Why houses are expensive compared to average earnings is due to the huge increase in developed land prices.
Single family homes have become relatively much more expensive than other forms of residential real estate and the affordability gap is growing.
People who bought high density residential real estate (apartments and town homes) have not seen the same growth in prices as for houses. However, single-family homes on a small lot of land, have dramatically increased in price.
Why is that?
Construction Costs
The construction costs of building a house, townhouse or apartment have increased, however, the value of land has increased at a faster rate. And houses require a larger land footprint than higher density accommodation.
Why houses are expensive is mainly a function of land prices. It’s the land that’s worth the money not the house sitting on it.
When you buy a single-family home these days you are really buying land that incidentally has a house on it. The property’s value is mostly in the land and the value of the home is becoming less important.
In the 1980s a new house cost 80% of the value of a property. The land was only 20%.
Nowadays, the mix has switched around. The land is around 70% of the value of a new property. The cost of the house is only 30% and becoming less important.
Building or buying a home is like buying a taxi business which may cost hundreds of thousands of dollars. However, you are buying a taxi license. The cost of the car is trivial compared to the cost of the license.
As a result, people have to build larger homes on smaller building lots to make building a new home economical. Most new homes have very little backyard space and are very close to the neighbours’ properties. They are almost like living in a large townhouse!
Compare Houses with Townhouses
The gap between the affordability of a single-family home and a townhouse (or apartment) has widened making house prices out-of-reach for many first home (and second home) buyers.
The average land size of an older home was twice or three times the area of a new building lot. It’s not just that the land prices have increased but the lot sizes have decreased making the land even more unaffordable.
A townhouse is usually built as a duplex with a common wall or attached to many other townhouses with common walls. Each townhouse has its own lot with a small patio-style backyard.
The average lot size per townhouse is around 150 square meters (usually 10 metres wide by 15 metres deep).
Let’s have a look at some real-world examples.
A new single-story home, with 4 bedrooms, two bathrooms, two living spaces and a double garage in the early 2000s. The land cost $98,000 for 600 square meters. The complete home with driveway and landscaping cost $145,000 to build. The property cost $243,000. The land was 40% of the cost of the whole property.
A new townhouse in the same suburb in the early 2000s. The townhouse was two-story with 3 bedrooms, two and half bathrooms and a single garage. The townhouse is on 150 square meters of land and cost $150,000. The construction cost of the townhouse was around $100,000 and the land component $50,000.
Compare the two properties In 2021.
Now in 2021, land in the same suburb is around $500,000 for 450 to 600 square meters. There isn’t much new land being developed in the suburb and property developers are drip-feeding the land to the market to keep prices high.
Property developers cannot acquire parcels of land large enough to make the required economy of scale to develop land into home lots. There simply aren’t many large parcels of land left in our major cities. My house lot used to be a part of a golf course that wasn’t making money and was sold to property developers.
The property developers have reduced the average lot size down to 450 m2 and the average frontage size down to 14 meters. This makes it more difficult to build a single-story home as the land is too small. As a result, most new homes are narrow lot, two-story designs.
A new single-story home in the same suburb today the land would cost $500,000 for up to 600 square meters. The complete home with driveway and landscaping would cost at least $260,000 to build. The total property cost would be $760,000.
The land component has increased by 410% ($98k to $500k), whereas the building cost has increased 80% ($145k to $260k).
The land would be over 65% of the cost of the whole property. In other more expensive real estate developments the land component can easily be over 70% of the cost of the whole property.
The townhouse is now valued at $350,000. The construction cost of a new townhouse would be $180,000 and the land component is $170,000.
The land component has increased by 240% ($50k to $170k), whereas the building cost has increased 80% ($100k to $180k).
So what does all this mean?
Home Building Lots are Expensive
As you can see from the above information building costs have increased by the same rate (80%) for both properties. You would expect that to be the case as there is little difference between building a house and a townhouse. The construction is the same – concrete slab, timber framing, brick walls and tile roof.
However, the cost of a home building lot has dramatically escalated.
Why houses are expensive is mainly a function of land prices. All land has increased in value but the rate of increase in house lots is almost double the rate of increase of land prices for townhouses.
Why is that?
There are many reasons including increases in the costs of clearing land, council fees, engineering fees, building roads, installing sewage and drainage, supplying utilities like water, power, gas, telephone and internet services.
However, the main reason is that as our cities grow in size there is less undeveloped land available for subdivision. The cost of developing land has become more expensive per square meter.
Let’s look at the above prices.
In early 2000s, the land component of the townhouse was $50,000 for 150m2, $333 per m2. The land value is now $170,000, so the cost per square meter is $1133 per m2
The 600 square meter house lot cost $98,000 in the early 2000s, $163 per m2. The land value is now $500,000, so the cost per square meter is $833 per m2.
Land (per square meter) for a townhouse used to cost about double the cost of vacant home lots.
Now the townhouse land is only 1.35 times the cost of vacant home lots.
Or, in other words, the cost for property developers to develop townhouse sites is much less expensive than developing an estate of vacant home lots.
Please read The Best Time to Buy Real Estate
Conclusion
Why houses are expensive is mainly a function of land prices. The value of the land component of a residential property has increased to the point where the majority of a property’s value is the land.
As land prices continue to rise and houses become more expensive fewer first home buyers will be able to afford a single-family home. More people will be forced into smaller properties, such as townhouses and apartments, which have a smaller footprint of land.
Eventually, our cities are going to follow the trend overseas. In a few generations we may all be living in apartments. The only way to get a single-family home on your own land would be to move out to a country town.