by Kevin Schofield

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This weekend’s read is an essay by Brian Potter titled “What Makes Housing So Expensive?” In particular, it dives deeply into the costs of constructing a new single-family home and looks at where there might be opportunities to reduce costs.

He divides up costs into three broad buckets: the cost of the land; the “hard costs” associated with construction; and the “soft costs,” such as design, administration, financing, and marketing. The land is about 20% of the total costs; hard construction is 55%; and soft costs are about 25%.

Breaking out the hard construction costs reveals an important lesson about the way houses are built. The foundation and framing together account for about 30% of the cost, but the remainder is a large collection of small costs.

Further analysis shows that the hard costs are split about 50-50 between materials and labor. This makes it very difficult to identify places where savings can be found. What makes this even more difficult is the distributed way in which houses are built by a cohort of independent trade workers, each with their own specialty: General contractors oversee the process, but carpenters build the frame, plumbers do the piping, electricians do the wiring, and dozens of other specialists complete the roofing, flooring, HVAC, windows, painting, drywall, cabinets, countertops, and so on. Further, most of the materials they use are already mass-produced, so there is little opportunity to find savings in materials. 

Potter also points out that while this standard approach of dividing up and decentralizing the work across a large number of trade specialists can keep costs low while reducing overhead, it also severely limits the opportunities for innovation in homebuilding that might dramatically reduce the cost. New materials or construction techniques would probably require coordination across a set of workers who currently work independently, which would add time and money to the project and probably constrain the workers who can complete the work to those familiar with the new materials and methods. So in all, while the hard costs represent over half the cost of a new house, it is the part that’s hardest to improve because it would require fundamentally changing the established model for construction that is used today.

Potter also points to a couple of items that people have suggested are a culprit behind high home construction prices, such as financing and permit fees, but in truth represent tiny fractions of the overall cost. On financing, which averages only about 2% of the total cost, he also notes that while everyone seems to agree that it takes too long to build a house because of permits and regulatory hurdles, the extra time doesn’t seem to be adding significant cost. We would see that in the financing costs (because developers would have to borrow money for a longer period of time), but we don’t.

Soft costs as a whole are small, with the potential exception of the builder’s profit, which ranges between 5% and 10% of the total cost depending on the kind of house being built.

That leaves the cost of the land as the remaining component of the cost — and perhaps the most complicated. Home builders report that on average the cost of the land is about 20% of the total cost, though there are many caveats to that. First, that’s the cost for new construction: For existing houses that go on the market, more of the price is attributed to the land, in part because the house itself depreciates in value as it gets older. 

Second, land costs do vary widely, with the highest costs in the places where buildable land is the scarcest: dense urban areas (like Seattle) that are largely built out already. Potter suggests that there are two factors driving the value of land: the “hedonic” value that people get from using and enjoying the space, and the “permission slip” value from being able to build on it. And people tend not to value the hedonic portion highly, while most of the value is attributed to the “permission slip.” And the permission slip is often controlled by zoning: the local laws that control what kind of activities can happen on a piece of land as well as the buildings (type, size, and number) that can be built to support those activities. 

This is a particularly relevant conversation this year in Seattle, as our elected officials work on a major update to the City’s Comprehensive Plan that could potentially make significant modifications to residential zoning. The Washington State Legislature recently made their own changes, mandating that multifamily housing buildings up to at least four units are allowed on nearly all residential-zoned properties. Seattle may choose to loosen the limits further, either in specific neighborhoods or across the city. 

What Makes Housing So Expensive?

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📸 Featured image via Trong Nguyen/Shutterstock.com.

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