The Expert Podcast

A lot of you have asked for some actual numbers on costs to build a house and what has happened to those numbers over the last year, and here's a good example. We're going to have a home price calculator show up on our website pretty soon, but in the meantime, here are some hard numbers. Bank of America’s real estate analyst division has put some numbers out that are kind of interesting, and I'll show you what's happening with the market.

First of all, it says house prices have been ballistic over the last two years, in part due to a shortage of materials, and that's only part of the story. What it says is that the supply chain is slowing. We know about that, but here, farther down, are the particulars: The bill for materials required to build an average-sized new single-family home increased 42 percent in the LA area up until 2021 and actually went up more than that after 2021. Materials cost roughly $35,000 more, so the value of raw materials in an average house is $118,000. So think about it—$118,000 minus $35,000. It used to be somewhere around $80,000 for materials. Now, it's $118,000, which is a $35,000 lift just on materials.

What other costs go into a house? It says labor and land costs constitute the remaining two-thirds. Okay, so $118,000 times 3 gives you roughly $360,000 for the cost of a new home, an average-sized home. By the time you sell and have a markup for the builder, those houses sell for about $415,000 to $420,000. That's the average price right now, the median price of a home.

So, if the cost of labor went up two-thirds and the cost of materials went up the same amount, land didn't go up that much, but that's not an equal third. Typically, you have your materials as a third, you have your labor as a third of the cost of building a house, and the other third is split 50/50 between the cost of land and the overhead for the builder or the contractor. If you have a house, let's just round it off to $300,000, you have $100,000 for materials, $100,000 for labor, $50,000 for the lot, and $50,000 for the construction process: the overhead for the builder, equipment, site work, insurance, bonds, and the fixed cost of that home builder. That price did go up because insurance is higher, and land price went up a little bit, but not much. So all those together add to the price of a house.

How is that going to affect the market? Well, it tells you right here that home construction has consistently outpaced inflation for the last 40 years. So, home inflation was always higher than the rest of inflation. It gives you a good list of what goes into a home: framing lumber (we know about that), the concrete foundation (we know about that), windows and doors, the trim work, siding, plumbing, cabinets, and there's a whole other list of other items. A lot of things go into a house, and they're all higher.

The big question everybody wants to know is: Is it going to go lower now that maybe demand is slowing? Maybe fewer people are buying homes? Maybe that's going to lower the price. Probably not, because all of the things that went into raising the prices in the first place are locked in. The labor costs to produce the items aren't going down. Taxes are not going down. The raw materials’ prices are not going down. Diesel fuel for shipping is not going down. All of the items that are subcategories of the finished house are all locked in. None of those prices are going down.

Sure, there may be some demand reduction on home purchases, but there's still plenty of people out there who need to buy a house. That may keep the price of houses from going up further, but it's not going to reduce the cost of a house lower. It's certainly not going to reduce the cost of the materials that go into a house. Just because buyers don’t want to spend the money to buy a house at a certain price, maybe $450,000 or $460,000, doesn’t change the fact that the lumber costs the same amount, that the flooring costs the same amount, that the labor costs the same amount.

You’re not going to be able to go to the employees of a home builder and say, "You know what, the buyer doesn’t want to spend this much for a house, so you have to take a pay cut." That’s not how it works. You’re not going to be able to go to the lumber yard and say, "Look, the new home market is reducing, so you have to charge less for your lumber." Their costs are the same. The cost of the logging, the cost of the diesel to get the log shipped to the mill, the mill expense, shipping from the mill to the lumber yard, all those costs are already baked in. They’re not going to go down, and there’s not a huge markup in these products to where, even if they wanted to, they could reduce the price. If anything else, they’re going to have to raise the price to get more markup to cover the fact they’re not selling as much volume.

Let us know what you think in the comments. If you're a home builder, what are you seeing with your clients? If you're a consumer, what are you seeing? If you're an employee, is there any pressure on your role or your income? Or maybe if you're on commission as a salesperson, is there any change in your commission rates? Tell us what you think in the comments.