Home Builders’ Pricing Power Will Be Tested This Year
Gross margins will be flat to slightly down this year as builders have less wiggle room to pass on costs as mortgage rates increase.
Rising materials costs and increasing mortgage rates will test home builders’ pricing power this year, as affordability for entry-level and first-time buyers becomes increasingly out of reach.
A new report from Fitch Ratings expects demand to be strong throughout the first half of the year, allowing for small price increases on new builds, but says trends could soften in the second half of 2021. The firm expects gross margins for most of the builders it rates to be flat to slightly down this year, particularly as builders have less wiggle room to pass on costs as mortgage rates increase.
The US Bureau of Labor Statistics’ Producer Price Index (PPI) for construction materials has risen year-over-year every month since August, and Fitch analysts expect the trend to continue as demand remains strong and supply chain issues linger on the materials side.
Lumber has been particularly problematic for builders this year, as its price reached an all-time high of more than $1,000/board feet (bf) earlier this year. The National Association of Home Builders (NAHB) has estimated these rising costs add approximately $24,000 to the price of a new home and has joined a host of other industry groups to ask that the Biden Administration include the lumber supply chain in a COVID-19-relaed executive order relating to critical and essential goods.
New and existing home pricing will likely increase 1-3% this year, according to Fitch. That price appreciation, taken together with rising mortgage rates, could affect affordability for many buyers.
“If mortgage rates increase gradually and the economic recovery is strong, homebuyers should be able to adjust to the new environment,” Fitch researchers write in the report. “However, if mortgage rates spike meaningfully within a short period of time, there could be a temporary shock to the housing market, as in 2018, when mortgage rates increased from an average of 3.81% in September 2017 to 4.87% in November 2018.”
Fitch cited Freddie Mac data showing that the average 30-year fixed-rate mortgage rate rose to 3.17% on March 25 up from 2.67% at the end of 2020.