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February 3, 2006 at 12:17 PM #6356February 3, 2006 at 12:50 PM #23389
powayseller
ParticipantI’m not sure you’re correct about the reason the condo projects have stalled. They have stalled bec. the banks don’t want to finance them without knowing the builders can sell them, not because the construction cost exceeds the sales cost. Any time construction cost exceeds sales cost, it’s because the builder overpaid for the land.
The value of a house is cost of land plus cost of construction.
The runup in prices is due to a runup in the cost of land.
February 3, 2006 at 1:27 PM #23390teatsonabull
ParticipantYou are dead right, powayseller.
Check out what Buffett and Munger had to say about replacement costs at last May’s Berkshire Hathaway shareholder’s meeting: (It’s no typo..he did say $60 MILLION DOLLARS AN ACRE)
Buffett: “A lot of the psychological well being of the American public comes from how well they’ve done with their house over the years. If indeed there’s been a bubble, and it’s pricked at some point, the net effect on Berkshire might well be positive [because the company’s financial strength would allow it to buy real-estate-related businesses at bargain prices]….
“Certainly at the high end of the real estate market in some areas, you’ve seen extraordinary movement…. People go crazy in economics periodically, in all kinds of ways. Residential housing has different behavioral characteristics, simply because people live there. But when you get prices increasing faster than the underlying costs, sometimes there can be pretty serious consequences.”
Munger: “You have a real asset-price bubble in places like parts of California and the suburbs of Washington, D.C.”
Buffett: “I recently sold a house in Laguna for $3.5 million. It was on about 2,000 square feet of land, maybe a twentieth of an acre, and the house might cost about $500,000 if you wanted to replace it. So the land sold for something like $60 million an acre.”
Munger: “I know someone who lives next door to what you would actually call a fairly modest house that just sold for $17 million. There are some very extreme housing price bubbles going on.”
If this is the next bullshit mantra fronm the real estate industry about how prices won’t “go below replacement costs”….then once again they are doomed!! Why don’t some of them “come around” to the realization that they have been wrong!!! It’s okay to make mistakes….just admit them and try to mitigate the damage for your friends and customers…if you don’t…I know of a whole lot of nice houses that are gonna be for sale REAL CHEAP in Arizona that you can probably move to after you’re run out of town!!
February 3, 2006 at 2:56 PM #23391San Diego
ParticipantI want to differentiate between HIGHRISE and typical 3-4 story, wood and stucco projects. If I could offer $300,000 condos in a downtown HIGHRISE, I am fairly certain that I could sell every one of them in a very short amount of time. The reality is that I would need to sell them for about $650 psf ($650,000 for a 1,000 sf unit)to make a profit right now. It is true that the DEBT and EQUITY markets are not convinced that the pool of buyers at these levels is very deep and therefore, they have curbed some of their lending and investment.
In a HIGHRISE, the land component is an expensive but minor factor. Currently, a 240 unit, 30 story tower on 60,000 sf in downtown San Diego would cost nearly $200 million including financing costs, design, permits, etc. The land accounts for 10% to 15% of the cost of the project.
In a single family detached home, land costs are approaching 55% of the finished cost of the house.
February 4, 2006 at 11:58 AM #23400Blissful Ignoramus
ParticipantExactly. The replacement cost is basically a sunk cost in the case of these new condo projects. The seller has a choice: 1) Wait it out to get his price or 2) sell for whatever the market dictates. You can’t force the market to give you back what you put in, and with the exception of cases where the developments are being paid for in cash up front (yeah, right) the seller can only wait so long.
February 4, 2006 at 4:54 PM #23403ParticipantI am keeping my comments focused on HIGHRISE buildings in San Diego. In the case of HIGHRISE (Type I, steel and concrete)developments in the Marina District and near PetCo Park, there are sophisticated investment groups (with longer investment horizons) who are very aware of the replacement costs of steel and concrete buildings. They will recognize when the market for these units is at or near replacement costs and will be in a position to take advantage. Right now (February 2006), the replacement costs of these HIGHRISE buildings is somewhere between $550 and $650 psf). Construction costs continue to rise and the best sites are already either under construction or under the control of deep pocket developers who will wait to develop the sites so that range may continue to rise. These huge rises in construction costs will doom many of the planned HIGHRISE developments in the inferior locations and they will not be built this cycle thereby effectively controlling the supply.
The wood framed junk that is being slopped up is much more at risk. It could easily retrench back to the original proforma prices (high $200,00’s) that the developers imagined when they were first marketed to the public. That would represent about a 25% retrenchment (from high $300,000’s back to high $200,000’s).
February 6, 2006 at 9:34 AM #23405Bugs
ParticipantThe high-$200s for those inferior units would still provide the developers with their original profit margins. Those prices could go to the mid-$200s before those developers started to actually suffer a loss. I think the high rises are actually at risk of suffering even greater losses (percentagewise) because in terms of utility they will still be competing with the lower priced units. Too many units and not enough buyers at these prices.
February 6, 2006 at 7:45 PM #23408ParticipantSome of the costs probably will decline – some won’t. Developer profit margins will be the first to go, followed closely by contractor overhead margins, as the builders try to keep their machine intact. Land prices will hold on for a while because most of those sites already have an existing use to provide some cash flow in the interim. Hard costs will be the last to fall; and the fees, permits, financing costs, marketing costs, etc., will probably stay the same or possibly continue rising.
February 7, 2006 at 1:37 PM #23413Anonymous
GuestOne consideration not touched on in this string is the extent to which construction costs (not land costs) have been influenced by the bubble.
How difficult is it for you to find a contractor to make improvements on your home? What if you needed to find twenty of them to build a condo?
What do you think manufacturers of steel rebar, parquet, kitchen sinks et cetera have been doing over the past five years? Raising prices, that’s what. Because they can. Because when you’re going to make a million on condo flips you don’t quibble over the price of the sink.
February 8, 2006 at 8:57 AM #23422ParticipantYes, I wonder how much construction costs will decline as builders and subcontractors have to try to get work. Having just finished building a house in San Diego, I noticed several factors which affect prices:
1. Workers’ comp. Many subs told me they pay $33 for every $100 in wages. That is a 33% tax on wages! Crews with illegals don’t have that markup, but if they’re hard workers, they get paid about $25/hr anyway.
2. Competition. Although the contractors are busy and can leave you waiting for weeks to work on your job, so many people have entered this business, that the competition puts a damper on prices. OTOH, they all can charge more, because everyone is busy. Once, I called every backhoe operator in the Yellow Pages. Each did not call back, or said they were booked for 2 -3 weeks at least. The only guy I could find was someone who worked for a local utility, and did the work on the side, with a backhoe we had to rent.
3. Material costs. I’m not sure about this component. Perhaps someone else knows how much lumber, concrete, drywall, appliances etc. have gone up in the last few years. When we were in the Midwest last summer, in a city that had never heard of a housing bubble, we went to Home Depot and compared the price of some 2x4s, and a riding lawn mower to the prices at our SD Home Depot. The prices were the same. There is also a huge remodeling movement, so more high end stuff is desired for kitchens and flooring. So who buys a $50 sink when you can get the $600 stainless steel Franke. Who buys a $50 faucet when you can get the $475 Grohe pull-out LadyLux? Why get the $250 Costco dishwasher, when there is a super quiet Miele for $1600? Now they tell me that top-freezer refrigerators are “rental grade”. You’re supposed to spend at least $2000 for the bottom-drawer freezer, or get the side by side or built-ins for $5K. Perhaps the quality of components has improved. OTOH, granite is so popular now, it has come way down in price. It is no longer restricted to luxury homes. Consumers expect a higher grade of finishes and appliances. And the high end appliances are NOT made in China: they come from the good old U.S. and from Germany. (Perhaps they have manufacturing facilities in Asia?)
I was impressed with the professionalism of the contractors. I did see a pride in workmanship and concern for pleasing the customer.
So I think construction costs in CA are higher because of the 33% workers comp tax on wages, held down by all the competition and raised by the scarcity of workers, and raised by the more expensive materials people put into their homes.
February 14, 2006 at 8:40 PM #23438nhamlin
ParticipantI would like to respond to the comment about replacement costs. The reasoning sounds good on the surface and the cancellation of condo projects certainly will tend to reduce downward pressure on existing units.
I predict that the writer has not yet had a ring side seat at a real estate down turn. In the mid 90’s many apartment buildings in City Hts sold for under $15,000 per unit. Apartment buildings sold for less than 1/2 the cost of building the fees and permits to reproduce them!!!
During the 90’s I was told by several apartment developers (actually former developers) they could not make a project pencil if they were building on free land.
The building of San Diego like any other city occurs in stops and starts. Remember all the see through office buildings in the early 90’s followed by 10 years of no office building construction.
We have been on an incredible roll for the last six years or so. That is an extremely long time for a building boom but it does not mean that the business cycle or the real estate cycle have been repealed.
The free market system is working even with all of the government interference. Contractors have been making huge profits, their workers are well paid, and people are flocking to the business.
Workers are busy building housing for the people building housing, for the people building housing. Even so it is getting easier to find a contractor to do bid on your project. The cost of building materials is stabilizing as more and more production capacity is brought on line.
When housing slows down, Contractor profits will plummet; building material prices will plummet, and land prices will crash!! In the mid 90’s finished lots were selling for less than the replacement cost of the curbs, gutters, and sidewalks already installed.
I own a 20 unit apartment building with condo permits put on it by a former owner. As little as six months ago the phone was ringing off the hook from brokers wanting to bring me an offer. They no longer call. At one point those permits made the property worth a $40,000 per unit premium over a similar building without permits. That premium has disapeared. That building is worth $800,000 less than it was worth a year ago! How much have replacement costs dropped?
Norman Hamlin
[email protected]
619 692-9496February 15, 2006 at 1:51 PM #23439ParticipantThis thread was written in regards to new, FOR SALE, HIGHRISE Type 1 projects, not 40 year old, wood structure apartments.
“In the mid 90’s many apartment buildings in City Hts sold for under $15,000 per unit. Apartment buildings sold for less than 1/2 the cost of building the fees and permits to reproduce them!!!”
Please show me one comp that proves this. Lets look at the math:
Purchase Price $15,000 per unit
Down Payment: $1,500 per unit
Interest Rate: 10% ($1,350 interest per year)
Taxes @2%: $300 per year per unitIf the property was rentable (not condemned, burned down, flooded, etc.), an astute investor would only need to gross $152.50 per month per unit to get a 10% return on their investment, not including any depreciation. I didn’t factor vacancy or repairs but I know that rents were higher than $152.50 per month throughout the 1990’s.
As far as your current 20 unit apartment, your $800,000 “premium” disappeard because the condo conversion market is flooded. Assuming that the property is in rentable shape, I would imagine that any investor looking at your property would value it based on its current rents. Replacement costs have nothing to do with your unrealized “premium”.
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