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A Wooden Roller Coaster

The fragile economics of lumber

September 01, 2021 Photo

The recent COVID-19 pandemic has upended nearly every aspect of life. Supply chains for everyday staples and luxury goods have been disrupted, expectedly impacting prices for all members of those chains, as well as end users.

Among the most widespread and significant of these disruptions concerns something most people may have taken for granted until recently: lumber, and the impact it has had on the building industry, along with other important materials. The totality of the impact of the lumber shortage has ramifications beyond construction and will impact insurance and construction claims as well.

Lumber is the end product of a series of processes that begins with trees, or timber. Once a tree is felled, it is transported to a sawmill, where it is then processed into a finished product, such as OSB (oriented strand board) or plywood. That finished product is then transported to lumber yards and hardware retailers for sale. Thus, the price of lumber is dependent upon each of these production processes.

Approximately 80% of timber globally is turned into softwood lumber, which comes from trees such as spruce and pine, because it is considered the most suitable for construction. Approximately 90% of residential structures in the U.S. consist of wood-framed construction, with softwood framing lumber comprising about one-fifth of the cost of residential construction. Bearing in mind how critical softwood lumber is to the U.S. construction industry, the impact of recent wild price surges cannot be overstated.

Between June 2020 and June 2021, the average price of softwood lumber had risen 154%, causing new single-family home prices to increase by approximately $35,000 on average. While lumber prices have only very recently nearly dropped back down to pre-pandemic levels, the sharp increase has and will continue to have lasting impacts.

Economic, Regulatory, and Environmental Causes

The causes of the recent lumber price surge are complex and varied, but can be compartmentalized generally into three categories: economic, regulatory, and environmental.

In March 2020, when the pandemic reached the U.S., logging companies, sawmills, and suppliers assumed demand would fall precipitously. Employers in the industry voluntarily reduced production for this reason, but also involuntarily reduced production due to employees falling ill with COVID-19. In a domino-like reaction, lumber suppliers and distributors stopped purchasing product and purposely depleted their inventories. The assumption underlying these decisions (that demand would plunge) was a gross misunderstanding of what was to come.

Not long into the COVID-19 lockdowns, demand for lumber swelled for a number of reasons that, in hindsight, appear naturally expected. First, as people spent substantially more time at home, they began investing more in their houses, performing upgrades, remodeling, and working on DIY projects that may have been put on hold earlier. For example, employers promoting remote working spurred additions of home offices. 

Second, demand for new homes with more space, particularly in the suburbs, surged as city-dwellers found that the premium of living in urban areas was not worthwhile when city amenities were unavailable during the lockdown.

Third, historically low interest rates and economic stimulus measures encouraged people to purchase larger homes and second vacation homes.

In the face of this growing demand for lumber, the supply chain was unable to respond fast enough, sending prices upward. Developing a new sawmill can cost $100 million and take two years to build. And existing sawmills have had difficulty retaining and growing their workforce.

Regulatory circumstances also contributed to the sharp rise in lumber prices. The U.S. relies heavily on Canada for its supply of softwood lumber due to Canada’s vast supply and developed infrastructure. In 2017, the U.S. Commerce Department concluded that the Canadian softwood lumber industry is heavily subsidized by the Canadian federal and provincial governments, causing the product to be “dumped” into the U.S. market. In that year, the Trump administration imposed an anti-dumping tariff of 24% on Canadian softwood lumber. 

In the middle of the lockdown, in December 2020, the tariff was reduced to 9%, however, as recently as May 2021, the U.S. Commerce Department set in motion plans to double the tariff to 18%.  The U.S. Lumber Coalition supports higher tariffs on Canadian softwood lumber, as domestic producers enjoy higher profits from the recently skyrocketing prices. These regulatory pressures have expectedly contributed to higher lumber prices.

Environmental factors have also applied upward pressure on lumber prices. Climate change has caused higher temperatures further away from the equator, pushing plant and animal species further north in North America and further south in South America. Among these species is the mountain pine beetle. This insect chews through the bark of trees, including those used to produce softwood lumber, converting the resin into pheromones, which in turn attract more insects to attack the tree, ultimately killing the tree. An outbreak of mountain pine beetles that began in the early 2000s has ballooned into an even worse upsurge, destroying 15 years of log supplies in the Canadian province of British Columbia alone. Thus, in addition to the tariffs on Canadian softwood lumber, damage to the supply is compounding the prices U.S. consumers pay for the product.

While all of these economic, regulatory, and environmental factors led to sharp increases in lumber prices, there were also related and remarkable price increases in other construction materials from June 2020 to June 2021, such as iron and steel (63%), nonferrous wire and cable (31%), and fabricated structural metal products (18%), among others.

The significant increase in the price of lumber over the last 18 months is made worse by the accompanying unusual volatility in lumber prices. Whereas a lumber supplier may provide a materials estimate good for days or weeks, it is now common for those estimates to be honored at times only for a matter of hours. These circumstances have caused many contractors to delay beginning new projects and suspend ongoing projects.

Prior to the COVID-19 pandemic, the average time for ground-up construction of a home in Florida was eight months; as of June 2021, that time has increased to 15-to-18 months. As any contractor knows, when there is a delay in one step of the construction process, it can have a domino-like effect on subsequent processes and expenses. For example, a delay in having framing lumber delivered to a job site can impact subsequent trades such as plumbers, electricians, and drywall subcontractors.  

Construction Industry Impact

To accommodate the volatility in lumber prices, many builders are including “escalation clauses” in their prime contracts, allowing them to pass on increases in price beyond a certain threshold. Aside from lumber prices, the difficulty in obtaining sufficient quality lumber is causing challenges for builders. Lead times for lumber and other key materials have crippled many builders. The Associated General Contractors of America (AGC) reported that the scarcity of key building materials, as well as the difficulty of hiring and retaining qualified workers, has caused construction employment to decline as recently as June 2021.

However, the residential and non-residential sectors have reacted differently to these trends. Residential construction employment has increased 1.7% since February 2020, while non-residential construction employment has decreased 6.2% over the same period. The differences in these rates highlight the strong demand for housing, despite increased costs.

Alternatives to lumber are being employed in a number of applications. For example, in lieu of wood siding, builders are considering vinyl, aluminum, or cement-fiber siding; in lieu of wood decking, builders are considering composite decking, plastic-based lumber, and bamboo; and a ground-level patio may even be substituted for a raised wood deck. Indeed, since 2020, stucco has become the most common exterior cladding material on new single-family homes, followed by vinyl siding, fiber cement siding, and brick/brick veneer. Wood products were used as exterior cladding in only 4% of new single-family construction in 2020.

A popular new alternative to traditional wood-framed construction is massive timber, or mass timber. This material consists of lumber boards that are trimmed, dried and glued together in layers. This type of stacking can create mass timber as large as 18 feet long by 98 feet wide. Mass timber includes products like glue-laminated beams (glulam), laminated veneer lumber (LVL), nail-laminated lumber (NLM), dowel-laminated timber (DLT), and cross-laminated timber (CLT). One key advantage of mass timber is that it is presently far less costly and more readily available than traditional softwood lumber, particularly because it is manufactured by a different supply chain.

In August 2020, the California Building Standards Commission unanimously adopted all change proposals by the International Code Commission for the design of tall wood buildings, allowing mass timber to be used for buildings up to 18 stories tall. California is among a number of states, including Oregon and Washington, to adopt these codes for the design of tall wood buildings. More states are expected to follow suit.

Insurance and Building 
Industry Implications

The wild shift in construction material prices in general, and in lumber prices in particular, is expectedly having an impact in the insurance industry. First, and most obviously, homeowners’ insurance premiums are increasing to keep up with increasing labor and material costs contemplated in replacement cost estimates in the event of a loss.

Second, the increased lead time for materials, including lumber, is causing construction projects to reduce or suspend work, which, in turn, causes employees to leave for other work in an already tight labor market. This leaves builders with a limited supply of workers, who are often unskilled. These workers are a primary contributor of subcontractor default insurance claims.

Third, as the residential construction market is far stronger and more resilient than the non-residential construction sector, many contractors are transitioning from the latter to the former. Insurers are expressing concern when commercial contractors move into the residential market without sufficient experience or competency, and these factors are now considered at the underwriting stage.

The “perfect storm” of circumstances has created an unparalleled upswing in lumber prices over the last 18 months. This upswing, as well as volatility, in lumber prices has had profound impacts on the construction industry, which has responded with changes in design, material selection, and project coordination and management. Importantly, with changes in construction materials, the employment market, and design and management, it is foreseeable that there could be an impact on construction claims that arise as a result of the material differences, on many levels, to new construction.

Since June 2021, lumber prices have nearly fallen back to pre-pandemic levels. It may be difficult to determine whether the recent impacts to the building industry are the beginning of a trend or a short-term reaction. Naturally, the market will follow the most economic alternatives to lumber, a number of which have come to the forefront since 2020.

However, the impacts of the price surge are likely to have lasting consequences, including the selection of building materials and building practices, as evidenced by the movement to encourage the use of mass timber. This demonstrates the volatility and likely unpredictability of lumber prices for the near future. Remote work has become widely accepted and is expected to underscore the importance of both living and working in comfort, which in turn will continue to strengthen demand for lumber and other building materials.

While lumber prices have already had a pronounced effect on insurance underwriting, the consequences in the insurance claims arena will likely not be fully appreciated for years to come.

About The Authors
Multiple Contributors
Richard Glucksman

Richard Glucksman is a partner at Chapman Glucksman Dean & Roeb.rglucksman@cgdrlaw.com

Ravi Mehta

Ravi Mehta is senior counsel 
at Chapman Glucksman Dean & Roeb. rmehta@cgdrlaw.com

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