The cornerstone of any 12-step program is to admit you have a problem, so let’s admit it. We have an affordability problem.
Both new and existing median home prices in the U.S. are at all-time highs. The median price as a multiple of median household income is at an all-time high. The share of median-income households that can afford to buy a median-priced home has fallen from 79% just ten years ago to 57% today. That’s an all-time low.
So it’s no surprise that sales are slipping as a result. Annualized existing home sales in August were 5.88 million, down 1.5% YoY and 11.7% below their January level. New home sales came in at 740,000, down 25.4% vs. January and 24.2% YoY.
Everybody knows the solution: Build more homes. We’re trying. Housing starts in August were 1,615,000 (also annualized), up 17.4% YoY. That’s not terrible, but it’s not anything Grandpa would have mistaken for a true housing boom.
So what’s stopping us from building more homes? Obviously the pandemic is a controlling factor at the moment. But that’s a one-off that will hopefully be in the rearview mirror by this time next year.
When COVID is long gone, we’ll still have to deal with the two bogeymen that come up every year in NAHB’s surveys of home builders’ most pressing challenges: the cost and/or availability of 1) skilled trade labor and 2) developed lots.
Labor has topped the charts for most of the decade. The supply chain is doing what it can. LBM dealers have invested millions in component manufacturing and prefab assemblies to reduce the need for skilled labor.
Most of the products that go into a house are sold turnkey, to take labor management off builders’ plates entirely. Increasingly that includes the last major holdout, the dried-in shell.
Trouble was, none of it seemed to help. Throughout the 2010s, complaints about a shortage of trade labor grew steadily no matter what suppliers did. By 2018, nearly nine out of ten builders were saying labor was their No. 1 headache.
And then suddenly it wasn’t.
In 2020, the share of home builders who said the cost and availability of skilled trade labor was a serious problem plunged from 87% to 65% even as housing starts posted their largest gain in five years. So what happened?
Everybody talks about a shortage of trade labor. Actually, we’ve got more plumbers, electricians, and HVAC techs today than we had in 2005. Roofers are down just 4%. Drywallers are down 36%, but we built 33% fewer homes in 2020 than in 2005.
Framing is the outlier. As of July 2021, framing subs employed 74,400 production and non-supervisory workers. That’s a whopping 57% shortfall vs. the 171,500 workers employed in July 2005.
It would be logical to assume complaints about labor declined because framing subs went on a hiring spree and started chipping away at the shortfall. It would also be wrong. The production worker headcount in July 2021 was actually a little below its levels in July 2017, 2018, or 2019.
Okay, so maybe offsite is finally getting legs and builders no longer need as many skilled framers. Wrong again. According to Home Innovation Research Labs, the market share held by modular and panelized slipped from 9.6% in 2019 to 9.1% in 2020. Stick framing was dead steady: 77.4% in 2019, 77.6% in 2020.
Only one number has changed significantly in recent years: framers’ wages. Wages are up 27% since 2017 and 55% since 2012.
Obviously that doesn’t prove wages are the reason builders can find framers now. The idea is an intriguing one, though. It’s almost as if there’s a connection between how much you pay and how willing people are to work for you.
It’s true that higher wages increase construction costs, which in turn affect home prices. But apparently labor is a minor factor. A recent white paper by the Urban Institute and Moody’s Analytics found that “the most significant impediment to building more affordable housing is the availability and cost of land.”
According to NAHB, the median size of a single-family spec lot in 2020 was 8,306 square feet. That’s roughly a walk-in closet larger than the 2019 median of 8,177 sq. ft., which was an all-time record low.
The median price of a lot in 2020 was $53,000—up 18% YoY and an all-time record high. You’ll pay nearly double that amount on the West Coast, for a lot that is 25% smaller. Even that’s still less than the hard cost of a developed lot in New England—but with a caveat.
On a per-square-foot basis, prices in Massachusetts are no higher than they are in Mississippi. But due to widespread density restrictions in New England, the median lot size is three times larger and so is the price: $120,000 for 0.9 acres vs. $40,000 for 0.3 acres in the deep South.
Buying the lot is only the first step, though. You’ll still need to get approval to build something on it.
In a December 2019 study of land use regulation in 2,450 communities across the U.S., the Wharton School of Business concluded that “there is no place (on average) where residential development is simple and quick.”
In highly regulated markets, you’ll spend an average of 8.4 months getting green lights from “at least three different entities that must approve (and, thus can veto) a project.” Even in lightly regulated communities you can plan on 3.4 months to coax at least two separate entities into letting you build.
Obviously all that regulating costs money. A May 2021 NAHB study says “10.5% of the final house price (is) attributable to regulation during development of the lot.”
In New England, the median home price in 2020 was $477,675. If regulatory costs are 10.5% of that, it adds another $59,545 on top of the $120,000 for the lot, which comes to $179,545 total for land development. Not including the house.
Then everyone is shocked—shocked!—that the median price of a new single-family home was $390,900 in August.
That’s how land regulation distorts the market. Clearly you can’t build a $200,000 home on a $179,545 lot. Land prices plus density restrictions all but force builders to build for affluent buyers.
Wharton’s study does note that a nascent “Yes In My Back Yard (YIMBY) political movement” is starting to nibble at zoning restrictions. Grand Rapids, Minneapolis, and a few other cities have eliminated single-family zoning. Oregon did the same in its metro markets, and California just followed suit sort of.
All that only illustrates how intractable the issue is. Any changes need to be made one state—or more often, one community—at a time. With California, Oregon, and a handful of cities on board, that’s roughly 100 markets down, 2,350 to go.
Plus, the fact that zoning has always been political means that we deal with it in modern American fashion—i.e., turn it into a pissing contest in which solving the problem takes a backseat to owning the other team.
If you had anything less than absolute faith in American ingenuity, you might well conclude that we’ve dug ourselves such a deep hole that we won’t be having a next housing boom.
Don’t go there yet. In 2020, the share of builders who said securing developed lots was a problem fell from 63% to 48%. That’s a 25% drop, the same as the decline in complaints about a labor shortage.
In other words, one out of every four home builders who thought land or labor was their most serious challenge in 2019 now thinks they’re no big deal.
Why the big change? Maybe builders were so upset about lumber that they forgot about land and labor. Seems unlikely, though. A builder forgetting to complain about something that bothers him is like Halley’s Comet: You may see it once, but you’ll have to live a long time to see it twice.
The more likely explanation is that builders decided to bite the bullet and pay the prices they need to pay to get the lots and labor they need to build.
That’s good to the extent that it means more housing starts, but starts won’t last long without sales. With affordability already stretched to the limit, it makes you wonder whether builders have figured out a way to sell homes despite inflated land and labor costs.
And apparently they have.
Single-family rentals (SFR) make up just over a quarter of all rental units. They’ve been around forever, of course, but they’ve always been owned by mom-and-pop landlords or small, local investor groups. In the wake of the 2008-10 crash, PE firms couldn’t resist the lure of 3.7 million repossessed homes at bank auction prices. The logic was that they could be flipped quickly or rented to people who couldn’t buy due to student debt, a recent foreclosure, low credit score, etc.
What they discovered is that there are also plenty of people who want to live in a single-family home and could buy one if they wanted, but preferred the “lock-and-leave convenience of renting,” as Forbes puts it.
That made the single-family rental (SFR) market a viable long-term investment. Institutional investors still hold minimal market share—most estimates say 2% or less—but they’re punching way above their weight when it comes to making life difficult for would-be homeowners.
“You now have permanent capital competing with a young couple trying to buy a home,” John Burns of John Burns Real Estate Consulting recently told the Wall Street Journal. “That’s going to make U.S. housing permanently more expensive.”
That’s not good for investors, either—inflated prices undermine their ROI. But this is exactly why PE managers have a reputation as the “smartest guys in the room.”
They made an end run around the competition with a model called built-for-rent. BFR communities “are entirely new subdivisions designed for renters (and) managed more like new apartment buildings,” reports WSJ, with multifamily-style amenities and all maintenance done by the property manager.
In Phoenix, for example, Christopher Todd Communities partnered with Taylor Morrison to build a 222-unit community of one- and two-bedroom single-family rentals. BB Living is partnering with Toll Brothers to build luxury rental homes, in Phoenix at first but with 20 more sunbelt markets on the drawing board.
Lennar recently launched a $4 billion venture to develop BFR communities and acquire SFR homes. Co-CEO Rick Beckwitt says it’s all part of “Lennar’s vision of becoming an ESG-driven homebuilding company” that helps people “live in brand-new homes at an attainable price point, all without putting up a down payment.”
That’s a very nice thing to do for people. Also profitable.
D.R. Horton recently built a 124-home community in a Houston suburb. It rented all the homes, then sold the entire subdivision to Fundrise, an online platform for property investors. WSJ says Horton’s profit on the sale was “roughly twice what it typically makes selling houses to the middle class.”
But don’t feel sorry for Fundrise, either. CoreLogic says “single-family rent growth increased 8.5% in July 2021, the fastest year-over-year increase in 16.5 years.”
This is good news for the supply chain, at least in the short term. It takes just as much material to build a rental as it does a for-sale home, and BFR will help keep housing starts going even if buyers can’t afford to buy.
It could make builders more receptive to upgrades, too. When your client buys 200 homes at a time and has to do all the maintenance, “builders opt for more durable materials, meant to last for the duration of their long-term investment,” says WSJ.
Whether BFR this will have a measurable effect on the channel is an open question. In theory, for example, it could drive panelization in the single-family market. A BFR subdivision doesn’t need as much curb appeal. If that means fewer one-off designs and more repeatable assemblies, panels might be cost-effective. Plus, speed is more critical since BFR homes generate revenue as soon as they’re finished.
The other question is whether BFR will get big enough to matter. Hunter Housing Economics says it currently accounts for about 6% of all single-family homes built in the U.S., and expects that to double in the next three years.
WSJ thinks BFR “is likely to become a dominant force in the rental housing market in the coming years.” Maybe. Amenities plus reliable maintenance may well make BFR more attractive than a mom-and-pop rental even though the rents are considerably higher.
Mom-and-pop landlords don’t appear to have a lot of weapons to fight back with other than price. If that works, it’ll drag investors’ ROI down and make BFR a less lucrative investment. If it doesn’t, smaller landlords might be forced to sell out—which would dump badly-needed inventory on the market.
“Investors are betting on significant rent appreciation over time because they fundamentally believe that our society will not get its act together in the housing space and solve our problems.” Scott Cox
Which in turn would goose renters to become buyers. A 2018 survey from UC Berkeley’s Terner Center for Housing Innovation found that 80% of single-family renters “not only want to own a home, but are hopeful that they will be able to move from renting to owning in the next five years.”
The decision whether to rent or buy often hinges on cost, and small changes could tip the scales back in favor of ownership—for example, if the land crunch eases up a little bit and builders ramp up production, or lending standards loosen up. If SFR’s momentum falters, investors may be quick to bail out and jump to the next hot ticket.
“Yields in the single-family for-rent business are actually not very impressive at the moment,” says land planning consultant Scott Cox. “Investors are betting on significant rent appreciation over time because they fundamentally believe that our society will not get its act together in the housing space and solve our problems.”
Hopefully investors are all wrong about that, but one way or another, we need more homes. If private equity can help pump up inventory levels, that’s a good thing no matter how it plays out.