SOI: A closer look

The nursery industry is forecasted to grow 5-7 percent in 2016 and 2017, thanks in part to healthy housing starts, rising home values and a recovering job market.

UCLA Anderson Forecast Director Edward Leamer points out that the U.S. is in its fourth-longest expansion since 1948. Using history as a guide — and given that the Fed will ultimately start raising interest rates later this year — Leamer says that some might think there is an 80 percent chance of the current expansion ending soon. Not so, he says, because the tepid pace of GDP growth, amounting to a modest, cumulative increase of 13 percent, so far is exceeded by only two of the other post-1948 expansions. As a result, the forecast says there is a 20 percent probability of an imminent recession.

Leamer says the expansion seems destined to continue for at least a couple more years and probably more due to other key factors: jobs, housing and cars. The modest gain in the employment to population ratio (3 percent more growth is expected to return to pre-recessionary levels) and the critical housing and automobile sectors are not yet in an overbuilt status. Therefore, when short-term interest rates do rise, sectors that are far from being overbuilt won’t likely crash.

Let’s examine some of the major economic indicators that are spurring the growth of the green industry and its products.

During 2015, housing starts have recovered to levels the United States hasn’t seen since the 2006-2009 timeframe, says Jeff Burch, managing director at Bank of the West. Burch is team lead for Bank of the West’s Nursery-Greenhouse business.

“Currently we’re seeing an annual rate of 1.1-1.2 million new housing starts,” Burch says. “Prior to the recession, we were at 1.4 million, which represented some overbuilding.”

Building permits, which are issued several months before construction begins, have grown considerably and almost reached pre-recession levels, Burch adds.

Existing home values are also on the rise. And when those increase, homeowners are more likely to spend money on interior and/or exterior improvements, which is a good indicator for the green industry.

Apartment vacancy rates in most metropolitan areas are approaching record lows. The shortage of available inventory is spurring new apartment construction.

“For the nursery and landscape market, new apartment construction will require larger, landscape-sized plants, not starter plants,” Burch says.

Continued stock shortages in certain plant categories will continue into 2016, therefore price increases next year and into 2017 should be expected or negotiated, Burch says.

“We’re hearing from many of our grower customers who increased prices this year, and have started negotiating price increases for 2016 and a few for 2017.”

The industry hears a lot about marketing to Millennials, but there are still a record number of Baby Boomers who will impact sales in the green industry. While this segment has been the most active gardeners, more Boomers are continuing to work into their 70s. Because of this, many are using landscapers because gardening is still a priority for them, but they’re not necessarily doing it themselves. This is a leading indicator that will likely continue for the next five or six years, says Burch.

Interest rates remain historically low – the lowest we’ve seen in decades. Although the Fed has said it will raise interest rates, the impact will likely be minimal, Burch says.

“I think the Fed has done a good job this time preparing the market that interest rates will increase, which reduces the shock or reaction that markets will have,” he says. “The Fed has made it pretty clear that between now and March 2016 they do intend to increase interest rates between 0 and 50 basis points.”

Nursery owners should consider fixed interest rate loans for any long-term debt in the way of equipment purchases, he suggests.

There’s certainly reason to celebrate when the economic indicators point to growth for the next year or two. But growers must be cautious of the role that weather plays in the health of the economy.

“We saw it in 2015 with the drought in the west, the floods in Texas and the early freeze in the northeast. If you’re a local or region-specific supplier, you have to continue to be conservative and stay disciplined in case your region is hit by a weather-related shock,” Burch says. “But I think at least from an economic indicator standpoint, it’s the first time in many years that I’ve seen every indicator supporting a positive outcome for the following year.”

Editor Kelli Rodda contributed to this story.

The Nursery Point of View

Cherry Lake Tree Farm president Timothee Sallin shares his views on the economy and its effect on the nursery market. To read more about Sallin’s observations, visit www.cherrylake.com and search for “plant market update.”

Besides the housing market recovery, the inventory of bank owned properties (REOs) is also significantly reduced, clearing the way for new home construction and sales. The reduction of bank owned inventory is an important indicator of the fundamental strength and health of the housing markets and a predictor of new home construction.

Home values have recovered to pre-crisis level and are now appreciating at a healthy rate. This is an encouraging sign as slow to moderate appreciation of home values combined with low inventory levels should promote fundamentally sound growth.

What implications does this have for the plant material market?

The demand for plant material is closely correlated to new housing starts. In a previous plant market update, we estimated that each one housing start correlates to 17 #30 gallon equivalent trees. Currently, demand for plant material created by growth in new housing is increasing at a faster rate than supply. This leads to disequilibrium in the market, increasing plant material prices and pervasive shortages of plant material.

The nursery industry simply cannot produce trees any faster than nature will allow. Nurseries are planting more trees in an attempt to respond to the growth in demand, but these trees will not be available for another 3 to 4 years. In the meantime, new construction projects are competing for a limited supply of trees and bidding the prices upward. In the summer of 2015, plant material prices were nearing the historic high point reached in 2007 at the tail end of the housing boom.

It is interesting to note that plant prices are approaching peak levels while housing starts are still less than 34 percent of 2006 peak levels. This is a reflection of just how much destruction of supply and production capacity occurred during the recession years. A significant number of producers exited the market and the total production acreage committed to nursery was substantially reduced between 2008 and 2012. Now we are experiencing severe shortages and price increases even though demand is still just a fraction of the demand present in 2006 and 2007.

Looking ahead, we can expect continued shortages and more price increases, as the housing market is poised to continue to grow and strengthen at a faster rate than plant material production. Three- to four-inch caliper oak trees will be the most difficult to source as these trees are typically required by codes and ordinances and very few substitutes and alternatives exist to meet the requirements.

While it is difficult to predict exactly how high and how quickly prices will rise, it is reasonable to expect tree prices to increase at least 25-35 percent over the next two to three years.
 

Labor market and wage rate inflation
Plant material prices are not the only input costs that are increasing. The labor market has also tightened significantly and labor wage rates have been rising as a result. It is likely that this trend will continue and we could be experiencing a structural economic shift in labor markets and wages.

As we have seen, the construction and housing industries are growing steadily creating significant demand for both skilled and unskilled labor. As the nursery industry gears up to fill the demand for plant material, they are increasing employment and drawing upon the same labor pool. Not to be left out, a strong tourism industry is adding significant labor demand as jobs are being created in the hotel, restaurant and service sectors.

Suddenly everyone is competing for the same labor and this is leading to significant wage rate inflation.
 

Implications for total landscape construction costs
The two primary direct costs of any landscape construction budget are labor and plant material. As we have seen, both of these inputs are increasing significantly. This is naturally driving the cost of landscape construction projects higher. On one hand, input cost are increasing, leading to higher cost escalation risk. On the other hand, the demand for landscape services is increasing as the overall economy begins to improve. Rational economic actors in these conditions will seek to increase their margins to offset the increasing risk and capitalize on the price elasticity of demand in a tightening market.

The bottom line is that labor cost, plant material cost and margins are increasing in landscape construction bids. This increases the overall cost of landscapes, which depending on your perspective, is either a good or a bad thing. Ultimately project owners and funders need to be aware of these trends so as to better anticipate costs and plan for their projects. Landscape companies with access to the highest quality plant material and labor sources will prevail in the coming years.