The Expert Podcast

Construction costs and home prices both of them are going up is one of them driving the other or are they unrelated well let's take a look at the numbers and the data behind it first of all there is a presumption that the housing market is overpriced that home values are in a bubble in prior videos we've shown how actually home prices are not in a bubble they're at this regular rate of increase over time as normally would have happened and if you don't believe us take a look at fortune it says right here you thought u.s housing prices uh market was overpriced it's actually one of the most affordable in the world it's only overpriced compared to the last 10 years which was artificially depressed in the last two years kind of brought it back into line of where it should be house price appreciation is no greater overall than it has been in the last hundred years.
In fact the ketchup is so severe that it says housing market is changing so fast that if you wait just a few months you might pay an extra 20 percent and they're talking about your mortgage payment some of that 20 is because of the mortgage rate increases so if you had considered buying a house let's say in november or december of 2021 at the price level that existed at that time and waited until march or april 2022 between the interest rate increase and the house price increase you might have a 20 percent higher mortgage payment so if you had example of a 1500 mortgage payment it might now be 1800 dollars.
So what about construction costs well construction cost and home prices are both going up and the punch line the answer to the question is they're both affecting each other the construction cost driven by lack of labor availability supply chain delays and inflation of the underlying components roofing concrete lumber are all driving up construction of new homes so the new homes are going to be higher what about resale homes how does construction cost affect the price of a resale home well if new home values go up 20 or 25 percent the resales are going to follow along because most people who buy a resale are going to peg the value compared to what a new home will cost.
And it says right here construction costs went up 17 and a half percent that's actually a little low between the lumber the concrete the labor it's more like 22 to 23 percent is what the price the construction cost of a new home went up now the selling price is going to go up more than that because when your construction cost goes up let's say 20 percent by the time you add up markup fixed cost overhead sales commission your transaction price is going to go up maybe 25 so if you had a house that would normally would have sold for 400 000 as a new home after all these increases that price might be 500 000 25 increase.
How is this showing up well some new home developments had buyers who had placed deposits on properties eight nine ten months ago beginning of 2021 and when it came time to do the closing some of the builders developers cancel their contract and put it on the market for a new buyer at a higher price we've seen prices go from exactly what we talked about 400 to 480 485 and the previous home buyer is shut out now sometimes they're given the option of purchasing the house for a higher price but a lot of times the builder doesn't want to deal with the hassle of trying to justify a higher price to the same buyer where a new buyer comes in they don't know about the 400 000 price that existed before so to them 485 that's what the house is worth.
That affects the resale market because a similar pre-owned house that somebody's selling might have previously been maybe 20 or 30 percent less than the 400 so that might have been 360 340. well now that house is going to sell for 400 or 410. it's going to pull the resale market up with it matter of fact the buyer who pays 485 or 490 for that brand new house might be selling their house to be able to move into the new house in fact it's going to be tough to get them to agree to sell their house for 350 if their new house is 500 basically the same house only knew so they're going to raise up their expectations on the resale side.
How is that going to also show up in higher end houses well when buyers start to look at a modest home that's 400 450 or 500 a luxury home that used to be in the 500 000 range might be worth spending an extra 100 to 150 to get bigger house 3 000 square feet luxury finishes so this home construction cost basis for builders that we see every day between labor materials sure it makes the new houses worth more but it also adds intrinsic value to an existing home that's already built because the replacement cost of that build is going to be so much higher and the seller of that house is going to realize that and not discount their house as much.
The other part of it is many homes that are resales have had a recent remodel and if you factor in the cost of that remodel again it's going to affect the overall sale price market value of that new home resale homes are also able to sell for more because of cops comparable sales are used by appraisers to come up with values for mortgage approvals and when the domino effect of new home increases building costs affecting those gets built into the market or baked into the appraisals it's going to gradually over time increase the appraisal capability of a resale home in fact it's not even catching up fast enough a lot of resale homes the buyer needs to come up with some extra cash to cover the appraisal difference but this day and age a lot of people are paying cash anyways so an extra 20 40 50 000 is not that big a deal to cover the appraisal difference.
So if you're a builder expect that your client your buyer is going to see higher prices and higher contract cost for a remodel or an addition as normal you don't necessarily have to be at 200 240 a square foot for a builder grade edition because the market is showing higher in fact you probably couldn't even deliver for that now anyways because of labor cost of materials if you're a client all the benchmarks that you've seen before are probably out the window because your builder has these additional costs.
Another area that is often overlooked as a cost is insurance the cost for builder insurance whether it's workman's comp general liability all the other types of insurance surety bonds that goes into a construction project are all elevated commercial lines insurance has seen a 20 increase in premiums just in the last 12 months and some markets are even closed where if you're a builder you may not be able to get the same coverage you had before the insurer and your agent may not have access to the markets to be able to provide you with a policy at all so many builders are going to excess and surplus lines coverage which also have higher premiums.
So all of these factors go into making new home construction higher remodels higher and even the resales will follow suit to have the values of existing homes as you've seen go up so neither one is really leading it it's kind of in tandem and the building costs might lead the resales and then when resales jump up it allows the market to be able to digest higher prices on the new homes.