The changing housing landscape has shifted the un-derlying cost components of home building. The proportion of the final price devoted to the finished lot and the construction costs have been relatively stable for the last 25 years. However, the rapid decline in land values, modest shifts in materials and labor costs, and a shift in the kinds of homes built have affected the absolute and relative share levels of each component.
Finished lot cost has been about one-quarter of the final sales price for the past 25 years. During that period, construction costs, materials, and labor, have accounted for half the final price. The remaining 25 percent covers marketing, sales commissions, interest, overhead, and profit.
As land and lot prices fell, the finished lot component dropped to one-fifth of the final price. Moreover, the average lot size increased as a larger share of the building in 2009 was custom homes and homes on the owner’s lot. As a result of the falling lot prices and the increasing lot size, per-square-foot lot prices dropped between 2007 and 2009 (the two most recent NAHB survey years).
Construction costs, i.e., labor and materials, rose at a rate less than overall inflation as the heavy demands on materials slackened significantly and construction labor unemployment rose. Most construction material price indexes have shown similar real declines although some building products are energy intensive, and their prices have risen or at least not fallen as a result of oil price increases. Also indicative of a rising share of custom homes and a falling share of speculative-built homes in 2009, the per-square-foot value of the construction component increased to $82 from $66 between 2007 and 2009 as size of the home declined and the overall cost remained nearly level.
This trend is not likely to continue, and the shares of each component will revert to their longer-term relationship as the market recovers. Lot and land prices are the largest wild card in this prediction, and the reversal will take longer in some places than others. Developed lot costs will rise faster than other costs because of the continued efforts by states and localities to impose new requirements on development. Moreover, state and local fiscal conditions will take time to heal and development will become again a source for refreshing depleted government coffers. Finally, the universe of financially able development companies has been diminished by the recent upheaval, and for some time the number of companies able to develop large tracts will be small and they will be able to command a higher profit because of their dominant position.
Construction material costs will rise as the world economy revives and demand for basic building components increases across the globe. Some industrialized countries and emerging countries are already seeing growth, and China continues to outperform all other countries. Energy costs will rise with overall growth as will those products that are energy intensive. Wage growth for construction workers will provide one of the weakest pushes to overall construction costs as unemployment will remain high for several years. However, some skilled worker shortages could occur until those former employees are attracted back to residential construction or new workers are trained.
The remaining components of the ultimate house price are under more direct control of the individual builder, and their future direction will depend upon the proprietor and company. Interest costs will greatly depend on the owner. Marketing and sales commissions will become a significant share of the remainder because attracting buyers will continue to be challenging. Finally, overhead may not constitute as large a share of the overall price as firms have learned to cut out any excess.
Profits are the final piece of the cost components, which include some proprietor compensation as well as return on investment. For the past 25 years, the profit share has averaged 10 percent of the sales price, but fell back to just under 9 percent in 2009 as competition from foreclosed homes held down profits.