Emotion Fuels Lumber Market Spike
Prepare for More Lumber Market Volatility Ahead
Obviously by now, you are well aware of what is happening in the lumber market, or at least, the results of whatever is happening in the lumber market. Yes, things are askew. I have held off writing this market report because there was such speculation regarding specific dated rulings that were due out involving investigations being conducted by the U.S. Department of Commerce. These investigations are the result of a petition filed by a U.S. lumber coalition against Canadian lumber imports. This coalition, made up of American lumber producers, is the plaintiff in one of the longest and most enduring trade disputes between two nations. The conflict started in the early 1980’s and its effects are still wreaking havoc on lumber markets today. (See “An Epic Trade Battle” A History of the Canadian – USA Softwood Lumber Dispute) While the housing numbers have remained relatively solid, with modest growth in single family and robust multi family activity, it is emotion that seems to be fueling the latest lumber spike. Triggering the emotion is the uncertainty that surrounds the lumber trade dispute and uncertainty breeds’ volatility, something that we have not seen in lumber markets in years.
Supply and demand can have a fickle relationship. The link between lumber consumption and lumber production seems like it would be relatively easy to measure, and normally is. But open markets are always subject to non-conforming influences, be they natural, or, as in this case, fabricated. Now that is not to say that the U.S. – Canadian trade dispute does not have merit, because the longevity of the clash probably says otherwise. But, what is not fabricated is the financial burden to the lumbermen and builders left staggered by massive price swings, both up and down, in the lumber marketplace. It can be extremely painful, to say the least, but it is not altogether without precedent. But, these precedents come with a caveat that would make Sir Isaac Newton proud - For every action, there is an equal and opposite reaction.
The current run-up looks very similar to the 2001 surge that occurred just before the U.S. imposed countervailing (CVD) and anti-dumping (AD) duties. In May, 2001 prices spiked similarly as markets anticipated CVD/AD penalties. Lumber started a firming trend just as the previous softwood lumber agreement ended. From April 6th to May 25th, Random Lengths Framing Lumber Composite (FLC) ran from $306 to $431, a spike of $125 mbf. Over the ensuing six weeks, prices fell, nearly retracing the upward spike. That was more than a month before any duties were put into place. Something about the current market feels different, especially in regards to the possibilities of intense downward pressure on the market. The FLC soared $70, or 20% over a five week period starting in late January as Canadian producers in particularly, pushed for higher prices in anticipation of duties expected later this Spring, which they believe will be retroactively imposed back to February. The market softened over the next three weeks through mid-March as buyers absorb inventory and tried to calm the market down. The past two weeks have seen strong lumber sales as spring building picks up and the market has seen a bump. Of course, every situation plays out a little different and hopefully, 2017’s spike does not fully follow the happenings of 2001. In August 2001, a CVD of 19.31% was imposed and made retroactive 90 day to May. An AD assessment of 12.98% quickly followed, bringing the total duties to 32.29%. The market quickly bumped upward on the tariff announcement but spiraled downward amid the 9/11 terrorist attack which led to a recession in the U.S. economy.
Realist of the market can only hone in on the numerical data of lumber supply and lumber demand. Lumber availability is calculated by adding domestic production and imports, and then subtracting U.S. exports. In 2016, domestic production increased slightly by just 3.3%, to 24.808 billion board feet (BBF). Total imports reached 12.839 BBF, up 30.3%, with over 96% of those shipments coming from Canada. Factoring out U.S. exports of 1.026 BBF, the total softwood lumber volume available in America was 36.621 BBF, an increase of 11.7%, and the highest level since 2007. Canadian imports accounted for 33.7% of the overall volume of lumber available in the U.S., one reason why the duty determination means so much to the U.S. lumber market. On the demand side, 2016 housing market posted modest gains over 2015. Single-family starts gained 9.3% over 2015 and totaled 781,600 units. Multifamily starts totaled 392,600 units, down 3% from the previous year, but still very strong historically. Total housing starts rose 4.9% to 1.174 million units in 2016, but well below historical averages during the 2000’s. The repair and renovation (R & R) market, also a big consumer of lumber products, was strong in 2015 as well. Lumber prices during 2016 did grind upward about 15% throughout the course of the year, but through all of 16`, the largest weekly swing of the entire year was $10 – and that only happened one time. On February 10th 2017, Contract Lumber’s composite index jumped $30 in one week, with the week prior posting a $14 gain and the week after $15 respectively. It certainly appears volatility has crept back in to the lumber market, at least for the foreseeable future.
You would have to go back to May, 2013 to see price levels like we are currently experiencing. So, when a marketplace becomes so accustomed to a reliable trading range, panic can set in when the market spikes, sending complacent buyers into the fray in preservation-mode, and further adding fuel to a red-hot market. An open winter in much of the U.S. has also kept projects moving forward and lumber material steadily flowing to job sites through the building season’s traditional slower months. It has been hard to build inventory levels; from the mill level, all the way through the lumber distribution chain, so the marketplace was ripe for a run like this, especially with what most analyst anticipate to be a very active building season just around the corner. There is ample concern that if the construction season gets out of the gate strong it will be hard to put downward pressure on an active lumber market. The general consensus - you should expect higher highs and higher lows for your lumber prices in 2017.
Affordability Will Challenge the Housing Market for the Foreseeable Future
The affordability of new homes is quickly rivaling labor and lot availability as the major challenges builders are facing in 2017. Rapid home price appreciation and tepid wage growth have combined to erode home affordability to its lowest level in eight years. Home prices rose steadily throughout last year with annual gains 7.2% higher than in 2015. The median new home price went from $296,400 in 2015 to $313,200 in 2016. The national median home price has increased 60% since the beginning of 2012 while average weekly paychecks have swelled by just 1%. It now take 22.2% of the median income to make payments on a median priced home according to Black Knight Financial Services. During the housing bubble of 2006, it took nearly 36% of the median income to afford a median priced home as home prices and mortgage rates were higher, so at least, homes remain more affordable than during the housing boom. But it’s clear that the market is now experiencing the most pressure – from an affordability factor – since the housing recovery began.
One major concern moving forward is rising mortgage interest rates. Benchmark 30-year mortgages have risen by more than 15% or 40 basis points since the election, to 4.19%, the fastest and steepest rise in over 5 years. Most believe we have seen the bottom on mortgage rates with the Federal Reserve announcing a series of intended rate hikes over the next two years. The 30-year fixed rate mortgage is projected to reach 4.60% in the 4th quarter this year and although low in historical terms, it would represent an 85 basis point increase from 2016. The relative change is important to homebuyers who shop on a monthly payment basis and, in fact, would represent the largest annual increase in 23 years. Rising interest rates will especially impact the 1st time home buyers who have largely been absent during the housing recovery so far. Many analyst were projecting that demographics and an improving economy were laying the foundation for a substantial increase in entry level buyers in 2017 but the mortgage rate increase, coupled with increased home prices on very thin inventory, will create major hurdles for millennials as they navigate the qualification and buying process.
There is some good news on the financing front. Even though rates are on the increase, credit is not quite as hard to come by as it was after the recession and the FHA has announced it will increase lending limits for 2017. They are raising both the Jumbo loan threshold to $424,100 and conforming loan limits to $272,665. Both increases reflect a raising confidence in consumer ability to repay larger loan amounts and will provide buyers with more options when it comes time to choose a home. Lenders are also bringing a number of new mortgage programs to the table that call for a modest downpayment and do not require buyers to purchase a FHA loan. More products from municipal housing agencies that assist many first-time home buyers are also being rolled out. This is in addition to the Federal programs (Freddie & Fannie) that allow for as little as 3% down for 1st timers with loan amounts below the conforming threshold. And the final piece of the financing puzzle is the influx of smaller banks and non-lending institutions that have re-entered the lending game. In addition to giving buyers more opportunities to find a lender that meets their needs, it has also created a more competitive landscape with lenders focusing on appealing to consumer needs. Also part of the lending landscape for 2017 is the anticipated reform to Dodd-Frank, the sweeping regulations passed in response to the 2008 financial crisis that were meant to protect consumers and the banking system. President Trump has promised to scale-back excessive regulations and Dodd-Frank is high on his list. The implementation of the act has contributed to a lackluster recovery in the housing finance market and slowed economic growth overall. Complying with the burdensome and costly provisions of Dodd-Frank has especially hit community banks hard, which is the source of a majority of builder’s construction loans. Hopefully, policymakers taking on Dodd-Frank reform consider current legislation introduced by House Financial Services Committee Chairman Jeb Hensarling (R-Texas), called the Financial CHOICE Act of 2016. Provisions in his legislation would roll-back significant components of Dodd-Frank, especially in several important areas – loosening of overly tight credit conditions, reform the structure and authority of the Consumer Financial Protection Bureau, exempt certain multifamily mortgage risk retention regulations, and generally prevent new financial rules from weighing too heavily on small businesses. We must, however, be careful to keep in mind that it was mortgage lending that led to housing affordability getting out of whack back in 2006 and spiraling the economy into recession. Mortgage programs increased buying power and drove up home prices, when in reality, without those products, the affordability ratio between home prices, incomes, and interest rates was nowhere near sustainable. Hopefully, we have learned our lesson.
Of all the challenges builders face, none is more critical than the availability of skilled labor and the associated elevated cost of getting work done in the trades. In a recent NAHB survey, cost and availability of labor ranked number one on the list with over 82% reporting it as their top concern in 2017 because they had all had projects impacted by the labor shortage in 2016. The housing upturn has strained a graying, shrinking pool of skilled tradesman, with few young laborers ready to pick up the slack. Our industry has seen its workforce dwindle due to a lack of vocational education option, a cultural shift away from traditional blue collar work, as well as a huge loss of talent during the last downturn. And reguardless of where you stand on Trumpmania, his immigration rules are likely to worsen the construction labor shortfall. Foreign born workers account for nearly 30% of all those employed in construction trades with some estimates higher than 65% among occupations that are central to building a home, such as framers, roofers and drywall installers. While most of these workers are U.S. citizens and documented work visa holders, there are certainly some undocumented workers who have slipped through the cracks. Estimates range from as high as 8 percent down to a low of 4% of the construction workforce. Regardless of how many their numbers, our industry can’t afford to lose any trade labor right now. I also think that we are at risk of alienating a large segment of these construction workers, especially the Hispanics, with the current immigration rhetoric and talk of border walls. They are a proud, hard-working culture and have to feel unappreciated and under-valued in the current climate. Imagine the hit to their mentality and motivation when they are busting their butt struggling to earn respect and a living wage, all the while helping to build American homes. It’s a complicated topic that is not going away.
In the aforementioned NAHB survey, the number two concern was the high cost and availability of developed lots. Over 67% of respondents rated the issue as a significant problem. Shortage of buildable lots has frustrated builders and developers alike. The process of bringing land on line has become exceedingly difficult, costly, and time consuming. Restrictive regulations, limited financing for lot development and buyer’s growing preference to live near cities where there is little unused land, are cited as the major culprits. Not only is land hard to come by but it’s laden with local entitlement charges, hook-up fees, and permitting costs that drive up prices. Density constraints, zoning approval and appeals process, Federal environmental rules, all have wreaked havoc on the development process, and all drive up the cost of a lot. It seems every new development invariably faces substantial opposition from local neighborhood committees, city councils, zoning boards, and a bevy of activist’s positioning. Some builders and developers are experiencing excessive fees as high as $30,000 - $50,000 on a lot – one reason it is so hard to bring affordable entry level housing to the market.
So there you have it – progress and uncertainty. We could very well post double-digit housing gains in 2017 but it all seems so very fragile, like it could go either way. It’s like you have to be prepared for accelerated growth and a possible recession, all at the same time. We have a President that is pledging infrastructure spending, loosening regulatory scrutiny, and tax cuts to accelerate the economy, all of which is music to the ears of the building community - progress. Conversely, we have a President that wants to deport millions of illegal immigrants (construction labor), instill protectionist tariffs (construction lumber), and withdraw from international agreements (T-PP & NAFTA), effectively changing how the U.S. economically engages with the world - uncertainty. Overall, it creates hesitation as it pertains to economic decisions because no one knows what to truly expect. This uncertainty has a way of paralyzing investment decisions that have real economic consequences, like purchasing a home. So, even though the current overall housing environment seems so positive, so confident, be aware that things can quickly change. Stay informed…significantly raise your level of monitoring financial, political, and world events, as painful as that may seem. Monitor and manage your level of risk - risk of any type. And be prepared for how best to exploit the progress as well as strengthen your resilience to recessionary shifts. Maybe you’ll want to change the name of your company to Chameleon Building Company, LLC.