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How The Declining Housing Market Could Impact LBM Professionals

05/31/2022


Please take a moment and name a wealthy economist. Crickets, right? Now make a list of wealthy operators - meaning presidents and CEOs who successfully run companies. Warren Buffett, Berkshire Hathaway; Elon Musk, Tesla; Tim Cook, Apple; Jamie Dimon, JP Morgan; Mary Barra, General Motors; Dave Flitman, Builders FirstSource; LT Gibson, US LBM; Steve Swinney, Kodiak Building Partners.


We could have thousands of people on this list.


Before I leap to address the rush of people claiming to know something about macro trends of the LBM Industry, please remember these points:


Economics is a profession that deals with theoretical rather than practical studies. Economic research might help you decide whether you should buy or sell your company; it might help you sound smart around the Memorial Day celebrations – but otherwise, it won't make you rich or successful, nor will it predict the economic future.


Being a great operator is a practical study that will directly support your wealth-building goals. Leaders who surround themselves with excellent people understand the key to building high-performing companies. Spend 100x more time and effort on improving your operating skills and ability to hire great talent rather than attempting to create your own macroeconomic crystal ball. Great operators build excellent teams. Excellent teams take share in a declining housing marketand the rubber is about to hit the road. It will be clear who is a great operator and who is not


The US housing market rage appears to be over at 1.7m new homes annually at the peak of this cycle. Affordability is the #1 challenge to the US housing market as demand seems to remain constant. Housing costs, interest rates, and buyer incomes determine affordability. This chart shows that rising interest rates and inflation of homes combine to deliver a big punch to entry-level homebuyers' monthly budgets. 


US housing demand centers on our healthy demographics of young people forming families and needing homes, combined with replacing old homes; 1974 is the median age of the existing home market. The housing market's health is the intersection of 3 factors: home prices, individual incomes, and interest rates. Inflation is driving up the price of homes, and interest rates are going up; 2 of 3 factors will likely decrease the US Home sales in the coming months.

How long will the US Housing market be on a decline? It's anyone's guess; my guess is 12 – 36 months, but no one knows. Interest rates must stay high long enough for 5-7% annual inflation to drop to the 3% target. Inflation rates are slow to respond, with supply chain lags and pricing slack. It is hard to see inflation falling to 3% in 12 months. The Fed also must sell off its bond holdings, currently at $8.5 trillion. Starting June 1, 2022, the Fed plans to reduce its holdings by $47.5 billion a month. After three months, the Fed would ramp up to $95 billion a month in asset reductions, a move that could drain liquidity from the money market for years to come. It will take 3 years to sell $3 trillion in bonds to hit the optimal balance sheet estimate.


How deep will the US new home sales decline? No one knows. 10-30% drop seems plausible.


1.7m @ 90% = 1.53

1.4m @ 70% = 1.19m 


What is the impact of lumber and plywood commodities prices falling? For home buyers, it offers a possible 10-20% reduction in the cost of a new home, but the rising costs of other materials and labor might negate those savings. For LBM Dealers, the lumber market went from $660 in January 2021 to $1600 in June 2021, and another run from $500 in August to $1200 in December 2021. Even the poorest run LBM dealers made a lot of money with the commodity inflation.


24% gross margins on $400 wood = $96

24% gross margins on $600 wood = $144

24% gross margins on $1200 wood = $288

24% gross margins on $1500 wood = $360


If lumber drops to $400, LBM dealers could be facing a 74% gross profit reduction on lumber sales in the coming months. At the same time, starting labor wages have gone from $12 per hour to $18 per hour, roughly a 50% increase, while other operating costs have also gone up. Is this when the LBM Industry breaks out of the 24% gross margin dysfunctional fixed thinking? LBM dealers had their day in the sun commanding prices; what happens when the tables turn and the home builders regain pricing control? Lower LBM dealer profits.


What can professionals expect?


  1. A shrinking housing market increases volatility and chaos and reduces profits. LBM dealers without a unique competitive advantage will lose share the fastest. What is a competitive advantage? Any service offering that is the oxygen builder customers need to survive. (Installed sales, design and engineering, prefabrication, pre-finish…)

  2. Companies with poor leaders make rash decisions, putting more pressure on the workforce and causing turnover of key people.

  3. Any companies and teams acquired since January 2019 are susceptible to significant layoffs. Any new owner's #1 concern is maintaining sales and keeping people long enough to assess the talent. It takes several months for the new owner to accurately understand the sales and operations teams' strengths and developmental areas. Follow this timeline: if your company was purchased in 2019, Covid hit March 2020, the workforce was slow to come back, and housing sales soared by the end of 2020. Sales raged throughout 2021, and profits piled up; through all the major acquisitions in the LBM Industry for the past 3 years, companies held on to virtually all the people. We predict that companies will aggressively start top grading talent and terminating people as profits drop. Leaders in these companies will quickly realize their limited authority as corporate HQs will force them to reduce the size of their teams, and they may have no control over who is terminated.

  4. Professionals with compensation hurdles tied to 2021 profits will quickly discover they will be working for NO bonus in 2022 and 2023, as you have no chance of surpassing 2021 profits. 

  5. Due to the record high valuations (7-11x EBITDA) for LBM Dealers that sold in 2020 and 2021, we don't see LBM Dealers selling at the current 4x valuations through this downturn. Companies looking for growth will double down on their efforts in recruiting talent from their competitors to gain share. 



More challenging times generate one of two reactions – the turtles who duck into their shells or the lions who take down the weakened wildebeest. 

Professionals - take action and make career decisions that support your family, personal, and professional goals. People looking for stability, cultural alignment, mentorship, and career growth - consider reaching out to our Misura Group team to discover your career potential. 


Hire Smarter™– Tony 

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