PerryChase – Thanks for your comments but I have to disagree with them. SDRealtor has a better handle on what’s involved in building a house.
I have been subidviding and selling land to builders for 30 years. I see their proformas and know how much they earn.
Builders make a lot LESS than you think. Booking profit is done through large volume and quick turnover in dollars, not high margins. Building is an extremely competitive business and builders keep one another in line in their efforts to bring buyers into their subdivisions.
$ 100 per foot for a new home (cost) is high. With the economies of scale, you can build a very nice tract home for $ 80-$ 85 per foot in today’s market (upper end and possibly more for less expensive homes — at basically the same spec level, a larger tract built home can oftentimes be cheaper per foot than a smaller one).
A custom or spec built home is a whole different analysis and in some areas can be as much as $ 300 per foot, depending on the level of spec. The cost to remodel a home can easily reach $ 400 per foot, depending on the improvments (my brother is a contractor and just finished an addition on a home on a flat lot that was $ 425 per foot because the home was older, demolition cost and matching of materials was difficult, etc.)
In the old days the rule of thumb for merchant builders was 1/3 for the land (finished lots, ready to go vertical), 1/3 for construction and 1/3 for overhead and profit.
Those ratios disappeared at the start of the last boom as land prices began to soar, in part due to the fact that entitlement processing took longer and longer because of the massive increases in environmental restrictions. (The last land deal I did took 15 years to bring to market – long lead times add to higher home prices because of the huge processing and holding costs of land).
Today, land can be as much as 50% of the cost of the new home (and higher with single built spec homes), and if construction is as much as 40%, it doesn’t leave a whole lot for the builder for profit and overhead. Again, merchant homebuilding is very risky because of long lead times.
An actual case in point from a recent transaction I participated in: Land $ 500,000 for a finished lot (all costs and fees); Construction $ 82 per foot (including financing), with the average size home being 3,800 SF. Projected sales price (homes are still being built and will hit the market in late fall): $ 900,000. Gross profit margin to the builder before taxes: 9.8%
The above analysis is fairly typical in today’s market. And margins are falling as prices are falling and the market is softening. At the height of the building craze on this last go around I saw margins as high as 20%, but those builders had bought the land years ago and entitled it themselves (they did not purchase “retail” lots).
But to say prices across the board will fall far below replacement cost, just doesn’t sit square with me. Again, the entire construction and building industry would disappear and we would be in deep caa caa. We better pray it doesn’t get to that.
So, although retail pricing may reflect $ 200 -$ 300 per foot or more, depending on the market area (my current home in Carmel Valley was purchased new at $ 308 per foot (with about $ 150,000 in builder upgrades) in 2003 and was recently appraised at $ 588 per foot, but I also put in about $ 300,000 in landscaping and other improvements. Will my home fall to a value of $ 294 per foot (50% drop) to a resale value of just under $ 1 Million?
I seriously doubt it. Again, I just don’t see prices falling across the board to a level that is far below replacemnet cost. There would be no incentive to build anymore and then existing housing stock would start to increase in value until an equilibrium was reached in pricing that caused builders to come back into the market.
Quite frankly, I am amazed at some of the predictions made on this forum. Just because someone says it doesn’t mean it is so. As I have said time and time again, nobody knows what is going to happen and the best we can do is simply observe, without emotion, the trends and then follow them.
Additional comment:
Daniel – Thanks for your perspective but again, long lead times are what keep land prices and indirectly, home prices high.
One recent deal I did went down as follows: Land Cost in 1988 dollars – $ 1.2 million; Processing Costs $ 5.3 Million (including carry). Sales price to give investors a reasonable return on capital: $ 30 Million. Time to bring to market (start home construction): 18 years.
There was tremendous risk in this deal and we didn’t get our approvals until 2003 (so for 15 years we didn’t even know if we would recapture our $ 6.5 Million, let alone make any profit). For nine years I negotiated with the Resource Agencies and almost got my land turned into a park. For that kind of risk, you want a decent return or you will move into other kinds of investments (which I have now done. It’s just way to risky at this point in the game to subdivide land in California, especially San Diego).
Again, long lead times (in California anyway) just kills you. In Texas you can get entitlements in some areas in 90 days. By the way, San Diego is one of the most environmentally restricted areas to build in the nation. We have huge bio-diversity here due to the climate and extremely aggressive environmental agencies and laws. Only Kauai Hawaii is worse as far as I know.
Believe me, these things keep land prices and indirectly building cost artificially high. The stuff you see going up now, especially in master planned communities, was designed and planned in the early 80’s and in some cases took twenty years to bring to market. Land prices are holding up remarkably well and I don’t expect to see any dramatic adjustments anytime soon. Most land guys I know would rather hold through a downturn than sell out at a hugely reduced price.
