Home Builders Caught in a Profit Squeeze

Like makers of cars, machine tools and soft drinks, home builders haven't had much luck passing on cost increases to consumers.

Lumber, still the primary material used to build new homes, is almost twice as expensive now as it was at the beginning of the decade.

Spurred by low interest rates and federal policies that encourage homeownership, a record number of Americans are buying homes. But buyers in the first quarter were paying only 7% more for new homes than in 1994, according to the U.S. Census Bureau's constant-quality price index. That amounts to a 3% annual price increase.

"In a low-inflationary environment, (builders) don't feel they have much leverage for raising prices," said Stanley F. Duobinis, director of forecasting at the National Association of Home Builders.

Competition in the highly fragmented building industry also holds prices in check, Mr. Duobinis said.

Even the largest builders-publicly traded companies like Ryland Group of Columbia, Md., and Toll Brothers - control only 10% to 12% of their regional markets and fear that if they raise prices, smaller builders will lure away homebuyers with lower prices or more options, he said.

As builder profits erode, construction loans become riskier, said Lawrence E. Helm, vice president and manager of construction lending at Charter One Financial, Cleveland.

Under pressure to hold its own in the fragmented lending business, Charter One doesn't feel it can tighten credit, Mr. Helm said. Competition is forcing the company "to do more lending to get market share," he said.

Meanwhile, slow price appreciation in both the new and existing home markets keeps homeowners from trading up, further dampening increases in new home prices. About 70% of new homes are sold to people who already own homes.

Given the bulge in the number of baby boomers in their late 40s, home builders had expected a surge of trade-up and second home buying. But, Mr. Duobinis said, they now believe that in keeping with past patterns-late marriages and postponed child rearing-boomers won't aid the trade-up market until more enter their 50s.

Builders also fret that the new tax rules that exempt up to $500,000 in home price gains from taxes will further hurt the trade-up market.

Over the years the trend toward bigger and more elaborate homes has boosted profits in home building.

The median home in 1984 was 1,640 square feet. Last year it was almost 2,000 square feet.

The extra space shows up in the form of a bigger and better-equipped kitchen, a family room, a media room, and a formal dining room. Two bathrooms are de rigueur.

The National Association of Home Builders estimates that since 1984 about a fifth of the price of a new home has gone toward overhead and profits. Profits have been a shrinking part of that pie-about 9% currently, the trade group says.

The group expects building to remain strong over the next year and home prices to increase about 5%.

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