The Expert Podcast

All right, so the big story in real estate is that the housing market is declining or crashing or in a crisis, whatever you want to call it. Well, what is the reason that home prices are still going up if fewer people are buying houses? Why are the prices still going up? And if that's the case, why are builders constructing fewer homes? We've talked about this before; we predicted this over a year ago that there would be a slowdown in the sales rate, the number of houses sold, and an increase in interest rates. Interest rates were going to go up, and they went up from two and a half percent to now almost seven percent—it's almost three times the interest rate.

But we also predicted that house prices will not crash. A lot of people are waiting for this big crash of house prices. Probably not going to happen. Here's why: There still is a huge volume of people that need to buy a house. More importantly, the inventory is not going to go up. Yeah, there are houses for sale, but many of those houses that are for sale are at a price that seems to be higher than what people are going to want to pay. But here's the problem: The sellers of those houses are not going to sell them at a discount.

Here's the difference between 2022 and 2008. When people were just slashing and burning, getting rid of houses, people in 2008 had two or three houses, couldn't afford them, and just needed to dump them or get foreclosed or do a short sale. Well, the people who own homes now don't have a distressed sale mentality. Underwriting for loans was very, very heavy duty for the last 10 years—20 percent down, good credit, good income, everything. Plus, the interest rates are low.

Think about that: You have somebody selling a house who has an interest rate that's two and a half or three percent. Why are they going to sell it? Because if they sell it, no matter what they get for it, even if they buy a great new house, now they have to pay seven percent on their new house. So even if the house is the same price, they don't even get any better house. Their mortgage is going to go up; it might go up a thousand or two thousand dollars more than what it was because their interest rate is now going to be higher. It's almost like a forced refinancing at a higher rate.

So sellers are thinking, well, if I can get a big price for my house, that makes it worthwhile. I'll sell it and pay the rate. These lower interest rates are a deal killer for inventory. By deal killer, I mean sellers don't want to sell their house. They're locked into a low rate, and you might say, well, those rates were only around for a couple of years—from 2019 to 2021, maybe into 2021. That's true, but anybody who had a mortgage before that—bought a house in 2010, 2011, 2012—even if their rate was higher, five or six percent, seven percent, guess what? As soon as the rates went down to two or three percent, they refinanced just like that.

So anybody who's not stupid refinanced their house when the rates were low in 2019 and 2020 and beginning in 2021. So everybody's got a low rate, unless they missed the boat. Everybody's got a lower rate than seven, that much I can tell you. So the people who would be potential sellers, they're not selling unless they get a big windfall. They don't need to. Right? You're almost better off renting it. The way rents are, if you have an extra house or a house you don't want, unless you can get big money for it, just rent it, put it on the rental market right now. Rents are through the roof, so the high rates are not going to solve the house price issue. The rising prices are not going to solve that, probably won't even solve the inventory problem. People still want to buy houses because they need a place to live.

So builders, at the same time, are also cautious. Builders are really scared right now because they're afraid that no one's going to buy a house, which may or may not be true. But a lot of builders made it through the 2008 to 2010 crisis. They're not going to go out on a limb and start building spec houses left and right, so no new inventory is going to come online. Whatever houses are being built right now will be finished, but the builders aren't going to be extending themselves to put more inventory into the marketplace.

Put a message below if you're a builder contractor—what are you seeing? There's a lot of remodels, a lot of repairs, a lot of additions. But new homes—unless it's one house built for one client, for a new house for them—are really not a big factor right now. And you know, lumber prices are still up from what they were four years ago. Materials are hard to get, so the prices are high. And more importantly, the regulatory burden of building a new house—between licenses, permits, fees, impacts, everything else—make it so that unless you know, the first hundred thousand of the price of a house, a lot of times goes into permits and fees and impact fees and licenses.

We saw a project, we were talking with a builder colleague of ours, that they were building a house in a neighborhood that was already established. It wasn't a new neighborhood. There was an infill empty lot, and they wanted to build a house for a client. And they went to pull permits, and the county where this property is located said, "Yeah, your permit fee is $5,800. Your tax rate is going to be another $4,200." And all the things they have to pay. Okay, that's fine, your inspection fees, whatever. But they also said, "Oh, by the way, we need more infrastructure in this subdivision. We need the streets repaved. We need two more fire hydrants, and we need new curbs put in, because if this house is going to put more impact on the neighborhood, so in order to get approved for your permit, you have to pave 180 feet of new road. You have to put in two fire hydrants, and you have to put a new curb on the south side of the street."

That's $30,000 to $40,000 worth of construction even at cost. So unless the bid in the quote with that in there was acceptable to the contractor's client, the house would never get built. The client ended up going for it because they wanted a new house, but try that with a spec home. Try putting another $30,000 to $40,000 expense into a spec house that you're just going to offer for sale in this marketplace. Builders won't do it.

So there's a lot of extra expenses being stuffed into these houses, and that's not counting the price of land. If you have $100,000 for impact fees and permits and taxes, if you have, let's say, another $100,000 for the piece of land, right? In different parts of the country, it's different. You might be able to get the land for $50,000 and the permit fees for $150,000, or vice versa. Whatever, but let's say you got $125,000 before you even start building. You know, counting excavation, site work, whatever. You got $200,000. Well, now you build a 2,000-square-foot house. Right? Let's say it's an average house; it's 2,000 square feet. Most houses are bigger. At $200 a square foot, which is, you know, pretty cheap, that's $400,000 in construction cost, plus $200,000 for the land and permits.

You have $600,000 in cost before you even try to amortize your capital. Before you even start paying back carrying costs, before you start paying back your fixed overhead as a builder—sales commissions, you sell a house, you got 8% in cost. So in reality, in order to make that project worthwhile, if you work on that project for 8 months or close to a year, right? How much profit do you want to make? Not even so much profit—how much income does that building company need to make to be tied up for a year? $100,000? Is that fair? I don't know. $100,000 is a lot of money, but how much is the managerial salary of a project manager worth for a year? $100,000. Right? Plus the carrying costs on all your equipment, your office rent, electricity. Builders have insurance and bonds and work comp insurance. So let's call it $100,000.

It's going to be way more than that. You got $200,000 just before you build a house. You got another $400,000 in construction costs. That's $600,000. Plus $100,000 in all your carrying costs, you're at $700,000. Right? If you sold the house for $900,000, minus commissions that you pay to a realtor to sell it, you're going to net maybe $800,000. Is that worth it? I don't know. I don't know. I mean, and now you're selling a $900,000 house that only has 2,000 square feet. So this is where the math makes it hard to do spec home construction. Certainly, there are parts of the country where you can do it cheaper. You can buy a lot for $20,000. Maybe you got $40,000 in fees. Maybe you can scratch together a little 1,500-square-foot builder-grade house with, you know, Home Depot laminate countertops for maybe, you know, maybe it's more like $180 a square foot.

So maybe now you have, you know, $300,000 in the house. So maybe all together you got $350,000. You sell it for $465,000, $470,000. Maybe you can sell that house. But in reality, that's not going to be a large volume thing because the builder doesn't have a lot of revenue to pay for the increased costs. Good luck trying to find contractors, subcontractors, and laborers. And framers, right? They don't exist. Right? There's a lot of builders that are paying $50 to $60 to $70 per hour for skilled tradesmen. I'm not talking about plumbers, electricians—that's more like $100 an hour. I'm talking about roofers, framers, sheetrockers, flooring, kitchen—that's $50, $60 an hour cost paid to the actual employee, plus work comp insurance, liability insurance, everything else.

It doesn't take much to add up that. So what does that mean? Let's get to the bottom line. Bottom line is, if you're a builder or if you're a homeowner, take all this into account when you're making your decisions. It might be a time to take a risk and build a house because if every other builder is pulling back and you put a house out there that's priced reasonably, especially if you don't have any other jobs—remodels or additions. Look, two, three years from now, there's still going to be a housing shortage. Right now, people are catching their breath at 7% interest, but people still need to live somewhere.

Maybe an investor buys it, rents it out, waiting for the prices to go down and then refinances at 4% five years from now. Right? There's a lot of ways to make the math work. The easier way to make it work is to do a paid-in-advance project for an existing homeowner—for a remodel, an addition. You know, maybe building an in-law suite