High lumber costs won’t cut starts or boost prices - Capital Economics
US Housing

High lumber costs won’t cut starts or boost prices

US Housing Market Update
Written by Matthew Pointon
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Surging lumber prices have led to delays in housing starts and an increase in some new home prices. But, while we expect lumber prices to remain relatively high over the next couple of years, the impact on starts and house prices will not persist. Beyond the short term, higher construction costs have little bearing on house prices, with the ultimate impact being lower land prices. Accordingly, we think starts can continue to rise and house price growth to slow even as lumber prices remain high.

  • Surging lumber prices have led to delays in housing starts and an increase in some new home prices. But, while we expect lumber prices to remain relatively high over the next couple of years, the impact on starts and house prices will not persist. Beyond the short term, higher construction costs have little bearing on house prices, with the ultimate impact being lower land prices. Accordingly, we think starts can continue to rise and house price growth to slow even as lumber prices remain high.
  • Lumber prices have kept on rising. Futures prices exceeded $1,300 per 1,000 sq. ft. earlier this week, more than four times the 2010-20 average of $325. A large rise in both single-family housing starts and home improvement spending is supporting demand, at the same time as supply has been tight due to several factors including a shortage of truck drivers, virus-related restrictions on social interaction and the ongoing outbreak of mountain pine beetle in Canada.
  • As mills return to full capacity and supply increases, we expect lumber prices will drop back. (See Commodities Update.) We forecast prices will fall to $600 per 1,000 sq.ft by end-2021, and $550 by end-2022. While that is a significant fall from present day highs, that still leaves prices up 50% compared to their 2019 average, and close to the peak seen in early 2018. (See Chart 1.)
  • What might that mean for housing starts and house prices? The recent surge in lumber prices has certainly led to delays in starts, as builders have held back on the expectation of a moderation in costs. (See Update.) There is also evidence that builders have passed on the increase in costs to their customers via higher house prices, which buyers have been willing to accept given the overall surge in house prices.
  • However, beyond the short term, higher lumber and construction costs more generally have little bearing on house prices or starts. House prices are not set by what they cost to build, but by the interaction between the demand and supply for homes. Demand in turn depends on a host factors including demographics, interest rates, taxes and house price expectations. Supply is mainly a function of the existing home market, which makes up 90% of homes for sale. Homebuilders are therefore price-takers. When planning on building a home, a developer will first work out what a new home will sell for, then subtracts construction costs and a profit margin, and uses the remainder to bid for land.
  • The ultimate impact of higher construction costs is therefore lower land prices. Admittedly, that can eventually feed through to lower starts and higher prices if that means no suitable lots can be found. But, with the office and retail sectors in bad shape following COVID-19, if anything the cost of land is set to fall back. Therefore, while we expect lumber prices to remain relatively high, that won’t prevent a further steady rise in housing starts and a fall in house price growth to 3% y/y by end-2022. (See Chart 2.)

Chart 1: Lumber Prices ($ per 1,000 sq.ft.)

Chart 2: Housing Starts & House Prices

Sources: Refinitiv, Capital Economics

Sources: Refinitiv, Census Bureau, Case-Shiller, Capital Economics


Matthew Pointon, Senior Property Economist, matthew.pointon@capitaleconomics.com