Sticker shock: coping with commodity price volatility.(On Your Mind)

We think of custom building as a productive endeavor, and while that is true enough, production represents only half of the story. Custom building companies are also voracious consumers. Concrete, wood, copper, mechanical equipment, lighting fixtures, appliances, labor, every thing that goes into a house first gets bought from someone else. And if costs for major items rise rapidly or become unpredictable, custom builders have a problem. Well, custom builders have a problem. Increasing global competition for commodities, skyrocketing energy costs, and a long-running expansion of the construction sector at home have caused price volatility, cost increases, even shortages of basic materials like concrete.

"It seems like everything from labor to overhead to insurance costs to, certainly, materials have just skyrocketed," says Mason Hearn, a design/build custom builder in Manakin Sabot, Va. "Things are just costing more than a year or two ago." And the pace of increase seems to be accelerating. "As a salesperson, it's hard to even keep up. Thirteen, fourteen years ago, when we started out, these markets were more stable," says Hearn. Back then he could base his pricing at least in part on recent experience; now he costs every item from scratch with each job, doing his best to project increases that may occur between the bid and the purchase. "A lot of what we sell is our ability to design and estimate hand in hand, and it's becoming more difficult every day to keep up with that." Hearn's clients are having trouble too. Sticker shock is nothing new in this business, Hearn says, but when remodeling projects hit $250 a square foot, "There's a lot more pause. These bigger-ticket items become harder to sell."

And while clients may need to adjust their expectations of what they can afford, Hearn sees a force pulling them in the opposite direction. Spurred by the media's touting of super-luxury homes--what Hearn calls "house-and-garden pornography"--clients' expectations can easily outstrip their resources. "They want and expect so much more. A nice kitchen no longer means just four appliances; it means seven appliances. Of course it has a wine cooler, of course it has a separate icemaker, of course it has 9-foot-tall cabinets. These things are considered standard." With both costs and expectations rising, "There's a lot of frustration built into the market." In order to sell jobs in this environment, Hearn says, "You have to more wisely prep your clients for what is coming, rather than not set that expectation and have them fall out of their chair." Yes, their friends' kitchen remodel cost $100,000. "But did that include the $10,000 range? Did that include the $7,000, 48-inch Sub Zero refrigerator? And was it yesterday or 10 years ago? When we do a good job of setting the clients' expectations up front, we do a better job of selling." Still, Hearn says, his closing ratio is not what he would like it to be. "Sometimes the client may cut back, sometimes the client goes elsewhere, sometimes the client decides not to do the job."

Despite cost increases in his market, Craig Denman's clients are not walking away or cutting back. "People who decide to spend $3 million on their vacation home in Whitefish, Mont., really don't have a problem with finances," he says. "They say, 'There's nothing we can do about it, we want it, and we're willing to pay for it.'" But Denman, too, is struggling with price spikes. "The volatility is just incredible, across the board." he says, and that makes writing a contract a high-risk proposition. "Like most people, we're adding a clause to our contract saying that we can't guarantee it." But many clients have resisted. As an alternative. Denman has begun breaking jobs down into three sequential contracts covering concrete and foundation, framing and mechanical systems, and interior finishes, respectively. With this approach, he says. "The project ...