What’s It Cost?
Rob Goodspeed has a post up on the economics of the decision to build on vacant land in the District. I’m into it and with him right up to this section:
Costs of construction can vary depending on a host of factors and the design and character of the structure. The RSMeans website provides a free calculator for zip-code specific costs for various types of buildings. Each estimate includes the building cost, contractor profits, and architectural fees. Using their free cost estimator, I estimated the cost of a 2,313 square foot wood frame apartment building. The estimates ranged from $806,766 on the low end to $1,120,508 on the high end. Recently contractors have been affected not only by increased costs of gasoline, but also increasing costs for metals, piping, and other raw materials. Furthermore, the historic preservation review process may have resulted in additional architectural fees.
I’m sorry, but if the cost to build a 2,300 square foot, wood-frame house was $800,000, nobody would ever build a thing in the District. Forget about it. Not only that, Rob is comparing the sale price of a property in Shaw to the construction cost, but the sale price includes the construction and the value of the land on which it sits–and for most properties in the District, the land value is at least as high as the construction value. If construction costs were $800,000, no one would build for sale unless they could get well over a million for the home. And we see infill construction throughout the city, despite huge variation in sales prices per square foot. Do we really think construction costs vary that much from Cleveland Park to Shaw to Deanwood?
So what’s going on here? I suspect the problem is that the cost estimation site Rob uses doesn’t have a single-family home category, so he has to estimate the cost for an apartment building. This will surely involve extra expenses, and it will also assume that the final property will be sold as 2-4 condos rather than one home.
Don’t get me wrong; it’s more expensive to build in the District than in the suburbs, where you could probably put up a 2,300 square foot home for under $200,000. But I think the reason that vacant lots aren’t developed as quickly in the city as they could be isn’t really related to construction costs. Rather, it’s about tangled ownership, zoning and permitting hassles, uncertain markets, and collective action issues–if you have a piece of property in an up and coming neighborhood, you can develop and sell it now for $500,000 or wait three years and get three times that. As such, everyone is waiting for everyone else to build.
August 18th, 2008 at 10:58 am
Yeah, I’ll bet the costs for an apartment building are much higher because of various codes that you don’t need for single-family homes, such as sprinkler systems and other fireproofing, etc.
Getting clear title on many of these vacant urban lots can be a huge issue.
This is also saying nothing of various on-site parking requirements that make the redevelopment of small, row-house lots difficult.
August 18th, 2008 at 1:50 pm
For an end-cost of a single-fam of that type, you should be able to build a house with nice finishes, trim, countertops, non-wavy walls, etc for ~$200-225/sf. Maybe $10-15 more in that market, not sure.
But credit is tight, and depending upon how long permitting takes (1 lot should be 3-6 months, max), you are carrying expensive paper for a long time unless you building custom and not spec.
August 18th, 2008 at 4:27 pm
The RSMeans construction calculator appears to exclude the cost of land. It estimates about $600,000 construction costs for a 3 story 2,300 square foot “apartment”, and includes $200,000 of design, fees, etc. These are reasonable estimates.
Townhouses are generally slightly cheaper to build than condos (excluding land costs). A townhouse could easily be built on the site referred to by Rob for under $400,000 (hard costs).
Taxes, permitting, and the general hassle of the DC government are the hidden costs. That’s what makes development in DC so challenging.
August 18th, 2008 at 7:09 pm
Taxes, permitting, and the general hassle of the DC government are the hidden costs. That’s what makes development in DC so challenging.
Indeed. My Byzantine last place was locally famous for making developers eat Pepcid and accrue interest on paper.
August 19th, 2008 at 11:40 am
”If you have a piece of property in an up and coming neighborhood, you can develop and sell it now for $500,000 or wait three years and get three times that.”
If! a/k/a Pie in the sky.
Would you pay $500k to buy into this wishful thinking? 3X in 3 years is not a credible scenario. Were it credible the property would be worth more than $500k.
- GovtWork
August 19th, 2008 at 11:52 am
It’s not the three years that’s important, it’s the action of the other landowners. The property is worth $500k without other developments around it, and $1.5 million with. Were everyone to develop now, everyone would win. Since coordination isn’t feasible, everyone waits.
Over time, individual landowners are forced by their particular financial constraints to develop. Eventually a critical mass is achieved and everyone rushes in. The equilibrium shifts. This isn’t an appreciation argument. It’s a collective action argument.
August 19th, 2008 at 12:19 pm
includes $200,000 of design, fees, etc. These are reasonable estimates.
Speaking as an architect who’s done a LOT of urban infill development, I don’t see how you get anywhere near $200k in soft costs. I mean, I’m looking at an order of magnitude off, or at least 5X. Architect’s fees are going to be in the neighb of $10k (unless you’re looking at something one-off and unusual, in which case these numbers don’t matter, because you’re evidently not trying to save $$)). Permit fees in the same neighb. Obvs. there’s interest and other carrying costs, but nothing like $175k. If you’re doing ground-up construction, historic preservation adds little time to the process, and maybe a few grand in fees (plus potentially higher construction costs, but you’re getting more quality for those costs - it’s not a sinkhole). Once you clear title and get a bank on board, you should be able to complete a building of this scale in ~10 months - 3 for design & permitting, 6 for construction, 1 for whatever.
The biggest diff. between urban and suburban construction isn’t the bureaucratic stuff everyone freaks out over (most suburbs have zoning and building codes, too); it’s that urban construction is generally one-off and infill, whereas suburban is tract housing. Economies of scale, plus plenty of elbow room - if your roof trusses arrive a week early to a constrained urban site, you’re screwed; if they come a week early on hell’s own 1/6 acre, you just pile em up over there and put down a tarp.
August 20th, 2008 at 9:46 am
”It’s not the three years that’s important”
- ryan, August 19th, 2008 at 11:52 am
Three years isn’t ‘important?’ then change 3 years to 30 years and reevaluate your scenario. Three years is important to anyone who understands the time value of money.
”Were everyone to develop now, everyone would win.”
- ryan
So it’s better for a developer to compete for tenants with a dozen new buildings than to be the only new building? because the added competition makes your new space more attractive at even higher per square foot prices?
What have you developed other than your erroneous theory of how the world works?
- GovtWork
August 20th, 2008 at 10:20 am
You’re entirely missing the point. Yes, new supply would place downward pressure on price, though in the context of the city or metropolitan real estate market, the effect would be pretty small.
On the other hand, there is positive pressure on prices based on the neighborhood effect of development. Can a landowner command higher rent for a retail property on a street filled with vacant shells or on a retail property surrounded with rehabilitated spaces? You walk around Washington and tell me. And the ability to attract tenants isn’t independent of the number of properties being developed. Demand for a lone property on a run-down strip is going to be quite low.
You seem impressed by your ability to play with marginal analysis. In urban real estate, there’s a lot more to it than that. There are significant positive externalities to development, so without coordination or government subsidies, we get less and slower good development than is optimal. And the proof is in the pudding. If you actually pay attention to urban redevelopment, you see that it proceeds at a trickle until a critical mass is achieved, at which time it becomes a flood.
August 21st, 2008 at 9:37 am
”You’re entirely missing the point. Yes, new supply would place downward pressure on price, though in the context of the city or metropolitan real estate market, the effect would be pretty small.”
- ryan
The downward pressure on rents in the new buildings is the point. The rental rate that new buildings can command is vital. Unless, as a developer, you’re in the business of losing money as a public service.
Your ’small effect’ on ‘the context of the city or metropolitan real estate market’ is irrelevant, a red herring introduced to obfuscate the fact that you haven’t the slightest idea what you’re talking about.
”If you actually pay attention to urban redevelopment, you see that it proceeds at a trickle until a critical mass is achieved, at which time it becomes a flood.”
- ryan
One cliche after another. Most urban redevelopment projects are disasters. It would be better to remove all zoning from a so-called blighted area and let the market provide. Unfortunately, the little fascist redevelopment masters of the universe think they know better.
- GovtWork
August 21st, 2008 at 9:53 am
Most urban redevelopment projects are disasters.
Ok, troll, you get no more comments until you actually set foot in a real city. That’s the most laughably false thing I can recall a commenter writing at this blog.
August 22nd, 2008 at 9:45 am
”Ok, troll, you get no more comments until you actually set foot in a real city. That’s the most laughably false thing I can recall a commenter writing at this blog.”
- ryan, August 21st, 2008 at 9:53 am
Your readers will decide 1) what’s true and false, and 2) who has real-world experience, and 3) at whom to laugh.
- GovtWork
August 22nd, 2008 at 12:35 pm
ryan Says on August 20th, 2008 at 10:20 am:
Now, look at putting together a portfolio in that situation. This creates a situation in which the average return is substantially greater than the median return. That situation favors those who can put together a broad enough portfolio of property to be able to participate in those areas that do take off.
And holding that portfolio reduces the incentive to invest a lot of time and effort into making that redevelopment take off in any given area, since there appreciable odds that you are spending time and money to simply shift gains from one property you hold to another property that you hold.
And of course its elementary game theory that “free markets” move in fits and starts when confronted with anything resembling a pure coordination game, so that an external intervention can easily result in a more efficient market outcome.
In the policy context, how do you target those smaller stakeholders who have a much greater exposure to gain and loss based on whether development succeeds in a particular neighborhood?
It seems like a version of the redevelopment loan forgiveness program would offer some promise. Identify target neighborhoods, identify qualifying borrowing, and refund interest expenses on the borrowing out of a set share of property tax increases from property value gains over the following five years.
Oh, and the pools are annual, so 1/5 of the pool in one year to those that financed the improvement in each of the five preceding years.
That seems like it would advance the trigger on when redevelopment in a designated neighborhood becomes a self-perpetuating process.
And of course, while those that move first must still wait longer to get their gain, as early movers, they also get a larger share of the interest sharing pool.