In a recent post in his continuing series on whether or not Seattle is in a bubble, Gregory Wharton took a look at the actual cost of producing new houses. After doing a bit of math on construction costs, he made the following claim:
...the comparative value of new construction for the median Seattle home is $326,600 not including land.That would actually be a pretty solid reason for housing prices to be as high as they are right now... if it were true. See, the thing is, I'm not convinced that it is true. Most of you probably read the news reports yesterday proudly proclaiming that sales of new homes nationwide were up in May. In those reports was an interesting tidbit of information about the price of these new homes:
The median price of a new home did drop to $235,000 in May...So, nationwide the median new home is selling to the consumer for $235,000, but in Seattle the cost to the builder to construct the median home is $326,600? $235,000 is the actual median sales price across the entire US, and does include land. Making what I think is probably a low-ball assumption that only 15% of the cost of these homes comes from the land itself, and allowing for developer profit of just 5%, the construction cost estimate obtained by looking at the actual median sales price comes in at $188,000—over 42% lower than Mr. Wharton's estimate.
So here's my question: Are construction costs in Seattle really 70% higher than the nation as a whole (without figuring land into the equation), or are Mr. Wharton's numbers a bit... off?
(Gregory Wharton, Seattle Real Estate Professionals, 06.21.2006)
(Martin Crutsinger, Seattle P-I, 06.27.2006)
Update: Mr. Wharton posted the following response in the comments, and I feel it is only fair to add it to the main post:
As the original author of the linked article, A few things:
1) Of course the numbers I use are retail in the sense that they include both material and labor cost at market rates. Most homebuyers are not in a position to build for wholesale prices, which can be much lower, and must also pay site supervision costs as well. Even my architectural clients have to pay retail unless they themselves are builders (which some of them are). Some builders are able to consistently build at low prices (Quadrant is an excellent example: they build at the very low end of the market and get all their lumber dirt cheap because they are part of Weyerhauser). Many are not. In fact, most large builders with efficient cost structures won't build right in the city because the costs are too high and blow their financial pro formas apart.
2) Construction costs in major cities are very much higher than they are outside of cities. There are a variety of reasons for that, but it's been consistently true for a very long time. I'm not comparing Seattle real estate prices to construction costs in Duluth, Iowa, nor to the national averages. I'm comparing them to construction costs in Seattle, Washington.
3) Six years ago, it was still possible to build a mean-level single-family detached house for about $100 to $110 per sq. ft. in Seattle. Those days have long passed. Now, to get into that price range, you have to cut lots of corners. The Quadrant homes I mentioned above typically don't have a lot of what we might consider basic features: base trim, appliances, and a bunch of other stuff. To get that, you have to pay a premium upcharge (that's where a big part of their margin is, actually).
4) Quality is a big issue being ignored by many of your commenters. If you were to actually try and rebuild many of the 1920s bungalows so prevalent in Seattle to the same quality level of finish they currently have, your construction cost would be well over the $160/sf number I was talking about (actually, it would be north of $200/sf). I know this because I've had clients ask me to do just that and it's amazingly expensive.
4) I am aware that Seattle is usually about 1.4 times the national average for construction cost. That number has been going up...a lot...in the last two years. From what I'm seeing in cost estimates during the last 24 months, I think the multiplier is now more like 1.5 to 1.6.
5) Even if we assume I'm off by a bit per sq. ft., the argument still holds. At $145/sf (the 1.4 multiplier from national average, rounded down to the nearest $5 increment), the mean 1,720 sq. ft. home has a hard cost of about $250K, not including land or soft costs or anything else. Add 20% soft cost and you get $300K. Since land premiums are running very high as well (as noted in the chapter following the linked one) add a round $125K for land cost for a city lot (which is actually on the low side if you go and price these things out) and you are now right at the median home sale price for May 2006 of $427K.
For all these reasons and more, I stand by my analysis.