Can the housing industry survive by only catering to the wealthy?

In the short-term, it appears the housing industry is aiming at the wealthy. Can this work in the long run?

It’s possible to get rich if your business only caters to rich people. But it’s hard to have a massive and really successful industry in the United States today if you only cater to rich people. There are only so many people in the country with good credit and lots of cash sitting around. And this week, we got evidence that one of America’s largest industries may be running into trouble because its products appeal only to the upper crust. I’m not talking about jewelry or apparel. I’m talking about housing.

And yet the article goes on to provide little evidence that the housing industry will be in trouble if it continues on this path. The profit margins are higher. The big builders, like Toll Brothers highlighted in the story (as they almost always are when there is a story about luxury housing), and the big investors who swooped in during the housing crisis are doing fine. There are not that many smaller builders left. A loss in building volume would probably mean some job losses in real estate, construction, banking, and other related services. But, perhaps the housing industry in the future is leaner and aimed at the upper end?

As I mentioned in Friday’s post, if markets work as they are said to work, there are plenty of opportunities here for businesses to jump in. Newer technologies can lead to cheaper housing units and lower construction costs. There is a huge need for affordable housing so there shouldn’t be a shortage of demand (even if it may be difficult to find sites where neighbors aren’t opposed to it). Doesn’t someone want to grind out profits at a lower margin? The question moving down the road is whether the housing industry will react in such a way or not. There is no guarantee that it will.

NAR economist: “major housing shortage” in the US

The chief economist for the National Association of Realtors suggests there is a major housing shortage:

“A major housing shortage exists in this country,” Yun said in a statement. “It is therefore disappointing to witness in March the continued lackluster performance in new-home building, which was the second lowest activity over the past six months. Home prices have risen by 41 percent and rents have climbed 17 percent over the past five years at a time when the typical worker wage has grown by only 11 percent. To relieve housing costs, there simply needs to be more homes built.”

My first thought on this reading this: builders and developers are still skittish from the 2000s housing bubble. Instead of risking overextending themselves, compared to the past they are now focusing on more expensive homes or rental properties. Oddly though, I have seen little media coverage regarding builders and developers. They may be a secretive bunch generally but why isn’t there more scrutiny of their actions and motivations?

My second thought: if there is indeed a housing shortage, what does this say about the state of the economy? A booming construction sector is often related to a good economy. It doesn’t necessarily have to be this way in the future, particularly if there is a shift away from sprawl and homeownership of detached single-family homes, even if it was true in the post-World War II era.

Finally, who might be held responsible if there is indeed a housing shortage? It is hard to rally potential homebuyers into a cohesive group. Is there a way to prod politicians and business leaders to act and if so, could their actions even effect much change?

Housing anxiety in America will lead to what kind of action?

A new poll suggests Americans are worried about housing:

According to a survey by the NHP Foundation, 75 percent of Americans are worried they could lose their homes, while 83 percent of respondents said that they were concerned about the rising costs of housing.

Some 30 percent of the respondents described themselves as “very concerned” that they or a close friend or relative could lose their housing, meaning that nearly one-third of Americans feels that a lack of affordable housing could represent a personal crisis. Another 27 percent described themselves as “concerned”—meaning more than half of respondents consider housing instability to be a looming danger.

Per the poll, about 40 percent of respondents say that they fear they could lose their homes due to job loss. This fear is not unfounded. Neil Gabler’s May cover story for The Atlantic cites Federal Reserve Board data that showed that almost half of U.S. households (47 percent) could not muster $400 in an emergency. A report by the Urban Institute shows that more than one-third of all American families (36 percent) have savings of less than $250. One-quarter of U.S. households have no savings at all…

The NHP Foundation finds that 80 percent of its respondents (1,000 Americans polled nationwide) say that they would welcome affordable housing in their communities. But affordable housing is rarely if ever posed to residents or voters as an up-or-down, yes-or-no question: “Would you like more affordable housing?” Sure, we all would. Except when it involves changes to the places where we live; then our neighbors flip out about it.

Perhaps builders will help with a shift toward constructing smaller homes. Or, as the quote above suggests, housing isn’t the primary issue: people anxiety about jobs which then affects housing.

Thinking longer term, I wonder what it would take to advance more drastic solutions to housing issues. Some possible turning points:

The homeownership rate continues to drop. Some might say this limits the American Dream while builders could note that this limits their profits and industry (which is also connected to jobs).

-Housing prices rise to where a larger segment of the market is paying substantially more than 30% of their income for housing. Even then, how exactly would this group turn their grievances into collective action?

-Another economic downturn leads to higher employment and more housing issues. Higher foreclosure and eviction rates could cause issues.

-A political candidate makes housing a major issue. As this article notes, no one is really talking about this.

-Could there be a major building or financial scandal that leads to reform?

I’m not sure any of these would lead to anything but temporary measures. Or, perhaps housing in the United States will simply slowly change: wealthier residents will be able to afford newer housing in better locations, people with fewer resources will have fewer and fewer options, homeownership will become less desirable, and all of this will be more clear in a few decades.

Recession decimated construction workforce

Here is another sign the construction industry has not fully recovered from the economic crisis: the number of construction workers is still low.

The new-construction housing market is slowly recovering from the turmoil of the recessionary years, but builders haven’t been able to pick up where they left off. More than 2 million skilled labor jobs were lost to the economy, and many of those workers are gone forever…

Nearly 30 percent of the construction workforce disappeared during the Great Recession, reports FMI Corp., a Raleigh, N.C., provider of management consulting, research and investment banking to the construction industry. Among its ranks are plumbers, electricians, roofers, bricklayers and carpenters.

The shortage seems to be worsening. According to FMI’s 2015 “Talent Development in the Construction Industry” survey, 86 percent of respondents reported shortages of skilled labor. That’s up from the 2013 survey, in which 53 percent of respondents reported such shortages.

It may take a long time before the housing industry approaches where it was in the early to mid-2000s. In the meantime, those workers have to do something and/or go elsewhere. Even with all the political talk about helping workers, I don’t remember anyone suggesting plans for helping construction workers in the same way that politicians have discussed manufacturing workers.

Additionally, I wonder what it takes to ramp up with a lot of new workers if the housing industry starts booming again. Businesses today tend to shed workers when times are bad, add when the economy picks up, and disregard training and upstart costs. However, it is not always simple to just hire large numbers of laborers.

Calculator suggests developers can profit and build affordable housing

The Inclusionary Calculator suggests developers can typically make 10% profits and build 12-15% affordable housing at the same time:

It can feel like a mantra among private developers: Requirements by municipal governments to include affordable units in market-rate housing developments make those developments unprofitable, even unfeasible. It may be one of the most frequently repeated claims about housing in general. Can it possibly be right?

The Inclusionary Calculator is an effort to settle this question—and to prove that one major assumption about affordable housing is a myth. Developed by the Cornerstone Partnership, the tool allows users to simulate the balance sheets for market-rate developments for any number of scenarios. It accounts for factors such as costs of production, financing, affordability set-asides, and parking requirements…

“In almost every case, we could target a 10 percent profit for the developer and still leave at least 12 to 15 percent of the units to be affordable,” McCarthy says…

So, not only does inclusionary zoning not raise the costs of market-rate construction beyond reason, it also does not raise the price of market-rate units for homeowners. It eats away at developer profits. That makes affordable housing a moral question, not a feasibility issue: Do leaders dare to challenge developers on their profit margins?

The Inclusionary Calculator is available here after watching a training video and registering.

This poses a fascinating question in the housing industry (as well as for other sectors of the American economy): just how much profit is enough? Very few people outside the housing industry would have any idea how much money developers and others make on the construction and sale of housing units. Perhaps the process is deliberately opaque or perhaps it is simply complicated. But, I wonder how the public in many communities would respond if they knew that 10% profits were generally possible while also providing affordable housing.

Of course, this is just one hurdle in the construction of affordable housing. Not allowing developers to claim that they can’t make money would help the process but in many communities, neighbors would still complain. A NIMBY response often takes over; who lives in affordable housing? What does this signal to outsiders? Won’t this lower our property values?

New homes shrink 40 sq ft; industry not sure what it means

The median size of new American homes shrunk during the second quarter – but barely:

Of the 206,000 homes that went under construction in the second quarter, the median size was 2,479 square feet, according to Commerce Department data released Tuesday. That was 40 square feet smaller—or about the size of a walk-in closet—than the high set in the first quarter.

What exactly this means is unclear.

Entry-level buyers tend to purchase smaller homes. In recent years, many younger people who otherwise would buy a home have opted to rent due to stringent mortgage-qualification standards, relatively sluggish job and wage growth, mounting student debt and preferences for living near city centers, where land and homes are more pricey…

Several economists and builders foresee a gradual leveling off or decline of the median size of newly built homes. Builders such as D.R. Horton Inc., KB Home, Meritage Homes Corp., PulteGroup Inc. and Century Communities Inc. have reported early signs of first-time buyers returning to the housing market in the past year…

David Crowe, chief economist for the National Association of Home Builders, foresees a “moderation” of the median size of newly built homes as more first-time buyers come into the market. But he added that it will take a long time for the shift to be reflected in the national median-size figure, because the factors buoying first-time buyers—a loosening of mortgage-qualification standards and growth in jobs and wages—are progressing slowly…

“If anything, we’re seeing people trying to get into the largest home they can afford,” said Marcie DePlaza, a division president at GL Homes, a Florida builder that anticipates selling 1,000 homes this year at prices ranging from about $200,000 to $2 million. “With interest rates as low as they are, people can push to buy the biggest [home] in the group” that they are considering.

In other words, the data could be taken as pointing in multiple directions. A number of builders and others are at least preparing themselves for the possibility that more Americans, particularly entry-level buyers, want smaller homes. Yet, the big homes make a lot of money and wealthier buyers are a known quantity.

In situations like this, I imagine the housing industry would try to hedge its bets both ways. Playing it conservatively might work better in the long run though it might mean that some opportunities are lost. Some of these trends – such as Americans eventually wanting smaller homes – have been discussed for decades. Still, it takes time for some of these factors to work themselves out such as the behavior of younger homebuyers or the overall state of the economy or whether homeownership is promoted by politicians.

Rising development costs in American cities

It is getting more and more expensive to build new developments in American cities:

Land costs in the urban cores have dramatically escalated, making it difficult for developers to find developable parcels that pencil. Adding to the issue of expensive land prices, in December 2014, the Wall Street Journal reported that construction costs are rising faster than the inflation rate: the U.S. Labor Department’s consumer price index had risen only 1.3 percent above the previous year, while the construction index was higher by 5.2 percent.

Land is scarce and expensive

In most major U.S. urban markets, the cost of land has risen aggressively, in line with the greater demand for urban living by millennials and empty nesters. In Los Angeles, for example, land for industrial developments—many of which are changing from industrial use to residential mixed-use—have averaged approximately $23 per sq. ft. at the beginning of 2014 and  by year‘s end, asking prices were as high as $32 per sq. ft. There has been and continues to be keen competition for every developable site, with the urban core expanding into previously blighted areas.

Current shortage of construction professionals and skilled labor

Construction employment was disproportionately affected by the recession. As a result, many construction professionals—both labor and management—left the industry. Across the country, there are 1.4 million fewer people employed in construction than there were at the peak in 2007, according to the U.S. Bureau of Labor Statistics. Many in the construction industry who lost their jobs during the recession have found new careers, and many skilled tradesmen left the industry all together. Compounding the shortage is the lack of high-quality training available to young people entering the construction workforce today…

Materials costs have little impact

Countering some of the rise in construction costs is the fact that most materials costs, apart from glass, have not greatly increased. Associated Builders and Contractors Inc. reported in April 2015 that, although concrete products prices are up 4.1 percent on a yearly basis, total input prices have fallen by 3.6 percent since the same time last year. For example, iron and steel prices are down 11.5 percent and softwood lumber prices are 7.4 percent lower than one year ago. Current crude petroleum prices are down 55 percent and crude energy materials prices are down by 43.7 percent from the same time last year.

If this is the case, this could have negative consequences in a number of areas including: it might take more to get the construction industry going to overcome these costs; this limits the incentives for developers to construct cheaper or affordable housing (such as starter homes); and only the really wealthy can purchase and utilize urban land.