High Costs Bedevil Builders

High Costs Bedevil Builders
Shortages of Lumber, Land and Labor Push Up Prices of New-Home Construction

Wall Street Journal
October 25, 2012
Robbie Whelan

New-home construction has picked up momentum in recent months after years of contraction. But the industry is facing a fresh challenge: building costs are going through the roof.

Builders are seeing the prices of materials, labor and land rise due to shortages and reduced capacity among manufacturers, subcontractors and developers. Some industry veterans say the price increases could be temporary, noting that supply-demand imbalances often occur early in a recovery. That happens in part because the industries that fuel the engines of the construction trade are wary about ramping up until they are sure the recovery is sustainable.

But rising costs mean many builders will try to pass along price increases to consumers. If too many potential new-home buyers opt instead for an older home, that could have implications for the economy. Sales of new homes provide a much bigger lift to economic growth than sales of older ones. The National Association of Home Builders estimates that each new home built generates about three new jobs.

“If somebody buys a new home, you’ve got to hire a bunch of construction workers to go build it,” said Michael Hanson, senior U.S. economist with Bank of America Merrill Lynch. If fewer new homes sell, he said, “that would mean less of a boost” to gross domestic product.

The Census Bureau reported Wednesday that the median price of a new home was $242,400 in September, up 11.5% from a year ago. The median price of an existing home was $183,900 in September, up 11.3% from a year earlier.

The cost of framing lumber, which makes up nearly one-sixth of the total construction cost of a home, has risen 21% in the past year. Makers of drywall, which is used to build interior walls, have boosted prices 25% since January and signaled more increases to come early next year. In addition, builders are paying more for land and labor.

“Builders have their backs against the wall,” said Robert Denk, senior economist at the NAHB. In a market that has just begun to recover, “it’s a very difficult time for builders to try and pass on costs to consumers.”

Yet some builders are doing just that. Carmeter and Curtis Lard started shopping for a new house in June, hoping to find a three-bedroom in Otay Ranch, a suburb of San Diego with good schools.

The first home that caught their interest was built by McMillin Homes and was selling for $401,000—the top end of their price range. Three weeks later, after the couple had qualified for a mortgage, the same model was selling for $418,000. The couple visited several other new-home communities but couldn’t find anything in their price range and gave up in August. Now, they are shopping for an older home.

“By the time we were qualified, the house was out of reach,” Ms. Lard said. “We didn’t realize it would be that difficult to buy here.”

Timber companies and drywall manufacturers, for example, laid off thousands of workers and idled capacity at plants when the downturn hit and want to see at least six months of rising demand before reversing course. (Lumber shortages are also the result of an infestation of bark beetles that has destroyed millions of acres of pine trees in the U.S. and Canada.)

Through the first half of 2012, the lumber available to U.S. builders measured 18.2 billion board feet, down about 45% from the peak of production in 2005. Shawn Church, editor of Random Lengths, a trade publication that tracks the price of wood, said “production is coming back from the 2009 trough” of 16 billion board feet produced through the first half of that year, “but very slowly.”

“The percentage gains are not nearly as significant as the gains we’ve seen in housing, and that’s one of the reasons we’ve seen prices rising,” Mr. Church said. “Throughout the year so far, mills have increased production incrementally by running on Saturdays. But there really hasn’t been any major capacity increases as far as more shifts or bringing idled mills out of mothballs, and the reason for that is there’s still a lot of uncertainty about 2013.”

Drywall manufacturers, in addition to raising prices, have stopped providing “job quotes,” which allow builders and contractors to lock in at low prices with their suppliers, for projects that might last several years.

“Any time there’s a price increase at the manufacturer level and we go to pass it along, we get a lot of questions from buyers,” said Ira Horner, a manager at Kent Gypsum Supply Inc., a drywall distributor in Kent, Wash. “As the price of materials goes up, it definitely is going to hurt the number of projects that take place.”

Land also is in short supply, at least in the places where consumers want to live, near jobs and good schools. In Gilbert, Ariz., near Phoenix, builders including LennarCorp., LEN -1.31% Shea Homes and Meritage Homes Corp. MTH -0.55% recently purchased 203 acres of raw land in a development called The Bridges, paying between $126,000 and $150,000 an acre. In the Spring of 2011, some investors were paying as little as $77,763 an acre for the same land.

“In the high-quality areas, land prices have at least doubled in the last two years, and finished lots have disappeared,” said Greg Vogel, chief executive of the Land Advisors Organization, a Scottsdale, Ariz., land brokerage.

Labor is another problem. Between 2007 and 2011, more than 2.1 million construction workers lost their jobs and many switched to jobs in other industries. “These are folks who lost their jobs, waited around for years and then found something else,” said Megan McGrath, a home builder analyst with MKM Partners. “The trick is getting the skilled labor force to come back.”

That will be easy in some regions, but not everywhere. Jonathan Jaffe, Lennar’s chief operating officer, said in a recent conference call that labor shortages are most acute in Phoenix, Texas and parts of Florida.

In Arizona, the Legal Arizona Workers Act, a 2010 law meant to crack down on illegal immigrant workers, has driven many seasonal workers from the state, said Margot Veranes, a union organizer for painters and drywall-hangers in Phoenix.