*The following blog uses information from NAHB’s article on the subject. We credit NAHB for providing us with this information.
According to the NAHB, lumber prices have declined approximately 56% since May 10, 2021. While that seems like good news at first glance, on closer inspection it becomes clear that the situation is still less than ideal for the construction industry. In fact, the NAHB states, “While the price of framing lumber has dropped roughly 50% over the past seven weeks according to Random Lengths, prices paid by builders have declined by a fraction of that amount.”
To better understand these differences in price, we should first learn about the Lumber Supply Chain itself. Typically, the supply chain for dimensional lumber has five stages:
- Forest – Timber is harvested from the forest and shipped to a sawmill.
- Sawmill – Saw logs are cut to dimension at the mill and shipped to a distributor.
- Wholesaler – The wholesaler delivers to lumber retailers such as lumberyards and building materials suppliers.
- Retailer – Customers purchase the product to use as a production input.
- End-User – The end-user (Ex. Home Builder) constructs a home.
Sources of Price Timing Differences
Builders should be asking the question, “Why are lumber prices supposedly decreasing while my price stays the same?”. This is likely due to a dealers’ inventory carrying costs as well as the potentially large differences between the price at which inventory is bought and sold. Essentially, the price is decreasing so rapidly that by the time wholesalers sell the lumber to retailers/end-users, the price has already decreased again. This makes it almost impossible for wholesalers to make a profit at the price they paid for the lumber.
The following information from the NAHB touches on more sources of price timing differences:
“To maintain margins, retailers and wholesalers do their best to buy low and sell high. At the very least, they try to avoid buying high and selling low, which happens to be the biggest risk in an environment of rapidly falling prices. For example, had a lumberyard quoted a client at prevailing prices two weeks ago, it would be taking a 25% loss relative to current pricing. Thus, a supplier that quotes clients at current market prices will consistently lose money when prices are falling.
Suppliers’ inventories will also tend to be tighter during periods of falling prices. Whatever inventory the business has on hand was expensive relative to current prices. This gives wholesalers and retailers incentive to run through that inventory while they can still get close to what they paid for it — and doing so without souring relationships with customers. And for reasons stated above, they will be “trigger shy” to buy more lumber than they are contractually obligated to provide to customers for fear of ending up with a load of inventory on which they will take a loss.”
When do Lower Prices Reach Builders?
All that is well and good, but when will builders see lower prices on lumber? Our hope is that builders will start seeing consistent price relief once the mill prices substantially decrease for an extended period. This process could take anywhere from a few weeks to a couple of months, depending on the rate and consistency of price decreases.
The timing of this process can vary depending on the builder size, supplier size, and the builder-supplier relationship. As is to be expected, the home building industry is one that is dependent on relationships. The NAHB spoke on the value of these relationships, “The length and quality of a builder-vendor relationship can positively affect how soon the builder is quoted lower lumber prices.”
Why do Builders’ Lumber Costs Increase with Market Prices?
To avoid any discrepancies, we will be using the portion directly from the NAHB Article:
“In contrast to the dynamics of an environment with falling prices, higher prices reach builders with a much smaller lag when market prices are increasing. The same forces that lead to large lags relative to mill prices on the way down can help explain why builders’ lumber costs may increase in tandem with mill prices.
Wholesalers tend to be “trigger happy” when prices skyrocket. As the cost of their inventory is low relative to cash prices during these periods, they will quote at or near current market prices. The environment is one in which wholesalers are assured to buy low and sell high.
However, wholesalers cannot predict when a bull market is going to end and buy their lumber according to how likely they believe it will last. As different buyers may have different forecasts, disparities in purchasing behavior can arise. A wholesaler that assumes lumber prices will keep rising for two months will buy more inventory than one assuming the run will last for two weeks.
Retailers generally have less buying power than wholesalers have selling power. In such a scenario, the retailer (e.g., lumberyard) is said to be a “price taker.” As a result, their inventory costs tend to increase in step with market prices. These higher costs are passed on to builders in order to maintain positive operating margins. Thus, lumber retailers are less likely than wholesalers to realize outsized profits when prices are rising.”
For more information on the decreasing lumber prices and how that affects builders, please contact an Insurance People Risk Advisor or follow this link to NAHB’s blog on the subject.