Trend Tracker July/August 2021

August 20th, 2021 by Nathan Hobbs

The Wall of Worry: Mid-Year Is the Perfect Time to Revisit Old Decisions and Possibilities

By Michael Collins

While working on the sale of a building products manufacturer recently, we received responses from two potential buyers. The first prospective buyer indicated that they were moving forward in evaluating the deal because, “demand in the market should be strong for the next few years.” About an hour later, a second potential buyer responded that they were dropping out of the process, “because of where we are in the building cycle.” These are both well-informed, private equity buyers with, presumably, relatively equal access to information about the state of the building industry. How can they arrive at such different views of the same market? More importantly, which is correct?

We can answer this question by considering an economic indicator that is related, though sometimes more than others, to the perceived health of the construction industry: the stock market. It is often said that the stock market climbs a “wall of worry” as it meanders its way upward over time. The building products industry shares both of these important characteristics. The first similarity is that it meanders, by which we mean that it does not progress along a smooth or predictable path. Second, its trend—when examined based on long periods—is always upward.

In this way, both potential acquirers, being guided by their market outlooks, may be right at any given time. In the short term, building products demand can fluctuate downward. This creates a focus on where we are in the cycle. However, the deck is stacked in our favor due to population growth, pent-up demand and other factors. Thus, we have the prevailing belief that demand will remain strong over the next several years.

A Market Levee

In the current market, though, there is a wave of unmet demand that is not being satisfied because many people who wish to build a new home or buy a larger home choose not to do so in such a frothy market. Rising lumber prices have driven up the cost of homes and remodeling projects. Buyers seeking an existing home in a strong housing market are learning that some unconventional approaches may be needed to become successful buyers. In some markets, this now includes making an all-cash offer for more than the list price of a home—sometimes amid a bidding process that has been restricted to a single day. Other times, buyers decide to make unsolicited offers on homes that have not even been listed for sale, hoping to avoid those auction processes altogether.

Such approaches are not for the faint of heart and many buyers will step back from the market and wait until conditions cool. This creates pent-up demand that is capable of carrying the market through a period when demand appears, in the short-term, to be cooling off. The opening of additional lumber mills and a resulting decrease in lumber prices would have the same effect, by allowing the market to burn off some of this excess demand.

Residential construction is expected to be even stronger this year, with some estimates placing the 2021 growth rate at 7% or more. We believe that— even if the market pauses for breath in the next couple of years—pent-up demand should be capable of fueling continued growth or at least providing a soft landing.

Michael Collins is an investment banker and a partner in Building Industry Advisors. He specializes in mergers and acquisitions in the door and window industry.

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