This story was originally published in Builder.

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In the fall, Neal Communities announced it would stop production on its affordable cottage home product. The Sarasota, Fla.–based production builder attributed its decision to the rising cost of land, labor, and materials—tariffs in particular—that caused the popular entry-level cottages to become so expensive to build that their core demographic was no longer able to afford them.

Neal sold its last cottage home in September, priced at approximately $244,000—just under twice the cost of the first one sold in 2008. According to CEO Pat Neal, the increasing price of steel, aluminum, and lumber over the past few years amounted to thousands of dollars in additional costs per home. With margins on starter homes razor-thin, this priced the company out of the cottage business.

“Everyone knows that it is hard for a working-class person in our state and region to have a home with a mortgage payment they can afford,” Neal said at the time, noting that economic policies have impacted his firm’s ability to continue to provide an affordable housing solution.

Out of all the factors that affect the sales price of a new home, materials price changes had the biggest impact in 2018, according to Tony Callahan, president and CEO of Kennesaw, Ga.–based Callahan Consulting Group.

“It would be easier to list the products that haven’t risen in price,” Callahan says. “I have seen increases in lumber, laminate flooring, luxury vinyl tile, luxury vinyl plank, quartz, garage door openers, drywall, insulation, roof tile, roof shingles, HVAC equipment, appliances, fiber-cement siding, and windows, plus labor in many trade categories. Lumber is the only one to fall back down in price.”

The impact of these price hikes is staggering. As tariffs were taking hold in 2017, Paul Emrath, vice president of surveys and housing policy research at the NAHB, estimated that they could lead to a $1,360 increase in the price of an average single-family home and a $1.1 billion loss in single-family home investment overall.

While the Trump administration’s tariffs have been making headlines since they were first implemented in 2017, they are far from the only factor driving price volatility. In fact, the reasons that a given product or building material might rise or fall in price are as varied as the products themselves. Shifting factors like inflation and supply and demand also have a major impact on the price of products that go into a home.

With all of these issues at play, it can be difficult to predict how material prices will behave over the course of a building project, especially those with multiyear build-out plans. However, builders have devised a number of strategies to protect themselves against the worst effects of price increases, regardless of their cause.

“Identifying alternative materials, tightening up quantity take-offs, and indexing pricing to cost drivers—for example, framing lumber to [wood industry data provider] Random Lengths—are more of a focus than they have been in previous years,” Callahan says.

Duties and Tariffs

For a time, after the Trump administration levied new tariffs averaging 20.83% on Canadian softwood lumber in 2017, lumber costs were the most notorious of the industry’s material cost issues. Analysts and builders followed lumber costs through the first half of 2018 to a peak of $575 per 1,000 board feet in June, while oriented strand board (OSB) peaked at $500 per 1,000 square feet, according to Random Lengths.

Trade tensions with Canada are nothing new, according to David Logan, director of tax and trade policy analysis at the NAHB, with the recent tariffs just part of a series of trade disputes between the U.S. and its neighbor to the north. “Each time this happens the dispute lasts between three and six years, and during this time prices tend to go higher, but they’re certainly more volatile than in periods where an agreement is in place,” Logan says.

The industry has also seen new tariffs on steel and aluminum products from all but a few countries, along with a 10% tariff on more than $200 billion in Chinese industrial goods. For a time the industry faced an additional 25% tariff on Chinese imports, but the U.S. pulled back on this plan in late February.

Joe Mandola, president of Houston-based Trendmaker Homes, says tariffs on steel have affected the price of many small items in new-home construction. “We don’t specifically put steel in the house other than steel lintels to hold up brick over windows and any openings in masonry,” Mandola says. “But then we’ve also got steel cables, and we’ve got rebar in our foundation, we’ve got garage doors made out of metal, and all that stuff has gone up in price.” Shaun Lin, product development manager at Thor Kitchen, adds that steel and aluminum tariffs have impacted prices in the home appliance industry as well.

Quartz surfaces imported from China have been hit especially hard, owing to an anti-dumping investigation in progress. Until the Department of Commerce (DOC) and the International Trade Commission make their final determination later this year, the DOC has assigned preliminary dumping margins of up to 341% on Chinese quartz products, currently collected as deposits on quartz imports, according to a DOC fact sheet. Altogether, anti-dumping margin deposits and other active tariffs have added up to 500% to the price of Chinese quartz surfaces over the past few years.

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Supply, Demand, and Competition

Since the height of tariff worries in 2017, some building materials prices have begun to stabilize. As of June 2018, both lumber and OSB have steeply dropped in price. Lumber prices fell by 43% from June to December 2018, moving to just under $350 per 1,000 board feet, while OSB prices fell 52%, to just under $250 per 1,000 square feet, according to Random Lengths. Nevertheless, these drops are relative; prices are still 10% to 12% higher than the previous record, which was set in 1997.

The same is starting to occur in the global steel market. “Steel prices have a downward bias in the United States, Europe, and Asia,” says John Anton, director of pricing and purchasing at IHS Markit, a data provider based in London. “Demand is not providing support and prices in mid-2018 were above equilibrium. Steel is moving from a seller’s market to a buyer’s market; most products should hit their floor in the first half of 2019.”

Ed Hudson, director of market research at Home Innovation Research Labs, attributes these softening prices not to any changes in the impact of tariffs, but to a drop in demand for new housing. As the prices of land, labor, and materials rose, the cumulative cost led to an increase in new-home prices. This, in turn, led to slowing home sales, new-home starts, and material sales.

Manufacturing Costs

The price of manufactured goods and building materials is dependent on market conditions as well as production and distribution costs. To keep up with these costs, manufacturers will periodically announce increases in the prices of their products.

In September, Mitsubishi Electric Trane HVAC US announced a price increase of up to 3.5% on a number of its products, due to “continued inflationary pressures, as well as increased manufacturing costs.” One month later, Generation Lighting announced a price increase averaging 6% across many of its lighting brands. Generation directly attributed the increase to the 10% tariff on Chinese goods, as well as “continued cost increases on raw materials and other expenses,” according to Matt Vollmer, Generation’s chief sales officer.

In January of this year, Carrier announced a price increase of up to 7% on its residential HVAC systems and accessories, starting in March. “The price increase reflects the current economic conditions, and the predicted conditions for the year,” says Kris Nielsen, associated director of branding and communication at Carrier. “We continue to see material expense increases in commodities, transportation, and other related costs of doing business.”

In some cases, according to the NAHB’s Logan, market volatility can lead manufacturers to announce price increases in anticipation of increased costs. “The volatility hurts the builders in terms of planning and increasing uncertainty,” Logan says. “But, it has also led to pre-emptive price increase announcements from suppliers and producers of those inputs, in particular gypsum, drywall, and wallboard. Over the past couple of years ... we’ve seen three to four, depending on the supplier, announce increases during that period. If you look into the earnings’ code, that’s to cover increased costs on their part.”

Raising Home Prices

If the cost of building a home suddenly skyrockets, increasing the sales price to offset the rise is a simple cause-and-effect approach, but depending on the product affected, that may not always be possible.

For builders that are active across a wide range of price points, increasing the cost of a higher-priced move-up home by a few thousand dollars will not price out customers in the way that the same increase would on an entry-level home, as it did for Neal Communities’ cottage product.

“As a percentage of the total sales price, the price increase will have less impact,” says Trendmaker’s Mandola. “However, we haven’t found a buyer at any price that is OK with a price increase. Buyers get just as upset at the highest price points as they do at our lower price points. The biggest difference is the higher-priced home buyer can likely absorb the increase, while we may have priced-out a buyer at a more affordable level.”

Doug Fulton, CEO of Tempe, Ariz.–based Fulton Homes, has found in his experience that price increases at higher price points have little impact on purchasing decisions. He believes they may even lead to sales. “Buyers typically have an idea of what they want out of a home and are willing to spend a few more dollars to get it,” Fulton says. “[Increases] typically encourage them to make a decision about what kind of home they want. It actually spurs sales and affirms the buyers in the pipeline.”

Material Escalation Clauses

Some builders and contractors mitigate price risk with material escalation clauses in new-home purchase contracts. These allow for the purchase price of a home to be adjusted if the cost of a certain material rises over a set amount during construction.

Fulton Homes does not make use of these clauses. The private builder delivered nearly 700 homes in 2018 and expects to deliver 1,000 homes in 2019. Its prices range from the $200,000s to the $730,000s. “Once we agree to a price, we hold it for [the customer],” Fulton says of his company’s position. “So when prices go up, we just make less money on a home.”

Like Fulton, Trendmaker Homes also doesn’t employ escalation clauses. The company specializes in move-up home construction, with some “villa” product aimed at empty nesters. It plans to deliver about 500 homes this year, with an average selling price in the high $400,000s to low $500,000s.

“[We] haven’t felt the need to have that clause, partially because we build a lot of spec homes, where we can adjust prices as construction progresses,” Mandola explains. “I think if a builder can institute the clause, enforce it, and still have a satisfied buyer—more power to them; however, I have not asked other builders about that part of their contracts.”

Because of the lack of an escalation clause in Trendmaker’s home contracts, homes that are already sold are the most vulnerable to materials price increases because there is no way to change the home’s price once the deal is closed, Mandola says. For homes built on spec, Trendmaker has some flexibility to raise the price, but that depends on the community’s type and price point, he adds.

As a member of the TRI Pointe Group, Trendmaker is able to take advantage of its parent company’s national agreements with major manufacturers to lock in price protections for a given period of time. This allows them more time to react to market movements.

However, as Mandola notes, this is not an advantage many smaller builders have. “Even though we’re a smaller builder here in our market, we’re able to leverage our larger footprint nationally. So as our CEO Doug Bauer says, it’s the best of big and small. We get to act big on that level, but then we get to react as a smaller builder and act quickly in our marketplace.”

Fulton notes that another solution some builders use to protect themselves from unexpected price increases is phase-building larger communities, or breaking them down into smaller sets of homes, each one with different price offers from different contractors. If a contractor needs to raise the price of his or her services in order to cover materials costs, he or she can renew their bid on the next phase, according to Fulton, and price their services accordingly.

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Alternative Suppliers and Materials

Sometimes, the easiest solution to a product pricing issue, especially one related to tariffs, is to find a different source that can give a price closer to the builder’s expectations. When Trendmaker executives hear that a price increase may be coming, the first thing purchasing staffers do is start to look for alternate sources, whether it’s a new supplier or a more cost-effective material, and respecify a given material if that option is available.

Builders can choose to source materials from countries not covered by tariffs, or from within the U.S. This has rung especially true in lumber sourcing, where builders have turned to U.S.-grown lumber over Canadian wood for some, but not all, framing applications.

“[The tariffs] made U.S.-grown lumber, in some areas, a little more attractive,” says Hudson. “For floors and for roof trusses, southern yellow pine has always been popular. But what’s happening now is we’re starting to see more southern yellow pine make its way into walls as a substitute.”

Neither Hudson nor Emrath have observed any pivot from lumber to other materials, such as steel or concrete. Employing a new building method requires a lot of time and training— effort that builders believe is more trouble than it’s worth to avoid a modest price increase.

“A switch from lumber to steel framing is not trivial,” Emrath says. “You don’t just put a steel stud every place you had a wood one. You have to re-engineer the entire home. And not everyone who’s an experienced framer with wood can immediately start working on steel.”

In other cases, builders are turning to alternative products to avoid high or volatile prices. For instance, tariffs on quartz may lead builders and contractors to alternate U.S.-made surface materials. Some quartz importers, in order to avoid the immense duties on Chinese quartz, have chosen to source from different countries, including Vietnam, India, Thailand, and Brazil, according to Jessica McNaughton, president of surfacing manufacturer CaraGreen. Other manufacturers are reformulating their surfacing to use glass as a starter rather than quartz, solely to skirt the tariff.

Because Trendmaker does not use quartz countertops as standard, the builder has been able to avoid those tariffs in particular. “Where we get more stuck is when we’ve got stuff that we’ve created as an included feature,” Mandola says. “That’s where it hits us a little harder. If it’s an upgrade, then the home buyer is willing to pay, and we just adjust our prices in our studio, for example, to pass on that cost.”

Planning for the Unknown

While signs point to declining materials prices for the rest of 2019, much uncertainty remains. However, Mandola is optimistic about his firm’s ability to adjust its strategies to continue to meet market demand.

“If we see a price increase coming, we’re going to react accordingly in how we can offset that cost through either renegotiating, respecifying the materials, or repricing the home, and we’re going to continue to have that same tack as we go forward,” Mandola says. “Here in the Houston market, we’re able to adjust pretty quick. We’re not mandated to build through specific planning and zoning municipalities [where] you’re locked into your product and it’s much more difficult to change. We can reintroduce new product or go back through and value enhance in order to refeature and in some cases redesign some areas of the home to make it more cost-effective.” These include a review and redesign of Trendmaker’s foundation and framing plans, squaring up to avoid offsets on the home’s perimeter, and monthly planning discussions at trade council meetings.

Meanwhile, Fulton’s priority is to keep production active and sales prices at levels that consumers can meet. “If the sales stop, then work stops, too,” he says. “Sometimes you have to remind [builders] of this, that the building business is cyclical. It always has been, it always will be. So at what point in what part of the curve of the cycle do you want to be, and how fast do you want to get back to the top, to where housing becomes unaffordable to the majority of the consumers and then we start building fewer homes?”

Callahan expects that materials price increases will continue to ease as the issue of affordability takes center stage with builders in many markets. New-home sales are down across the country, he says, and eroding affordability will exacerbate the decline. “We are entering the next housing cycle, and builders will be less and less able to pass these increases on,” he adds. “Builders will more and more look for alternative materials, suppliers, and installers.”

This story was originally published in Builder.