29 November 2017

The Limits Of Cheap Construction

FastCompany magazine features a new approach to building a decent quality house (basically a modern cottage) for just $20,000 of construction costs for the structure itself. It is a one bedroom, one bath house that would occupy half of a city lot and is too small to get zoning approval without a waiver from planning officials, probably well under 1000 square feet with no basement or garage. But, it turns out that there is a lot more that goes into a house than construction costs.

What would it actually cost to build one in Colorado on a for profit basis?

My estimates for Castle Rock in Douglas County, Colorado ($200,000 with $1,650 per month of housing related costs) and for Denver, Colorado ($160,000 with $1,400 of housing related costs) are spelled out below. 

The Castle Rock housing cost is more expensive than existing one bedroom apartments in Castle Rock by $519 a month, so it would make no improvement in housing affordability, even considering the benefits of owning versus renting.

The Denver housing cost would be pretty much identical to existing one bedroom apartment rents (with with a hedge against rising rents and an eventual path to own the home and pocket appreciation in its value over time).

Honestly, you can probably already get a one bedroom, one bathroom single wide manufactured house which is uglier and shoddier (with a shorter useful life and more risk of storm damage), for about the same price ($22,000) which would actually have fewer building code issues due to federal regulations prohibiting anti-manufactured housing building codes, for a comparable price without any major innovations in construction methods.

This is pretty much the rock bottom of what you could do in terms of single family home housing affordability in cities with jobs in abundance that is achieved through reduced construction costs, which you can see is pretty modest even with state of the art efforts to reduce construction costs. But, the real gold in the affordable housing game is to find a way to tweak zoning laws and building codes that are barriers to affordable housing.

In contrast, if these kinds of houses could be added as accessory dwelling units (granny flats) by existing Denver home owners in areas zoned only for single family homes, this could be an extremely affordable option ($950 a month) opening up one bedroom units that could rent for about $450 a month (32%) less than the existing average one bedroom rent. Renters in these accessory dwelling units would get a quality residence that looks nice and is sturdy in a decent existing neighborhood which is probably safe and has decent schools, that would only need minimal new infrastructure to meet the needs of its growing population.

It would expand diversity in residential neighborhoods, without creating a concentration of poverty (since more than half of residents in these neighborhoods would be existing single family home owners who are much more affluent) and would probably involve better than average tenant vetting (since owners are finding a single tenant who will live in their backyard). It would also fix a serious affordable housing shortage in Denver where housing costs are growing because new construction can't keep up with new people moving to Denver, and would put downward pressure on rents for all units in the city, including conventional apartments.

Castle Rock, Colorado as a single family home on a normal sized residential lot.

Build a house like that in Castle Rock, Colorado and your sticker price to a buyer purchasing it new is closer to $200,000:

* $80,000 for a water tap hook up
* $20,000 to build the structure
* $5,000 for a foundation 
* $2,000 per unit for xeriscaping
* $50,000 for the lot
* $12,000 for a realtor to sell it when you're done,
* $20,000 per house profit (10% which you need to in order to make it worth a developer's time)
* $8,000 per unit for development fees (to pay for municipal improvements like sidewalks, parks, storm sewer extensions, city road extensions and school infrastructure)
* $3,000 per unit for haggling with the building code inspector and getting a zoning variance for the size of the house and setting up an HOA which land use officials would require. 

There are big economies of scale if you build more in the HOA and entitlements department, but it is harder to get a zoning variance if you build a lot of units in one neighborhood, since suburbanites fear that affordable housing means crime and bad schools. 

Still this is affordable in an area where low end single family homes cost $300,000 to $500,000 each.  On the plus side, this solves your too small to get a mortgage problem (it isn't cost effective and there isn't a financing infrastructure in place to get a $16,000 mortgage).

Suppose that the buyer gets a 30 year fixed rate mortgage with 4% interest, no points, and a 5% down payment plus all closing costs (about $2,500) out of pocket.

Our buyer has to come up with $12,500 ($10,000 down and $2,500 closing costs), roughly a full three month emergency fund's worth for someone with an income high enough to afford it.

You could get an owner's monthly payment for buyers with good credit down to $1,650. This breaks down on a monthly basis as:

* $955 principal and interest
* $100 property taxes
* $100 homeowner's insurance
* $140 gas and electric bills
* $115 internet service
* $  45water, sewer, and trash pickup with xeriscaping
* $  50 HOA dues
* $145 allowance for modest home and xeriscape landscaping maintenance

This is quite a bit more than the average rent for a one bedroom, one bath apartment in Castle Rock of $1,131 a month.

A working class couple holding down one full time minimum wage job ($10.40 per hour in Colorado) at $20,800 per year would make $41,600 per year combined (a lower middle class single person working full time at $20.80 per hour would be in the same position). A couple (or individual as the case might be) could afford that monthly payment.

There'd be no room for kids beyond maybe on infant though, but modest income empty nesters or young couples or same sex couples or single people in their 20s or 30s, could be good fits to the situation.

Denver, Colorado on half of a normal residential sized lot.

Build a house like that in Denver, Colorado and your sticker price is closer to $160,000, because the land is more expensive, but the infrastructure is in place and you wouldn't need an HOA.

* $100,000 for the lot
* $20,000 to build the structure
* $5,000 for a foundation 
* $2,000 per unit for xeriscaping
* $12,000 for a realtor to sell it when you're done,
* $16,000 per house profit (10% which you need to in order to make it worth a developer's time)
* $5,000 per unit for haggling with the building code inspector and getting a zoning variance for the size of the house. 

You could cut the 5% down payment and closing costs combined to about $10,500 ($8,000 down and $2,500 closing costs), again the entire emergency fund of a family that could afford it.

You could get the monthly cost to about $1,400 a month (no HOA and a smaller principal and interest payment) which includes some payment of principal on the mortgage every month and hedges against Denver's rapidly rising rents with a fixed rate mortgage. 

This compares to an average rental cost for a one bedroom apartment in Denver of $1,390 a month, pretty much the same cost as renting.

It might be possible to afford with this a combined income of $34,000 a year, which is possible on two minimum wage jobs (on 40 hours a week and one 25 hours a week), or one $17 an hour full time job. 

This would be very competitive with rent for a one bedroom apartment for a working class couple or lower middle class individual.

Denver, Colorado as a Granny Flat rented by the existing home owner.

The economics would change dramatically if Denver allowed owners of home currently zoned single family to build accessor dwelling units of this size with straight zoning on their lots either for family, or to rent, financed by the existing home owner with a home equity loan on the existing home for the entire amount.

It turns out that affordability is all about leveraging the sunk costs of existing infrastructure and maximizing the efficiency with which we use valuable city land (which is valuable precisely because it is developed).

Total cost: $40,000

* $20,000 to build the structure
* $10,000 for new utility hookups (water, sanitary sewer, natural gas, cable, electricity)
* $5,000 for a foundation 
* $2,000 per unit for xeriscaping
* $2,500 per unit for zoning and building compliance, getting a new mail box, etc.
* $   500 HELOC charges

The monthly additional principal and interest payment would be $190 a month, and once you add additional property taxes and insurance costs, and an allowance for additional maintenance you are up to maybe $240 a month, add $560 a month for utilities for the new units, and the owner's marginal monthly cost for the new unit is $800 a month.

The owners might very well be wiling to rent this one bedroom, one bath stand alone unit in their backyard for $950 a month, netting a profit of $1,800 a year plus all principal payments on the loan and increasing the value of the owners' home in the long run by at least $40,000 for no significant out of pocket costs not financed by the rent. This is an investment many homeowners in Denver would be happy to make. It would also potentially facilitate housing an extended family since as an adult child who still lives at home, or a parent or parents living with their children on a pretty affordable basis.

This compares to an average rental cost for a one bedroom apartment in Denver of $1,390 a month, so it would be much more affordable (32%) than existing market rent rentals.

This would be challenging to afford for working class individual holding down a full time minimum wage job ($10.40 per hour in Colorado) at $20,800 per year. Ideally, a renter would have at least $26,000 a year of income which would imply a full time job at $13 a year, which is still very much a working class job in Colorado. Alternately, you could have have a couple holding two part-time minimum wage jobs each working 25 hours a week, or perhaps one working 30 hours a week and the other working 20 hours a week, which would be very doable.


Dave Barnes said...

this is great, easy-to-understand analysis

Doug said...

Great info, but I think your costing for an ADU is too low. I talked to a few contractors about building a 1 bedroom ADU in my backyard and the estimates started at $100k. This price was too high, so we never did plans or detailed costings.

Also, $80k for a water meter in Castle Rock. Wow!

andrew said...

I can confirm the water meter cost from personal experience in my law practice.

Re the cost of the ADU. The referenced article is about a new technology for low cost, high quality housing construction and the analysis here looks at the cost if that technology was adopted and performed as promised. It is represented as a major reduction from the status quo (although it is comparable with the lowest cost manufactured housing with existing technology that you can buy which is much lower in quality than stick built ADUs or this proposed new technology). I don't disagree that a decent quality ADU stick built using status quo technology are significantly higher than the amounts used in this analysis.

The point of this analysis was to use that even with very low construction costs that zoning changes are much more effective at making housing affordable than lower construction costs, and that premise would hold even if the cost of construction were increased by $60K in each of the three examples.