Why Home Construction Prices Are Rising

From lumber to concrete to paint, home construction prices are rising. And this has left both homebuilders and renovators feeling handcuffed, despite a historic housing shortage.

But why are home construction prices rising?

There are many different factors at play – and some of them might surprise you.

Supply vs. Demand 101

Anyone who remembers even the most basic economic lessons from school understands the importance of supply vs. demand.

Simply put:

• Supply refers to how much of a commodity is available in the market as a whole for consumers to purchase, provided by the producers at a specific price or within a certain price range.
• Demand describes how much of that commodity the consumers desire and are willing to buy from the producers at a specific price or within a certain price range.

If the supply outweighs the demand, then the perceived value (how much consumers are willing to pay) drops, bringing prices down with it. But if the demand outweighs the supply, then the perceived value and the price tag rises.

This relationship between supply and demand is very much at the heart of why home construction prices are rising… and why they’re likely to continue growing into 2022.

Prices Rise Because Suppliers Misjudged Demand

There’s no denying that the national response to the Covid-19 pandemic had massive impacts on the economy.

Some of the restrictions – including social distancing and the forced (temporary) closure of some businesses – put extra stress on the ability of suppliers to maintain pre-pandemic production rates.

Together with an expectation that consumers being similarly affected would cause demand to drop, many suppliers cut their production rates drastically.

This makes sense from an economic point of view.

After all, suppliers have their own expenses to cover. A drop in demand could easily lead to a huge surplus of supply, forcing prices down.

Usually, this is where market research would help suppliers cut back on supply production in measure to a reasonably projected drop in demand. But with no reliable, recent precedents to base a projection model on, suppliers had to estimate changing demands almost blindly.

Unfortunately, it turns out suppliers misjudged demand rates. And, as a result, production levels dropped more drastically than would have been ideal.

This caused the demand to outweigh the supply – which has the ripple effect of driving prices up.

Changing Homeownership Trends Increasing Demand Further

In a recent post, we talked about The Future of the Home Remodeling Industry. One of the things that came up is that homeownership trends are changing.

According to a chief remodeling analyst, there was a huge boom in first-time homeownership in 2020.

As early as January 2020 – before the pandemic became a reality for all of us – experts were already warning that years of low housing production created an imbalance in housing supply vs. housing demand.

This only became more pronounced due to the pandemic, including the misjudged demand and resultant drop in supply production.

And with the Millennial generation acting as a driving force of the boom in first-time homeownership, we’re seeing another ripple effect exacerbating that imbalance.

A Vicious Cycle in the Making?

The irony is, this demand for home building and home renovations is also considered a driving force behind the economy’s recovery. Home remodeling alone is conservatively projected to account for $352 billion in 2021.

This is good news, of course. But it also heralds the possibility of a vicious cycle in the making.

After all, suppliers are already under a lot of pressure to increase production rates to fill the existing deficit and catch up with current demand.

And that means increased expenses too, including labor and transport costs. With increased expenses comes further price increases, at least until there’s a better balance between supply and demand.

If the prices get too high, we could see consumers backing away as budgets shrink.

This could potentially cause demand to drop drastically due to its reliance on the consumer’s desire for a commodity and their willingness to pay a specific price to have that want or need met.

So if the price does eventually cause demand to drop as drastically as expected initially, suppliers can start running into issues covering their expenses.

And once again, supply rates could drop… potentially just as prices have been forced down enough for demand to pick up again.

This means home construction prices and the increasingly precarious relationship between supply and demand could very well be a vicious cycle in the making.

Rising Home Construction Prices – A Light At the End of the Tunnel?

Not all is doom and gloom, of course. And based on my experience in the home remodeling industry, I think there’s a light at the end of the tunnel.

I already mentioned earlier that the home remodeling market is looking healthy for 2021 and is considered one of the driving forces in our recovering economy.

And with the economy as a whole expected to grow at least 6.8% in 2021, we can tentatively expect to avoid a housing market crash any time soon.

You have to remember that willingness to pay is closely tied to the ability to pay. For massive expenses like meeting the rising home construction prices, this almost always includes receiving and repay loans.

And with the Federal Reserve making it clear they don’t plan to increase interest rates yet, that ability is looking healthy. Notwithstanding current uncertainties regarding forbearance policy timelines and future implications, of course.

At the outset, we look well-poised to avoid any vicious theoretical cycle as the industry moves toward creating a better equilibrium between supply and demand.

And as we do, we might see the rise in home construction prices slowly balance out as well.