| Published: May 19, 2021

The Soaring Costs of Land and Lumber

We recently interviewed Thad Taylor, director of agribusiness lending and forest products specialist with Horizon. Rising real estate prices are all over the news, with reports of homes selling well above asking prices.

While not in the news as much, the same phenomenon is happening to farmland and timberland tracks, impacting many farmers and forest products operators.

At the same time, we're experiencing record high lumber prices, causing challenges across the industry, especially with construction projects. Thad discussed these issues along with their impacts.

First, let’s talk about real estate and the rising cost of farmland and timberland in recent months. From your perspective, why is this happening and why should buyers be concerned? 
It all comes down to supply and demand. Some of the changes in historical demand forces and supply dynamics are some of what's causing this. Buyers should be aware, instead of concerned, with what's going on right now. Buyers need to be aware that if they participate in the market right now, they'll be paying more for a given property, than they did two years ago.

Some of the supply-related forces and demand-related factors that you see right now are because there's a lot of businesses that have learned to cope with employees working from home, and home can be a lot of different places. It doesn't necessarily need to be at the office. People have more flexibility now as to where they live. That's causing a little bit of change in demand in certain areas, where maybe there wasn't as much before.

The other factor is supply, or the things that make properties come onto the market and cause sellers to decide to list with a real estate agent. Some of those things maybe haven't changed very much, and if that supply tends to trickle in at a given rate, historically speaking, it really doesn't change. If there's any uptick in demand for additional listings, that can change pricing, at least in the short-term. 

That’s an oversimplified way to cover it, but one of the things we know about the pandemic is that there have been businesses that have been hurt and individuals financially impacted. But like with any other beneficial or painful economic event, not all sectors are always impacted symmetrically. Not all individuals are impacted exactly the same way across the entire economy.

There are businesses out there that are doing well and looking to expand. There are individuals who've been less impacted and maybe have significant savings that they want to deploy or need to move, for one reason or another. Those things all conspire to have an impact on real estate market. 

Another couple of things worth mentioning are the Dow is up year-over-year, about 34%. For people who directly or indirectly participate in the equities market, it makes people feel a little bit more wealthy and a little bit more competent.

Additionally, advertised 30-year mortgage rates are very affordable with rates between 2.75% and 3%. That allows people to be confident with bid behavior when they're acquiring real estate. 

Lastly, the Federal Reserve liquidity facilities issued in 2020 are about $542 billion. That's a large injection of liquidity in the US economy. 

So a combination of additional liquidity, a lot of which has made its way into the US equity markets, the Dow being up 34% year-over-year and fairly affordable interest rates, all allow people to go into the real estate market, who want to acquire real estate and do so with some competence.

The parallel to that is those things that create that competence, they can also go away in a hurry too. 

Those are some of the economic or supply and demand forces I see in this real estate market.

What are the impacts of the current market conditions for individuals who want to finance their land purchase? 

If a person is going to buy today and borrow a significant percentage of their purchase price for real estate, there's a chance that the comparable sales that are used for appraisals will lag today’s market because appraisals are depended on historical comparable sales. If comparable sales from 2019 and 2020 are being used for the construction of an appraisal or the analysis to make an appraisal today, those historic sales prices are going to be what drive appraised values today, and a buyer needs to be aware of that.

It may cause their lender to not want to lend upon the entire purchase price, but possibly a more conservative evaluation, which is going to rely on the appraisal. 

Therefore, a buyer should be prepared for putting cash down to cash fund a bigger portion of their purchase today as compared to a few years ago because today's appraisals might not support today's asking prices.

There usually is a lag between when real estate sales occur at an elevated or depressed price and when the appraisal comparable sales ultimately catch up with that market trend.

Next, let’s talk about the sky rocketing lumber prices, which are significantly adding to the cost of any building project. What’s your perspective on this increase and what can we expect for future lumber prices?
I'll start with some of the facts and then I'll get into some observations of mine. Like any kind of discussion of economics, a lot of that is subject to interpretation and assumptions, but I'll start with the facts here.

The most recent southern lumber prices for softwood are about 192% above where they were a year ago. That's a significant rise in softwood lumber prices, and softwood being the material that's used to frame and build houses. Hardwood lumber, on the other hand, is used for molding, flooring and trim in most residential construction. We'll stick just to softwood lumber because it drives construction costs for houses, barns, second homes, cabins, etc. Those prices are up about 192% year-over-year, which impacts the quoting cost and the construction cost for any new project.

That increase in price has to do with a lot of things. Now we'll get into some of the economic discussion and the assumptions. 

Ultimately, this comes down to supply and demand as well, and the supply is not so much driven by the amount of softwood standing timber in the United States. It's driven by the weakest link in the supply chain, no matter how many softwood trees are standing in the United States. The various links in the supply chain include mill capacity, trucking capacity, warehousing capacity, planing mill capacity and kiln drying capacity. All of those various things have to work in sync in any supply chain, in order for the industry to deliver what's demanded on time. In this case, those things cannot be changed in a hurry. 

What can be changed in a hurry is consumer behavior. If we have consumers who stockpiled in their mind and in their bank accounts over various projects that they would like to do, they can deploy that pent up demand fairly quickly. It's just a matter of deciding to do the project and getting your checkbook out. 

What can't be deployed fairly quickly is a 25% increase in mill capacity, a 28% increase in trucking capacity or a 40% increase in planer mill capacity. Those things cannot be deployed as quickly as the swaying human demands and decisions to get a checkbook out and deploy some liquidity into the construction market.

So those are some of the things that are impacting lumber pricing right now. I think we're going to see lumber pricing come down a little bit in the coming year, as some of the additional supply response has come online, like I mentioned about mill capacity. 

Mill capacity can be added, but it's simply not the flick of a switch. It might take anywhere from 12 to 18 months for additional mill capacity to come online or for a given mill to be able to add a shift or additional hours in the economy. Where folks have struggled running businesses here in the last several months is getting incremental labor to run their facilities.

Nonetheless, I think we're going to see some of the demand slack off just a little bit, and it doesn't have to slack off too much in order to impact pricing, and I think we're going to see a supply response.

It might take a little bit of time, but I think we'll start to see lumber prices start to fall back in line with historical levels, somewhere around 12 to 18 months from now.

As we wrap up, is there anything else you would like to share with our listeners today?
If a buyer in today's market has the ability to be patient with this market, there could be some benefits to waiting just in case this recent increase doesn't have a lot of legs and might be fleeting. If a person can afford to be patient, there might be some benefit there. 

On the other hand, if a person does need to move quickly and can't afford to potentially lose out on an opportunity, it certainly makes sense to participate in this market especially if they don’t have other alternatives. 

However, in this market, given the speed with which the market has risen and given some of the overall economic liquidity factors that seem to be behind some of this, there might be some benefit to being patient with this market.

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