WHAT’S UP WITH LUMBER PRICES?
While being stuck at home during the covid pandemic, you decided to take on a home project. If that project that included lumber, you may have had some sticker shock while paying for it at the local lumber yard or hardware store. You may have thought that the store was over charging for convenience, but nationwide everyone is experiencing a lumber shortage and thus price increases across the board.
Below is an explanation from Langbeen Builders on how current lumber prices have developed from Spring 2020 until present.
Why Have Lumber Prices Gone Up?
Price Theory:
Price theory is an economic term that implies the price for any good or service; it is a relationship between supply and demand. Simply, the more people want a limited resource the more the owner of the limited resource can charge until the demand for the resource becomes sustainable. In the same manner, if a limited resource becomes more limited (less supply) and the demand remains the same, the owner of the limited resource can charge even more until there is less demand for this resource.
For more information:
https://www.investopedia.com/terms/l/law-of-supply-demand.asp
In addition, lumber versus other building materials trade as a commodity. This means that the price changes frequently based on supply and demand. The only way a resource can trade as a commodity is if there’s enough supply and demand for the well-defined resource, i.e., a particular stock, bond, or in this case, lumber. Commodity trading is typically beneficial for the consumer during normal non-pandemic times; the consumer can easily get the lowest price for products.
Langbeen Builders’ Decision:
Back in March 2020, when the pandemic first hit, there was concern about what the world was going to look like. This triggered financial markets to drop quicker than ever seen in modern history. Big investors were anticipating a frozen economy for months to years, so they sold a lot of positions to avoid losses. Langbeen Builders made the decision to not start construction of any new homes unless they were already under contract. This meant the company did not begin a new project for about eight weeks despite a lot of demand for new homes.
Midway through May 2020, there was still a lot of demand for new homes and financial markets were recovering, so Langbeen Builders decided to move ahead with pulling permits and building, trying to catch up from the lost eight weeks by starting several new projects all at once.
Inelasticity of the Demand and Supply Curve:
In March 2020 when Langbeen Builders stopped building new homes, they were not the only builders who stopped construction. Due to the inactivity in building, lumber experienced a dip in prices due to the low demand. Anticipating a more long-term dip in demand, lumber manufacturers responded by lowering the supply of lumber as well as costs.
When Langbeen Builders decided to try to catch up for lost time, lumber supplies were diminished, yet the company had requests for almost twice the amount of lumber as before the building shutdown. With lumber manufacturers unable to increase production as quickly as they had decreased production—due to hiring shortages and safety issues— there was a shortage of lumber in the market.
Not only is it hard for lumber manufacturers to suddenly increase supply, it’s difficult for developers and builders to slow demand. Once a home or building is under construction, it’s almost always the right financial decision to continue the project despite increased costs and the threat of a loss.
The inability to shift supply and demand quickly is called “inelasticity of the demand and supply curve.”
For more information:
https://www.investopedia.com/ask/answers/012915/what-difference-between-inelasticity-and-elasticity-demand.asp
SOURCE: NATIONAL ASSOCIATION OF HOME BUILDERS
Summary:
With the inelasticity of supply being lower and the inelasticity of demand being higher for lumber during the months of June – September 2020, there was a record increase in the price of lumber.
Projection:
With both supply and demand being inelastic (not easy to change), developers, builders, and consumers will be living with high lumber prices for a several more months. There’s already light at the end of the tunnel as we’ve seen futures contracts drop sharply in value for lumber.
As supply and demand return to normal, lumber prices are expected to drop, unfortunately lumber prices are not anticipated to return to the pre-pandemic price levels as quickly as they went up. This also depends on how both the demand and supply reacts; if they both over correct, there could be a sharp drop and sharp increase again.
At a recent supply chain summit with the White House, National Association of Home Builders reported: “In another positive development, many in the residential construction industry may have seen media reports about the recent sharp drop in lumber prices. While this is good news, the lumber crisis is far from over. Most builders have not been able to take advantage of this development because producers are still selling off lumber that they purchased from mills when prices were at their peak.
Moreover, sawmill output continues to lag. During today’s meeting, NAHB underscored that if supply does not increase fast enough to meet demand, we may find ourselves in the same situation as last November, when lumber prices posted a similar steep reduction only to reverse course and move to record-high levels.”
What is Langbeen Builders Doing?
Building will continue but at slow, steady rate until lumber prices become more affordable or home prices increase enough to justify increasing production again.
Five new spec homes will begin in the fourth quarter of 2021, including a raised slab foundation instead of a framed floor crawlspace foundation. Using this type of foundation should reduce the construction cost and subsequently the selling price to the consumer.
Selling prices are being evaluated as the builder’s margin can’t absorb increased lumber prices.
Reference
1. “At NAHB’s Urging, White House Holds Supply Chain Summit,” July 16, 2021