New home construction: good for investors?

The cost to construct a new home has been rapidly rising. The national average is now $291,324. This is a 134% increase over 1998 costs, and up 33% from 2017 levels. With this rapid rise in costs, are new homes still a good investment?

First let’s look at the cost breakdown and the factors contributing to the increase.

According to the National Association of Home Builders’ (NAHB) Construction Cost survey (conducted in September of 2017), just over half of the final sales price goes to construction costs, 21 percent to finished lot costs, and 10 percent to builder profit.

What is contributing to the increasing costs of building a home?

It seems the construction industry has a perfect storm of factors coming together to drive costs higher. Most notably, tariffs, labor shortage, and the lack of affordable housing.

Tariffs.  One of the biggest factors affecting the cost of new home construction is the high tariff on housing materials. A spike in lumber prices caused by the Trump administration’s tariffs on Canadian wood products is one of the biggest contributors to rising construction costs. The cost of lumber has risen 62% since January 2017.

Labor Shortage.  The lack of construction workers is also contributing to increased costs. Almost 230,000 building sector jobs are unfilled. Many construction workers left the industry during the Great Recession and never returned. As a result, builders must pay more, projects are taking longer and costs are increasing.

Permit Issues.  Increases in local building regulations and zoning requirements are also contributing to higher new home prices and resulting in fewer starts.

Cost containment efforts

New home builders have a vested interest in containing new home construction costs. The final cost will affect their ability to attract investors, market the property and make a profit. Cost containment efforts being used include;

• Builders are turning to alternate, lower cost materials and including flexible allowances in their contracts. Flexible allowances give clients the option of switching to alternate products that may not subjected to added taxes and levies.
• To address the labor shortage, builders are revamping pay structures as well as adding incentives and bonuses. A growing number of construction firms are also turning to staffing firms.
• Builders are trying to work with local officials to lessen the burden of regulations and requirements.

Investment outlook

Even with the rise in construction costs, there are still good opportunities for investors when it comes to new home construction projects. We are in an affordable housing crisis so there is plenty of demand for the right product. Tax incentives, particularly those related to Opportunity Zones, will make certain new home construction projects more advantageous for investors. Another new development strategy that is gaining in popularity is investment in build to rent properties. This strategy has become more attractive to investors as the pricing gap between new homes and older homes has shrunk. Plus, new homes have the added benefit of more predictable and lower maintenance costs and higher rent-ability versus older properties.

Conclusion

The cost of constructing a new home is rising and this trend will likely continue into the foreseeable future. Builders will need to become more creative to produce the product consumers want and still make a profit. Investors may need to be more selective when choosing a project but indications are that new home construction will continue to be a good bet.

If you are planning build, check out our loan programs here.