Real Estate Investing: Strategies To Guard Against Volatility in Materials Markets

July 29, 2021

2021 represents uncharted waters for individuals who rely on lumber, steel and other building materials in their daily operations. Individuals in all segments of real estate development and construction, from home flippers to commercial and residential real estate developers, are feeling the effects of the spiking costs of raw materials. This year, random-length lumber futures have hit a record high of $1,615, representing a sevenfold gain over their low point in early April 2020. Between 2009 and 2019, futures had averaged less than $400 per thousand board feet. After a recent correction over the course of the past few weeks, prices are still significantly up from that previous average. Lumber futures are down more than 45% from their peak, below $600 for the first time in months. This article discusses several causes of the limited supply of building materials, the recent correction and corresponding strategies to ensure that your company’s investments are protected against certain pitfalls associated with continued fluctuations in various materials markets.

Factors Leading to Increased Prices of Materials

Several factors have contributed to this brave new world in construction. First, the COVID-19 pandemic and related economic recession have driven mortgage interest rates to a historic low. These low interest rates have pushed a scramble for a limited supply of homes in the existing home market, and a corresponding boom in the demand for newbuild homes as prospective purchasers compete for the limited housing supply. Second, an increase in population of mountain pine beetles that has been plaguing the lumber industries of Canada and the Pacific Northwest United States has increased lead times in both lumber production and the construction of new mills as the lumber industry has shifted south even prior to the pandemic in response to the infestation. Third, existing mills and steel producers continue to experience staffing issues that began during the early days of the pandemic and have lingered for several reasons. Finally, interruptions experienced in trucking and by other freight carriers, combined with high tariffs on imported materials, have further decreased the availability of building materials.

Historically Low Interest Rates

The United States has never experienced a housing market quite like this. Following the initial COVID-19 shutdown, many apartment and city-dwellers made a break for the suburbs. Home builders have experienced a rare upshot in demand as this suburban sprawl continued, with more former commuters able to work remotely. Expecting a fallout in real estate analogous to the housing market in 2008 and 2009, the Fed made a point to drive interest rates down to spur housing demand. With many consumers staying home and saving money that may have been spent on dining out or activities, some homeowners and first-time buyers had additional funds to purchase or renovate existing properties. Combining with low interest rates, people began to borrow and build.

Lingering Effects of the Mountain Pine Beetle Infestation on Canadian and North American Lumber

The mountain pine beetle is a tiny pest with large effects in lumber. The beetle is estimated to have chewed through 15 years of lumber supply in British Columbia according to the Financial Post, or enough trees to erect 9 million single-family homes. The mountain pine beetle has understandably chilled the lumber industry in the areas most affected by the pest and sent existing lumber industry locations south in the search for mill locations that remain unaffected. As mills went south, corresponding machinery and raw materials involved in the opening of new mills has increased lead times for new mill openings out two to three years, rendering the lumber industry less responsive to the increase in consumer demand than it might have been without the influence of the beetle infestation.

Staffing Issues in Steel and Lumber Production

Like many industries affected by the COVID-19 pandemic, lumber and steel production have lost a significant proportion of their labor force. After shutdowns early in the pandemic, lumber supply was cut short. Certain segments of workers have remained out of commission to illness, career changes or other life changes spurred by expanded unemployment benefits. Rural populations where the lumber industry thrives are also losing population year by year.

Freight and Trucking Delays

When compared with the lumber and steel industries’ labor forces, the freight and trucking industries have been similarly affected by the pandemic. With decreased numbers of workers and increased demands for many types of goods, trucking costs have increased, and shipping times have lengthened. As Americans increasingly order online, an increasing demand for a finite workforce of truck drivers and number of available trucks meets a bottleneck.

The Recent Correction in the Lumber Market Versus Other Commodities

The prices of lumber have fallen, though not at the same breakneck speed at which they previously rose. Comparatively, lumber prices are still quite high. The Wall Street Journal has covered Random Lengths’ framing lumber composite index which dropped in June from $1,210 to $1,010 in one week. Since the May peak, lumber prices have dropped nearly 60%. Compared with last year’s price of $459, the figure is still not inspiring collective confidence in the stabilization of the market.

Henry D’Esposito, a JLL senior research analyst in construction, said in a recent post that “[s]ome developers are already taking a wait-and-see approach to projects during the pandemic are hesitant to jump back in for fear of buying at the top of the market.” Many economists and industry professionals are projecting a stabilization in the construction materials markets to come about in a range of one to three years. Stinson Dean, founder of Deacon trading, expects lumber to trade at inflated prices for the next three to five years. By contrast, Samuel Burman, an assistant commodities economist, has predicted a “sharp fall” in lumber markets over the next 18 months.

Officials at the Federal Reserve have long argued that there will not be large-scale runaway inflation as a consequence of release from COVID-19 lockdowns. Federal Reserve Chair Jerome H. Powell has referenced the recent correction in the lumber market as evidence for that proposition. At a news conference covering the most recent decision not to raise interest rates, he stated that “[the inflation readings] will be like the lumber experience” and demand will abate with higher prices. Other essential commodities in construction, however, such as copper, aluminum and steel have not mirrored the correction of lumber, and volatility in these markets may continue for some time.

Strategies: How To Guard Against Volatility in Materials Markets

In the short term, the demand and related prices for building materials remains high. Certain homebuilders and developers are pausing projects in the hopes that prices will continue to fall or stabilize sooner rather than later. For other investors, including those for whom a pause in building is not an option, there are available active steps to protect one’s investments and ventures from various issues that may arise under current unique market conditions.

Securing building materials for anticipated projects early may be a priority. For those who are able to continue production, a squeezed supply will increase the value of completed projects. Ensure that insurance coverage for construction projects is broader than typically expected to adequately cover those values and to ensure that your business does not incur penalties for insufficient coverage. In this time range, cashflow may be an issue for businesses in the acquisition of raw materials. Borrowing options such as a business lines of credit may be useful to remediate liquidity issues and ensure that you do not lose out on potentially lucrative investments and projects.

When contracting for materials and services associated with constructing or renovating real estate, ensure that certain safety valves are in place to account for fluctuations in pricing and ensure that your project remains viable despite potential price increases. A skilled real estate attorney can make all the difference in protecting your interests in conducting real estate transactions during these unprecedented times. If you would like to discuss how to protect your business against such market volatility, reach out to Matt Viola at mtv@kjk.com or 216.736.7253.