Cost of Construction

[New Guy]

Being involved on the financial end of construction, specifically the insurance end, I have seen first hand how high costs have driven the extremely high cost of construction we see today.

All of my clients saw their insurance costs triple from the late 90’s to about 2004. However, relief is here. Since about 2004 to now, insurance costs are down roughly 50%. There are obviously a multitude of other factors that contributed to increased construction costs but I will focus on insurance costs because that is what I know.

In the early 2000’s, subcontractors had no choice but to raise their prices to homebuilders as their costs skyrocketed. As construction costs went up, builders began passing homebuyers the bill and charged more for homes (again I am oversimplifying). The increased cost per square foot spilled over to existing homes and in part fueled the increase in price.

However, given these cost reductions and the overall psycology of the homebuilding/construction business, I expect construction costs to decrease substantially over the next few years. My clients are very nervous about the state of the market. There is certainly less work today than there was a few years ago. As competition increases for less and less business, they will reduce their prices and prices of homes will come down. At least, I hope.

[lindismith]

Are you referring to Workman’s Comp?

[Bugs]

Some of the price increases are construction costs, but much of the increases are in the land costs and profit margins. Typical site “value” at Bressi Ranch is in the $350,000 range right now, whereas it would have been less than $100,000 just a few years ago. The $250,000 increase represents 35% of the current price of a $700,000 unit over there right now, and the primary reason the site costs are so high is because the market would pay it.

[lindismith]

What are the typical profit margins in construction? I have asked this before, but no one could answer….

[New Guy]

Workers’ Comp. is the line of coverage that has experienced the largest declines. It is also the most expensive coverage that most subcontractors have. One particular client of mine paid $2MM last year for WC and this year is paying $1.2MM!

Most other lines of coverage are flat with the exception of catastophe lines (i.e. earthquake, flood, etc.) due to the effects of Katrina.

I expect General Liability costs to come down for subs in the coming years as legislation that went into effect 1/1/06 has improved their vulnerability for construction defect claims.

[lindismith]

Bugs, can you elaborate on your post? I have often wondered how the land is valued? When you say the market, do you mean what developers will pay? And by extension, what consumers pay for their homes?
How is this data tracked? Who keeps the records?
When a development fills up, and there is no more land, how do they keep valuing it?

We have touched on some of this before, but I’m just now putting it all together – I seem to remember a post about Warren Buffet saying something about his multi-million dollar home in Laguna wasn’t really worth the multi-millions, that it was really the land….

On a related note to construction costs – my office manager just told me her husband who is a supervisor at a construction remodeling company is experiencing the slowdown. Their biz is down 33% over last year, and they just laid off 2 supervisors. The owner pulled her husband aside, and told him if it comes down to it, he may be letting all of them (5 supervisors) go, but he’ll keep her husband. Her husband called some his suppliers to ask “what was going on.” They all told him it’s county-wide, but that “they expect it to pick up soon.”

[rankandfile]

How about professional liability/errors & omissions rates? Are they decreasing as well?

[powayseller]

lindi, what are those supervisors planning to do? Leave San Diego? What is happening to those supervisors can be multiplied by tens of thousands of people next year. When those people leave SD, the stores they frequented will have less business, and so the decline starts. Who said you don’t need a recession to see home prices drop? All you need is home prices to stay flat, so MEW stops, and our construction dependent economy starts the lay offs.

The land costs are a large component of the house price. In our case, land value was 1/3 of sale price at time of sale.

workers comp is a huge cost, 30% of labor pay. So if the well driller charges $100/hr, then $30/hr of that is workers comp. This rate was quoted to me by every sub that I asked. This is why illegals are so much cheaper: subtract FICA, Medicare, and workers comp, and for half the pay they still end up with the same wages.

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