The Challenges of Building More Homes
Here’s something we’ve talked about before on this channel. When it comes to home construction, one of the things that people talk about with the housing market is just building a bunch more houses—that’ll solve the housing shortage, reduce rents, and lower prices of houses that you could buy. Well, in theory, that sounds great, but in reality, the houses are not being built fast enough. Here’s an article from Housing Wire about why we won’t build millions of new homes, and as a licensed general contractor, we know why—because the permit process and the approval process are still very, very difficult, and there’s still some uncertainty in the market.

The Permit Process and Market Challenges
You might say, “Well, gee, the prices are high on housing prices, you should be able to build a house and make a profit.” That’s assuming you can sell it. If the housing market has high prices but not a lot of people are buying, you could build all the houses you want, but if no one’s going to buy them at that high price, you could be stuck. People are still hesitating on buying houses because interest rates are still stubbornly high. They have come down a little bit from their highest levels, but they’re still kind of up there, and people are not realizing the increased income it would take to buy a house.

Rising Costs and Labor Shortages
At the same time, builders are stuck with higher construction costs. Materials prices went up with inflation—they really didn’t go back down. Labor costs are much higher, and finding quality subcontractors, tradespeople, and workers is still very, very difficult. So even if you want to build a home, you have to find enough trade people. The quality might not be as good as you normally would expect, which means you have to go back in after the fact and fix things, which costs more money. That also doesn’t take into account the fact that if the approvals and permits take a long time to get from your government planning board, you’re going to be sitting on the carrying costs of that property for a long time. Then you have to count on the fact that the house is getting sold.

Profit Margins for Builders
We looked at some closing statements for some recent transactions that a builder had done. They built a house—a new home, reasonably priced. This was in an area of the Southeast. They sold the house for about $460,000, and we looked at the settlement statement. After they paid all their subcontractors, their building loan payback, and the land block, they walked away with net proceeds of about $30,000, which is a little bit less than 10%. Now, the builder may have made more money—they may have taken out some money during the construction process—but in reality, that’s probably about right. If you build a new home, you may do a net profit of about $30,000 on a $460,000 house.

The Time and Effort Behind Each Project
Now, you might say, “That’s good, you made $30,000,” but think about it—the process of constructing that home probably took about a year. By the time you subdivided the land, got the permits, did the site work, did the grading, poured the foundation, framed, roofed, installed mechanicals, and completed all other steps, it was a long process. Then you have your sales commission, which was included. The sales commission on a $460,000 house is going to be about $25,000 that you pay to the real estate agents. So at the end of the day, you made $30,000 running that project for a year.

The Pressure on Builders
Now, they probably built two or three houses in a year. But if you’re a builder and you want to make $200,000 or $300,000 a year, you have to construct, complete, and sell eight to ten houses a year—that’s almost one a month. And you also have to make sure you’re not going to get stuck with any houses. If one of the houses you build is tough to sell because maybe the floor plan you picked out isn’t good or the lot isn’t as desirable, you could get stuck with it.

Renovation as an Alternative
So the market is kind of stuck. What are people doing about this? Well, some homeowners are deciding not to buy a new house because it’s tough to find one. So what are they doing? They’re renovating. They don’t want to risk the frozen housing market. If you have a home that you live in, like the area, and are familiar with the location, but the house itself doesn’t work, many people are now renovating because they say it would be too hard to purchase anything else.

The Costs of Moving vs. Renovating
If they sold their house, they would have to pay a 5% or 6% commission. They would also need to buy a new house, get all new furnishings, and move. A $500,000 house with a 6% commission is $30,000. Moving might cost $5,000. New window treatments and landscaping could be another $5,000. Other expenses, like new appliances, could add up. By the time you’re done, you could have $50,000 in relocation costs just from one house to another. So why not spend $100,000 and just redo the house you’re in—maybe add on square footage, renovate something?

Why Builders Favor Renovations
More and more people are choosing to renovate, and builders like it because it’s an easier project. The builder might still make $20,000 to $30,000 in profit on that same project without having to come out of pocket as much for land, commissions, and other costs. So it’s kind of a win-win. More homeowners and builders are looking at the renovation process. It requires fewer permits, does not add any capacity for the town’s infrastructure, and doesn’t require new sewer, water, or electrical work since it’s already there. It’s also easier to get approved than a new home in many areas.

Impact on Housing Supply
It also doesn’t change your taxes as much. Your real estate taxes are based on the home value. Sure, when you renovate and add to your home, your home value increases, and your taxes might get reassessed. But when you buy a new house, you’re jumping to a whole new tax base, which could be difficult. The only downside to renovation versus building a new house is that it doesn’t add any new housing stock. The housing market doesn’t gain more homes for sale or more move-up houses for first-time buyers.

Housing Shortages and Market Impact
You’re going to find that the housing market is not adding new housing units fast enough to keep up with growing demand. Many estimates say there’s about five million houses too few for the current need in the market. That means lots of people are living doubled up as roommates. Many people are living in long-term hotels and motels, which is not good. We need more housing units freed up at the single-family home level. That way, people can move out of apartments, renters can move into homes, and those stuck in motels or homeless situations can move into apartments as availability increases and prices stabilize.