On today’s show we’re talking about the materials cycle. Construction costs are influenced by the cost of materials. These commodities vary due to short term supply and demand fluctuations.

Last year, the industry was buzzing about the rising cost of steel due to the trade negotiations with China. A lot of the steel used in US construction is sourced in China these days and the tariffs on imports meant that Chinese steel would be more expensive. The price of US Steel went up to match the higher price of Chinese steel.

It seems that every time a major hurricane makes landfall in the US, there is a spike in the price of lumber. These storms create extreme demand for construction materials, especially in the Southern States. The ripple effect is felt through-out North America. We saw this after Hurricane Harvey soaked Houston. We saw it when Hurricane Laura smashed through Southwest Louisiana last month. I have friends who have been grumbling that prices for plywood have tripled since earlier this year. I even saw 2×4 lumber priced at nearly $8 per stud last week. I’ve never seen lumber studs priced that high.

I’m going to introduce you to the metric for lumber commodity futures. Lumber commodity prices are measured in USD per 1000 board feet.

Over the past 25 years, these prices have fluctuated in a range between $200 per 1000 board feet to $400 per board feet. As recently as March of this year, prices were below $300. By 14th September of this year prices hit an all time high of $984 per 1000 board feet. Two days later, by the 16th of the month, prices had fallen nearly $380 to $600 per 1000 board feet.

Lumber futures prices fell 3% just today in the time it took me to record this podcast episode. The question is twofold:

1) What is the right price for planning purposes if you have a new project that you’re undertaking?

2) How do you plan your project to take advantage of the most advantageous pricing.

When prices spike, it’s because of a short-term supply demand imbalance. The choke point in the system are the lumber saw-mills.

There is actually a surplus of trees. The past three decades saw more acreage planted than at any time in history. Many of these investments were made by those seeking a recession resistant investment. Trees grow by about 15% per year, regardless what the economy is doing. As many sawmills sought greater efficiency and lower cost over the past decade, many smaller sawmills closed down. The result was a significant reduction in sawmill capacity across the industry. That sawmill capacity was better tuned to the average demand and resulted in better profit margins for the sawmill companies. This reduction in capacity also exposed the industry to greater price volatility for finished products. That’s exactly what we’re seeing right now.

If you’re a developer, rehabber or builder who relies upon price stability in order to make your margins, how do you plan your projects?

This comes down to an exercise in risk mitigation. If you know you’re going to use lumber in the next year, and your cost of borrowing funds is, say, 5%. You can store lumber for up to a year for a very low cost. If you can get your lumber at a price that meets your budget, you should consider locking in at that price, or pre-purchasing the materials and storing them yourself in order to guarantee that security of supply.

If you failed to do that, then waiting a few weeks might be the smartest thing to do. In any industry that is sensitive to commodity prices, you need to pay close attention and manage your supply chain accordingly. Southwest Airlines was the most profitable airline in the US for nearly a decade simply because they had done a better job of securing long term fuel contracts at a price that made sense for them.