In recent months, President Trump implemented several new tariffs spanning a whole suite of consumer and hard goods. With these new tariffs, Trump is attempting to create domestic jobs by reducing the U.S.’s reliance on foreign trade partners such as China. While the premise of tariffs is to push the price of foreign goods higher and making domestic goods more attractive to consumers, Trump’s tariffs will likely have the opposite effect on residential real estate. This policy instead will likely result in baseline cost increases in home construction and remodeling. That’s a tough pill to swallow for home shoppers at a time when real estate prices are at an all-time high and homes are becoming less affordable for the average American.
What’s Being Taxed?
Canadian Wood: Canada has long been a significant exporter of softwood lumber to the U.S., particularly pine and spruce that is used for home framing. After the last lumber trade agreement expired in 20151, the U.S. and Canada went back to the table to renegotiate. Enter Trump’s new tariff in spring of 2017.
Chinese Products: In September of this year, the president announced more than $200 billion of tariffs on Chinese goods, spanning more than 6,000 different items. Many of the items (463) are common in new home construction or remodeling, including iron nails, flooring, granite, tiles, sinks, roofing, cement, paint, appliances, and more. Tariffs started at 10 percent with the potential to rise to 25 percent – a move that has been resurfaced several times by the administration.
Metals: In May of 2018, Trump imposed tariffs on imported steel (25 percent) and aluminum (10 percent) from Europe, Canada, and Mexico. The appliance sector is being hit twice in this instance: once from the tariffs from China and again for companies in the U.S. who manufacture them.
The Economics Behind Tariffs
Trump campaigned strongly on his ability to reduce the U.S.’s trade deficit and rework trade policies. Tariffs, in theory, are meant to keep domestic producers competitive with foreign competitors while helping to raise government revenue. Tariffs fell off significantly after WWII, and last year only accounted for 1 percent of federal revenue4. The White House isn’t forecasting a significant uptick in 2019, estimating that revenue to rise to $40.4 billion. While the government isn’t using tariffs to raise meaningful capital, the U.S. is able to be more competitive with foreign countries. However, prices are rising as a result.
The real impact of these tariffs on U.S. production is on the commodity materials used for end products, which could have meaningful cascading effects. While the U.S. could experience an increase in steel jobs domestically, it’s likely there will be a decline in jobs from all other industries that are dependent on steel due to the higher prices – construction as an example. Raising prices on imports won’t necessarily correct the trade imbalance, as the U.S. is not currently prepared to meet production needs. The timeline to build up production capacity is a long-term bet and it’s unlikely the tariffs will be in place to see that bet payoff.
The impact of tariffs is that if domestic production cannot make up 100 percent of supply required, the prices for the product will increase up to the level of the tariff. In the case of steel, China is a large enough producer that the commodity price combined with the tariff has created a new market price. This is something taught in economics 101 courses, where an increase in the marginal cost of a product in a competitive market will result in a price increase.
Steel manufacturing in the U.S. is about 80 million tons a year, down from the peak of more than 100 million ten years ago5, while global production is 1.7 billion metric tons, according to Worldsteel6. While it may be easy to revert to Trump’s campaign promise to bring manufacturing jobs back to the U.S., the Competitive Enterprise Institute found that steel and aluminum tariffs would only raise costs for domestic companies and hurt jobs. George W. Bush’s steel tariffs in 2002 cost nearly 200,00 jobs and $4 billion in lost wages before they were withdrawn in 20037. News of Trump’s steel tariffs haven’t encouraged manufacturing so far: The Wall Street Journal found in June that “…employment in each of America’s top 10 steel cities has grown slower than the rate of growth for the U.S. as a whole8.”
The wood industry has already seen a significant rise in costs. Canada is one of the largest supplies of lumber. Around 33 percent of the lumber used in the United States in 2016 was imported, with more than 95 percent coming from Canada, according to the U.S. National Association of Homebuilders9. Since the tariff went into effect in 2017, the cost of 1,000 board feet of Canadian lumber was up nearly 80 percent from June 2017 to June 2018, according to data from Random Lengths10. While the tariff is meant to even the playing field for U.S. producers, the costs end up landing on builders, who are already battling rising wages. The National Association of Home Builders estimated the lumber tariff has pushed the cost of an average home up by $9,00011. Builders absorb some of those material and labor costs, but the rest are usually passed on to home buyers.
The impact on the steel and aluminum tariffs have wider reaching implications, for instance, the price of oil. Steel is a crucial component in oil production, and Timothy Dove, CEO of Pioneer Natural Resource, expects a 20 to 25 percent increase in the cost of products that use oil because of the steel tariffs12. Aside from the economic trust that is tied closely to the oil prices, oil is used in a significant amount of home-related goods, such as paint, roofing, flooring, furniture, insulation, appliances, and more. All in all, oil impacts about 10 percent of home construction costs, including transportation of products. Fluctuation in oil prices could add another 3 percent to the overall price of a home.
The Impact of Tariffs on Residential Real Estate
Home affordability continues to be an issue across the country. The median sales price for new homes sold in October 2018 was $309,70013. Given that the average American earns about $62,000 a year14, and assuming a 20 percent down payment, the average American can afford a home valued at approximately $278,000 to keep within the recommended 30 percent threshold of income used for housing-related expenses. There’s already a $50,000 disconnect between what the median homes are selling for and what people can afford, and the potential impact from the added costs of tariffs has the potential to be quite negative for new construction home buyers in 2019.
Since tariffs impact the materials required for nearly every phase of home construction, the increase in baseline costs can rise quickly. Based on a review of Economic Input-Output data15, 16 percent of the cost to build a home is impacted by tariffs. A 20 percent tariff would increase the cost of a home by 3.2 percent. With a median home sale price in October of 309,70016, a 3.2% increase in the cost of a home would add about $10,000 just to the initial cost of the median-priced home. With increased home size or upgraded finishes, home buyers should expect costs to grow in accordance.
Another factor to consider is the looming end to the historically-low mortgage interest rates in recent years, which could compound these costs. Assuming putting 20 percent down on a home will cost an additional $2,000, this adds another $7,000 in interest payments over the life of the loan (assuming 30-year at 4.5%), bringing the cost of the tariff to $17,000 over the lifetime of the loan. As many experts don’t expect rates to stay below 5 percent in 201917, this 10 to 15 percent increase in costs can only be magnified as rates rise. Looking back a year to when rates were at 4 percent, the lifetime cost of a loan of the median-priced home was $550,000. Changes put in place by the tariffs and the current tax plan could increase the total cost of a $327,000, and could result in an increase of $162,000 in total costs with a one percent increase in mortgage rates.
These costs expand beyond new home construction and into the remodeling space as well. When homes have become unaffordable in the past, homeowners have made the choice to remodel their existing home as opposed to buying a new home. However, the 16 percent cost added to new homes also applies to remodeling and repairs to existing homes. The home remodeling and repair market is $324 billion a year, based on the Leading Indicator of Remodeling Activity from Harvard’s Joint Center for Housing Studies18. While the projected growth is expected to soften in 2019, the LIRA predicts spending will reach a high of 7.7 percent before drifting down to 6.6 percent by Q3 201919. Homeowners with plans to remodel should expect a similar increase in costs to new construction home buyers, 3 percent on average, but some projects, like flooring for example, could swing as a high as 15 percent.
Looking Forward
These tariffs have a wide enough reach to impact all aspects of residential real estate, not just for those looking to remodel, build a home, or buy a new construction home. For example, should the China tariffs expand to more categories, it’s possible they could have much wider impacts. The appliance market is worth $24 billion20, and adding a 10 percent tariffs would mean $2.4 billion in costs that would need to be paid by someone. That someone would most likely be the consumer who purchases the appliance.
Builders should adjust their pricing to address the potential volatility and provide transparency on the timeline of their quotes to homeowners given it is unclear as how long these tariffs will be in place. Potential home buyers and current homeowners alike need to be aware of how these rising costs can impact their budget going into 2019. While the common rule of thumb is that homeowners should set aside 1 percent of their home’s value toward home repair, given the unknown state of the market and cost of goods, it may be prudent to set aside more in 2019 to account for pricing changes.