Shares of home builders have had a nice run since the election, driven by healthy profits and rising confidence. That sweet spot is likely over, and the shift will put a damper on the overall housing market.
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Home builders have benefited from stable costs and rising prices. Operating margins at 13 public builders tracked by research firm Zelman & Associates averaged 10% in the first quarter, well over the 8% median over the prior 25 years.
The sweet spot is under fire by rising costs, ironically emanating from Washington.
Lumber is the most visible driver of higher material costs. The Trump administration last month proposed a 20% tariff on Canadian lumber imports. The revival of the decades-old trade fight has pushed framing-lumber prices to their highest level in more than a decade.
That matters a lot to the bottom line: Analysts at Evercore ISI estimate that lumber account for 9% of builders' costs. And it isn't just lumber that is going up in price. Flooring manufacturer Mohawk Industries, for example said in its first-quarter earnings call last month that it has been raising prices across a broad array of products to offset rising costs.
Labor costs, too, are on the rise. The construction industry unemployment rate, at 6.3% last month, has fallen back to its levels during the housing boom. On Tuesday, the Labor Department reported that the quits rate -- the share of people leaving construction jobs voluntarily and a sign that they think they can get new jobs easily -- stood at 2.5% in March, the highest since early 2008.
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If anything, the official figures may understate how tight the market has become for an industry that has traditionally relied heavily on illegal immigrants. Pew Research estimates that Illegal immigrants account for about 13% of construction workers, and in some construction occupations their share is significantly higher. A quarter of brick and other masonry workers are working in the U.S. illegally, for example, Pew says.
Curtis Stevens, chief executive of construction material supplier Louisiana-Pacific, said on the company's first-quarter earnings call last week that home builders were complaining about "labor availability and quality, and the negative impact of aggressive enforcement of immigration."
At minimum, higher costs will cut profit margins, which will likely hit home builder shares. Higher mortgage rates may add to the pressure. The Federal Reserve will likely raise rates later this year and further drive up mortgage rates when it starts running off its pile of Treasurys and mortgage securities early next year.
The more important issue is how this pressure affects the housing market, which was one of the few bright spots in the first quarter. And since housing helps drive spending of everything from cars to couches, the risk is the economy may end up on a shakier foundation.
Write to Justin Lahart at email@example.com
(END) Dow Jones Newswires
May 09, 2017 13:26 ET (17:26 GMT)