Wednesday, September 23, 2009

You Paid Too Much for Your House: Building Costs vs Purchase Price

Home Prices (retail) versus Actual Cost to Build the Home last 100 Years


You (probably) Paid Too Much for Your House: Building Costs vs Retail Purchase Price
“Success breeds a disregard of the possibility of failure.” - H. Minsky, Economist

From the web site http://doctorhousingbubble.com comes this graph tracking the following items for the last 100 years:

- Home Sale Prices: what people paid for their house (i.e. the retail price).
- Building Prices: cost of materials and labor to build a home or structure
- Population Growth in the USA (supply vs demand not always the factor you think it is)
- Interest Rates for home Mortgages

For me, this data is very telling.  I have been preaching for the last 15 years that U.S. housing prices are over valued. (See my earlier post on why I KNOW home prices are over often valued.  http://shantyworld.blogspot.com/2008_05_01_archive.html )

Let's look at few key data points this graph tells us about the last 100 years of housing costs:

1.  Housing prices, more or less, had some correlation to building costs until about 1943-ish. After the Great Depression and after the War, the US economy stabilizes, employment & the population increases, there's a minor spike in housing prices.  Notice, however, there is no  proportional correlation between building costs and actual home sale prices from 1945ish  through 1980.  With the exception of a few short-term blips, Housing Prices are somewhat flat between 1943 until 1977 (as a function of building costs) AND increasing population (i.e. demand).  Starting in 1982,  Building Costs appear to  actually trend DOWN until 2002, yet the selling price of Homes rises dramatically through 2008.  There is an irrational spike up in prices in 1998, while the cost of Building remains flat.  (So granite counters and stainless steel appliances et al, are NOT justification for an additional 25-50% in price.)

2.  Dropping Interest rates seem to serve as a catalyst for justifying housing price hikes.  Perhaps, this controlled "supply vs demand" is working to almost fix prices to favor the seller (and all who benefit from housing sales) -- and not the buyer.  Interest rate fluctuations mostly seem to affect the cost of building materials (probably to suppliers) -- but seems to have a deleterious affect on the sales price.  One can not even argue that demand increased as population increased because for most of the last 100 years, and until about 1955, prices remain proportional to population growth as a function of demand.  Between 1958 and 1978 prices remain flat, even while the population (and arguably demand) increases and interest rates rise (for the same period.)  But again, even increases in Buildings Costs have no proportional correlation to Housing sales prices (after 1945.).  In fact, starting about 1979-80, Building costs start to trend down, while the cost to buy a house spikes up dramatically until the 2008 financial meltdown.  Interest rates are at their highest levels between 1980 - 1990, while Building Costs are dropping, and the selling price of a house is rising (over the same period.)  

The Housing purchase price doubles between 1982 & 2008, while the cost to build has steadily trended down for most of the same period.

What's missing from this chart is real wage earning power for the middle class.  We know that during the last 30 years, wealth for the top 2% of Americans grew at astonishing rates, while real net worth and income for the middle class actually dropped. (See Document:
 ).

From The New Economist, "..the richest 1% hold one third of the total wealth in the economy.. Inequity rose sharply after 1979." [end of quote]  (i.e. the Reagan / GOP wealth transfer era.)

Again, ShantyWorld.com covers some of these topics in earlier posts, but I'll repeat a few key points because too few seem to grasp the inherent conflict of interest driving this false valuation of housing over the last 30 years:

a.  Developers, Contractors/Builders have a built-in incentive to sell housing (or any construction) for more than it is worth.  When property owners (buyers) don't have impartial 3rd party advocates (i.e. an architect, lawyer, engineers) working for them, they are more likely to over pay, and get inferior systems, inferior buildings.  How do you know that the Builder you hired is installing X, Y, Z properly?  Clearly the chart shows buildings costs have little correlation to the actual selling price after 1978.  Building costs actually went down after 1978, yet the sales price for homes climbed dramatically.  Also note, the 1980s Reagan era also ushered in the modern era of de-regulation and the dilution of consumer protection against predatory financial products.  Business should earn a profit for good work. But when does that profit become excessive? at 25% over costs? 50%, 100%, 200%? 300%?  as we've seen the last 15 years?

b.  Realtors are generally paid as a percentage of the final sale price  for a property.  There is a built-in incentive for Realtors to want the price for any property to go higher, as their profit/earnings is tied directly to the sale price.  The Realtors' goal is to CLOSE at the highest possible price.  So, why would Realtors want to see housing prices and appraisals drop in 2009 (as compared to prices 3-5 years ago?)

c. Banks & Mortgage companies have a built-in incentive to see higher housing prices.  The larger the loan amount, the more Banks can make (as long as the borrower is deemed not to be a high risk.  The ability of home owners to pay more didn't really increase over the last 50 years (because real wages for the middle class have been flat), Banks just decided to take more risks.  See comments (below) regarding Economist Hyman Minsky's foretelling of how risk-taking would result in a collapsed economy.

d.  Cities /  Municipalities and Politicians have an incentive to see property valuations increase. After all, property tax revenue is a function of retail housing prices.  Increases in property values is a false measurement through which politicians measure their own effectiveness at governing and public policy.  Politicians, developers and contractors exploited the American sickness of trying to keep up with the Joneses and conspicuous consumption.  (Appraisals are a function of so-called "comparable" sales prices.)  The industries & sectors complaining about the current appraisal levels are contractors, developers and those who overpaid for their house (and the banks who pushed these phony inflated valuations on people unable to assume high debt risk levels.)

It is my opinion that the cost to build a new house is (roughly) represented by 35-40% spent on Materials (& systems), versus 65-60% spent on labor.  It is about the same (labor) cost (as averaged over the entire development costs) to install an energy efficient window versus an inefficient or lesser efficient window. It's generally NOT 20%, 30% or 40% more to use a better system.  So using a better product generally doesn't add 30-100% to the budget over the cost of the entire project. Over time, the decision to use quality systems (not high-end systems) generally adds value and often pays for itself versus opting for the lower quality.

e.  "Location, Location, Location" is a social [salesman rhetoric] construct: 30% truth, 70% faux social meme (used to create wealth via societal & cultural bias.)  "Location" is a wealth apportioning method used and exploited by Developers, Realtors (salesmen), corporate banking, politicians, the affluent etc., to justify artificial valuation for the purpose of private profiteering at the expense of others.  The 'location' topic is too expansive to cover in this post but deserves a mention.

SO, IT IS NO SURPRISE THAT THE COST OF BUILDING many U.S. HOMES HAD LITTLE TO DO WITH THE RETAIL SELLING PRICE -- at least over the last 60 years. (See DrHousingBubble chart.)  The people who can least afford to lose money on a construction project (or buying a home, property) are the ones who are likely to benefit the MOST by hiring a team of advocates (i.e. architect, engineers, attorney, accountant etc.) to help  them through the project process.

According to Bryan Bell, only about 2% of new home buyers work with an architect.
Yet, we know that houses designed by architects, are more likely to increase in value (over more sustained periods), cost less to operate, be more attractive, even cost less to build (for the same products & systems), are less likely to rapidly decrease in value, and will be more comfortable than homes purchased from a developer or home builder-led properties.

Many would now agree the greed of corporate banking and the major players (above) driving retail property pricing and financing largely created a structural weakness that led to the 2008 financial collapse.  Of course, individual property owners have a role in the global financial collapse too: borrowing more than they can afford; running up high debt-to-savings ratios; leveraging too many of their assets; spending (borrowing) for the purpose of appearing more affluent (to others) than they actually were, etc.  Perhaps the most grievous act of all:  those who remained quiet (in the public & private sectors) as this house of cards was built around all of us.  Many people did see the 2008 economic collapse coming -- not just economists and bankers.  

No society can tolerate irrational double-digit price % increases (over a short period) in housing, health care, food, water, and other BASIC HUMAN NEEDS, out-pacing real earnings for average workers, and think said price increases are sustainable over time (where the profits go primarily to a small minority.)


Economist Hyman Minsky warned of these boom/bust economic cycles and unearned profit ratios.

“Success breeds a disregard of the possibility of failure.” - H. Minsky (d. 1996)




Minsky's writings put forward the idea that patterns in economies repeat themselves, and that all Democracies MUST have some level of regulation, if they are to last-- or be doomed to catastrophic failure (and ultimately, extinction.)  Apparently, Nobel Prize winning Paul Krugman often speaks of Minsky's work and insights.


The Boston Globe article also discusses some of Minsky's ideas (many penned more than 20-35 years ago) about how to correct a faltering capitalist economy.  From the Boston Globe article:


quote:


...In his writings, Minsky looked to his intellectual hero, Keynes, arguably the greatest economist of the 20th century. But where most economists drew a single, simplistic lesson from Keynes - that government could step in and micromanage the economy, smooth out the business cycle, and keep things on an even keel - Minsky had no interest in what he and a handful of other dissident economists came to call “bastard Keynesianism.”
Instead, Minsky drew his own, far darker, lessons from Keynes’s landmark writings, which dealt not only with the problem of unemployment, but with money and banking. Although Keynes had never stated this explicitly, Minsky argued that Keynes’s collective work amounted to a powerful argument that capitalism was by its very nature unstable and prone to collapse. Far from trending toward some magical state of equilibrium, capitalism would inevitably do the opposite. It would lurch over a cliff.
This insight bore the stamp of his advisor Joseph Schumpeter, the noted Austrian economist now famous for documenting capitalism’s ceaseless process of “creative destruction.” But Minsky spent more time thinking about destruction than creation. In doing so, he formulated an intriguing theory: not only was capitalism prone to collapse, he argued, it was precisely its periods of economic stability that would set the stage for monumental crises.
Minsky called his idea the “Financial Instability Hypothesis.” In the wake of a depression, he noted, financial institutions are extraordinarily conservative, as are businesses. With the borrowers and the lenders who fuel the economy all steering clear of high-risk deals, things go smoothly: loans are almost always paid on time, businesses generally succeed, and everyone does well. That success, however, inevitably encourages borrowers and lenders to take on more risk in the reasonable hope of making more money. As Minsky observed, “Success breeds a disregard of the possibility of failure.”
As people forget that failure is a possibility, a “euphoric economy” eventually develops, fueled by the rise of far riskier borrowers - what he called speculative borrowers, those whose income would cover interest payments but not the principal; and those he called “Ponzi borrowers,” those whose income could cover neither, and could only pay their bills by borrowing still further. As these latter categories grew, the overall economy would shift from a conservative but profitable environment to a much more freewheeling system dominated by players whose survival depended not on sound business plans, but on borrowed money and freely available credit.
Once that kind of economy had developed, any panic could wreck the market. The failure of a single firm, for example, or the revelation of a staggering fraud could trigger fear and a sudden, economy-wide attempt to shed debt. This watershed moment - what was later dubbed the “Minsky moment” - would create an environment deeply inhospitable to all borrowers. The speculators and Ponzi borrowers would collapse first, as they lost access to the credit they needed to survive. Even the more stable players might find themselves unable to pay their debt without selling off assets; their forced sales would send asset prices spiraling downward, and inevitably, the entire rickety financial edifice would start to collapse. Businesses would falter, and the crisis would spill over to the “real” economy that depended on the now-collapsing financial system.
From the 1960s onward, Minsky elaborated on this hypothesis. At the time he believed that this shift was already underway: postwar stability, financial innovation, and the receding memory of the Great Depression were gradually setting the stage for a crisis of epic proportions. Most of what he had to say fell on deaf ears. The 1960s were an era of solid growth, and although the economic stagnation of the 1970s was a blow to mainstream neo-Keynesian economics, it did not send policymakers scurrying to Minsky. Instead, a new free market fundamentalism took root: government was the problem, not the solution.
Moreover, the new dogma coincided with a remarkable era of stability. The period from the late 1980s onward has been dubbed the “Great Moderation,” a time of shallow recessions and great resilience among most major industrial economies. Things had never been more stable. The likelihood that “it” could happen again now seemed laughable.
Yet throughout this period, the financial system - not the economy, but finance as an industry - was growing by leaps and bounds. Minsky spent the last years of his life, in the early 1990s, warning of the dangers of securitization and other forms of financial innovation, but few economists listened. Nor did they pay attention to consumers’ and companies’ growing dependence on debt, and the growing use of leverage within the financial system.
By the end of the 20th century, the financial system that Minsky had warned about had materialized, complete with speculative borrowers, Ponzi borrowers, and precious few of the conservative borrowers who were the bedrock of a truly stable economy. Over decades, we really had forgotten the meaning of risk. When storied financial firms started to fall, sending shockwaves through the “real” economy, his predictions started to look a lot like a road map. [END OF QUOTE.. the article is much longer.]




Again, the people who can LEAST afford to waste money building, renovating a home (or any structure, space) are the ones who would BENEFIT THE MOST by hiring a team of advocates (i.e. architect, engineers, attorney, accountant etc.) to help  them through the process.



For more Information & Analysis on these topics, please also see:



- Housing Valuation is Largely a Scam (at the retail level) - http://shantyworld.blogspot.com/2008_05_01_archive.html

- Construction Nightmares: More common than you think.  http://shantyworld.blogspot.com/2008_02_01_archive.html
- More info on Economist Hyman Minsky - http://en.wikipedia.org/wiki/Hyman_Minsky  and


Graph via http://doctorhousingbubble.com

©ShantyWorld.com 2009.  All Rights Reserved by ShantyWorld.com. No portion of this post may be reproduced without written permission of ShantyWord.com.


























Saturday, September 12, 2009

How to Triple the Cost of Building A House

3 Residents, 4 bathrooms: "We've Only Asked for the Barest Necessities."

 

Many people come to architects seeking assistance in renovating a house -- either one they've found or one they're already living in.

On more occasions than I can recall, I've had nearly the exact same conversation with a client as the one here in these scenes from the Cary Grant movie, "Mr. Blandings Builds His Dream House" (1948), co-starring Myrna Loy (as Grant's wife.) The movie is as timeless and as accurate now as ever.

One of my all-time favorite scenes from the movie:

 

Notice, the architect's first recommended design was in line with the client's budget. Failing to take the recommendations of your architect (or attorney) is a path to financial cost overruns. Is it any wonder our nation is now in the middle of this financial housing disaster? You can lead a horse to water..

The people who can LEAST afford to waste money building a house are the ones who would benefit the MOST from working with an experienced Architect.  It's a lie that working with an architect will cost you more money than if one depends (solely) on a builder.  The Architect's Fees are often not more than 4-8% of the entire development cost for new home construction.  More often than not, experienced architects provide a path to a better designed, more efficient, safer structure than what average developers & builders offer the public.  Better designs mean higher resale value.  Architect designed homes hold & appreciate in value more than Builder /Developer led properties.

Because an architect's clients have an advocate working for them, they are less likely to pay $600 for a $150 window.  If there are 30+ windows in an average size house, that could represent $4k-$15K in savings on one line item alone.  Considering that is but one way my clients save money building a house, it is easy to see how hiring an architect not only pays for itself, but can save you tens of thousands of dollars when building a new house.

And if you think it's better to go it alone without an architect's help when building, ask yourself how CNN Hero Liz McCartney's St Bernard Project is able to rebuild homes in New Orleans damaged by Katrina for $15K (w/ donated labor), but a contractor charges you $100-300K to do the same project on the open market.

With all the talk about green and eco-friendly retrofitting, haven't you ever wondered why the structures weren't better built in the first place? Developers and some builders build for obsolescence.  Like the Detroit auto-building industry the last 35 years, the goal was manufacturing obsolesence so it would create a large repair/ maintenance sub-industry.  American auto dealers make more on maintaining oil-based cars than electric cars.  The same is true of the home building industry over the last 35 years. Build it cheaply, so home owners have to call the Builder or contractor back for repairs, replacements.  Instead of buying a quality $300 faucet that lasts 20-35+ years, people buy the cheap $60 faucet, get charged $200-250 by a plumber to install it every 5-7 years. Which method is really cheaper?

Building "green" or sustainably is not expensive-- it's a choice and priority.  We already know some the benefits that building green provides:  saves operational & maintenance costs, reduces your utility bills (in some cases to zero), reduces heat-island effect (lowers temperature) in urban areas, reduces toxic run-off into our waterways, sewers, cuts down on green house emissions, carbon etc.

The homes we designed, generally don't need to be retrofitted for better insualtion in order to save money, or to be more eco-friendly.  They were designed properly the first time. Therein lies the difference between buying a builder's cookie-cutter house versus a home designed by an Architect.  

What are you doing to prepare for building or remodeling your next project?  If you don't know where to start, consider contacting a licensed Architect for help on how to get started.  Architects do much more than just provide permit plans.  We design safer structures, save you money, can help you build green, can help you stay on budget --to name just a few things.  Feel free to contact us if you need help with your project.  We are here to help you realize the home you deserve.

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