The Perfect Storm - Part 1

Part 1: The Pendulum Has Swung - Lumber Market Dynamics Swing in Favor of Producers

The return of a demand driven wood products market has set the stage for some real heartburn for consumers of lumber products just as construction activity is rebounding from the depths of despair it has been mired in over the past five years. Lumber prices have increased significantly throughout 2012 and the forecast is for continued strength and increased volatility as we move into the new year. With such a tenuous balance in attracting new buyers to the market right now, the industry is extremely concerned about affordability. No one knows at what level new buyers will become reluctant to move forward; however, everyone admits that there is certainly a level at which price increases to the new home market will stunt the housing recovery.

"Fourth quarter is typically a time you can count on weakening lumber market conditions, not be faced with a 40% escalation in price."

No one can argue that lumber has surged dramatically since late 2011. Most key components of framing packages have increased anywhere from 50, to over 100 percent. The real questions buyers ask is how high will it go and how long will it stay there. Most lumber buyers have dusted off their crystal ball, which has long been stored far from their work space, (probably somewhere close to their latest FSC lumber pricing), and have the orb placed front and center at their work station, so they can consult it on a regular basis. What perplexes many lumber traditionalists (and most lumber buyers certainly fit into this category), is the time of year the market has made this exceptional run. Fourth quarter is typically a time you can count on weakening lumber market conditions, not be faced with a 40% escalation in price. But that’s just what greeted buyers who were hoping to cover needs late in 2012 or anticipating needs for early first quarter 2013. Now they are left with busted lumber budgets and considerable uncertainty of just what to do, dizzied from how fast and how hard this pendulum has swung.

Our industry is notorious for explaining lumber market swings with a simple supply-demand rationalization and ultimately, they are correct. Certainly, if lumber demand outstrips supply, prices will go up. But one must plunge below the surface to better understand the complex dynamics that impact today’s lumber supply-demand relationship, especially if you are trying to anticipate what the future holds in the coming months and years. To many, their ability to predict lumber market trends with some measure of success will be the difference between a profitable project and a dud. According to a recent NAHB home price study, the material and labor to install a rough framing package represents roughly 15% of the total construction costs of a home so blowing your framing budget can have a catastrophic impact on the overall financial success of your project. 

In our upcoming installments of The Perfect Storm—Exploring Critical Factors Impacting Your Rough Lumber Scope, we will “plunge below the surface” alongside notable industry leaders to explore many of the supply-demand components at play as well as the framing labor challenges ahead. Many will be obvious indicators that are meticulously tracked and used in the basic formula for determining and forecasting both the health of the lumber and housing markets. But other, lesser known influences, will also be investigated so we can get a clearer picture of just how complex the lumber market has become in our global economic environment. But first, we must identify just what has taken place over the last fourteen months that has drawn us all to this topic in the first place. The Pendulum Has Swung, will focus on looking back at the market so we can breaks things down to better understand its impact. 

Volatility Returns
People who purchase lumber as part of their job description are no stranger to the pricing volatility that exists in the market so it’s hard to believe that this, or any market run, could catch us off guard. However, no one I have talked to predicted the market run-up we just experienced in 2012. Consequently, a vast majority of lumber buyers are in a real quandary. They need wood for upcoming projects but their threshold for absorbing the wood at current price levels is intolerable, at best. A price swing of this magnitude can crush a framing budget regardless of built-in contingencies and some projects may run the risk of being delayed, renegotiated, or even shelved. 

Historically Speaking
Lumber buyers are essentially a cross between a well-schooled history buff and a psychic. They religiously pour over past construction project budgets and lumber data trying to draw correlations and predictions for what the murky future may hold. For the most part, that formula has worked reasonably well over the last forty years. But, I would suggest that the whole process has become much more complex in the last decade and therefore, much riskier, and with considerably higher stakes. Projects, and the structures themselves, have become so much larger and significantly more complicated than in the past. Take, for instance, the last two projects our pre-construction department processed for a client. The first consists of 5 floors of wood framing on top of a two-story concrete parking structure with several radius exterior walls. This high profile building will sit on top of a hill in a major metro downtown revitalization district with limited storage area and extremely tight working conditions. The second is a 290-thousand square-foot structure with 3 floors of wood framing sitting on top of first floor retail that has a combination of concrete, steel and wood framing requirements. Each of these projects present their own unique framing challenges and off-the-chart pucker-factors. Unfortunately, framing budget pressures has the GC considering several low bid options even though the numbers are questionable and failure seems imminent. Yet, that’s the mentality we have to compete with to get jobs. These scenarios are more the norm than the exception in today’s dynamic construction market. A successful project will require all players to be on top of their respective game while the margin for error will continue to shrink and risk factors will skyrocket.

Be sure to share your comments below on how you've been affected by this volatile lumber market and stay tuned for Part 2 of "The Perfect Storm" where we'll dive deeper into the details and numbers behind these market swings and how all of this impacts real world projects.
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