A couple of weeks ago, Zonda’s Todd Tomalak published an article in Builder titled “What Does 2023 Have in Common with a DeLorean?” Here’s a hint: It is not about traveling back to 1955 and maneuvering your Mom into hooking up with your Dad to ensure that you’ll be born.
It’s about how 2023 in the LBM supply chain will be remembered, says Tomalak—not like the classic sci-fi comedy Back to the Future, but rather the DeLorean: “lots of flash and some innovative ideas, but serious issues underneath the hood.”
If you’re an LBM dealer, you probably won’t be surprised to hear that you’re sitting on the engine block. Here’s why:
It’s common knowledge that the supply chain—ours and everyone else’s—got run over by a dump truck when COVID hit in 2020. Initially we thought we’d be back to normal sometime this year if not before. Then Russia invaded Ukraine and set off Cold War 2.0, which now has the entire planet’s shorts in a knot.
The New York Fed’s Global Supply Chain Pressure Index, a mashup of logistics data from around the world, says the situation is better today than it was a year ago. But that doesn’t mean normal, and Tomalak says we aren’t likely to get there anytime in the near future.
Come to think of it, this does read a little like sci-fi. Just not a comedy.
Supply chain disruptions don’t need to be severe if they’re widespread. The issue is coordinating upstream inputs: i.e., raw materials, components, and labor that go into manufacturers’ products. Production planning is no easy task under normal conditions. It’s doubly difficult in today’s environment, and even worse if you rely on imports.
When upstream inputs get glitchy, inventories throughout the channel get out of balance. That forces end users to change their ordering patterns, which throws the whole thing even further out of whack.
So far we’ve avoided a pileup because a huge backlog of unfinished projects is propping up demand. Workers who kept their jobs during the 2020 lockdowns accumulated over $2 trillion in excess savings when there was nowhere to spend their money. Once the initial crisis passed, they started spending it on housing.
That made production planning relatively easy. Whenever the question was “How much inventory do we need?,” the answer was always “More.”
Now both the backlog and the excess savings are shrinking. At some point in the not-too-distant future—maybe the latter half of 2023—they’ll no longer have the horsepower to keep the housing market going. When that happens, production planning will get dicey again.
But in the meantime, supply chain disruptions are subsiding across the economy, including residential construction. Materials aren’t the only cause of jobsite delays—labor cost and availability is a factor, too. But materials still account for a little more than half of the problems, in part because of the way we reacted when the road first got rough.
“When COVID-19 first emerged, the housing industry initially focused on demand,” says Tomalak. “It would have been wise to focus on locking down suppliers because upstream disorder took a year to manifest itself.”
Wise, but also counterintuitive. From February to May 2020, annualized existing home sales fell nearly 30%, from 5.7 million to 4.01 million. Literally everyone in the industry—builders included—believed housing demand was collapsing and slammed on the brakes to limit their exposure.
No one expected the market to bounce back out of the ditch as fast as it did. By July, sales were tracking 5.9 million. In October they hit 6.73 million, nearly 20% above February’s level. It’s no wonder the channel got caught flatfooted.
Now we’ve apparently got a mulligan. Home sales sprung a slow leak about a year ago and are still deflating. As of January, sales were down 36.8% from their most recent peak. As always, starts aren’t far behind: 1,309,000 annualized housing starts in January left us down 27.5% from the most recent peak (1,805,000 in April 2022).
Product availability is reasonably stable right now thanks to the slowdown plus the backlog of unfinished homes, “but don’t get complacent,” says Tomalak. “Disorder takes time to manifest, but it hits us over the head when it finally becomes clear.”
So how do we avoid getting whacked a second time when the next recovery kicks in? If you’re aggressive, you may want to take Warren Buffett’s advice about being greedy when others are fearful.
The best time to negotiate favorable terms with suppliers is when everyone else is pulling back, says Tomalak. Long-term commitments help manufacturers manage volatility, and presumably help you jump the queue if supply does get shaky.
That would make for a smoother transition once the recovery kicks in. The most recent peak in housing starts was in 2021, at 1.601 million. Most forecasters think we’ll dip to somewhere between 1.2 and 1.3 million starts this year, then start to climb back out in 2024.
Forecasters can be all wrong, of course. Long-term commitments with suppliers might backfire if the economy nosedives and the housing downturn drags on. But while economists admit that they aren’t sure what’s going on, pretty much everyone agrees that there are powerful forces pushing back against a long, severe recession.
At 6.4%, inflation is elevated but no longer the boogeyman under Wall Street’s bed. Job growth is strong and may stay that way (despite the Fed’s best efforts) because the worker shortage is in great part a demographic issue.
Ever since the pandemic, Baby Boomers have been retiring at nearly double their normal rate. The labor force participation rate for prime-age workers (25 – 54) is just slightly off its 1990s peak and Fed Chair Jerome Powell says we’re still 3.5 million workers short of a full deck.
Last but by no means least, Cold War 2.0 will goose the economy. New factories to produce semiconductors and EV batteries have gotten most of the media attention, but Ukraine is burning through more ammunition each month than the U.S. produces in a year. “The Pentagon is racing to re-arm,” reports CNN, “embarking on the biggest increase in ammunition production in decades.”
Not just ammunition, either. Between Ukraine and Taiwan, a new arms race is in the works, which means more manufacturing to produce weapons systems. These days, manufacturing plants are automated wherever possible. But even automated factories need workers and those workers will need housing.
At the moment, we’re as short on housing units as we are on artillery shells. For-sale inventories of existing homes are less than half of what they should be. A big part of the reason is that no one with a 3% mortgage wants to trade up to 6.5%, which means it’s going to be up to home builders to fix the problem. Pressure to fix it is only going to grow as manufacturing heats up and starts generating jobs.
Residential new construction isn’t the only housing boom on the horizon, either. If homeowners in the 3% club aren’t willing to move, they’ll almost certainly be eager to upgrade and expand as soon as the economy stabilizes.
Right now remodeling is facing its own downturn—if you can call it that. The Harvard Joint Center for Housing Studies’ Leading Indicator of Remodeling Activity (LIRA) says we’re staring down the barrel of the first quarterly decline in home improvement spending since 2009.
But the word “downturn” means something different in remodeling. Even if Q4 activity does fall 1.5% as expected, home improvement spending will still post a 2.6% YoY increase.
Followed by another boom. “I think 2020 to 2030 will be remembered as the ‘Golden Age of Remodeling, but with a Recession in the Middle,’” says Tomalak.
In the meantime, however, people are worried. Last week Bloomberg described the direction of the economy pretty well in just three words: “It’s anyone’s guess.”
The good news is that a lot of things that could go wrong haven’t. Hopefully it stays that way. But even if we do go into recession, it’s hard to see a scenario that doesn’t culminate in a whole lot of construction activity.