Home Depot announced its Q3 earnings last week—and the numbers are good news for real estate investors. This is despite the fact that the overall takeaway from the home improvement giant’s sales figures is one of decline: a 3.1% year-over-year comparable sales decrease in the third quarter of 2023.
What matters about this result is that it’s lower than the Wall Street prediction of a 3.3% decline. Home Depot’s earnings per share were also higher than predicted: $3.81 actual versus $3.76 expected. The company’s online sales also increased by 5% year over year.
Prices Stabilize, Inflation Drops
These seemingly small gains are significant because they signal a gradual stabilization of prices in the home improvement sector. In an earnings call, Home Depot’s CFO Richard McPhail said that ‘’the most important observation we’ve made is that the worst of the inflationary environment is behind us. And as a result, retail prices are settling in the market.’’
The inflationary environment that The Home Depot’s CFO refers to had a lot to do with construction material and labor shortages during the COVID-19 pandemic. Lumber shortages alone, combined with a huge increase in demand for lumber, had a huge effect on construction and home improvement costs.
But it wasn’t just about the lumber. The prices of concrete, gypsum, and insulation materials also skyrocketed.
Initially, the rising prices did not deter homeowners determined to complete their renovation projects. Eventually, though, spiraling inflation in the sector made new construction and renovation increasingly unaffordable.
The result was a fall in demand as homeowners and investors were no longer able to keep up with the rate of inflation, which at its peak in 2022 reached an eye-watering 16.1% on residential buildings. It’s almost redundant to state that BRRRR investments and house flipping became largely unprofitable. In a related story, Home Depot reported the worst sales figures in 20 years in Q2 2023
But What About Construction Costs?
Are the days of construction inflation fully behind us? No. In fact, according to the latest Quarterly Construction Cost Insights Report, tight labor market conditions in the construction industry are still pushing up the prices of several key materials, including concrete, gypsum, and insulation.
These high prices are continuing to put pressure on what The Home Depot’s CEO Ted Decker calls the ‘’big-ticket categories’’—that is, purchases for projects of over $1,000. Smaller projects are still dominating the (very modest) increases in sales in the sector.
However, there is some good news here. Some construction materials are seeing huge reductions in cost—and these are key materials essential for renovation projects. The prices of lumber, steel pipes, and aluminum have seen double-digit decreases over the past year. Overall, the Construction Cost report identifies the same trend as Home Depot’s assessment: a stabilization of prices and a more predictable environment going into 2024.
Decker refers to it as a ‘’rational environment,’’ where construction prices will see predictable and reasonable increases, not double-digit fluctuations. This predictable trajectory will be key for real estate investors, particularly house flippers and BRRRR investors. The success of a BRRRR investment portfolio directly depends on the stable prices of construction materials: it’s BRRRR 101 that the total renovation costs have to be factored into every BRRRR budget.
Reno costs are a decisive factor in the final profit the investor will make on the property once it’s been renovated and sold. And while the BRRRR method is one of the quicker ways to build a solid portfolio in real estate, it still takes time to budget, plan, and execute a house flip. It’s a process that’s only really feasible when your rehab prices don’t shoot up uncontrollably before you’ve even begun.
The Bottom Line
So, is the construction industry out of the woods? Not quite. But is the sector moving toward a more stabilized state? The Home Depot sales figures indicate that it is, which will allow BRRRR investors to budget accurately and not have their portfolio growth derailed by unpredictable construction inflation patterns.
In the words of The Home Depot’s Merchandising EVP Billy Bastek, the renovation purchasing environment ‘’has returned to a kind of pre-pandemic times.’’ It will be a while before—and if—the actual construction costs return to anything like pre-pandemic times, but we can be fairly confident that they won’t once again shoot through the proverbial roof in 2024.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.