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[Solid Masonry] Are Builders About To Become Deconstructed? Because The Numbers Don’t Seem To Add Up

John Philip Mason is a residential appraiser with 20 years experience and covers the Hudson Valley region of New York. He’s a good friend and a true professional who provides unique insight to appraisal issues of the day. Here is his weekly post called Solid Masonry. This week John addresses the profit squeeze for builders. Jonathan Miller

During the past several months I’ve noticed a growing trend when out in the field appraising new residential construction. In speaking with long-time builders I keep getting asked the same question, “What’s happening to home prices?” Upon further inquiry I’m finding more and more builders who are convinced the numbers no longer add up. That is, after they figure in the current cost of acquiring building lots, plus their projected hard and soft costs, there is little or no profit left. Experienced builders are left wondering what to do despite the mounting evidence that tells them it’s time to lay low.

Their numbers and instincts seem to correspond with numerous statistics being cited in the media lately. Increasing prices in land, building materials, labor, energy, insurance and the cost of construction funding are massing an assault on their livelihood. These are just a few of the many examples I found:

  1. Area Contractors Battle Rising Cost Of Materials [1] by Todd Pack and Naomi Snyder of Tennessean.com. Here the writers cite various figures such as “On the whole, construction material costs grew by 10% in 2004 and 6% last year, according to a new survey by the Associated General Contractors of America.”

  2. Costs Stifle Construction Boom Builders Brace For Rise In Material Prices, Interest Rates [2] by Rodney Tanaka of the WhittierDailyNews.com. While citing escalating construction costs, Mr. Tanaka attempts to provide reassuring rhetoric that in fact the new home construction market is healthy. But he concludes with some ominous predictions, including one by Leandro Tyberg who says, “My gut is telling me if construction costs continue to rise at the rate they have risen in the last 24 months, projects will die.”

  3. At the same time demand for new construction seems to have diminished greatly as large scale developers such as Toll Brothers released their latest numbers. The RealEstateJournal.com article Toll Brothers Posts 49% Jump In Net But Trims Forecast [3] by Janet Morrissey sounds positive enough. However, upon reading further we find “Orders, which serve as a barometer for revenue the company will receive when a home is delivered three or four quarters later, plunged 29% in the fiscal first quarter that ended Jan. 31.” Ouch!

  4. Meanwhile, the cost of short term borrowing (i.e. construction loans) is going nowhere but up. In his article, Get Ready For No. 15 In A Series At The Fed [4], Mr. Louis Uchitelle of the NYTimes.com seems to think the new Federal Reserve Board has something to prove with more rate increases waiting in the wings. He writes, “They all really want to project a sense of continuity with Greenspan,” said Tom Schlesinger, executive director of the Financial Markets Center, “and they are going to err on the side of cautiousness if that is what it takes to do this.”

At the same time we are left looking around and asking ourselves, just how much new construction inventory is available? I’ve done an informal survey by searching three different MLS systems covering the suburbs directly north of New York City. The straight answer is, more than half the communities currently have 12-24 months of new construction inventory, based on their rates of absorption in 2005. Not too bad, but wait a minute, absorption rates are down in 2006.

The combined impact of these market forces is certain to leave some builders over extended with inventory worth less than they paid for it.

So if builders can’t recoup their expenses, are they about to become deconstructed? Because the numbers don’t seem to add up.