• Matias Soto

Keeping Up with Demand and Cost Constraints

Updated: 2 days ago



Population growth brings about new households every year. In the United States, there is a birth every 8 seconds, a death every 12 seconds, and an international migrant arrives every 46 seconds. There is a net gain of one person every 17 seconds {1}. Factors such as net migration, the economy, cost of education, social norms, healthcare, and government policies affect population growth {2}. Although they show similar trends sometimes, population and household growth are not always correlated. For example, during an economic recession, population growth rates may remain steady, but household growth rates may decrease. Such was the case during the recent recession. Yearly net new households went from about 1.5 million in 2006, to 1.25 million in 2007, 0.75 million in 2008, and 0.5 million in 2009 {3}. However, population continued to increase at virtually the same rate when compared to previous years, according to data from the U.S. Census Bureau {4}.


An increase in the housing supply could help increase the household growth rate and allow more young adults an opportunity to a starter home.

The reason household growth does not always match population growth is due to economic factors. In young adults, ages 25-34, household headship rates have only recently begun to match population growth rates. From 2002 to 2018, the US population grew by 14.7 percent for ages 25-34, while household headship in this age group only increase by 7.1 percent. This can be explained by the fact that more young adults are still living with parents or grandparents. In 2017, 22.8 percent were living with parents/grandparents. This same figure was only 12.1 percent in 2000. Studies have shown this is partly driven by the lack of affordable housing in many metro areas. High rents and home prices delay the ability of young adults to form new households. Although in the past generations they tend to catch up by age 40, the lack of affordable housing in today’s market might be an additional barrier {3}.


Regardless of household growth reaching expected levels again in 2016-2018, new construction was still depressed relative to demand {3}. The residential construction industry has obviously shifted its approach. Housing supply used to exceed household growth by an average of 30% since 1974. This is no longer the case since 2011, when housing costs reached its lowest point and residential construction no longer produced a surplus of housing. Memories of the housing bust has made builders and lenders more wary of speculative development that would expand the housing supply too rapidly {3}. The lack of supply is even more prominent for the low-income household segment, due to labor shortages, and increasing costs of materials and land, making it less profitable to build for such market {3,5}. An increase in the housing supply could help increase the household growth rate and allow more young adults an opportunity to a starter home. In the past, government subsidies have helped drive the growth of starter homes {6,7}. Similar programs are available today (opportunity zones {8}), but they require a larger participation by the private industry to meet the current needs for affordable housing.


Construction Industry Cost Constraints.


The median home price in 2018 in the U.S. for new housing was $326,400 {9}. According to the National Association of Home Builders (NAHB), there are six main areas impacting the sales cost of a house: finished lot cost, total construction cost, financing cost, overhead and general expenses, marketing cost, sales commission, and profit. The bulk of the cost comes from total construction cost (61.1%) and finished lot cost (18.5%). Profit margins tend to be narrow, reported at 9.1%, leaving little room for a possible price reduction that would make houses more affordable. Within the total construction costs, there are eight categories of work done in the building process: site work (6.2%), foundations (11.8%), framing (17.4%), exterior finishes (14.1%), major systems rough-ins (14.7%), interior finishes (25.4%), final steps (6.8%), and other (3.8%) {10}. These costs are dependent on the type of materials and construction methods used. Changing these numbers would require a significant shift in the type of construction.

Median household income in the U.S. in 2018 was $61,937 {11}. Using the 30% affordability line, as standardized by House and Urban Development (HUD) {12}, the median family could pay the mortgage of a $230,000 house (assuming 30-year loan, 3.5% interest rate, 3.5% down payment, 1% private mortgage insurance, 1% homeowner’s insurance, 1% property tax rate). Even if profit margins were eliminated, the house sales cost would be about $297,000. This would require a monthly expense of about 40% of income, still far from affordable to the median household. Other costs need to be reduced in order to bring homes prices closer to a target median value of $230,000. That represents a cost reduction of about 30% with respect to the median home price. This is significant considering the narrow margins in the industry.


An important cause of the high sales costs in new construction is the size of the houses being built today. The median size of new single-family built in 2018 was 2,386 sq. ft. This is about a 20% increase in size from 2000, and almost 50% increase from 1980 to 2018. This increase is linked to the view many Americans have of houses as assets that can appreciate. The ability to buy a larger property means that the homeowner can make more money once the house is sold in the future {13}. This phenomenon is more accentuated in the U.S., with houses 600-800 feet larger than other highly industrialized nations. The construction of the highway system and the housing policies of the post-war also help drive a boom in suburban development that led to the growing demand in housing and land space. Eventually, this trend continued upward by every successive generation defining success by even larger homes {6}.


“It seems unlikely that the construction industry will be able to alter its costs significantly under the current paradigms.”

Although house sizes have increased significantly in the past 40 years, the price hike cannot be attributed completely to the size increase. New house sales costs increased about 30% from 2000 to 2018, and 65% from 1980 to 2018, after inflation adjustment {9,14}. Both percent increases are more than the respective increases in square footage. Other likely factors are the increase in overhead, building and inspection fees, infrastructure, natural disaster preparation, materials, land, and added insulation due to new regulation. According to the NAHB, up to 24 percent of the cost of a new home is due to government regulation – it is spent on regulatory burdens, impact fees, taxes, and the cost of delays from the regulatory process {6,15}. It seems unlikely that the construction industry will be able to alter its costs significantly under the current paradigms. A possible solution is to increase the supply of housing. However, with household growth rates staying virtually constant since 2016, and the construction industry’s lack of desire for speculative development, a reduction in housing costs will have to come through a different strategy {3,16}.


Bringing Down the House Costs


The first step in cost reductions is the reduction of the house itself. Affordable housing strategies must be rooted on the idea of providing a down-sized, entry-level home. This house can still be a valuable, durable asset, without encompassing all the luxuries of a McMansion {6}. The median sales price and square footage of new single-family houses sold in 2018 were $326,400 and 2,386 sq. ft., respectively {9}. This gives a median price per square foot of $137. A $230,000 house at the median price per square foot would have a median size of about 1,700 sq. ft.


However, costs associated with residential construction are not always linearly related to size. Which means a $230k house might be smaller than the estimated 1,700 sq. ft. Additionally, making homes smaller reduces the builder’s profit margins. Nevertheless, size reductions should be considered as part of the plan to bring more affordability. Certain aspects of the house could also be eliminated when trying to sell more affordable housing. There’s certainly a market for smaller, simpler houses at a price point closer to $230k {6}.


“More specifically, offsite construction could most likely reduce costs in framing, exterior finishes, major systems, and interior finishes. These categories comprise about 45% of the total sales price, according to the NAHB.”

In addition to reducing house size, other aspects can also be made more efficient. An analysis by the Boston Consulting Group on offsite construction points to some of its advantages with respect to conventional construction. According to them, offsite construction allows for more productization by using digital platforms; less onsite labor which reduces risk and eases project management; different materials that can be easier to transport; and fewer tools onsite and for shorter duration {17}. These advantages point to possible cost reductions in terms of total construction cost. More specifically, offsite construction could most likely reduce costs in framing, exterior finishes, major systems, and interior finishes. These categories comprise about 45% of the total sales price, according to the NAHB {10}.


Other advantages of offsite construction that have been identified are adding economies of scale, having a controlled environment inside a factory, less onsite risk of injuries, and a more dependable labor force with less employee turnover {17,18}. In general, offsite construction brings the advantages of mass production at the building level, which is a step beyond the mass production of products and materials. Not only are parts used in the construction of the house being built in a factory, entire sections of the house can be prefabricated and delivered to the job site for assembly. This way of operating can also help minimize work delays and rework due to human error. Those are costly mistakes that drive up the cost of a house. Another 5% of the cost is associated with overhead and general expenses. Offsite construction can potentially help reduce overhead costs due to a more streamlined operation.


The Secret Sauce.


The two main strategies of a profitable business in the affordable housing space are: a reduction in operational costs and an increase in supply. Reduction of operational costs and consequently, house sales price, can be achieved via the offsite construction approach. It brings all the advantages discussed above. As mentioned, 50% of the sales price could be impacted by doing offsite construction. Lean manufacturing methodologies could also be added to the operation to increase profitability. Although implementing lean methods takes time and careful planning, such changes could be added to the business after some of the building procedures have been established.


Increasing the supply of homes is challenging for conventional construction companies. It requires adding more sub-contractors, crews, and overhead. It also requires additional investment. Incurring into debt without the assurance of a return of the investment is risky. Although such risks have paid off in the past in the construction industry, current times have proved to be too unstable for such operations. The recent shift in the industry to no longer keep an overstock of houses proves that it’s no longer willing to take such risks {3}. Additionally, building smaller houses also presents a risk to conventional builders because it’s also a shift in their way of doing business. This is generally not the direction many builders want to take {6}.


“Due to our cost savings in the method of construction, higher quality materials can be used, resulting in a better home.”

Offsite construction brings more flexibility to changes in supply. Because most of the operations are contained within a factory, scaling up or down can be achieved by changes in the number of shifts and productivity throughput. Lean manufacturing methods aids this need for flexibility as well. By keeping a lean inventory and building prefabricated house sections just-in-time, the business is not required to pursue a substantial debt instrument in its efforts to scale up. Some scaling of on-site operations will be necessary – but only about 20% of the total construction cost.


Petros Builders uses offsite construction and lean manufacturing in its operations. Our floor plans reflect the need to decrease the square footage of the house without decreasing its quality. Our current floorplans are 880, 1156, and 1444 sq. ft. Using the country’s median price of $137 per square foot, these homes could be afforded by households with incomes of about $33,000, $43,000, and $54,000. However, our efficiencies make it possible for these costs to be even lower. The walls of our houses are built using prefabricated 4-ft formwork panels, which are assembled onsite, and filled with concrete. This modular process makes the size of the house easily scalable, if needed. Construction materials are of the highest quality for durability, cost of ownership, and comfort. The prefabricated 4-ft formwork panels are fitted in the factory with all the necessary layers. This includes the reinforcing mesh, insulating foam, and plastic sheathing moisture barrier. Additionally, walls are designed to withstand high winds and impact of storm debris {18}.


Similarly, roof panels are prefabricated in a factory and assembled onsite. They use a metal skin to withstand hail and storm debris and are filled with highly-insulative foam. They provide durability to environmental conditions, energy savings, and comfort to the homeowner. Due to our cost savings in the method of construction, higher quality materials can be used, resulting in a better home {18}. Petros Builders is actively pursuing partnerships with real estate developers, non-profit organizations, and government institutions, to increase its housing production. A larger supply of homes helps lower overhead costs per house even further. Consequently, these savings can be passed on to households in need of affordable, durable, dignified housing.



Partner with us today:

Email: hello@petrosbuilders.com

Web: www.petrosbuilders.com

ENDNOTES

1. U.S. Census Bureau. U.S. and World Population Clock. (2020). Available at: https://www.census.gov/popclock/.

2. Pettinger, T. Factors that affect population size and growth. Economics Helps (2019). Available at: https://www.economicshelp.org/blog/469/development/factors-effect-population-size-and-growth/.

3. Joint Center for Housing Studies of Harvard University. The state of the nation’s housing. (2019).

4. United States Census Bureau. Available at: https://www.census.gov/.

5. PK. Historical Home Prices: Monthly Median Value in the US from 1953-2019. DQYDJ (2019). Available at: https://dqydj.com/historical-home-prices/.

6. Sisson, P. Why we can’t build small homes anymore. Curbed (2020). Available at: https://www.curbed.com/2020/3/10/21168519/homes-for-sale-american-home-suburbs.

7. Sisson, P. Why buying a house today is so much harder than in 1950. Curbed (2018). Available at: https://www.curbed.com/2018/4/10/17219786/buying-a-house-mortgage-government-gi-bill. (Accessed: 6th April 2020)

8. OpportunityDb. The Ultimate Guide to Investing in Opportunity Zones. Available at: https://opportunitydb.com/guide/.

9. U.S. Census Bureau. Highlights of Annual 2018 Characteristics of New Housing. (2018).

10. Ford, C. Cost of Constructing a Home. HousingEconomics.com (2020). Available at: https://www.nahbclassic.org/generic.aspx?sectionID=734&genericContentID=271883&channelID=311.

11. Guzman, G. New Data Show Income Increased in 14 States and 10 of the Largest Metros. United States Census Bureau (2019). Available at: https://www.census.gov/library/stories/2019/09/us-median-household-income-up-in-2018-from-2017.html.

12. U.S. Department of Housing and Urban Development. Rental Burdens: Rethinking Affordability Measures. PD&R Edge Home

13. Pinsker, J. Why Are American Homes So Big? The Atlantic (2019).

14. U.S. Bureau of Labor Statistics. CPI Inflation Calculator. Available at: https://www.bls.gov/data/inflation_calculator.htm.

15. Emrath, P. Government Regulation in the Price of a New Home. HousingEconomics.com (2016). Available at: https://www.nahbclassic.org/generic.aspx?sectionID=734&genericContentID=250611&channelID=311&_ga=2.29263867.67624733.1593699766-1703856553.1593699766. (Accessed: 7th February 2020)

16. United States Census Bureau. Historical Households Tables. (2019). Available at: https://www.census.gov/data/tables/time-series/demo/families/households.html.

17. de Laubier, R., Burfeind, A., Arnold, S., Witthöft, S. & Wunder, M. The Offsite Revolution in Construction. Boston Consulting Group (2019). Available at: https://www.bcg.com/publications/2019/offsite-revolution-construction.aspx.

18. Petros Builders. Home. (2020). Available at: https://www.petrosbuilders.com/.

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© 2020 Petros Builders, A 3Space Makers, LLC Partner

13618 Poplar Circle, Suite 303

Conroe, Texas 77304

936.776.4191

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