Construction market: home values and construction costs out of whack
When buying a new house costs way more than the money it required to be built, problems arise across the construction sector and related fields.
BuildZoom published a new national study called "Paying for Dirt: Where have home values detached from construction costs," which analyzes the detachment between the value of a home and the cost to build it in key U.S. cities.
The study estimated the average home value to replacement cost ratio for the largest U.S. metro areas and related measures, mapped by zipcode within each city. It found in coastal metros, new home construction can be almost four times the cost of rebuilding existing structures. Competition among developers is what maintains the tether between the average metro-area home price and the cost of its construction.
It matters because construction costs influence developers' decisions about whether and what to build, determining how the housing supply — and home prices — evolve. Profit-seeking developers don't build homes with construction costs exceeding expected sales value, resulting in less new construction in metros that has an average home value below the average replacement cost. Portland didn't make it into the top 10 highest average land value per home by zip code (it was all California and New York, where average home values exceed $3 million), but the study found zoning restrictions are preventing builders from supplying the market with more homes that buyers want.
In California, where restrictive land use policies have contributed to driving up housing prices, the average land value per home was $931,000 in San Jose. Houston is known for its freer zoning policies and had an average of $133,000.
The study found the high cost of housing in expensive in coastal metros isn't driven by construction costs, but rather by the high cost of land, which reflects a scarcity of zoned units (not of land) — for Portland, that means inside the urban growth boundary that preserves the natural forest, for one, and other recent policies that have come into play since the post-Recession building boom: inclusionary zoning, the residential infill project and the design overlay zone assessment project will probably have effects on the market.
Issi Romem, chief economist with BuildZoom, explained it to the Business Tribune.
"The estimated home value to replacement cost ratio (so not the difference but the disparity, measured as a multiple) is slightly lower in metro Portland than in metro Seattle, and it is much lower than in the coastal California metros and in the New York and Washington, D.C. metros," Romem told the Tribune. "It is roughly similar to metro Philadelphia, California's Inland Empire (east of L.A.) and Denver — and really Seattle, too. It is a good deal higher than places like metro Charlotte and Dallas, and much higher than places like metro Cleveland or Detroit."
The Portland-Vancouver-Hillsboro area is rated 15th in home value to replacement cost ratio by this study, which is topped by San Jose-Sunnyvale-Santa Clara, Calif. and concluded with Buffalo-Cheektowaga-Niagara Falls, New York.
As for average home value, the Portland area is twelfth, beneath some pretty impressive names: San Jose, San Francisco, urban Honolulu, Long Beach, San Diego, New York, Cambridge, Seattle, Washington D.C., Sacramento and Denver.
Romem said when an area has a high home value to replacement cost ratio, it suggests there is an unmet demand for living in the area: if enough homes were built in the city to reduce the home values to close to construction costs, they wouldn't go empty.
Metro Portland today has about 2.4 million people.
"Suppose — I'm just going to make up some numbers — that Portland kept building more and more homes until everybody wanting to live there and willing to pay at least 1.2 times the replacement cost had already moved there. At that point, housing prices would have fallen to 1.2 times the replacement cost and there would be more people living in Portland, let's say 4 million," Romem said. "The 1.5 million people who want to live in Portland in this made-up example, but who are only willing (and/or able) to pay somewhere between the made-up 1.2 times and real 1.66 times replacement costs, those 1.5 million people comprise what I am calling 'demand not being met,' and in a sense they are being excluded from metro Portland."
In this way, the home value to replacement cost ratio is a rough measure of unmet demand — or people being excluded.
"It is a function of how many people want to live in the area, what they are willing pay, and what housing is available," Romem said. "Metro Portland's location suggests that its "unmet demand" is more modest than in those metros ranking higher, and vice versa with respect to the rest."
In replacement costs, Portland measured up 16th. In improvement value, Portland ranked 15th. In average land value per home, Portland ranked 11th
"Portland is rather typical in terms of the age structure of its housing stock, which drives the depreciation in my estimates," Romem said. "That average land values and average home values rank similarly, 11th and 12th, means that in addition to a rather typical age structure, Portland is also not extreme in terms of its home value to replacement cost ratio — land values and the difference between home value and replacement cost are closely related."
And then there's upzoning: "Upzoning will spark a great many debates pitting NIMBY versus YIMBY and growth advocate versus preservationist," Romem said. (That's those not-in-my-neighborhood types who are silent about undesirable neighborhood functions moving in, whether it be industrial or density, until it's proposed in their 'hood.)
"If done on sufficient scale, upzoning will dampen housing price appreciation. Of course, that begs the question what is sufficient scale, which is closely related to the question how much do you want to dampen housing price appreciation," Romem said. "Odds are — and this is my cynical guess — that whatever scale of upzoning Portland achieves will be insufficient to maintain housing prices stable, or even growing at the average national pace. No North American city has succeeded in doing that since WWII, except through sprawl — which I am not condoning."
The problem is upzoning will allow more people to live in metro Portland, which will slightly reduce population growth in the south side. Upzoning will also make traffic and congestion worse in the short- to medium-term.
"In the long run, investments in infrastructure could improve things (and self-driving cars will re-shuffle how many things work), but that will come at a cost, and is generally easier to do ahead of urban expansion rather than retroactively," Romem said. "Congestion is unwelcome by those already in Portland, but the question is whether the benefit from accommodating more people (and businesses) — including the benefit to those who would otherwise be excluded from Portland — is worth the congestion cost."
The disparity between the appearance of homes and their price tags is more than a home buyer's gripe: it is a telltale indication of restricted housing supply. Restrictions governing land use, installed by incumbent residents or their predecessors, "are exclusionary by nature and amount to the gating of access to opportunity," the study concluded.
BuildZoom helps contractors connect with jobs by allowing users to submit projects, search licensed contractors, view remodeling history of properties and get competitive bids on projects. Its data and analysis department includes economic analysis, remodeling charts and statistics and permits filed by publicly traded companies.
Read the study here.
By Jules Rogers
Reporter, The Business Tribune
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