The recent downturn in the housing market is putting to the test builders' adeptness at calculating the long-term impact on their bottom lines from warranty claims. A recent analysis conducted by the newsletter Warranty Week, which looks at the warranty expenses of 30 public builders (including some that build manufactured housing) in 2006, shows that some builders play the odds a bit more aggressively than others.

The newsletter examines documents filed with the U.S. Securities and Exchange Commission and finds these companies reported a 14 percent increase in warranty claims last year to $946 million. During this time, their aggregate sales increased only 4.7 percent to $111.2 billion. Even though the dollar amount of claims had been rising for these companies over the past several years, 2006 was the first time in three years that the percentage growth of claims outpaced their sales percentage increases.

Among the industry's 10 largest builders, Pulte Homes' warranty claims rate—i.e., claims paid divided by sales made—was the highest, at 1.2 percent of sales, followed by Lennar (at 1.1 percent) and Beazer Homes (at 1 percent). On the other hand, M.D.C. Holdings saw its claims rate decline by more than 10 percent, the only company among those analyzed with a double-digit falloff.

Some builders, this survey finds, are more conservative than others about squirreling away funds to cover future anticipated claims. Pulte, for example, ended last year with a reserve fund of roughly $120 million, or about eight months' capacity; whereas Hovnanian Enterprises ended 2006 with a reserve fund of $93.5 million at a time when it was paying out claims at a rate of $6 million per month, meaning that its reserve capacity was 15.5 months.

ACTUARIAL ANOMALY: For the first time in three years, warranty claims in 2006 rose at a faster rate than that of new-home sales, most likely due to the market downturn.

“It's not so much science as it is art,” says Eric Arnum, Warranty Week's editor, who tells Builder that the newsletter's survey shows how seasonal fluctuations in builders' sales make calculating accrual rates extremely difficult. “If you put too much money into your warranty reserve, you're reducing your earnings and that becomes unproductive money. But if you're under-reserved and something goes wrong, that can be a magnificent hit to your earnings, and a serious embarrassment because you have to report it, Bloomberg finds out, and the conclusion your customers draw is that your product is breaking down faster than you can account for it.”

Jerry Belfiglio, vice president of risk management for Toll Brothers (whose warranty claims were 0.6 percent of sales last year), points out that Toll, like other builders, offers 10-year structural warranties on its homes. So its longer-term risks get more challenging to gauge when the number of homes it is selling year to year becomes less predictable, as is now the case. Clark Stewart, a vice president with Eastwood Homes in North Carolina, says his company has seen a “big spike” in warranty calls from customers because “we're more focused on it.” The company has been soliciting such calls from owners as part of its customer service efforts.

In a down market, some buyers don't need much prompting to complain about flaws in the homes they've purchased, observes Sandra Stewart, a partner with Los Angeles–based real estate law firm Cox, Castle, and Nicholson. The firm has been getting more calls from builders about “post-closing complaints,” which she says seem to translate to “a lot of second guessing about the product.” As the market recedes, buyers get nervous about anything that might decrease their property values—a nervousness which quickly manifests itself through calls to builders if anything goes wrong. Stewart also notes that, during down periods, builders tend to reduce the size of their customer service departments, which can heighten some owners' anxieties.

Freeway Fumes

A new study finds that children who live near highways lose lung capacity.

As land costs have risen in recent years, builders have turned increasingly to urban infill sites, and parcels close to major highways are particularly attractive to commuters. But a study from the Department of Preventive Medicine at the University of Southern California, Los Angeles suggests that children who grow up in neighborhoods within 500 meters (about a third of a mile) of a freeway risk impaired lung development. Previous studies indicated that children living by highways were more likely to develop breathing problems, such as asthma, but this was the first study to suggest that breathing in exhaust for several years could impact the growth of children's lungs.

Researchers for the study tracked the lung development of 3,677 children, starting at age 10, for eight years. The children who lived within 500 meters of a freeway had a 3 percent impairment in the amount of air they could exhale compared to a control group of children who lived 1,500 meters (just under a mile) from the same highway. Children who moved away from a highway, but stayed in the same community, actually gained lung capacity. The study was published in TheLancet.com, the online version of the British medical journal.

- P. Curry

Lumbering Up

Despite the current weakness in housing demand, lumber prices are climbing.

Framing lumber prices, which have trended down since early 2006 and have been consistently below $300 per 1,000 board feet since mid-2006, may be headed back above $300.

According to the Random Lengths lumber market report, framing lumber prices on June 1 were $295, with structural panels reaching $306 per 1,000 board feet.

According to a report from Random Lengths, the price pick-up for lumber may be due to a renewed balance between the demand for lumber and supply. Demand for lumber has taken a hit during the housing industry downturn; as fewer houses are being built, demand for framing lumber has waned.

The lumber industry was slow to adjust its production, and timber production outstripped the housing industry's ability to absorb the supply. As a result, framing lumber prices declined from regularly being over $400 in 2005, to the high $300s in early 2006, to below $300 for most dates after September 2006.

A trade agreement (the U.S.-Canada Softwood Lumber Agreement) implemented in November 2006 also helped curtail the lumber supply from Canada, says Bernard Markstein, NAHB senior economist. That reduced supply, taken together with continued cutbacks in lumber production domestically, could bring the supply-demand equation back into balance, according to Random Lengths.

And that shifting balance could lead to increasing prices for builders, says Markstein. - E. Butterfield