Lumber prices have truly spiraled out of control. Yes, we’re seeing some drops—prices have dropped 40% since May’s peak. But many investors believe higher prices are here to stay.
While it has inspired some great memes, the at-one-time 232% (!) increase in lumber prices since the pandemic began has put an enormous amount of pressure on rehabbers and developers. Indeed, the explosion in lumber prices adds an estimated $36,000 to the costs of building a new home!
So what is going on? Why are lumber prices so high? And what should real estate investors do about it?
First: Why are lumber prices so high?
One relatively minor component of the increase in lumber prices is inflation in general, which is certainly higher than the 2.6% reported by the CPI.
The CPI tends to underreport inflation because it doesn’t take things like housing or asset prices into account. Money is usually created through credit (bank loans) or the Fed buying assets (such as bonds). This means that inflation is usually seen first in assets and not in commodities. And there has been a lot of money creation over the past year. Something like a quarter of all the money in circulation was printed in 2020 or 2021.
And not surprisingly, asset prices have skyrocketed recently. For example:
- House prices are up 16.9% since the beginning of 2020.
- The Dow Jones is at a record high despite the recent recession and is up 77.6% since its trough in March 2020 (and up almost 12% since the beginning of 2020).
- Cryptocurrencies are out of control.
And then, of course, there’s lumber.
Lumber is a key input in housing construction, meaning its price will be affected by money creation faster than other commodities’. But lumber has its own issues that are causing it to rise much, much faster than the rate of inflation generally. And these issues all come down to good old supply and demand
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Supply down, demand up
Why are lumber prices so high, right now? It turns out that supply and demand are undefeated, and right now, demand for lumber is soaring at the same time that supply is way down.
We’ll start with demand.
There was a general consensus that the real estate market was going to crash when COVID-19 came around. Turns out predictions are either worth next to nothing, or hindsight is 20/20 (or both) because the exact opposite happened.
Much of this was because of the money creation mentioned above. But a more long-term issue also exists: The United States has a housing shortage.
One report from Freddie Mac notes that “The U.S. housing market is 3.8 million single-family homes short of what is needed to meet the country’s demand.”
This housing shortage has been brewing ever since the financial crisis of 2008. Since that crash, housing construction has been extremely sluggish.
From 2000 to the end of 2007, total housing starts were over 1 million each year and went over 2 million from 2004 to the crash. That was evidently too much. But even still, the number of starts cratered down to around 500,000 and only slowly increased from there. The number didn’t even cross over a million per year until the beginning of 2020. Then COVID-19 hit, and the number of starts crashed again, as seen on the Visual Capitalist blog.
Many job sites and the like also had to be temporarily shut down during the pandemic. When they started again, safety protocols delayed construction even more. Now they’re playing catch-up as housing starts have once again increased dramatically.
With historically low interest rates, people want to buy houses. But we have a housing shortage, and the market is squeezed with historically low rates of inventory. For example, in Jackson County, Missouri, where I am, there are only 0.6 months of inventory—literally one-tenth of what a “balanced market” would be. Delayed construction, low cost of funds, and historically low inventory have sent demand through the roof.
At the same time, supply is down—way down.
Those same shutdowns for housing construction affected the lumber industry even more. As the Deseret News points out: “A lumber industry that saw contraction and consolidation following the 2008 housing crisis and subsequent Great Recession was further hamstrung by forced shutdowns and workforce reductions under rules aiming to curb the rise of COVID-19. Now, even as lumber production ramps back up, a frenzy of home buying and renovation activity… around the country, driven by consumers throwing off the shackles of pandemic-induced home isolation, has skewed the market and led to price increases.
Many lumber mills are still closed down even today.
The tariffs on Canadian lumber (which were 20% until cut to 9% in December 2020) didn’t help either.
Overall, low supply and high demand mean prices go up. And in this case, it means they go up a lot.
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What should real estate investors do?
Inflation is here to stay, but in all likelihood, lumber prices will continue to normalize over the next six months or so. As a Wells Fargo report notes, “The supply-demand imbalance will eventually remedy itself as operating restrictions are eased, supply chains normalize, and mills more fully reopen.”
Indeed, much of this was caused by unexpected resilience in housing prices (which is now being accounted for) and the COVID-19 shutdowns (which are abating).
In the meantime, though, it would be wise for real estate investors to target rehab projects on the smaller side. The “paint and carpet” jobs conspicuously lack a need for lumber.
Of course, in a tight market like this, avoiding large rehab projects might not be feasible. If so, you need to make sure to fatten up your budget higher than what you had been allocating.
Don’t be foolish and chase yield. If the deal isn’t there, it isn’t there. Don’t sit on the sidelines, but also don’t be gung-ho to buy just any deal in a market as hot as this, with lumber prices as crazy as they are right now. At this time, it’s okay to miss on most deals and only get the few that still make sense.
Why Are Lumber Prices So High? Here Are the Primary Reasons is written by Andrew Syrios for www.biggerpockets.com