Construction cost predictability is tricky and growing more difficult at a moment the new home sales narrative plot-line needs practically nothing more right now than predictability.
Yesterday's existing home sales data on July from the National Association of Realtors, whose total of 5.34 million reflects a 0.7% decline from June, and a 1.5% year-on-year drop, tell a part of the story that should by all rights tilt the playing field more in favor of new home builders.
Overall inventory of existing homes for sale is still tight--having declined for 37 months going back to June 2015, and this past month remained flat, year-on-year.
The big gaping mismatch in the market is for homes at the lower price rungs, and that's where new home builders have finally gone all in with land, design, development, and investment in entry-level programs, an operational shift years in the making.
New home construction is the market's answer to scarcity among resales available for sale, and a full activation of new home sales at the lower end--below high $200ks--is a long-awaited dimension of a full, broader-economy-affecting housing recovery, relieving scarcity-related pricing pressures, and better balancing demand and supply.
Helping that narrative is easing mortgage availability--which has risen three quarters in a row and is now at its highest level since 2013.
Everyone knows how that's gone, and now, as interest rates on mortgages drift inexorably upward, a playing field that has finally tilted in favor of builders bringing more new home communities priced at more inclusive average selling prices may wobble and, suddenly, tilt back in the other direction.
Zillow senior economist Aaron Terrazas notes in his commentary yesterday about the NAR existing home sales release:
Three years of exceptionally tight inventory and exceptionally strong price gains are catching up with the market, and are visible both in softer demand from stretched buyers and a still pervasive — if somewhat easier — inventory crisis. Home value appreciation has slowed considerably in a number of notable markets, including some that were among the nation’s fastest-growing just a short time ago. Inventory seems to be at or near the point at which it can’t fall much lower, and has begun to rise in several markets. Price cuts are becoming more common, especially at the higher end of the market where competition is less fierce. Growth in rents has flattened, removing some demand from the market that had been coming from renters desperate to trade their escalating lease payments for the stability of a monthly mortgage payment. Rising mortgage interest rates and record-high prices are putting a squeeze on affordability, especially in some higher-priced markets that experienced rapid job growth over the past half-decade – and the rising housing costs that came with it. And finally, the impact of tax reforms eliminating a number of lucrative tax breaks utilized largely by homeowners in pricey and/or highly taxed areas may be starting to show.
This is why the focus on construction costs right now is so fraught with intensity. A year ago, builders believed that the biggest risk to their ability to model costs and construction cycles was labor capacity, and its constraints.
Today, while labor constraint in discrete parts of the trade ecosystem at discrete seasonal moments in time are still a big unsolved challenge, the bigger risk to modeling--and making important arbitrage decisions on prices paid for materials and products in the distribution channel--impacts those materials costs. And the cause of most of that agita, and the one moving the dial the farthest and with the most volatility right now, is tariffs.
Here's a take from IHS Markit research analysts and the Procurement Executives Group, on what's going on with materials price pressure trends, and why they're so hard to predict right now.
The current headline IHS Markit PEG Engineering and Construction Cost Index registered 58.9, 9 points lower than July, indicating prices rose at a slower pace in August compared to July. The decline in the current headline index was due to more respondents noting unchanged prices compared to the previous month. Both materials/equipment and labor sub-indexes showed pricing increases.
Price increases for materials and equipment were weaker across the board in August; the index posted a loss of 8.8 points, falling to 60.7. The indexes were lower in 10 of the 12 categories, though 11 of 12 were above the neutral threshold of 50, with the index for turbines falling to the neutral mark of 50.0. The biggest losses were in the indexes for the three steel categories, turbines and heat exchangers. The only category that experienced faster price increases this month was ocean freight.
“Trade uncertainty continues to weigh on procurement, and the volatility in the index demonstrates the erratic effects of trade disruptions on supply chains,” said John Anton, associate director – pricing and purchasing, IHS Markit. “The pricing environment for materials and equipment is made worse by uncertain policy duration, potential company exceptions, country exemptions and the combination of tariffs and quotas. Those buying from South Korea or Brazil face delivery failure.”
As nature abhors a vacuum, those who invest capital in real estate, development, and construction detest a lack of predictability. It slows things down. And that doesn't even count for the impact of tariff repercussions on consumer spending, behavior, and confidence, a big force factor in demand for new homes.