Minding the Appraisal Gap
When costs exceed value
Last I wrote, I focused on the Wall Street Journal article on Rockford, Illinois, Rockford Is Now America’s Top Housing Market After an Improbable Turnaround. While celebrating the good news, I also asked if we are ready to grow yet? Housing supply is still at all-time lows, job growth is anticipated to advance at recent unprecedented levels, building permits are still few and far between, and housing prices are still rising. We are not yet growing our housing stock. Add in obsolescence and we are headed in a negative direction meaning we are losing more homes to demolition, or slated for demolition, than we are gaining new. A city cannot grow this way. A city cannot sustain a population this way. A city cannot maintain flat real estate tax rates this way. Inventory is essential to our future success in business growth as people who choose to work in and around our community need places to rent or buy.
For what it is worth, Rockford is not alone in its low inventory position. Much of America is inventory constrained; however, not all American cities are low in inventory. We are starting to see those communities who addressed the barriers to building new units (single and multi-family) level out and have a more balanced market. Prices are stabilized and rents are actually coming down to more bearable levels.
Why does this matter? Several reasons, including the economic health of a community, access to affordable housing for our workforce is imperative, and as we will see at the end of this article politics. Can today’s leaders solve this inventory problem before the next election cycle in which they are on the ballot? If not, a recent study, What State Housing Policies Do Voters Want? Evidence from a Platform-Choice Experiment, suggest voters may choose candidates who can solve this persistent issue. Housing will be a vote casting decision factor.
Today’s post will share what other communities are doing to address their lack of production, but before we jump in, I’ve heard we need to understand the numbers behind this issue and why developers aren’t clamoring to communities, including Rockford to build more housing when demand is high. Simply - costs still exceed sales or rent prices.
First, the estimated national price to build a home in 2024 is still higher than sale prices in many areas of the country. Below are the averages for new home material costs only – note the exception of land and labor specifically.
Source: The Home Atlas
As the following chart shows, single family construction costs have risen significantly since we saw the last big building wave, in the late 1990s and early 2000s. Interest rates have risen as well. We are no longer in the 2%, 3%, or 4% mortgage rates and near equally as low construction loan rates, keeping in mind a developer also needs to borrow money to build a home or project. Those interest rates/costs also increase construction costs.
Source: The Home Atlas
Again, the above national historic cost trend excludes labor and land and represents materials only. Note the price of materials has doubled, or nearly doubled in all US cities since the housing boom of the late 1990s.
Now let’s dial in new single family housing construction costs for Rockford, IL.
Source: HomeBlue
Note: the above price estimates, unlike the prior price trends mentioned, include labor, but exclude land and site costs, meaning grading, landscaping, etc.
Since there is little new construction occurring in Rockford, I looked to those “Hot” sale prices, again up 52% from last year, as the Wall Street Journal cited in its article. What follows is the last 15 sales listed on Zillow for the City of Rockford, IL.
Source: Zillow
It is the point of this review that there is still significant difference between new construction pricing and the sale of existing homes, that also include the land and landscaping. Yes, there is a premium for new construction, but it can not be significantly more than the existing homes in the neighborhood that surround it. Let’s look at four samples from this list of the last fifteen sales. Those pictured below are shown in the greyed box in the chart above.
Source: Zillow
Included among the four homes pictured above are the highest per square foot cost ($155., 8440 Blue River Road) and the median per square foot price ($107., 5140 Farmington Close), again inclusive of land and landscaping. The Blue River Road home is among the newest built homes of recent sales. The Silverthorn home represents the largest home of the fifteen.
The following chart represents three new construction scenarios comparing them to similar homes from the listing of sales presented. Keep in mind, the homes above are sold at prices at the height of our market’s price points – up 52% from last year. This increase closes the gap that has long been prevalent in communities like Rockford; yet a gap remains.
New Home vs. Existing Home
The first scenario, in the chart above, compares the highest price per square foot home, the Blue River Road home with a new construction house of the same size, with comparable finishes for a cost per square foot of $190.00 indicating the middle of the premium construction class referenced earlier in this piece. Add in the lot price, of a nearby lot pulled from Zillow and the house costs $88,110.00 more to have new, or 26.1% higher than the comparable in the market. While there can be argument for a premium for new construction, an appraiser cannot justify the 26.1% premium for an equal house that lacks landscaping. Landscaping is not included in the analysis.
One could suggest that the data is skewed and perhaps other homes in the same neighborhood may provide a better example. Considering four comparable homes sold near the Blue River Road, in only one case, that of the 319 Verona comp, at $166.00/sq ft, does the scenario get better and the new construction comparison gets to a 19% gap over the existing comparable. The other three past sales comparisons drive higher cost gaps in new construction vs. existing comparable scenarios.
Source: Zillow
Looking at the balance of the New Home vs. Existing Home chart above, the largest home, also the highest sale price in the chart, comparable on Silverthorn Drive boasts a new construction price 85% higher than the existing. The median price and size homes from the chart shows a 58.1% premium for a new home of like quality and location. This gap is what has kept annual new home construction to be consistently at levels countable on our fingers as is evidenced in the following chart.
Source: FRED
Now getting to the meat of this article – how do we change this? For one with experience in the housing sector, I can state there is no one single answer. Studies and reports will say the same. Several issues are compounding this problem and solutions must come from all angles; however, the local municipalities have the largest possible solutions in their control.
At home, the City of Rockford is currently waiving costs for building permits and water connection fees while abating property taxes for three years as long as construction starts before December 31st of this year. There is absolute economic value to this, but not enough to overcome the new construction price gap. The city is also aiming to reverse the land use regulations adopted in 2008 for some platted lots and subdivisions. As I wrote in November of 2023, in Reforming Land Use Regulations and Housing Production, Zoning Code – A Rockford, IL Review, this may reduce costs by another $28,000 (estimated) and help to bridge the gap more. Since many of these restrictions applied to subdivisions where construction falls into the standard grade construction, the assistance here will have more impact, and while it still doesn’t close the gap, we are getting closer to price exceeding costs for the standard grade construction category. As is evidenced in the New Home vs. Existing Home chart the largest gaps are in the middle and upper construction qualities.
What are others doing?
The following are examples of other’s work to improve and drive housing production. These examples are cited in the National League of Cities (NLC) Housing Supply Accelerator Playbook. NLC is an organization comprised of city, town and village leaders that are focused on improving the quality of life for their current and future constituents.
Pre-Approved Architectural Designs:
· Fayetteville, AR - The City of Fayetteville is developing a program to streamline residential construction in its Downtown and Walker Park neighborhoods by offering pre-approved architectural designs. This initiative aims to expedite the permitting process, saving residents time and money while providing new housing options. There will be 30 designs available, including single-family homes, townhomes, duplexes and cottages.
· Groveland, FL - The City of Groveland, located in fast-growing Central Florida, recognized the need for a more streamlined residential development process. The city developed a portfolio of pre-approved architectural plans, complete with zoning and code approval, to alleviate the financial burden, time constraints and uncertainties typically associated with small-scale residential projects. The city is reducing impact fees for missing middle housing types and delaying fees for any developers using the pre-approved plans to allow for smaller developers to secure necessary financing.
Developer Assistance/Incentives:
· Columbus, OH - The City of Columbus introduced a $100 million Housing Action Fund aimed at expanding affordable housing options in Franklin County, implemented by the Affordable Housing Trust for Columbus & Franklin County in collaboration with Franklin County, corporate partners and The Columbus Foundation.
· South Bend, IN - The City of South Bend has introduced the Build South Bend online toolkit designed to assist small-scale developers in sourcing properties, performing due diligence, producing necessary permits and more. The toolkit reflects a collaborative effort involving local banks, contractors, real estate agents and various city departments.
· Austin, TX - The Austin Small Developer Training Program, funded by the Austin Housing Finance Corporation, offers a unique opportunity for small-scale developers, historically excluded from the market, to play a larger role in addressing the region’s housing challenges.
· Atlanta, GA - The Mayor’s Faith-Based Development Initiative (FBDI) seeks to create a pipeline of community-based organizations that leverage existing development incentives to expand affordable housing development.
Land Use/Building Codes:
· Boston, MA - In 2022, the City of Boston conducted and released the Public Land for Public Good: Citywide Land Audit. This comprehensive audit inventoried all city-owned and quasi-city agency properties, pinpointing vacant or underutilized parcels.
· Carrboro, NC - The Town of Carrboro is taking steps to address its affordable housing needs by using publicly owned land parcels.
· Tacoma, WA - The City of Tacoma launched the Residential Infill Pilot Program to allow construction of missing middle housing within predominantly single-family neighborhoods while maintaining harmony with neighborhood patterns and character. It permits four housing types, ranging from two-family residences to small multifamily and cottage housing development.
· Yuma, AZ - The City of Yuma introduced the Infill Incentive Plan to promote infill development and revitalize neighborhoods. Developed through collaboration among city departments, the plan establishes the Infill Overlay District (IO) and offers incentives to encourage development within this zone. The plan includes the Infill Incentive Toolkit.
· Several communities have adopted a full array of appropriate building codes such as the International Residential Code (IRC) or the International Existing Building Code (IEBC) to ensure that the more restrictive components of the International Building Code (IBC) are not encumbering production of new units by adding unnecessary time or cost.
Continuous Municipal Improvement:
· Portland, OR – Annual Survey, This survey is conducted annually to inform the City’s ongoing permitting improvement efforts.
· Rancho Cordova, CA – Decision Engine, The city adopted a new enterprise permitting, planning, code management, and licensing solution that easily allows citizens to connect and engage online. Rancho Cordova was the first city in the nation to launch a unique tool as part of the Enterprise Permitting & Licensing system called Decision Engine.
These are but some examples of the good work American cities are doing to increase housing production by reducing the time and money necessary to get a project off the ground. We can all learn from others, so I am hopeful a few of these efforts can be considered and help us bridge the gap and incite new housing production in Rockford to meet our current and growing workforce needs.
Is there public support for these changes? As previously noted in the study, What State Housing Policies Do Voters Want? Evidence from a Platform-Choice Experiment, the answer seems to point to yes! Excerpted from the study, “If most voters want lower home prices and rents but do not believe that more supply would make a difference, what policies do they imagine would work instead? And when push comes to shove—when voters have to choose between realizing their housing policy preferences and their preferences with respect to other social and economic matters—do they even care about housing policy? These are the questions we tackle in this paper[1]. The paper goes on to prove voters do care. Overall, we find very broad support—in the range of 75% to 90%—for price controls, demand subsidies, “inclusionary zoning” (requirements that developers set aside units for low- or moderate-income households), more government spending on affordable housing, and restrictions on Wall Street buyers.” We will discuss this last item, institutional buyers, in an upcoming column.
The long and short of it is, voters care. Business owners who cannot house their employees care. I encourage all to engage with your elected officials and encourage them to consider some of the work other cities are doing. Now is the time to be engaged and push for changes that will aid in the production of new housing. If we miss this window, chances are the pendulum will swing again the other direction and we will see property taxes increase while we watch demand die.
[1] What State Housing Policies Do Voters Want? Evidence from a Platform-Choice Experiment, Elmendorf, Nall, & Oklobdzija - April 29, 2024 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4811534