As a Builder, I am extremely interested in the current debate about the home building and mortgage finance industry. One comment I have heard repeatedly over the past several weeks is the need to return to "sound mortgage standards" based on home values of 2.5 to 3 times income, 30 year fixed rate mortgages at 80% loan-to-value and a 20% down payment. But just how realistic is this?
According to the U. S. Department of Housing and Urban Development, the median household income in the U.S. in 2007 was $59,000. If we return to sound mortgage standards, median home values would have to be $147,500 (2.5x) to $177,000 (3x).
So under "sound mortgage standards," a household earning the median income would have to save $29,500 (2.5x) to $35,400 (3x) - 50% to 58.5% of their annual household income - for their down payment before they could purchase a home. Is this realistic? I did an informal poll of mortgage lenders and found that, home buyers with down payments of 20% or more accounted for approximately 30% of the purchase transactions over the past 12 months and approximately 70% of home buyers purchased their homes with less than 20% down.
According to the U.S. Census Bureau, the median home price in the U.S. is $231,000, so median home prices would have to drop 37% to 48%. Is this realistic? Even those homeowners who purchased their homes using "sound mortgage standards" would owe more than their home is worth.
According to the NAHB / Wells Fargo Housing Opportunity Index, which tracks the sale prices of homes sold in 223 metropolitan statistical areas, there were actually 77 markets in the U.S. where the median home price is less than $147,500 and 107 markets where the median house price is less than $177,000 in the 1st Quarter of 2008. Those include 23 MSA's in Texas, 13 in Ohio, 12 in Michigan, 11 in Florida, 10 in New York, 7 in Illinois, 7 Pennsylvania, 5 in North Carolina, 4 in South Carolina, 4 in Indiana, 4 in Tennessee, 3 in Georgia, 3 in Arizona, 3 in Oklahoma, 3 in Massachusetts, 2 in Maryland, 1 in West Virginia, 1 in Colorado, 1 in Kansas, 1 in Montana, 1 in Wisconsin, 1 in Washington, 1 in New Jersey, and 1 in Minnesota. And if you want to stay in Idaho, you can move to Pocatello. Of course, there's no guarantee that the median home price in these markets won't rise as more people move there in search of homes with sales prices low enough to allow them to qualify for mortgage under sound mortgage standards.
The Housing Opportunity Index is based on the sales prices of all homes sold in the MSA which includes both existing and new homes. Considering the data on existing and new home sales in the U.S. in the 1st Quarter of 2008, it is probably safe to assume that most of the homes sold were existing homes.
As a Builder, I would love to be able to build and sell new homes for under $148,000. But is that realistic?
According to the National Association of Home Builders Economics Department Construction Cost Survey, the average new home built in the U.S. in 2007 was 3,340 sq.ft, was built on an 11,968 sq.ft. lot, and had a total sales price of $454,906. At 11,968 sq.ft., that equals a finished lot cost of $9.31 per sq.ft. The finished lot cost was $111,452 and accounted for 24.50% of the Sales Price. The cost of the raw land accounted for 40.8% of the finished lot cost and the development cost accounted for the other 59.2%.
Construction cost was $$218,810 or $65.50 per square foot and accounted for 48.1% of the Sales Price. Labor cost is typically about 20% of the Sales Price or 40% of the Construction Cost so in the average home, the labor cost would be approximately $90,981 which is actually 41.6% of the Construction Cost. According to the U.S. Department of Labor Bureau of Labor Statistics May 2007 National Occupational Employment and Wage Estimates, the median hourly wage for construction occupations was $17.57 plus 21% for payroll taxes and insurance equals $21.25 per hour. So dividing the labor cost by the hourly cost, the number of man hours required to build the average house was approximately 4,000.
The cost of construction financing marketing (2.4%), sales commissions and marketing costs (6.8%), overhead and general expenses (7%), and the builder's profit (11.2%) account for the remaining 27.4%.
According to the U. S. Department of Housing and Urban Development, the median household income in Idaho in 2007 was $51,500. If we return to sound mortgage standards, median home values would have to be $128,750 (2.5x) to $154,500 (3x). If I use the same percentages as the average new home built in the U.S. in 2007 for finished lot cost, I would need to be able to purchase the finished lots for $31,544. The raw land cost at 40.8% would be $12,870 per lot. Assuming a density of 4 dwelling units per acre, the raw land cost would need to be around $51,500 per acre. Is that realistic? Possibly.
In the Boise City - Nampa MSA, finished lot costs start at about $6.50 per sq.ft. Using this cost per sq.ft., the lot size would be approximately 4,850 sq.ft. Is this realistic? There are developments in the area with 4,500 - 5,000 sq.ft. lots, but these will need to become the norm.
However, there are other factors that need to be considered. The cost of materials used in land development, like steel, concrete, pvc pipe, and asphalt continues to increase. As fuel costs continue to increase, so does the cost to operate the equipment used in the construction. Fees also continue to increase as does the time required to obtain the necessary approvals. This added time equates to additional costs. So as development cost increase, something else will have to decrease in order to maintain a finished lot cost of $31,544. Is this realistic? Will land owners be willing to accept less per acre for their raw land? Can the lot size be decreased even more and the density increased?
If I use the same percentages as the average new home built in the U.S. in 2007 for construction cost, my construction cost at 48.1% of the Sales Price would need to be $61,929 and 41.6% of the construction cost or $25,750 would be labor cost. According to the Idaho Department of Labor 2007 Occupational Employment and Wage Report, the median hourly wage for construction trades workers in the Boise City - Nampa MSA $13.85 plus 21% for payroll taxes and insurance equals $16.75 per hour. So dividing the labor cost by the hourly cost, I would have to build the house in 1,010 man hours. Is that realistic? Not very.
Let's look at it another way. Idaho's hourly labor cost at $16.75 per hour is $4.50 or 21% less than the national cost of $21.25. We'll assume material costs are about the same. Adjusting the average per square foot construction cost figure for the difference in the labor cost would give us a per square foot cost of $59.78 ($65.50 x 41.6% x 21% = $5.72 / $65.50 - $5.72 = $59.78). Dividing the construction cost of $61,929 by $59.78 per square foot, the homes I build would be just over 1,036 sq.ft. Is this realistic? How many households do you know who would want to live in a 1,036 sq.ft. home?
In conclusion, how realistic would it be to return to "sound mortgage standards" based on home values of 2.5 to 3 times income, 30 year fixed rate mortgages at 80% loan-to-value and a 20% down payment? Not very. Doing so would certainly change the home building industry which historically accounts for 10% to 15% of the gross domestic product of the U.S. We would build fewer new homes and the ones we do build would be much smaller homes on much smaller lots. And home buyers would certainly have to adjust their expectations.
Maybe I should start building apartments
Chuck Miller GMB CGB MIRM CMP MCSP CSP
President / Builder - Chuck Miller Construction Inc.