The Expert Podcast

So, what’s going on in the construction industry? What does the data show? And what are some hidden factors that might have some surprises for contractors, builders, and even clients in the next couple of years?

First of all, the construction industry report has some basic information about the Producer Price Index. We all know that inflation is up, but also, what’s the backlog of construction? It’s higher than what it was a year ago. In June of 2021, the backlog is now higher than it was then, but it’s down from what it was a month ago or two months ago.

Why is that? Well, some new projects are not being initiated because interest rates are higher, and people don’t want to dive into building a project with higher interest rates. This has more going on behind the scenes than what it seems. It’s not that it’s a permanent downslide in construction projects, and here’s why.

Real estate has kind of painted itself into a corner. The real estate market is trapped. It can’t go up, it can’t go down. It can’t really go up because prices really can’t sustain themselves higher than what they are now. The price for a typical new construction home—let’s say a 2,000-square-foot house with land acquisition, permit fees, legal fees, and the cost of construction—is going to put the product at about a $600,000 to $650,000 house, maybe $700,000 if you have more than builder-grade finishes.

In most parts of the country, a $650,000 to $700,000 house is affordable for a solid number of people. It’s not a rich man’s house, but let’s say it’s not a middle-class house either. Once you start building a house where you have to start the price with an eight or nine—close to a million dollars—now you’re really limiting the market for that house. Sure, there are people that can buy that house for $800,000, $900,000, or a million bucks, but it’s a whole different ball game compared to a $600,000 or even a $700,000 house.

When people are out there in the marketplace thinking, “I’m going to buy a $500,000 house, maybe $550,000,” if you offer them something that’s $600,000, $625,000, or $650,000, they can probably stretch to that. But if now you’re going to $800,000, it takes out a large swath of the population. A $600,000 house at a 6% mortgage means a $3,000 to $3,500 a month mortgage payment. There are a lot of people who can swing that. It’s not cheap, but there are people renting for $2,000 or $3,000 who can jump up a little more to buy a house.

If you’re talking about an $800,000 house on a 6% mortgage, now you’re looking at a $4,500 to $5,000 monthly payment. That’s a whole different ball game. The number of people who can afford that budget is much smaller. So, the price point really can’t go up.

It also can’t go down because, for most homes, unless you build a very small house with cheap fixtures and low land costs, it’s tough to build a house that you can sell for $500,000 or less. You can’t do it. By the time you buy the land, pay the permit fees, and pay for the construction, plus closing costs, commissions, and everything else, if your price point is under $500,000, it’s not worth building. You’re going to lose money on it, especially now with the future of real estate being uncertain.

Until that becomes clearer, no one is going to want to build a house that’s $500,000 or less. So, the real estate market is trapped in a range—$550,000 to $650,000. It can’t go up, it can’t go down. But there’s still a shortage of homes on the market. There are still more people who want to buy houses than there are houses available.

Everybody needs a box around them. Every person, family, or couple needs four walls and a roof. Whether it’s a single-family home, an apartment, a condo, or a rental, everybody needs a box to live in. But there aren’t enough boxes to go around. It’s like musical chairs—people are out there wanting to live somewhere, but there’s no place to live.

So, we need more houses. Prices can’t go up, and they can’t go down. That $550,000 to $650,000 range—or roughly $500,000 to $700,000, depending on how you look at it—is where the market is. It’s not going to crash lower than that because it can’t. It’s not going to go much higher than that because it pushes homes out of range for the majority of buyers.

But there’s still a need. So, if you’re a builder and can take advantage of this market—maybe acquire some land, or take advantage of other builders not using up the workforce—there could be an opportunity. Maybe some contractors or framers are now available because other builders aren’t using them. If you can use this window of opportunity to build a few homes in the $550,000 to $650,000 range, even if you’re scared of the market, it might be a good risk to take.

It’s very unlikely that you won’t be able to sell a new house for $599,000—new house, 2,000 square feet, in a decent market. The market isn’t going away. There might be hesitation, some fear, and it might take three months to sell instead of three weeks, but people aren’t going to stop buying houses. Everyone needs a place to live.

Take it as food for thought.

What else is going on with the numbers? Here’s what we talked about: The confidence index is down—decrease, decrease, decrease. Staffing decrease. Sales decrease. Profits decrease. These are all confidence numbers. In the last month, design contracts have decreased. A reading of 50 means no growth, so while there’s still a little bit of growth, it’s about even. Billings have decreased, but it’s still about even.

There’s still close to a trillion dollars in construction starts. It’s down from a month or two ago, but it’s up from a year ago. If you’re a builder, you don’t want to get in over your head, get too leveraged, or go too crazy. But there may be an opportunity right now to lock in landowners.

Raw land is a lot less liquid than a house, so some landowners might be getting nervous that they’re sitting on land that’s not moving. This could be the time to sell. If you can make an offer—maybe do a partnership agreement where you don’t have to come out of pocket for the land but instead build a house and get a solid contract—that way, you’re not at too much risk for the land or out of pocket for a big sum.

You’re only covering materials and some labor, not the land acquisition itself. This could be an opportunity that turns into something valuable in the next two to three years. By the time your project is complete, people will still need a place to live, and your house might be the only one available.