Marty Mitchell’s company in Rockville, Md., builds homes priced from $700,000 to $1.6 million. Business is brisk and could be better. Costs of everything from lumber to labor have been rising faster than anyone in the industry imagined only a short time ago. “We certainly expected some increases as the market improved, but costs have really shot up in the past six months or so,” says the deputy chief executive officer of Mitchell & Best Homebuilders. That’s putting the squeeze on margins even as companies like Mitchell’s raise home prices.
As the U.S. housing industry recovers from its worst downturn since the 1930s, builders are having to cope with steep cost increases for various materials as well as rising land prices and shortages of skilled labor. “We’re seeing somewhat of a bottleneck,” says Michelle Meyer, senior U.S. economist at Bank of America (BAC). “Higher costs are one reason home construction is not rebounding faster,” she says. Housing starts, including single- and multifamily homes, advanced 7 percent in March from the prior month, to a 1.04 million annual rate, the highest since June 2008, the Commerce Department reported on April 16.
Suppliers of products such as drywall and wood are testing the strength of the recovery by boosting prices. If prices stick, these companies will ramp up production. The wholesale cost of softwood lumber climbed 30 percent in the year ended March, data from the Department of Labor show. Oriented strand board, an engineered wood, climbed 68 percent, while gypsum products that include drywall rose 18 percent. Manufacturers “are raising prices dramatically, and once they’re convinced that these prices are going to stick, they’ll start reinvesting in those plants,” says John Burns, CEO of Irvine (Calif.)-based John Burns Real Estate Consulting, which provides research to developers, construction-product manufacturers, and investors. “Those can take a year to get up and running.”
In some areas of the country, many skilled contractors “have left in favor of greener pastures” such as better-paying jobs in the energy industry, says Brad Hunter, chief economist for Metrostudy, a homebuilding consulting company. The labor shortage is most acute in Phoenix, in part because its housing collapse and recovery have been more pronounced. Also some Mexican immigrants who worked in construction left Arizona after the state legislature passed a strict immigration law in 2010.
Construction costs account for close to 60 percent of the price of a new home, according to data compiled by Bank of America, while the cost of the lot makes up 22 percent, the second-biggest expense for homebuilders. In a March 20 earnings call with investors, Lennar (LEN) Chief Operating Officer Jonathan Jaffe acknowledged that in some markets—notably Florida, Arizona, and California—the company is deliberately slowing the pace of its homebuilding, choosing to boost margins more than sales, while waiting for more land to become available. Toll Brothers (TOL), the largest U.S. luxury-home builder, is raising prices in about 60 percent of its communities as demand improves, according to CEO Douglas Yearley. Material and labor costs that rose by $4,500 per home for all of last year were already up by an additional $3,000 in the first quarter of 2013, Yearley said during a March 4 presentation. “We have more than offset those costs with pricing power,” he said. The median selling price of a single-family new house rose to $247,000 in March, according to Commerce Department data, up 3 percent from a year earlier.
Pricier new homes may divert buyers toward relatively less expensive, previously owned ones, says Millan Mulraine, an economist for TD Securities. That would help reduce the pool of existing properties waiting to be sold. “The faster the drawdown of inventories, the closer we’ll get to a more normal housing market,” he says.