2020 Year End Lumber Market Report - Part 2

Expectations in the 2021 Housing and Lumber Markets

I have always been a firm believer in starting a new year with the right mindset. Approaching the coming year with renewed vigor, optimism, and fortitude is critically important in order to navigate the many challenges life generates. This will be especially true coming off one of the most disruptive years our nation has ever seen. It would certainly be easy to be in a bit of a COVID-19 funk. But while there is little doubt we will all be forever changed by the experience of traversing through this global health crisis, our ability to somehow glean the positives from this situation will go a long way in determining how we bounce back from this unprecedented calamity. I am acutely aware that the effects of this pandemic are on one hand, indiscriminate, and conversely, very discriminate, especially when analyzing the impact it has had on certain business sectors. The housing industry was initially deeply concerned that the entire industry could tank, and the challenges the business sector faced, and continues to face, are significant. But the resiliency and diversity of the housing market has been an inspiration to our country’s economic engine that we can, in fact, survive the onslaught of a pandemic.  

Housing Outlook

Given housing’s year-end momentum, revised projections from multiple housing analysts is that U.S. starts should finish around 1.38 million units in 2020, an increase of 6.2% over 2019, a solid turnaround given the economic fallout from the spread of the coronavirus. Single-family housing, the backbone of the industry, has fared particularly well coming out of shelter-in-place orders back in March, and could finish the year more than 10% above last year’s performance. Multi-family starts have generally underperformed on the national stage since the onset of the pandemic, averaging 343,000 units (SAAR). The previous six months, apartment and condo construction starts averaged 477,500 units (SAAR). Multi-family activity seems to be very regionalized with some markets performing well, while others struggle. Single-family’s starts share of overall residential housing starts currently sits at 77%, their highest level in over a decade. 

All of the current dynamics that enabled housing to post gains in 2020 are still active moving into the new year. U.S. housing starts are projected to average above 1.4 million units in 2021 according to the average from five major housing entities analyst’s forecasts, with single-family growth continuing to lead housing’s advancement. Record-low interest rates, currently below 3% (30-year fixed rate), continue to motivate new home buyers, even as home prices escalate. Additionally, demand for new homes will continue to be bolstered by favorable demographics, evolving geographical shifts brought on by the pandemic, and significant inventory deficits, both in new and existing homes. The home has become more than just a living space. There has been an emphasis on shelter space for work, study, and other purposes induced by COVID-19. Also, with more companies allowing their workforce to work from anywhere, many people are no longer tied to their proximity to an urban hub, or even a specific city for their employment. NAHB chief analyst, Robert Dietz, says that the country is already experiencing increased buyer activity relocating out of urban areas into the suburbs, exurbs, and smaller rural towns.   

Builder confidence, as measured by the NAHB/Wells Fargo Housing Market Index (HMI), recorded its highest reading ever in October, after posting the previous record a month prior. The November HMI, while down slightly, was still in record territory. The rising optimism is a reflection of the consistent growth in housing start data over the past few months, both in housing starts, and permit activity. Positive economic news has also helped bolster builder’s confidence level as GDP registered a sharp rebound in third quarter after seeing declines in the first and second quarters. The bounce back followed a gradual reopening of the economy in the wake of COVID-19. The unemployment rate has continued to improve after jumping to almost 15% in April. The November unemployment rate fell to 6.7% and expectations are for it to continue to experience bumpy improvement. But the leading economic indicator that builder’s and potential home buyers dote on are mortgage interest rates. Thankfully, the Federal Reserve’s intervention designed to stabilize the housing market by purchasing mortgage-backed securities when the pandemic first showed its teeth, has had the desired effect. The current rate is more than a full percentage point below the 2019 average. The Fed intends to stick to their policy until at least 2023, so mortgage rates should remain low by historical standards, for the long haul.

It has largely been the record-low mortgage rates that have helped offset rising home prices as the building community continues to be challenged to build affordable homes. The Case-Shiller Home Price Index showed home price growth across the U.S. accelerated 4.8% year-over-year through 3rd quarter. A major portion of homebuilding’s activity has been concentrated in the higher end of the market with sales of million-dollar homes doubling in the past year, according to the National Association of Realtors (NAR). For housing to continue to move forward, the lower end of the market has to gain momentum. That means that the number of first-time buyers – upon whom sellers trading up depend on – has to rise. The need for suitable, affordable shelter is now more important than ever. Unfortunately, first-time home buyers tend to be lower wage earners, a segment of the population that has been disproportionately affected by the current increase in job losses due to the pandemic. The major headwind facing builders is how to construct affordable homes in the current environment given exorbitant development and construction regulatory fees, rising lot prices, record lumber and building material costs, as well as ever-present labor challenges. It is certainly a daunting task, and it will take a collective effort, and creative minds on all fronts to meet these challenges head-on. The resiliency and diversity of the construction industry will once again be on display if we are to meet that challenge. 

Lumber Outlook 

Last year was a harsh reminder of the volatility to which commodity markets are often subject to. The outlook for lumber costs in 2021 are somewhat convoluted since we continue to deal with so many unknowns. The fact that we enter the year at such elevated price levels would normally lead buyers to speculate that there is more risk to the downside than there is of setting new record-highs in 2021. The problem is, there is no “normal” when the world is turned upside down battling the effects of a global pandemic. Lumber buyers tend to be creatures of habit. Most have developed purchasing strategies based on historical data cultivated from years of experience. There was generally a predictability to buying cycles, even during explosive times. Most of those strategies have been rendered obsolete, at least for the foreseeable future. Lumber buyers have been forced to develop a new playbook, focusing on defensive tactics.  

Lumber industry analysts have projected that the average price of lumber, will be down next year from the record high levels we experienced in 2020. It’s hard to envision any kind of major downward correction at a time when order files extend, and prices continue to soar early in this new year. The overarching feeling most buyers have right now is will I be able to procure enough critical inventory items in the short term, to satisfy what I have sold. That is not a position any buyer is comfortable with. Producers are currently firmly in control of the market. Channel inventories are very low at every level of distribution, especially in the middle of the market, where large brokers, who would typically have hundreds of carloads of lumber available to sell, lack product. That leaves virtually no competition for the mills from secondaries, in a market frantic for wood.  Given the current inventory environment, there will need to be significant restocking in the coming months to ensure sufficient wood availability heading into the 2021 building season. For that to happen, forest products producers will have to maximize production capacity throughout the U.S. and Canada. That seems unlikely given the coronavirus-related labor constraints much of the country is experiencing. That does not bode well for the prospects of lumber prices falling significantly.

What is more likely to happen, is that the lumber market will remain elevated through the early part of the first quarter as buyer’s battle over limited mill offerings. It is hard to envision any scenario where production overwhelms demand through the first quarter. Inventory levels are just too low, and the backlog of units on the books to be built, grows every day. It’s certainly possible that winter weather will enter the fray and alter the dynamic, causing a little choppiness in prices. But for right now, everyone is uncharacteristically busy for January, with little risk of a significant slowdown. It is entirely possibly that we could approach our index’s all-time high set back in September, sometime in January. Nine-foot studs and OSB are currently at record-highs. OSB, in particular, is shaping up to be a major concern in 2021. Limited supplies and elevated pricing is expected throughout the marketplace.       

As we move into the 2nd quarter 2021, it will be very interesting to see if the DIY segment has follow-through after surprising the market with a bevy of home improvement projects during the 2020 lockdown. Many analyst expect the surge in DIY spending to fade from its torrid pace in ‘21. I’m not necessarily onboard with that thinking. I believe that there were many projects that were unable to move forward last year due to shortages of materials, or ultra-busy contractors. With that in mind, and with much of the workforce still at home, I expect the home improvement sector to continue to flourish next year, with both the over-the-shoulder DIY, and pro repair & remodel markets taxing lumber supply at times. That will especially be true if another round of stimulus checks start to hit mailboxes early this year. 

There are two wrinkles on the trade front that could also impact lumber supply into the U.S. to the positive in 2021. The U.S. Department of Commerce has dropped the duties on Canadian lumber from 20%, down to 8%. That could theoretically increase the amount of Canadian lumber shipped in to the U.S. to take advantage of the improved mill net returns. Imports from Canada were off by more than 10% in 2020. But in the current trading environment, where production is struggling to meet demand, the lowering of trade duties will have no effect on lumber prices. Also, European suppliers have been actively importing more volume into the U.S. market to take advantage of the record high prices. While imports from Europe were up 30% last year, the volumes so far have offered very little price relief. Long-term, these two developments could help the rebalancing of supply and demand that’s needed to improve pricing and reduce volatility. Neither will have significant impact in the first half of 2021.

While all attention tends to gravitate to commodity lumber pricing and availability, there are many specialty building material manufacturers that are also struggling to keep up with demand. Delayed shipments have become the norm, adding to the frustration of protracted lead times. And now, in an attempt to better manage production, many manufacturers have announced that their products will be subject to allocations in 2021. Key products that are the most concerning include engineered wood products (EWP), shingles, drywall, interior doors, exterior composite trim products, and door lock sets. Of course, builders are experiencing supply issues with many other product categories like appliances, light fixtures, and masonry products.   

One of the most watched developments early this year will be just how the swearing-in of a new President (and a new political party) will impact the overall economy, and the housing sector specifically. A couple of concerns for builders would be the rolling back of many of Trump’s deregulation orders, some of which would negatively impact the building industry. Also vulnerable under a Biden administration will be the streamlined permitting process advancements that were a priority for the Trump Presidency, especially in land development and water quality permitting. Another area of great concern to the NAHB is the potential modifications to the status of the independent contractor. The Biden administration will be heavily influenced by labor lobbies, whose efforts tend to support reclassifying independent contractors as employees. Another concern for builders is how the OSHA enforcement regimes may tighten under Biden. On the positive side, expect the Biden administration to relax immigration policy which will undoubtedly offer the construction industry needed labor relief. Regardless of your political persuasion, you can expect changes anytime new leadership takes over. Some of those changes may be beneficial for your building business, and some may not. A Biden presidency will be no different. 

Of course, the biggest order of business as we turn the page on a chaotic 2020 and look forward to the future, is for you, your family, and your co-workers, to stay safe as we pilot through what is hopefully the culmination of this pandemic. We have taken the health and safety of our Contract Lumber family very seriously over the past year, and it’s important that we continue to observe the guidelines and recommendations that are in place to help put COVID-19 in our rear-view mirror as quickly as possible. It has been difficult, and we have asked our team to make many sacrifices. But through it all, we are humbled by the trust you, our customers, have shown in us to be a partner in your efforts to build America. We are truly blessed to have the best team, and the best customers in the industry. Adversity only makes us appreciate those relationships even more. Together, we will confront every challenge put before us. Here’s wishing you all a healthy and prosperous New Year!