Residential Building Products
Date June 2016
By The Numbers
- Tariffs of 25% and 10% took effect on June 1 for imported steel and aluminum from the European Union, Canada, and Mexico
- Canada imposed matching retaliatory tariffs on July 1
- Continuing favorable homebuilding and remodeling trends bode well for values for building products manufacturers and wholesalers
- Construction costs may increase as tariffs take hold
Housing starts mixed: For 2018 to date, housing construction starts have varied by region and in total over last year. While U.S. residential construction starts (unadjusted units) in May 2018 were at their highest since July 2007, June saw a 9.9 percent decrease for the month, and a 4.1 percent decrease over last year. However, residential building permits, also a leading indicator, decreased at a lower rate of 1.5 percent in June over the prior year, and rebounded somewhat for July with a 4.2 percent increase. Notwithstanding the decline in June, total building permits authorized in 2018 (to date) have outpaced 2017 by 5.0 percent, indicating potentially higher demand for building products heading into the third quarter.
Total U.S. unadjusted housing starts were up 7.8 percent through the first half of 2018. These numbers continue to support the housing industry’s steady recovery since 2011. Consequently, the Federal Reserve Board has raised interest rates twice in 2018 in response to strong economic growth, low unemployment, and a slight rise in inflation, and is expected to raise them twice more before the end of the year. While economic conditions remain generally favorable for home ownership, it remains to be seen how wage growth and tariffs on lumber, steel, and other building supplies may impact housing numbers in the coming months.
Regional Homebuilding activity affects demand: Year-to-date for 2018 the total number of U.S. housing starts has varied widely by geographic region. Regionally, the West recorded a significant 17.7 percent increase in new privately owned (unadjusted) housing starts through June, followed by a 7.8 percent increase in the South. For the same period, Midwest starts decreased 2.9 percent and Northeast starts declined by 2.8 percent. Lenders should be aware of variations in regional demand as most building supplies are consumed locally due to high transportation costs.
Remodeling rates improving: The strong rate of spending on home renovations and repairs is expected to remain positive, according to the Leading Indicator of Remodeling Activity (LIRA) released in April 2018 by the Remodeling Futures Program at the Joint Center for Housing Studies of Harvard University. This growth bodes well for the construction and building supplies industry and for overall recovery rates on building products. The LIRA projected that annual growth in homeowner remodeling expenditure would remain above 7 percent throughout 2018 and into the first quarter of 2019. “Strengthening employment conditions and rising home values are encouraging homeowners to make greater investments in their homes,” noted the Managing Director of the Joint Center for Housing Studies. “Upward trends in retail sales of building materials and the growing number of remodeling permits indicate that homeowners are doing more, and larger, improvement projects. While the overall outlook is positive, one area of concern is the slowing growth in sales of existing homes, since sales traditionally trigger significant renovation spending by both sellers and buyers,” noted the Associate Project Director in the Remodeling Futures Program at the Joint Center. Adding, “Even with this headwind, annual spending on residential improvements and repairs by homeowners is set to exceed $340 billion by early next year.”
Ranking recoveries: While other inventory categories are not as straightforward to value, there are some general rules of thumb to keep in mind. Shingles, insulation, wallboard, and other commodity-like products are commonly standardized and widely marketable, meaning that gross recoveries are typically strong. However, drywall is typically lower recovering because it has slim margins, has high transportation costs, and is prone to breakage. Other items such as fasteners, moldings, windows, and doors are marketable but have specific applications, resulting in higher discounts. The least marketable and lowest recovering categories include anything that is colored such as siding, composite decking, or moldings with custom profiles. While there is a market, it’s much more limited and buyers demand steep discounts.
Some building products are made-to-order including roofing and flooring trusses, custom millwork, kitchen countertops, and bath vanities. Special orders can be high or low recovering depending on the circumstances. If they are backed by an order, they usually have a high recovery value because it is assumed the customer will take them for a project that’s underway. However, special orders that are abandoned, refused, or returned are typically very low recovering. Lenders should look to appraisers to understand the nature of special orders. It is recommended that any inventory with a deposit against it be made ineligible. Work that is in-process, such as custom hanging doors or roof trusses, is not typically converted. Rather, it’s assumed these items would be sold to competitors at a steep discount.
Expenses can add up: In general, gross recoveries are typically high for building products distributors, but often the biggest surprise for lenders is the liquidation expenses that, in some cases, can be as high as 20 percent. Most sell to either retailers or pro builders, which rely on delivery of products to stores or job sites. In such liquidation scenarios, costs to maintain a delivery fleet are typically included in the liquidation expenses and can be as high as 7 percent. For companies that rely heavily on salespeople to maintain customer relationships and market products, an additional commission expense may be built into the liquidation scenario. Depending on whether buildings are owned or leased, real estate may also contribute to the expense burden
Seasonal swings: Not surprisingly, the building products industry is a very seasonal business; April through October is typically the high selling period during which time as much as 70 to 80 percent of sales may occur. However, variations in the weather can shift this timeframe from year to year, which is why a high-low analysis is typically recommended. Values can swing by as much as 5 to 15 percentage points between seasons. Appraisers can help lenders understand the additional risks associated with low season liquidations to mitigate exposures.