Friday, March 17, 2017

New Homes are Bigger and More Expensive

For the first time in years the average size of a new home actually dropped last year. According to the National Association of Home Builders, NAHB last year's median home size was 2392 square feet down from a peak of just over 2465. This in stark contrast to the median of just over 2000 SF at the turn of the millennium and 1400 SF in the early 1970s.

The development costs have gotten so high that builders truly struggle to make a profit on floor plans that have less than 2000 square feet. Most people are unaware of the cost of developing a lot.

Let's say a developer buys a plot of say 20 acres and decides to make a residential subdivision. There are many fees and studies required to get approval for the subdivision. There are also substantial costs to get connected to services. There are essentially two broad classes of expenses, General development costs and individual lot costs.

The broad costs are things like, cost to divide, traffic impact studies, infrastructure, environmental studies and mitigation, etc. The individual expenses are electrical, water and sewer connections, other utilities, lot prep and excavation, etc.

These are costs that have skyrocketed over the last few decades as state and local entrenched un-elected bureaucrats wield a mighty pen. This has been a big part of the upward trend in home size. Builders are trying to recoup all of the development costs by building bigger and more expensive homes.

Most people are unaware of just how much money is sucked into the bureaucracy. Don't get me wrong, there are many legitimate concerns, 'we the people' should have about how land is developed, but it the heavy hand of government is a bit out of control at the moment. I am not a land developer so for the purpose of this article I am using broad strokes and general estimates based on my experiences and research. Different markets and conditions lead to a great many variables, but the following represents a good idea of how it works.

Let's say that 20 acre parcel sold for $1,250,000. The developer would spend somewhere around $750,000 to get the subdivision through the system. This includes the endless parade of traffic and environmental studies, water runoff studies and appropriate mitigation, etc. Now the builder could have small 100 lots or 50 large lots. But the large lot will only net the builder maybe at best $10,000 more on price and maybe he could build bigger more expensive homes on the larger lots. So why have a subdivision with 50, $500,000 homes when she can have 100 $350,000 homes? The difference is an extra $10,000 in gross revenue for the development. More lots helps to spread out the costs to reduce the overall impact of the broad development costs on each individual lot.

Next the developer will have to build the public infrastructure. Yes my friends the developer pays to put in infrastructure that is then deeded back to the local government agency. There's another $1,000,000. So now we have 100 lots at a cost of $2,000,000 or $30,000 per lot. The developer has to get the individual lot expenses in line as permits to build, are needed, utility connections and such. A city sewer connection alone is somewhere in the neighborhood of $7000-$15000 depending on the local area. By the time it is all said and done, that little postage stamp lot has a cost of around $70,000-$80,000. The developer will sell the lots to a builder at a 8-10% profit so now the lot is around say $85,000 To build a very basic style of house with modest grade materials, two story, 1800 squares will run about $100 per foot. That means the raw costs to build in this scenario are upwards of $265,000. The builder will  need to make a 8-10% profit so that modest home hits the market at $290,000. If the home is built with nicer amenities and materials such as slab granite counters, solid wood cabinets, high grade flooring, fiber cement siding, etc. the build costs jumps quickly into the $150 per foot range. Now that 1800 SF luxury home is coming in at $390,000.

Developers take on a great deal of risk for what ends up being a modest 8-9% profit. Done right real estate developers can succeed and prosper, but the landscape is littered with development failures. If we want to create a market for new homes that our future generations can afford, perhaps the first spot to look is the bureaucracy.

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