Building Materials & Supplies Trends
COVID-19 Industry Brief
EFFECTS OF THE CORONAVIRUS ON THE Building Materials INDUSTRY Updated May 19, 2020
- Pre COVID-19 Market Sentiment: Prior to the coronavirus pandemic hitting, revenue for the building products industry was forecasted to decline slightly in 2020 based primarily on an expectation of a softening housing market and North American economy. The industry had been growing over the five-year period ended December 2019 at an annual growth of 1.8 percent supported by a housing market that had been expanding steadily since the recovery from the Great Recession began in 2009. The first quarter 2020 results prior to the pandemic were stronger than expected and the housing market and demand for building materials was robust in February 2020.
- COVID Impacts: In all regions, building product distributors were deemed essential businesses allowing these businesses to remain open if they chose. Home center volumes of lumber products were reported to be a bright spot in the lumber business in March and early April, with companies noting that people were making use of their time away from work to complete home projects. Some distributors said they continued to ship steadily to job sites where builders were trying to finish projects. However, some projects were interrupted by changing regulations, as city, state, and federal officials reacted to the virus threat.
- Housing Market Impacts: COVID-19 has reduced residential and commercial construction activity. In most jurisdictions, existing construction was allowed to proceed, but the initiation of new projects has been limited in some regions, and the impact of complying with social distancing rules as well as the availability of inspectors and supplies has limited activity. The residential building permit rate for April 2020 fell to 20.8 percent below the March 2020 rate, 25.3 percent below the February 2020 rate, and 19.2 percent below the April 2019 rate. Privately owned housing starts fell by 30.2 percent in April 2020 following an 18.6 percent decline in March 2020 and were 29.7 percent below the April 2019 rate. On April 23, 2020, JP Morgan Chase predicted a 51.3 percent drop in housing starts by summer from pre-pandemic levels, with a quick recovery to follow.
- Interest Rates: The interest rate adjustments made by the Federal Reserve Board in early March 2020 have had a positive impact on the housing market. The average 30-year fixed-rate mortgage dropped from 3.72 percent as reported by the Federal Home Loan Mortgage Corporation, known as Freddie Mac, for the week of January 2, 2020, to 3.28 percent for the week ended May 14, 2020. This should have a positive impact on housing longer term, but availability of credit both in the primary mortgage market and the secondary home equity market has been curtailed due to the pandemic. Total residential real estate loan volume has fallen since early April by about 1.0 percent likely reflecting the impact of weakened consumer confidence since the beginning of the year, job losses, and lower loan demand due to falling rates of housing starts and new building permit applications.
- Lumber Sales Reports: Despite the restrictions, sales of lumber in April were strong throughout the United States. Random Lengths, a trade journal that tracks lumber and other building products market conditions, reported in its May 8, 2020, newsletter that “dealers in all regions across the U.S. raised their sales expectations for lumber and panels,” which still trailed year-ago levels by about 12.7 percent…Jumps in sales expectations for May were most notable in the Midwest, South Atlantic, and Northeast regions.” Treated lumber demand, particularly from home centers, was “unrelenting” according to the Random Lengths report.
- Roofing Segment: Roofing results have been weak on a year-over-year basis, due primarily to benign weather patterns in 2019. The first quarter of 2019 had heavy roofing sales due to an active hurricane season in 2018. One large manufacturer in the space reported that the first quarter 2020 sales were down approximately 15 percent from 2019, which were up 20 percent over 2018; sales were reported as especially weak in the second half of March. Beacon Roofing Supply, a large distributor in the space reported weakness in roofing sales as well, but reported only a 1.3 percent decline for the first quarter compared to the prior-year period. Both companies expected weakness in April and May due to COVID-19 impacts.
- Tile Segment: A large tile retailer reported a strong first quarter, with sales up 8.5 percent year over year, but was seeing a drop off in sales and foot traffic by 50 percent in April 2020.
- First Quarter 2020 results: First quarter results from Huttig Building Products were positive for the first quarter of 2020, due to a strong housing market and economy. Nevertheless, the company expects conditions to be weak in the second quarter, and on May 4, 2020, announced it had proactively taken the following steps in anticipation of the pandemic impact: “…communicating with vendors and customers, seeking modification of payment and other terms of rental and procurement agreements and monitoring our accounts receivable. We have also reduced inventory levels to meet an anticipated decrease in demand and have implemented cost containment measures, including lay-offs, wage reductions, suspension of matching contributions to our qualified defined contribution plan, and eliminated non-essential spend. We have also delayed or cancelled certain planned capital expenditures.” Boise Cascade also published its first quarter results on May 7, 2020, reporting a sales increase for the first quarter of 12.3 percent, driven by a sales volume increase of 17 percent, offset by lower prices. Despite the positive results, the company curtailed or reduced operating schedules at essentially all of its manufacturing facilities and reduced activity levels at all distribution facilities due to COVID-19 related impacts.
- Valuation Outlook: From an outlook perspective, the building products industry is driven by commercial and residential construction activity. How the housing market reacts to the COVID-19 pandemic is uncertain; the building products distribution market will likely be directly impacted by whatever the outcome is in this sector. The interest rate adjustment made in early March 2020 is likely having and will have a positive impact on the housing market. From an inventory appraisal perspective, other than temporary impacts and commodity pricing issues due to the typical turnover profile of businesses in this sector, Gordon Brothers would not expect to see large declines in valuations. Special orders may be impacted if construction and/or housing projects are delayed.
Date October 2021
- Experts predict construction revenue will increase 5.2% in 2021 aided by low interest rates.
- Data suggests spending on improvements and repairs to owner-occupied homes will increase in 2022.
- Low housing supply, low interest rates and increased disposable income continue to drive demand for residential construction activity.
- Existing home sales have neared the record highs of the mid-2000s. The median home sales price increased 14.9% and housing months’ supply increased from 3.5 to 6.1 year over year as of August 2021.
- Gordon Brothers expects the building supplies market will remain strong from an inventory appraisal perspective, in part because of ongoing product shortages and steady demand for both public and private construction driving higher recovery rates.
By The Numbers
Low Interest Rate Environment Supports Construction Revenue: The COVID-19 pandemic hindered growth in 2020 resulting in a 0.4% decline in industry revenue. Decreased business activity, unemployment and labor shortages led to delays in projects and less demand for sector services. As the U.S. economy continues to recover from the effects of the pandemic, consumers who weathered the crisis without financial distress are taking advantage of the limited supply of homes for sale, driving up prices and creating a barrier to entry for less financially secure buyers. A low interest rate environment will likely support ongoing growth, with construction revenue expected to increase 5.2% in 2021 per research firm IBISWorld.
Experts predict the residential building market will generate 35.5% of total revenue in 2021, representing the largest industry segment, followed by nonbuilding construction at 23.5%, commercial building at 22.1%, municipal building at 12.4% and industrial construction at 6.5%.
Home prices rose more quickly in the 12 months ended July 2021 than in the previous decade. Robust demand and limited supply drove this surge in pricing, with the largest gains in rapidly growing western states. Prices increased by 28% in Boise, Idaho, 22% in Austin, Texas and 23% in Tacoma, Washington for July 2021 over July 2020. Additionally, home price gains exceeded income growth in 2020, increasing the national price-to-income ratio to its highest level since 2006.
“These outsized increases have raised concerns that a home price bubble is emerging,” says Daniel McCue, a Senior Research Associate at the Harvard Joint Center for Housing Studies. “But conditions today are quite different from the early 2000s, particularly in terms of credit availability. The current climb in prices instead reflects strong demand amid tight supply, aided by record-low interest rates.”
Valuation Outlook: Residential building products have steadied after an initial period of disruption to supply and demand in 2020. Although the building supply sector continues to face uncertainty and supply chain issues in the short term, sales for building material and garden equipment retailers increased 15.4% for the eight-month period ended August 2021 compared to the previous year, according to U.S. Census Bureau data.
Looking ahead, the building products distribution market will still face supply chain issues, tariffs and extreme weather. Experts suggest current interest rates will likely continue their positive effect on the housing market. And while the pandemic continues to affect certain areas of the U.S. more severely than others, improvements in vaccine rates may alleviate some pandemic-specific challenges for the building supply market.
From an inventory appraisal perspective, Gordon Brothers expects to see continued strength in building products markets, especially as product shortages continue to roil markets and both public and private construction demand remain robust.
In a rising price environment, liquidation discounting tends to decrease as buyers focus on securing supply and locking in low pricing. However, a sharp price correction is possible as high market prices increase capacity utilization and supply chain issues subside.
Home Improvement Rates Remain Strong: Data suggests sector operators will benefit from growing consumer finances over the next five years as per capita disposable income increases and the unemployment rate declines. Growing disposable income will likely result in more industry projects bolstering industry revenue. However, price increases have had a countering effect on demand. Lower housing stock levels and stricter credit lending has pushed out some buyers while low interest rates continue to attract others.
Data suggests spending on improvements and repairs to owner-occupied homes will increase in 2022. The Leading Indicator of Remodeling Activity projects the four-quarter moving rate of growth in home renovation and repair expenditures will reach 8.6% by the second quarter of 2022.
“With a financial boost from recent federal stimulus payments and strong house price appreciation, homeowners are continuing to invest in the upkeep and improvement of their homes,” says Chris Herbert, Managing Director of the Joint Center for Housing Studies. “This lift in incomes and ongoing strength of the housing market are providing homeowners incentives to make even greater investments in their homes this year.”
“Although the recent surge in DIY activity is slackening as the economy continues to open up, homeowners are undertaking larger discretionary renovations that had been deferred during the pandemic,” says Abbe Will, Associate Project Director in the Remodeling Futures Program at the Joint Center for Housing Studies. “A shift to more professional projects should boost annual homeowner remodeling expenditures to $370 billion by early next year.”
Home Sales, Price and Supply Recovering From COVID-19 Lows: Household growth in the suburbs and small metro areas was on the rise before the pandemic and has accelerated since its start, particularly among younger buyers who were ready to own homes and have more space to work remotely. In 2020, existing home sales increased 6% and new single-family home sales jumped 20%, putting total home sales at their highest level since 2006. Homebuying surged despite historically tight supply; in late 2020, months’ supply for existing homes dipped below two months for the first time ever, while median time on the market hit a record low of 18 days.
Median sale prices are also on the rise. As of August 2021, the median sales price of existing homes in the United States was $356,700, an increase of 14.9% over the same period in 2020. The pandemic and its effects on supply chains and labor markets drove this increase and that of the monthly supply of U.S. homes, which rose from 3.5 in August 2020 to 6.1 in August 2021.
As supply chain challenges subside, reducing lead times for materials, the market will no longer support these inflated housing costs. Gordon Brothers expects building supply costs will decrease and supply will match demand, leaving consumers to seek a return to pre-pandemic housing prices. This return to normalized market pricing may take years and could be extended by economic downturns or disruption from coronavirus variants.
Ranking Recoveries: While valuations of inventory categories vary, some general guidelines may apply. For example, standardized products like shingles, insulation, wallboard and other commodities are widely marketable, meaning gross recoveries are typically strong. However, drywall typically sees lower recovery value because of its slim margins, high transportation costs and propensity for breakage. Other marketable items like fasteners, moldings, windows and doors have specific applications, resulting in higher discounts. Custom and colored items like siding, composite decking and moldings are the least marketable and lowest-recovering categories as buyers typically demand steep discounts.
Some building products are made to order, including roofing and flooring trusses, custom millwork, kitchen countertops and bath vanities. Recovery on special orders vary depending on the circumstances. Special orders that are abandoned, refused or returned typically see low recoveries. Appraisers can help lenders understand the likely recovery of special orders. Gordon Brothers recommends any inventory with a deposit against it be made ineligible. Products that are in process, such as custom hanging doors or roof trusses, are not typically converted but rather sold to competitors at a steep discount.
Expenses Can Add Up: Building products distributors typically see high gross recoveries, but lenders should also consider liquidation expenses, which can reach 20% in some cases. Liquidation sales to retailers and professional builders rely on delivery of products to stores or job sites. In such liquidation scenarios, delivery-related costs are typically included in the liquidation expenses and can be as high as 7%.
Companies may need to factor in an additional commission expense for sales teams to maintain customer relationships and market products. Real estate costs related to owning or leasing buildings may also contribute to expenses.
Seasonal Swings: The building products industry is a seasonal business. Between 70% to 80% of annual sales occur April through October. Variations in weather can shift this timeframe from year to year, so Gordon Brothers recommends a high-low analysis.
Values can swing by as much as 5 to 15 percentage points between seasons. Appraisers can help lenders understand the additional risks associated with low-season liquidations to mitigate exposures.
Note: THIS PUBLICATION IS PROVIDED FOR INFORMATIONAL MARKETING PURPOSES ONLY. THE MATERIAL CONTAINED HEREIN SHOULD NOT BE REGARDED AS ADVICE, NOR RELIED UPON TO MAKE FINANCIAL, OPERATIONAL OR OTHER DECISIONS; NOR SHOULD IT BE USED AS A SUBSTITUTE FOR AN ASSET APPRAISAL. ACTUAL RECOVERY VALUES MAY VARY FROM TRANSACTION TO TRANSACTION AND THE RECOVERY VALUES REFERENCED HEREIN
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Reference sources:FEDERAL RESERVE ECONOMIC DATA, IBISWORLD, NATIONAL ASSOCIATION OF REALTORS, JOINT CENTER FOR HOUSING STUDIES OF HARVARD UNIVERSITY, U.S. CENSUS BUREAU, TRADING ECONOMICS