sign that the lumber market is poised for continued potency.
The multi-family housing market has taken the spotlight in the recovery accounting for over 30 percent of the housing starts in 2012. Single family starts were up just over 18% in 2012 while multi-family showed more than a 35% increase with a majority of the multi-family growth centered in 14 major urban areas. The new construction housing sectors are poised for near 30% growth in 2013. The remodeling sector, which actually consumes more lumber than new construction (15.4 billion board feet to 11.7/bbf), is also expected to exceed 2012 performance by 25-30%.
However, this recovery is anything but ordinary as economic uncertainty continues to plague consumer confidence. According to Gallup’s U.S. Economic Confidence Index, a poll that tracks consumer confidence daily, only 44% of Americans say the economy is getting better, and while that number has continued to improve over the last two years, it still translates into a major deterrent to consumers taking on new debt. Also in the background is the uncertainty people feel when our Nation’s leadership is reluctant to act together responsibly to resolve major issues that dramatically impact our country.
The Plus Column
Several key components seem to be working in favor of the housing recovery. The first is low new home inventories. Unsold, new home inventory in the U.S. is at its lowest level in almost 50 years. Coupled with the existing home market having worked through the worst of a backlog of foreclosed and distressed properties, the market seems ripe to react to the pent up demand created during the recession. Another significant positive is that the industry is blessed with record low interest rates. Last year saw a record low annual average rate of 3.7% and while some analyst expect rates to edge up to the mid 4% range, others feel that mortgage interest rates will not raise above 4%. Regardless, if rates stay in that range financing a new home or project remains extremely affordable.
Stuck in Neutral
Home prices, both new and existing, increased in 2012 which is very encouraging. However, between 2006 and 2009, home prices declined about 35% nationally leaving a lot of ground to make up. New home prices were up nationally by an annualized rate of 6% in the first 10 months of 2012. But, the most critical factor in attracting sustained growth in the housing sector is rebounding property values. If you want prolonged housing growth the move-up market will be vital and with an estimated 25% of residential mortgage borrowers currently in a negative equity position, we have significant challenges to overcome in that arena. The unemployment rate has fallen to 7.8% but job growth still remains sluggish as does household income growth. Consumer debt-to-income ratios are also worrisome to economist.
Builders site several potential obstacles that affect the demand side of the housing recovery. One of the most critical is tight mortgage lending conditions. Access to credit is a significant constraint to business. Lending for new homes is still oppressively tight and remains an obstacle to further progress residential real estate healing. Banks are leery of underwriting mortgages, especially at today’s historically low interest rates. However, with 90-95% of mortgages either underwritten by or ultimately off-loaded on to Government controlled agencies, the banks have minimal long-term exposure. In addition to low rates, the Federal Housing Administration is underwriting many new mortgages with down payments as low as 3.5% so there are a few positives amid the mortgage lending chaos.
Another obstacle is the declining inventory of buildable lots. In Columbus, Ohio for example, Binns reported that since 2008, 11,460 homes were built, but only 4,301 lots were developed. And, that is most likely the norm across the country as land development just became too costly and too risky during the recession. Now, you can’t develop land fast enough to keep up with even the modest growth we are experiencing which is certain to cause lot prices to escalate. Other major concerns include the raising price of materials and labor shortage issues (both of which are explored in our Perfect Storm series).
Several broader economic and political issues are also on builders minds, including tax reform, ObamaCare, and immigration reform. While comprehensive tax reform is needed to restore the competitiveness of America’s small businesses, repealing the mortgage interest deduction would have an adverse effect on the entire housing market, potentially reducing home values and slowing sales. ObamaCare imposes significant new mandates on employers who already struggle to provide affordable health benefits to their employees. A recent survey found that a majority of small businesses are less likely to hire new employees as a direct result of the healthcare mandate. Immigration reform continues to be a magnet for controversy in this country and it especially presents challenges for the entire construction industry. Labor shortages are currently burdening many builders and general contractors in most trades but they could quickly escalate to extreme levels if our leaders do not take a reasonable approach to immigration policies and procedures. Of particular concern is the undue burden and potential liability on employers of forcing them to certify the work eligibility of their employees. This is seen as an extreme measure and is causing alarm throughout the building industry.
So, yes, the housing market has turned the corner and this increased demand looks legitimate, healthy, and sustainable. You would think everyone associated with the construction industry would be giddy. But, at best, cautious optimism abounds given the many obstacles that lay in wait to undermine our progress. It’s hard to think that any one obstacle by itself could subvert the recovery but collectively, they could certainly squelch this resurgence.
As always, Share your comments below on your experience with this volatile market. Be on the lookout for our next installment of The Perfect Storm where will dissect the supply-side of the lumber market to learn what is causing the imbalance in the lumber supply chain.
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