Lumber and Housing Market Outlook
The positive vibe surrounding the building industry right now cannot be denied. And while new home sales, starts and overall confidence levels have taken a bit of a hit the last couple of months, most housing analyst project that the recovery will be in full swing in 2014 and beyond. In this report, we will take a glimpse into the lumber market as well as review key housing and construction indicators in an effort to provide analysis of how this year’s building season may play out.
Let me start by passing along a quote I read recently. My apologies to the author for not recalling its origin, but then again, it could have come from the lips of just about anyone who relies on the building industry for a paycheck. “I get all the housing news I need right now on the weather report.” A solid dose of winter has significantly hindered building activity throughout much of the country in the first two months of the year. The deep freeze and winter storms have dipped far into the South, creating havoc for both the building and lumber industries. The inability to pour concrete is pushing back project start times while lumber production, consumption and transportation continues to be hampered. Many are calling this one of the worst winters they can remember. With jobsite shipments stalled, the need for dealers to replenish inventory positions has been drastically reduced, regardless of how much “value” there is in the current lumber market. That lack of consumption and subsequent replenishment has left the lumber market bouncing around looking for levels, showing no real sign of strength or any major weakness. Some lumber products have been slowly grinding downward but only because sellers are accepting counters on prompt ship lumber. On shipments two weeks out or further, they are holding their prices hoping to forge through until a break in the weather leads to a round of buying. Producers, for the most part, are optimistic with spring around the corner (14 days and counting), relatively low inventory levels in the distribution chain, and strong housing projections.
A legitimate fear right now is how all of the construction delays are potentially setting up a real logjam when the weather does break. Many believe concrete, underground plumbing, and framing trades will not be able to meet demand causing labor and material markets to spike and likely adding build-days to many construction schedules. A sign of how these delays are impacting construction schedules was evident last week when the Central Ohio Builders Association announced that their yearly Parade of Homes was being pushed back a month. Adding insult to injury is the current concern over a lumber market supply pipeline disruption due to weather affecting incoming and outgoing rail car shipments. We have seen several major suppliers struggle to get loads to us on time due to this issue and although expected to only be a short-term nuisance it’s just one more thing to disrupt continuity.
Stud markets have remained relatively strong for the current level of activity which has many worried about the potential upside volatility for nearly all species of studs. Longer length studs seem particularly vulnerable due to growing demand for nine and ten foot walls. Order files are out well into March at many stud mills. Southern Pine markets have been able to stave-off deep price cuts mainly because of squelched production due to weather problems. Given that pressure-treaters and truss plants have, for the most part, stayed out of the market when they would have normally been buying inventory has some traders expecting a strengthening of the Southern Pine market.
The panel market, on the other hand, has shown no real signs of strength but buyers have been reluctant to take significant inventory positions, even though sheet goods are currently approaching 52-week lows. New OSB production that came online in 2013 is partly to blame but also distributors and dealers are generally exhibiting some caution, remembering vividly the pain of the market collapse last spring. That’s when supply channels positioned themselves far ahead of normal inventory levels based on the frenzy brought about by the forecast that the economy was going to rebound in excess. The “buzz” widely circulated that mill production would not be able to meet demand, in effect shutting out those that didn’t buy in. Like most others, we also got caught up in the emotion of overly optimistic expectations and the concern of potential key product shortages. I can’t help think that experience is not playing a part in current buying mentality.
Regardless of past history, most dealers currently have significant levels of booked business. And even though productivity has been hampered at the job site this winter I would describe builders and suppliers collective psyche somewhere between guarded optimism and euphoric bravado. Most everyone admits that the American housing landscape sentiment is exceedingly positive. But I think it is very important for our industry to stay grounded. That is to say, yes, housing is in recovery mode, but there are many fragile components to the resuscitation process. Let’s explore some of those key housing indicators and the potential headwinds that can impede housing’s performance this year. Our goal is to provide information that can be used to help us all make better informed business decisions in 2014.
First, let’s look at the single-family new home construction market - the backbone of America’s housing. Single family home production resurgence will continue to climb in 2014 but not without its challenges. NAHB chief economist, David Crowe, has forecasted an aggressive 822,000 starts, up nearly 200,000 over 2013 levels when single family starts reached 617,800. That’s over a 32-percent growth in activity over last year although still falls well short of historical averages. For instance, the average single-family housing starts from 2003 through 2006 were over 1.5 million per year. Consumer confidence is returning to pre-recession levels and household balance sheets are on the mend. However, one key ingredient within single-family housing that has not rebounded as quickly is the sale and construction of entry level homes. For housing to achieve long-term recovery and sustainability, we will have to unlock the pent up demand of the first-time home buyer market, individuals 25-34 years old. Year-over-year household formations are on the rise and are now averaging 620,000 verses just 500,000 during the housing downturn. At the height of the housing boom, the US was producing 1.4 million additional households every year. Now, we have to get them back into the market. We will tackle some of the critical obstacles first-time home buyers face later in this article but for now, just understand that analysts forecast single-family starts to rise slower than traditional recoveries based on this sustained decline in the homeownership rate in this 25-34 age group. At the other end of the single-family housing spectrum, luxury housing demand is showing significant strength. New home loan applications of $625,000 – 729,000 were up 57% from 2012 and applications for over $729,000 were up 41%. So builders are focusing on these “move-up” buyers purchasing second and third generation homes. The result is that builders are selling fewer, but higher priced homes, thus making their profits through margin rather than volume.
Multi-Family activity has really been the shining star that has helped lead the housing recovery out of the recession. With low rates of vacancy and increasing rents, the multi-residential sector will continue that trend, albeit at a slightly slower pace. Apartments outpaced expectations last year when NAHB forecasted 299,000 starts. Multifamily finished at 305,600 starts in 2013, up over 25% from the previous year. This could, in part, be the result of strengthening rental property needs due to lower than anticipated purchase activity from first time home buyers, the segment that fuels the housing ecosystem. For 2014 David Crowe is forecasting a 9% increase to 333,000 multifamily units. That brings the total number of building starts for 2014 to 1.15 million units or an overall increase of 24.5%. Of course, there are a few things that have to happen for those numbers to become a reality and we will explore those in the second half of our report.
The critical ingredient to housing’s success is the employment picture. The National Association of Home Builder’s predictions for 2014 hinge on the US economy creating an average rate of 200,000 new jobs a month. That’s up from an average monthly rate of 182,000 in 2013. The US Bureau of Labor Statistics reported that only 113,000 new jobs were created in January. Ironically, the construction sector generated 48,000 of those jobs, further evidence of the virtuous cycle in which housing drives jobs and jobs drive housing. And even more important is the creation of well-paying jobs that lead to household formations and new home demand at more normalized level verses a level suppressed by economic anemia. Nowhere is that income growth more important than the first-time home buyer market, a segment that has seen average incomes decline in the past two years. These declines stunt the entry level buyer’s ability to qualify for credit and thwarts their confidence in investing in housing. According to Lawrence Yun, chief economist for the National Association of Realtors, this recovery does not feel quite right even though unemployment has been declining measurably – from 10% at its peak to the current level of 6.6%. He claims that if you look at the employment rate – not the unemployment rate – you see how many in the adult population have jobs, and we have not made any progress since the depression began. It currently stands that only 58% of adults are working, well below the historical trend of 63%. So, until increases in job and income growth further restore more consumer confidence we can expect a somewhat muted housing recovery, especially in the low-end spectrum.
Another closely watched component impacting the housing recovery is housing affordability. The healthy and broad-based gains in home prices in 2013 will help set the stage for continued recovery in the housing sector in 2014. According to real estate research firm, Zillow, home prices appreciated at a rate of 6.6% in 2013 partly due to low inventory levels of for-sale homes. Expectations for home appreciation for 2014 is more guarded and in line with historical rates at 3.4%. Some markets, especially ones that lost the most value during the recession, are sure to show higher appreciation levels. However, there is some evidence that the new single-family home market may be experiencing some “affordability shock” that started surfacing in late 2013 and is carrying into the New Year. Builders, hit with price escalations for land/lots, building materials, and labor were passing through large home price increases. Combined with higher mortgage rates, potential buyers stayed on the sidelines and the robust housing recovery lost some of its momentum towards the end of the year. So far in 2014, while new home sales have fared well, new home starts have declined. Most point to the weather as the culprit but starts also slowed down more than the normal seasonal dip in places that didn’t have Mother Nature issues. Balanced appreciation is important in order to attract sellers of existing homes wishing to cash in on equity gains restored since the recession which, in turn, trigger new home construction opportunities. The caveat is that new home prices must stay reasonable in order to make this move-up market feel they are not over-extending their housing investment.
Home mortgage markets are also being closely monitored for their impact on the advance of the housing market. Specifically, rising interest rates and access to credit are under close scrutiny. Tighter credit standard will likely be an impediment to home buying due to the formal implementation of the Consumer Financial Protection Bureau’s (CFPB) new qualified mortgage (QM) and ability-to-repay (ATR) rules. Close to 20% of borrowers who qualified in 2013 probably won’t be able to do so under the new guidelines. These rules, which went into effect in January, were enacted as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The second rule, ATR requires that originators make a good faith effort to verify a borrower’s ability to repay the mortgage and imposes stiff penalties if they do not. The QM rule requires full documentation of income, assets and employment, a maximum of 3% points and fees, and a cap of 43% debt-to-income ratio. It is this debt-to-income ratio that is a mortgage application killer for would be first-time buyers. Young purchasers, many with large student loan debt, are finding it difficult to qualify with the 43% requirement. National Realtor Association research conducted in late 2012 indicated that with large amounts on credit cards, auto loans or leases and student debt (averaging over $21,000), these young adult’s (ages 24-35) debt-to-income ratio exceeded 60%. It may be many years before they can qualify under these new standards. Some banking analyst feel that by late 2014 the market will see a return of private capital and secondary markets which will make it possible for non-bank lenders to offer non-QM loans to less-than-perfect qualified borrowers. But, these loans will come with significantly higher interest rates to more accurately reflect risk-based pricing - further eroding affordability.
Rising mortgage interest rates are largely blamed for housing soft finish in 2013 and all eyes are watching rates leading into the 2014 building season. Due to the tapering of the Federal Reserve’s Quantitative Easing Program rates are likely to continue to rise. The Mortgage Bankers Association forecasts that 30-year fixed mortgage rates could work their way up to 5.5% this year, still at the low end of historic rates. One phenomena that mortgage analyst expect this year is a reversal in the percentage of refinancing compared to home mortgage originations. In 2013, refinancing accounted for 63% of mortgage originations with 71% in 2011. This year, purchase loan originations are expected to represent 61% of all home mortgage activity. The multi-billion dollar question everyone wants answered is, will rising interest rates along with rising home prices reduce affordability enough to negatively impact housing’s momentum, especially in an economy that continues to be plagued by wage stagnation.
There are also several other challenges that deserve our attention. Their level of impact depends on your perspective and circumstances but they all represent some degree of threat to the overall health of building activity this year. Labor availability may prove to be a real hindrance to builders coming out of this downturn. This is an issue close to our hearts here at Contract Lumber because of the high amount of turnkey services we provide and I can tell you first hand, this is a legitimate obstacle to overcome. Given that the nation’s new home sales are currently at a level 35% below the 50-year average this shortage of skilled construction labor is most assuredly not a short-term problem. Collective action across the industry will be needed if we are to find a resolution. Availability of developed building lots is another significant concern to builders in many regions. Developers are lagging demand at this point, pushing land prices higher for builders who rely on others for developed lots. And finally, one little discussed problem builders and existing home sellers are running into is obtaining accurate appraisals for their property. Lenders are balking at deals because appraisals are not matching the selling prices. This is requiring more out of pocket cash, price concessions, or both and is forcing cancelation of many deals.
In conclusion, 2014 is shaping up to be a very solid year for America’s housing market. And while we are a little slow out of the gate, the optimism in the housing sector bodes well for the overall U.S. economy because when consumers buy homes they also buy furniture and other goods and services, spreading out the economic benefit across many industries. Yes, there are abundant challenges and barriers to success and profitability but compared to three years ago, even these problems are tolerable.
30 Year industry veteran, Don Dyson serves as Business Development Director for Contract Lumber. Don maintains a keen interest and focus on educational efforts while getting to know each of our customer's businesses so we can better serve each one individually. He has become “affectionately” know as the chief “turd polisher” here at Contract Lumber.