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Rising Costs and Material Shortages Could Deter Housing’s Boom By Builder.com

Brand substitution, reducing SKUs, and introducing escalation clauses are strategies builders are using to combat the impact of supply chain issues.

When COVID-19 became a global pandemic, the short- and long-term impacts of the virus on the overall economy and construction industry were unknown. Shelter-in-place orders meant many Americans were bound to their homes and the closing of non-essential businesses left many Americans furloughed or laid off. Such factors led many to predict housing would slump or crash. As the economy entered into a recession in the spring, manufacturers—particularly lumber suppliers—curtailed production, anticipating the housing sector would face contracted short-term demand.

However, as people stayed home, do-it-yourself (DIY) activity increased. Home improvement retailers Home Depot and Lowe’s remained open for business, and as homeowners flocked to stores to pick up supplies, retailers sent more orders to lumber suppliers at a time the housing market also began to rebound, according to Meyers Research chief economist Ali Wolf. Building materials manufacturer LP Building Solutions says its growth in volume sold through retail channels has been “remarkable,” particularly during the initial phases of the pandemic.

“Home sales stalled out for six to eight weeks [after COVID-19 hit the U.S.] before roaring back, which also put demand on lumber suppliers,” Wolf says. “Mills started to ramp back up production, but the lost time plus the increased demand has pushed prices up.”

As suppliers attempted to catch up on orders while demand ramped up during the late spring and early summer months, many builders were forced to place orders without concrete delivery dates or prices. The result of insufficient supply to meet soaring demand has caused prices of building materials, most notably lumber, to soar during the summer months.

According to the NAHB, the composite price of lumber has increased by more than 170% since mid-April, causing the average price of a new single-family home to increase by $16,000. The market value of the average multifamily home has increased approximately $6,000 over the same time period due to lumber prices. OSB prices have also tripled in recent months, and the average delivery times for many materials are growing.

Amid the supply-side constraints and rising prices, housing still remains in high demand as a bright spot of the recovering economy. The NAHB/Wells Fargo Housing Market Index (HMI) reached an all-time high of 83 in September. NAHB chief economist Robert Dietz says the HMI, which has been conducted by the NAHB for the past 35 years, is at a high reading because of improved prospective buyer traffic, low interest rates, a renewed focus on home, and rising demand in lower-density markets, such as the suburbs and exurbs. Wolf says builders are currently able to raise prices and still be met with “insatiable demand.”

New-home sales remained strong through August, increasing 4.8% from July and reaching post-Great Recession-high of 1.01 million at a seasonally adjusted annual rate. New-home sales are estimated to be 14.9% higher for the first eight months of 2020 compared with the first eight months of 2019. In the resale market, pending home sales reached a record high in August, rising 8.8% from July and more than 24.2% compared with August 2019.

However, on the supply side, challenges persist for builders even as manufacturers ramp up production to meet demand. Steve Hilton, chairman and CEO of Scottsdale, Arizona–based Meritage Homes—ranked No. 7 on the latest Builder 100 list—says the company has experienced more temporary supply shortages in the past two months compared with the early part of the pandemic. Jon McReynolds, Garman Homes division president in Raleigh, North Carolina, notes the company has seen shortages in lumber, tile, hardwoods, and lighting. While most shortages have been isolated, McReynolds says Garman—ranked No. 197 on the Next 100 list—has had to make a few new selections related to flooring products.

Going forward, Dietz says the NAHB anticipates such supply chain constraints will slow the growth currently being experienced for single-family construction.

Direct Impact on Builders
Amid surging builder confidence, nearly half of builders surveyed by Meyers Research in July reported experiencing supply disruptions, particularly in appliances, up 30% from the first week of July. A survey of 300 division presidents across the country during the last week of August found 80% reported supply challenges could impact their 2020 and 2021 sales plan.

Beyond lumber, Wolf says builders have reported major challenges not only with sourcing appliances (air conditioners, refrigerators, washing machines, etc.) and hardware, but also with getting those products delivered.

McReynolds says curtailed production and supply chain disruptions, particularly with flooring products, have most directly impacted work schedules.

“When flooring is delayed, we have to rework our schedules to allow for other things to progress, or we have to put the home on hold and wait for the material or reselect something that is available at that time,” McReynolds says.

As builders work to maintain margins and work schedules as costs go up, they are increasingly passing costs onto consumers. McReynolds says Garman has increased prices at the community level and adjusted lot premiums, but those adjustments have not been dollar for dollar with material price increases. Several builders have included escalation clauses in contracts with customers, stipulating that if prices—particularly lumber prices—increase by a certain percentage, then customers will be required to pay the extra costs. Such escalation clauses can help guard against steep changes in prices between quoting and contract signing.

“The costs have gone up and for the most part we’ve been able to pass most of those costs onto the customer by raising the price of our homes,” Hilton explains. “The customers have been absorbing it, but costs have increased substantially.”

According to Wolf, the cost increase is currently being “happily absorbed” by consumers eager to purchase in today’s low-rate environment.

“Unfortunately, there isn’t a lot that can be done to combat these [cost] increases as they are impacting everyone similarly,” McReynolds says. “We have to continue to pass along the increases when possible and bid out certain things when it makes sense for our business.”

However, there are risks that as prices continue to rise faster than incomes, the affordability problems that existed pre-pandemic could return. On the affordability front, the NAHB estimates 59.6% of new and existing homes sold between the beginning of April and end of June were affordable for families earning an adjusted median income of $72,900, down from 61.3% of homes sold during the first quarter of 2020. The percentage of affordable homes for median-income earners was the lowest reading since the fourth quarter of 2018, according to the NAHB.

“Going forward, lumber prices do pose a risk to the sustainability around the [economic] recovery, but historically there has been a seasonality to lumber prices and if that pattern holds true this year, we could see prices come down later in the year,” Wolf says. “The mills are [also] hiring again and bringing back furloughed workers, which should help with more supply hitting the market.”

Builder Response to Supply Shortages
Builders have limited options when facing supply shortages, but substitution and lowering SKUs are among several strategies being implemented to limit disruptions. Builders in situations where their usual supplier cannot provide a product have increasingly substituted with other brands of appliances, plumbing fixtures, and door hardware to mitigate any disruptions in production.

For Hilton and Meritage Homes, reducing SKUs—a strategy implemented prior to the COVID-19 pandemic—has been beneficial for the company. Meritage presents buyers with a handful of curated product collections, all at the same price point, which removes the pressure for the buyer to try to find the best deal and doesn’t overwhelm buyers with too many choices. Hilton points out that Meritage used to offer 56 dishwasher options. Today, the company offers the six most popular dishwashers manufactured by its supplier, Whirlpool, because those products have the biggest quantity.

“We’re going to have a lot more success in being able to procure those dishwashers, for example, than we are some of [Whirlpool’s] slower-selling, more expensive models,” Hilton explains. “That goes on and on for every component of the house, whether it’s door locks or plumbing, fixtures, or carpeting or tile.”

Hilton says offering fewer selections in their curated collections also helps vendors deliver and makes Meritage “more predictable” and cost-efficient. He adds that the benefits were being reaped before the pandemic, but the strategy has also helped significantly in the COVID-19 environment.

McReynolds says COVID-19 has impacted business at Garman Homes from every direction in some form, and one step the company has taken in response is extending cycle times when possible to ensure customers’ homes are complete when they go to the closing table.

“At the end of the day, we want to take great care of our customers and make sure that when they close on their new home, that they absolutely love it,” McReynolds said. “There isn’t really anything new-home buyers hate more than having a punch list when they close on their new home.”

Suppliers Beginning to Increase Production
To meet burgeoning demand for their products, many manufacturers have started to restore curtailed production. Boise Cascade began this process at the beginning of the third quarter. While early demand was strongest in the Southeast and Texas—within states that began reopening the earliest—Rob Johnson, vice president of engineered wood product sales and marketing, says the engineered wood products and plywood producer is now seeing strong demand across the entire country.

“We are seeing, and are working through, periodic short-term disruptions at many locations as we return to normal production levels,” Johnson says. “However, we have not experienced significant supply chain disruptions that would limit our ability to meet customer deliveries or an inability to source raw materials to meet our production needs.”

LP Building Solutions saw similar demand patterns, though the manufacturer says it is not experiencing COVID-19-related impacts to its distribution patterns.

The NAHB is attempting to tackle rising material prices and subsequent shortages for builders on two fronts: through encouraging increases in domestic production and through advocacy for a new Softwood Lumber Agreement with Canada. The association has submitted letters to Commerce Secretary Wilbur Ross, U.S. Trade Representative Robert Lighthizer, and President Donald Trump, calling for officials to re-engage with Canadian officials to combat what the NAHB calls a “threat to housing and the economy.” A new softwood lumber agreement could potentially end tariffs averaging more than 20% on Canadian lumber shipments to the U.S., providing pricing relief for builders. In its advocacy, the NAHB has called the substantial price increases in lumber categories “unsustainable, particularly in light of the housing affordability crisis.”

As efforts are being made to help increase supply, it is uncertain how long demand will remain at its current levels.

“I think these supply chain issues are going to put pressure on prices, which needs to be passed on to consumers, which will eventually cool off demand to some degree,” Hilton says. “But it’s still too early to tell what the long-term impact is going to be.”

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