February 14th, 2011 12:01 PM by Lehel S.
With interest rates near rock-bottom levels, most people realize it's only a matter of time before loan costs start to rise. After all, what comes down in the mortgage world always has a way of going up.
But what seems to be forgotten is that construction costs also will eventually go back up too. And the rumblings of that phenomenon are already being felt in most building-product categories.
"Builders are resisting raising their prices, but ultimately they're going to have to," said Bernard Markstein, vice president of forecasting and analysis at the National Assn. of Home Builders. "Builders are not going to build at a loss."
Residential construction costs are still down from their peak in September 2008, Markstein said. But the overall price for building materials has been on the upswing year over year since the summer. And in December, the producer price index — published by the Bureau of Labor Statistics for selected building materials — registered its largest gain of 2010, 4.5%.
The month-to-month increases in the cost of key building materials aren't nearly as severe — 0.4% in October, 0.4% again in November and 0.7% in December. But as Markstein sees it, the message is clear: "If you want to buy a new house and are in a position to do so, you should do it now."
Even though hard construction costs have fallen during the housing recession, they now account for nearly three-fifths of the price of a home, according to the latest National Assn. of Home Builders survey. That's a big shift from nine years ago, when construction costs accounted for just half the price of a new home.
With the exception of construction materials, every cost component of building a house — the finished lot, financing, marketing, sales commissions, overhead and even profits — has gone down since 2002, the NAHB said.
Nine years ago, builders were pocketing roughly 12% of the sale price on average as profit. In 2009, the last year for which the home builders association has figures, the typical profit on a new house was 8.9%. And given the state of the market last year, it's probably safe to say profits are still falling.
Not all builders are feeling compelled to mark up their wares. In Chicago, where just over 3,000 new homes were built and sold last year, there is little demand. Consequently, there is little incentive to raise prices, said John Wozniak of J. Lawrence Homes in Wheaton, Ill.
"We used to build 36,000 new houses a year, so we are not seeing much in the way of cost pressure," said Wozniak, the current president of the Home Builders Assn. of Greater Chicago. "But that doesn't mean we are making any money either. We're selling just enough to keep the lights on and a little more."
But London Bay Homes, a builder of semi-custom and custom homes in southwest Florida, is feeling the pinch. "We're working on pretty tight margins now," said Stephen Wilson, the Naples-based company's chief financial officer. "If we don't raise our prices soon, [profits] would be completely eroded."
Wilson's best guess as to when London Bay's prices might start rising: "It might be another three or four months, but it could be two or it could be six."
Harley Constant, director of purchasing and estimating for Highland Homes, which builds 250 to 300 homes a year in central Florida, doesn't handle pricing. But he assumes his Lakeland-based company will have to start raising prices soon, "probably by the end of March," he said. "We have to pass it along."
Right now, though, prices are the lowest they've been in years. Highland Homes' lower-end models used to start at $130,000 to $140,000. Now they start in the high $90,000s. And London Bay's construction costs are currently 35% to 40% lower than they were at the height of the building boom.
According to Ed Nolan, London Bay's director of purchasing, "Declines in material and product costs as well as labor have created a buyer's market for builders."
For home buyers too. But all that is about to change, owing in large part to the cost of energy and worldwide demand.
Manufacturers continue to report a "troubling head wind" in the cost of their raw materials, according to the most recent monthly survey of building-product companies by Zelman & Associates, a New York financial analysis firm. When asked to specify where the cost pressure is being felt, one maker told Zelman researchers, "Everything. The global economic recovery has driven almost every raw material higher."
NAHB economist Markstein agreed. "All the commodities are up, but lumber is probably up the most," he said.
After falling from a run-up last spring, the cost of the softwood lumber used for framing rose sharply in November and December. Hardwood lumber used in flooring and cabinets is up too, as are millwork, plywood and oriented strand board, a plywood substitute.
About the only key construction materials not currently rising are cement and concrete products, such as brick and block.
Should there be an uptick in demand or a disruption in supply — such as the recent 32-day strike at one of the world's largest copper mines in Chile, which then halted shipments indefinitely after an accident at its ore-shipping terminal — prices have nowhere to go but up, Markstein said.
If demand for their products is sustainable, companies will rehire the workers they have let go, reopen shuttered plants and increase their capacities and inventories. And when that happens, the economist hypothesized, prices will probably flatten out again and possibly even fall.
But for the moment, he said, producers are "reluctant" to restart plants and recall workers. And until they are convinced that higher demand and prices will persist, their ability to meet demand is limited.