Dirt Is Expensive
Sitting around waiting for housing bubbles to burst and to finally be able to afford a place to live in your city of choice? Don't hold your breath, says contractor Gregory Sullivan. He explains why the cost of desirable real estate isn't plummeting anytime soon.
September 25, 2007 - 3:24 am
ARCHITECT, n. One who drafts a plan of your house, and plans a draft of your money. -Ambrose Bierce
There was a housing bubble. That’s bad, right? Pretty soon most of us will be living in a tent in Potter’s Field and Dorothea Lange will be taking our picture. Well, one man’s meat is another man’s poison. All you procrastinators ought to be able to buy a house now for a song, am I right? Wrong.
Houses are still fabulously expensive. The laws of supply and demand seem to be taking a vacation if you’re looking for a fixer-upper. Why does it cost so much to buy a house?
The short answer is: because it costs a bundle to build a house on a plot of land anywhere you’d care to live. And even though the stock of existing houses always dwarfs the supply of new houses, it’s the cost of building a new one that keeps the cost of buying an old one high. Who can we blame? It must be those evil developers.
I’m not sure whether “evil developers” is all one word, or hyphenated. But I do know that I rarely see or hear the word “developer” alone anymore. Well, I was one of those evil developers myself, so let me tell you why your house costs so much.
First, let’s examine the home buyer’s situation. Let’s say you work for Apple Computer. Everybody loves them. They’re not evil. What’s their profit margin? According to Computerworld, the iPhone had a gross profit margin of 56% on each device. Spiffy. Apple’s dropped the price some recently, but the cost of components is dropping too; and they get a piece of the action from AT&T, so let’s go with it. A 50% gross profit margin is not unusual in the software business, either. Apple likes whatever you do for them, and pays you a pile to afford to go out and get an evil developer to build you a house. What’s his profit margin?
Let’s open our Means Residential Square Foot Costs for 2007. If the general contractor builds you a 2000 square foot house, of average quality from simple standard plans, he’s gong to charge you $85.40 per square foot. That’s $171,000. His cut of that, for overhead, plans, and profit, is $12.39 per square foot. That’s $25,000, or less than 15% Gross Profit Margin. Remember, everything from his spiffy pickup truck to his cell phone is coming out of that before he sees a dime. You can modify the square foot price by where you live; Means lists location factors for major metro areas. The cheapest place I can find is Clarksdale, Mississippi at 66% of the average, The most expensive is New York City, at 134 % of the average. How hard it is to work, and how hard up for work the contractors are, makes a difference. There are no parking meters or unions in Clarksdale, I imagine.
How many houses would a general contractor need to build every year to make a living and cover his overhead at $25,000 each? If he was one guy with a bunch of subcontractors on speed dial, (like I was) and built a house every 3 months, (hard to do) he’d be poor. The actual net profit for the General contractor might be just 3 to 5%. And that’s if the weather cooperates, and nothing gets stolen, and he didn’t add wrong in the estimates. And for his trouble he has a very large exposure to risk, especially if he does anything on speculation. And you have no pity for him. He’s evil, remember? If you build a bigger house, the cost per square foot goes down, as long as the extra space is just a door, a few windows, a big plastery space and some carpet and not an in-home theater. He has to supervise more, it takes longer, but his dollars per square foot goes down. He charges you extra for every little thing you add, and you hate him for it, but he’s not getting rich. You could always save the $25,000 and be your own general contractor. How hard could it be? Yes, you could quit your job making twice what the general contractor makes and do it twice as slowly as he does. Ahem. The concrete’s here. Perhaps you should have dug a hole first.
You may have noticed that you can’t buy a house for $171,000 where you are. That’s just the cost of the house, and not an elaborate one, either. The dirt it sits on is fabulously expensive now, too. When I was a young man here in Massachusetts, the ratio a bank or mortgage company would figure for land to building was about 25% land to 75% building. But over time, the land started getting harder to find and permit, and by the eighties it was more likely to be 33% land. What’s the land under your house worth right now?
Who can we ask? Something called the Finance and Economics Discussion Series at the Divisions of Research and Statistics and Monetary Affairs of the Federal Reserve Board tracked such things in “The Price of Residential Land In Large US Cities” Here’s the punch line:
So where I live in the Northeast, in 1984, 38% of the value of a house was the land it was on. It’s gone up until in 2004 it’s 64% Using my own house as an example, a little work on Zillow, using the Means estimators, and checking the local real estate listings, I come up with about 52% land cost, which is not far off the national average. Look at the West Coast: 74% of the cost of your house is tied up in the land it’s on. And that’s an average for the region; in San Francisco, for instance, it was a whopping 88.5%.
New England was an anachronism for a long time. The most common method for home building was small-scale general contractors building one, or at most a few, homes at a time, with very few being for speculation. The rest of the country saw the rise of the corporate builder; companies like Pulte and Centex and Toll Brothers, who would develop hundreds, then thousands of homes at a time. Along came regulation. Conservation Committees. Open Space Land Banks. Wetland set-asides. Zoning went from filling out a form and identifying your project as Industrial, Commercial, or Residential , to a process that makes selecting Supreme Court Justices look straightforward. Endangered species got first dibs, even if they were just snails. After a while, the NIMBYs (not in my back yard) got the upper hand by hamstringing the development of lots, and eventually the BANANAS (build absolutely nothing anywhere near anything) pushed the process to its logical conclusion. Only someone with very deep pockets, a lot of time, and a lot of lawyers could afford to get permits to build things anywhere many people live. Big corporate builders could maybe outlast even the most hardened BANANAS if they had enough lawyering, or maybe by buying political influence if need be, and in many places they are the only ones left in the game now. And a corporation, whether it’s Apple or Toll Brothers, exists to get every dime it can. The houses become an afterthought. Can you get your hands on the land, and get a building permit is the only question. That’s the reason people buy a perfectly good house and tear it down to build another, flashier one now. The land under it is too valuable to leave beneath a two bedroom ranch, and the lot it’s on has already run the rapids of regulation.
So back to the chart, the cost of the structure doesn’t vary all that much by region, but land costs where you want to live matter a great deal. What causes the scarcity that drives that price? You’re very enthusiastic about living where you want to live, it appears. Look at the premium you pay to play Musical Condominium Chairs in a place like San Francisco, for instance, instead of buying a county in northern Maine with the same money. It’s very, very difficult to build anything — or tear anything down, for that matter — and San Francisco isn’t getting any bigger, especially when “anti-sprawl” legislation gets going. There is a scarcity, driving up the price, and it’s very real. So you mutter obscenities under your breath and you write a check with the same number of digits as your new phone number for a house. But there’s a risk.
The price of constructing a house goes up most every year, but modestly, really. The population goes up, too, so there won’t be any empty houses when all the grandmas shuffle off. Steady as she goes, so far. But if you’re paying up to 90% of the value of your house for its location, you better be sure that someone’s going to want to live there in the future; and just as badly — preferably worse– than you do. That means you are relying above all on local, state, and to a lesser extent, the federal governments, as well as your fickle neighbors, plus people who like to chain themselves to a fence and chant outside a construction site, to safeguard the value of your home, and the continued local availability of the livelihood that supports it.
Good luck with that.
Gregory Sullivan is a licensed Construction Supervisor in the State of Massachusetts. He makes furniture at: www.sippicancottagefurniture.com, and blogs at www.sippicancottage.blogspot.com