If you have been active in real estate over the past 18 months, you know that a lot has changed since spring of last year. Although housing prices and the cost of labor and materials needed for construction were rising at a troubling rate prior to the emergence of the COVID-19 pandemic in the United States, the trend, like many during the pandemic, has only accelerated. Today, the surge in lumber prices alone has added more than $35,000 to the price tag of an average single-family home, for example, while National Association of Home Builders (NAHB) chief economists warned at the end of April 2021, “We need to do everything we can to increase domestic supply [of lumber], including producing more domestic lumber …. It is a matter of housing affordability.”
For real estate investors, the cost of lumber and other trends related to new construction in today’s housing market do not necessarily have to mean you are out of options for investing. However, these trends do affect many tried-and-true strategies for investors.
Here are three things you need to know about new construction investments in 2021 before getting involved in your next deal.
1. New Construction Costs are Not Just Associated with Lumber
Because lumber prices are relatively easy to track, analyze, and explain, the media tends to focus heavily on these costs. This is especially true since there are trade-related policy issues also associated with lumber costs.
However, sometimes the coverage can be misleading. That $35,000 mentioned above? That is actually the cost associated with lumber in an existing home. Rising lumber prices have added only about a third of that to new-construction homes, the NAHB reported at the same time.
Costs adding the new construction expenses include slowing production, cost of other materials such as drywall and copper, and the cost of land itself, which is up 11 percent.
2. Land Costs are Not Slowing Down Land Grabs
Because of the rising costs and limited availability of vacant land (new lot supply was down 20 percent year-over-year in April), developers with access to land are engaged in all-out “land grabs” in many parts of the country. Imagine the bidding wars currently going on for attractive single-family residences, then multiply the volume exponentially. You would have a fairly good idea of what is going on in the vacant-land space, right down to the emotional incentive to acquire land at any cost.
Builders are over-bidding on land in some cases and, in others, investors funding the deals are not necessarily getting good deals on land for development because there is too much pressure on the builders to acquire the land at any cost.
“There is a literal land grab going on as builders are scooping up lots to better match housing supply with demand,” Zonda’s chief economist, Ali Wolf, observed. She warned that new-construction is currently “underperforming its full potential,” a trend likely to last as long as lot shortages continue. She also noted that builders are engaged in hot competition for supply in suburban areas, pushing up prices in those areas as well.
3. Don’t Forget to Price Commodities
Many new-construction investors are beginning to be intrigued by alternative building materials, such as steel, in order to combat the effects of skyrocketing lumber prices. For example, steel-frame construction for residential real estate is emerging as a viable alternative for developers willing to adjust their construction strategies to accommodate new materials.
However, just changing the emphasis in construction from lumber to steel will not necessarily improve the situation unless an investor is working with a developer with an established, contractual pipeline of steel supply. After all, the cost of steel products, which are used in all new construction in the form of some beams, sheet metal products, and wiring, was up nearly 20 percent year-over-year this past March.
Gypsum prices were up nearly 7 percent at that time, and copper prices had risen 27 percent. In fact, some analysts are predicting that copper will soon enter a “super cycle” (along with oil and gas, nickel, and lithium) due to its use not just in housing but also in solar and wind energy generation, electric cars, and battery-charging technology.
New Construction is Not the Only Option
In April, many investors began to seriously consider new construction as an investment strategy because it felt slightly more accessible than existing-home investments. This was due to the release of some slightly misleading data in the housing industry in April that made it appear that new construction homes might actually be more affordable than existing homes.
While median prices for both types of property are currently high and still rising, the truth of the matter is that in most cases, if you buy judiciously with an eye toward how much lumber you are likely to need to renovate a fix-and-flip or a rehab-to-rent property, you can certainly still generate greater returns acquiring existing properties rather than building new ones from the ground up.
Robert Dietz, NAHB’s chief economist, emphasized, “On a per-square-foot basis, within comparable markets, a new home is still priced higher than an existing home.” The issue, of course, is that there are not many new or existing homes available, and most individual investors are finding it makes the process of finding and acquiring viable investment properties much easier if they pair up with established, boutique investment firms operating in accessible markets mainly in the southeast. Dietz himself noted that home prices are “overall cheaper” in the southern United States, which is naturally increasing competition in this part of the country.