The surge in home prices throughout the US has been startling, to say the least. Rewind back to March of 2020 and very few would have predicted the meteoric rise in real estate and its impact on other industries, notably building materials. The laws of supply and demand explain a fair amount of this phenomenon. However, a closer look reveals a unique set of circumstances that have created the latest housing bubble. How did we get here and what’s next for those of us building or renovating a home?
Housing Supply was Low before the Pandemic
This chart tells it all. The supply of single-family homes never recovered from the global financial crisis in 2008. In fact, from 2010-2019, we had the lowest amount of homes built in any decade since the 1960s. Lots of explanations here from a tight construction labor market, increasingly difficult local restrictions on building, a focus on multi-family building. When Covid hit, supply shrank even more as folks pulled their listings. The housing construction industry, facing labor shortages, could not make up the difference.
Then demand surged during the pandemic
When the pandemic hit and global lockdowns ensued, the very predictable happened – a global recession. What wasn’t predictable was the massive V-shaped recovery in housing demand, particularly single-family homes outside of urban centers. Again, no single smoking gun here, rather a confluence of factors.
#1 Money is cheap
Mortgage rates were and still are historically low so the affordability factor remains high for homes. In March of 2020, the Fed cut rates to zero and launched (another) quantitative easing program. Translation: mortgage rates went super low. Central banks are still signaling that rates will stay low for a very long time. Even if interest rates increase a bit, the affordability index should remain in the range we’ve seen since 2009. The increased savings during the pandemic also helped with this.
#2 Millenials are Buying Houses
Irrespective of the pandemic, America’s biggest generation ever, millennials, are aging into prime home-buying age. They makeup approximately 38% of homebuyers’ share and are getting married and having children and looking for a home, either their first or second. While student debt and low savings still impact purchasing power, there has also been significant wealth creation within this generation, translating into larger, more expensive first home purchases.
#3 The Exodus from Cities
The pandemic did a decent job of removing the luster from city living. When indoor gathering wasn’t possible – dining out, cultural events – the suburbs became a lot more appealing, hence the exodus. People from all demographics made the shift to more suburban homes, places that can accommodate living and working simultaneously. 60% of suburban single-family homes are selling within two weeks of listing and on average prices are up 10% YoY vs city prices up only 2.4%.
So basic supply and demand explain the surge in home prices. We will stop short of predicting for how long this run will last but regardless it’s our reality today. It’s also having major knock-on effects on the building material industry, notably in the form of shortages, backlogs, and significant cost increases.
Does Housing Demand Explain the surge in Building Material Costs?
The answer is yes and no. Again, the unique effects of a global response to the pandemic play a role here. Recent price increases in building material differ but a representative case study is lumber prices which get most of the headlines.
Supply Chain Issues Abound
Similar to the housing stock, US wood production has not recovered beyond the peaks last seen in 2005/06 (prior to the global financial crisis) so heading into a very unpredicted housing demand surge in 2020, the industry was not ready. This is all understandable, given 2019 was also a weak year for lumber demand. So with the initial shock of the pandemic, the lumber industry cut production and laid-off workers. As described above, the rapid recovery in housing demand coupled with the huge increase in DIY projects, left the lumber industry with super low capacity and inventory. Add to this the lockdown effects on production (labor shortages, reduced shifts) and we got a negative supply response to a positive demand shock. The result conveyed in this chart :
The lumber story is in some ways unique and the price increases contribute meaningfully to the overall cost of new home construction. Depending on who you ask, it’s adding anywhere from $15,000 to $25,000 to the cost of a new build. Hence the headlines. But as the chart below shows, there are many other materials hitting record highs in March 2021 (bars in blue), notably plywood, copper, steel, and yes insulation. Anecdotally, the major insulation companies all announced price increases in Q1 of around 10%, citing raw materials prices and logistics constraints.
Let’s not forget Shipping and Logistics Costs
On top of the underlying material cost, shipping is now also more expensive. It’s always been a significant contributor to the overall cost of materials and is even more so now. Again, this can be partly explained by the global pandemic and the basics of supply and demand.
The main issue is Americans spending money on goods fulfilled in Chinese factories. This demand exceeds the availability of containers in Asia to carry them to the United States, resulting in higher shipping rates, not to mention newsworthy delays at ports like Oakland and Long Beach.
What’s next for building and renovating homes?
The cost of building or renovating will remain elevated. We’ll stop short of predicting future material prices but suffice to say that the cost of working on or building a home is unlikely to decrease (substantially) anytime soon. This should continue to support a robust DIY market (a good way to remove high labor costs) but will keep pressure on would-be homeowners’ budgets. In fact, through the past year, final demand pricing for construction services has grown only 2% YoY in March. It’s reasonable to think pricing has room to increase.
Even with higher pricing, the pressure on margins for home builders will remain because of higher material and labor costs. Per the NAHB, it’s the single biggest concern among homebuilders. A valid concern is that some builders will cut corners in order to eek out a profit on a project, or put another way… lower quality standards in an effort to keep costs low. Homebuilders may be experimenting with less expensive materials that they are not accustomed to. In sum, lower quality building could be taking place in both new builds and renovations. If you’re involved in a project, it’s good to be aware of this.
The good news is that more builders are looking at alternative materials, either because the cost is more competitive, supply is available, or both. For us at Havelock, we are seeing this every day we and we can confirm a spike in interest from builders, contractors, and installers.