Author: S.C.
1. Executive Summary
While we continue to see a more resilient construction market in the U.S. than in Europe, certain European markets – Germany in particular – are showing signs of stabilisation. The pace of the recovery from current levels cannot be predicted, as it depends on a variety of exogenous factors such as monetary policy decisions, trade and immigration policies, and other political and geopolitical aspects; however, the recent datapoints suggest a transition phase for construction markets, moving from contraction to stabilisation and, hopefully, further down the road, expansion.
2. U.S. Construction Activity
US construction activity has stabilised around 2019 (pre-covid) levels after a volatile period in 2020-2022. Since the sharp rise in interest rates that started in 2022, new home sales have been solid while existing home sales have been very weak, as owners have been reluctant to sell their homes and refinance their mortgages at higher rates.
There is a widespread consensus that the US housing market is undersupplied and that there is a strong need for both new homes and renovations. Overall, combining various aspects to gain a more holistic view of the U.S. housing market, we see that most fundamental indicators indeed point to solid fundamentals for the U.S. construction and renovation market going forward (excluding the risk of unlikely “mass deportations”):
The very low level of existing home sales suggests that once interest rates normalise, there should be a pickup in renovation activity, either by sellers to make their homes more attractive for buyers, or by buyers who wish to improve their newly purchased homes. This would be positive for lumber manufacturers and certain manufacturers of engineered wood products that are more exposed to the R&R market (e.g. decking). Inventory for sale is, in aggregate, at historically low levels (Figure 1), held down by low inventories of existing homes.
Figure 1: Housing inventory and household estimates. Source: U.S. Census Bureau.
Currently, a warning signal in the U.S. housing market comes from the high inventory level of new homes for sale (Figure 2). While this signal should not be underestimated, it should also be understood in the context of the broader market environment. Homebuilders have been increasing their focus on speculative construction (see Meritage Homes’ strategy, for example) – that is, the construction of new homes not yet sold – in order to compete with existing homes in terms of move-in availability for the buyers. Now, in the market there are buyers who want a new home, for example a nicer one, and buyers who need a new home, for example because they are moving or getting divorced. With the number of households in the U.S. growing, there is a need for new construction, because even a pickup in existing home sales would not provide enough supply – who sells a house, generally will have to buy another one.
An increase in existing home sales should lead, as expected by homebuilders, to increased competition. As a matter of fact, the increase in new homes inventory for sale with relatively stable housing starts, points to construction levels above what the market can absorb in the current environment. This may be due to interest rate headwinds and may also be an inevitable risk to be taken in order to compete with existing home sales, once they will pick up. In any case, the rise in new homes inventory increases the risk of a cyclical slowdown in new home sales (and construction), should existing homes sales activity increase significantly on the back of lower, or at least stable, long-term interest rates.
Figure 2: New homes for sale inventory and housing starts. Source: U.S. Census Bureau.
This could have a negative impact, at least on a relative basis, on sales of timber products that are mostly used for new construction, like OSB for example. This is one of the key reasons why in January, the exposure to certain U.S. companies in the portfolio that are particularly exposed to OSB sales, was reduced. The other reason was the relatively rich valuation, which compounded the risks.
3. European Construction Activity
As already commented in other reports, the situation for the construction sector in Europe has been even more challenging than in the U.S.
German construction activity is down to levels last seen during the global financial crisis and the European debt crisis. On a positive note, however, German building permits appear to have normalised (Figure 3). Combined with normalising interest rate policy in Europe and increased real estate transaction activity – according to CBRE estimates, FY24 investment volumes in Europe should be higher than 2023 – there is a case to be made for the construction cycle to be bottoming out. While much lower than the peak reached in 2022, net migration to Germany remains positive , supporting demand for housing.
Figure 3: Residential building permits in Germany. Source: Statistisches Bundesamt.
Finland is another important country for timber construction and one that has seen a dramatic slowdown in construction activity. On a positive note, also in Finland building permits and starts appear to be bottoming out. In Finland, net immigration was stronger in 2023 than in 2022 (2024 statistics are not available yet) although first-time applications for residence permits based on employment were lower in 2023 and are expected to fall slightly again in 2024 .
Figure 4: Residential building permits, starts and completions in Finland. Source: Statistics Finland.
In other countries, like France, the normalisation pattern is less clear and political issues have been weighing not only on economic confidence but also on interest rate risk premia, offsetting some of the benefits from the ECB’s loosening of monetary policy. Nevertheless, early signs of a bottoming pattern have appeared also there (Figure 5).
Figure 5: Residential building permits (not seasonally adjusted) and starts (seasonally adjusted) in France. Source: Ministère de la Transition écologique et de la Cohésion des territoires
4. Disclosures and Conflicts of Interest
Some or all the companies mentioned in this report may be included in the Timber Finance Forest-Based Construction Basket tracker and are part of the Timber Finance Carbon Capture & Storage Index. Timber Finance Management and/or the Timber Finance Initiative may have commercial relationships or be in discussions with some of the companies mentioned in this report. Specifically, Stora Enso is a member of the Timber Finance Initiative association.
Please note that this research is prepared for information purposes and targeted to institutional investors in Switzerland. It does not represent investment advice and does not take into consideration the individual requirements, risk tolerance and goals of an investor. Recipients who are not Swiss institutional investors should seek the advice of their independent financial advisor prior to taking any investment decision based on this report or for any necessary explanation of its contents.
The information presented in this report is obtained from several different public sources that we consider to be reliable. Nevertheless, we cannot guarantee the accuracy of the presented information. The information used may change quickly and we are not committed or obliged to modify the reports base on new information. The opinions and views expressed in this report reflect those of the author at the point in time of its compilation and may vary at any time. Valuation methods like DCF and any other analysis or expert judgement do not provide any guarantee that the target price or fair value will be reached, for example because of unforeseen changes in financial or economic conditions.
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