The goal of the Fed’s decision to increase the benchmark rate was to ultimately lower prices. That is now beginning to happen, but many other things have been affected in the meantime. One is builder confidence. As can be expected, rising interest rates are causing lower demand for buyers, including new construction buyers. That means builders are getting less business. This is not a good sign in an environment that many believe is best solved through increased construction.
The Fed’s decision may be starting to solve one issue, but is it actually the optimal solution? Could something else have been done? Maybe, maybe not. According to the National Association of Home Builders (NAHB), the Housing Market Index (HMI), of which builder confidence is one component, was actually already below 50, which is the midpoint indicating neutral confidence. This is despite multiple laws making construction easier, especially for affordable housing. HMI dropped 5 points from 38 to 33 between October and November. Back in November of 2021, it was at 83. The builder confidence score in particular dropped six points from 45 in October to 39 in November. Though the problem is national, with decreases in every region, different regions have different levels of builder sentiment. The South dropped the most, by seven points, but still has the highest builder sentiment of any region at 42. Builder sentiment is by far the lowest in the West, at 29, despite only dropping five points. The smallest change was in the Midwest, dropping merely two points from 40 to 38.
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Two more bills aimed at increasing multi-family construction go into effect July 1, 2023 after Governor Newsom signed them into law in September. These are AB 2011, called the Affordable Housing and High Road Jobs Act of 2022, and SB 6, the Middle Class Housing Act of 2022. Both laws sunset nine and a half years later, on January 1, 2033.
AB 2011 adds a secondary review pathway for some multi-family construction projects. If the project meets affordability standards and site criteria, the review will not take into account conditional use permits or environmental impact reports. The site must be primarily commercial, and unless it’s a commercial corridor, 100% of the units must be below market rate. Even if it is on a commercial corridor, 15% of the units must be below market rate. AB 2011 also includes provisions for fair pay and additional training for construction workers. SB 6 expands the types of buildings that can be constructed in areas zoned for office, retail or parking. These buildings may be residential if they meet certain other criteria, many of which are similar to the requirements set forth in AB 2011.
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Construction has had multiple ups and downs in recent years as a result of the pandemic and surrounding economic factors. Throughout it all, multi-family construction has actually done pretty well. In fact, it’s currently at its highest rate in the last fifty years in terms of total number of new multi-family constructions. Unfortunately, that doesn’t mean it’s high — construction has been in a slump for the past thirty years, and meanwhile the population has been increasing.
Los Angeles has it the worst of any US metro, underproducing by about 400,000 homes. This is despite the fact that it’s also one of the top metros for multi-family construction. In large part, this can be attributed to the fact that it is the second most populated metro in the US. But the real issue is restrictive zoning laws, which are only recently being changed in California. The vast majority of homes in the Los Angeles metro are single-family residences because that’s what the lot’s zoning allows.
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The housing crisis is a well-established issue and many efforts have been made, or are in the process of being made, to address it. Most of these efforts are focused on low-income housing, since it ensures that the greatest number of people are served by it. However, San Diego faces a different issue. A significant number of residents don’t qualify for affordable housing programs and are instead looking at middle-income housing. Unfortunately for the city, they aren’t able to receive federal subsidies for middle-income housing construction.
So now they’re beginning to devise a plan. The city’s Middle-Income Housing Working Group has recommended a combination of immediate actions, short-term plans, and long-term plans. Immediate steps include streamlining codes and review processes, creating a list of public land available for middle-income housing construction, and converting public facilities to mixed-use structures. Future plans include tax modifications, a public rent registry, construction loan guarantees, investing in community land trusts, and redirecting philanthropic funds to middle-income housing.
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New constructions are always built to certain specifications, whether that’s tract uniformity or client’s wishes. In the latter case, the client is usually also going to be resident. That’s starting to change, as investors are noticing that renting is becoming a lot more common as prices rise. Investors are now getting new constructions built for the express purpose of renting them out.
Only 3% of new construction SFRs were build-to-rent in 2019. By the end of 2021, this number jumped to 26%. It’s not entirely clear if this will continue to increase or not. While increased inventory of rental properties does benefit renters, renting is rarely a desired state. Almost everyone would prefer to buy if they can afford it. But it’s not renters pushing the trend. It’s the investors, and they stand to benefit as long as renters must continue to rent, whether they want to or not.
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Accessory Dwelling Units (ADUs) have been contentious for a while, but SB 9 has passed recently, ostensibly making them easier to construct in California. Unfortunately, this hasn’t panned out as well as expected, as local governments aren’t entirely on board. They’re trying to sidestep the requirements by introducing zoning ordinances that effectively, but not explicitly, ban ADUs. Zoning restrictions have always been the largest obstacle to ADUs.
What clearly isn’t much of an obstacle is popular support. Particularly in California, major cities are seeing support of over 70%, even up to 80% in San Jose. But California isn’t the only state. Nationwide support is at 69%, with the remaining 31% split between opposing and indifferent. It’s no surprise that more renters than homeowners support it, since they’re more likely to be searching for housing. But both groups show strong support — 76% of renters and 66% of homeowners.
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With government support having ended, this may prompt people to think the economy has stabilized and recovery is imminent. But this is just the precursor to a stable market. The market needs time to adapt under normal conditions, and probably won’t become stable again until 2024. The main factor in overall recovery is the job market, which has yet to fully recover, and a stable real estate market requires construction to catch up to demand.
Some policies remain from government actions during the recession, though. Three laws — SB 10, AB 345, and AB 571 — will help out in construction efforts. SB 10 allows more areas to be zoned for up to 10 units, AB 345 allows ADUs to be sold separately from the primary residence, and AB 571 prohibits impact fees on affordable housing. Two more laws, SB 263 and AB 948, reformed bias training for real estate professionals. This legislation should have lasting impact in making the recovery more comfortable.
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While it’s now legal to build multiple units on land previously zoned for single-family residences (SFRs), the cost of construction is still high. The costs of acquiring a site, making sure to conform to environmental codes, and building from scratch definitely add up. Builders aren’t able to work out a positive return on investment for new constructions.
They can cut a lot of the costs by using existing structures and renovating them. But, many of these structures are zoned for commercial use only. There are certainly zones that can be commercial or residential as needed, but not nearly enough to satisfy buyer demand. New zoning laws in the Los Angeles metro area and in the San Francisco Bay Area have facilitated conversions from commercial to residential, but even that isn’t enough. And in areas without these new policies, such as the San Diego and Sacramento metro areas, conversion rates are dramatically lower.
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Builder confidence plummeted in April 2020 after the start of the pandemic and recession. As time went on, they slowly regained confidence since demand was high. But demand was too high, and lumber prices accelerated upward, causing builders to hesitate again. Builder confidence is below the levels from the start of 2021, though higher than it was in mid-2020.
Now, lumber prices are starting to fall back down. But the reason for that is decreasing demand and rising interest rates, the exact opposite of what caused prices to rise in the first place. With demand decreasing and prices now on a downturn, builders still aren’t sure whether it’s a good or bad time to buy lumber. They’re expecting more vacancies, which means less need for new construction.
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In Long Beach, construction has now started on a seven story residential building on The Promenade. The structure, currently named The Inkwell but subject to change, will have 189 units as well as 10,000 square feet of commercial space on the ground level. It will also have a fitness room, club room, pool decks, and pool. Subterranean parking is available, with 268 car stalls and 40 bike stalls.
The Promenade is an established commercial district, with multiple popular restaurants within walking distance of the new building. Business owners in the area have mixed feelings about the new construction. While it’s sure to bring more traffic to the area once it’s completed, we can guess that’s probably 18 to 24 months away from now. In the meantime, dust and construction noise are likely to cause a dropoff in activity for local businesses, particularly during lunch hours. Some of these businesses are just getting back on their feet after a rough time during the pandemic.
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The nonprofit company Restore Neighborhoods LA (RNLA) has just built a small homeless housing development in the Vermont Knolls neighborhood of LA. The cost per unit to build was a mere $225,000, less than half of the $500,000 average for homeless housing in LA. With only eight units, it does little to solve homelessness on its own, but RNLA hopes its financing strategy can be used by others to build more affordable housing faster.
How many builders get money is called the “lasagna of financing” — acquiring funding from several sources, including city, county, state, federal, and private sources. Going through this process takes time, as each different source requires a different application and approval process, and things could change between getting approval from one source and being rejected by another. It could also incur additional costs, such as application fees and hiring financial and legal experts. RNLA instead avoided this bureaucracy by opting for mostly single-source financing. They received the entirety of their $920,000 loan from a single private company called Genesis LA, and the rest of their financial support came from LA county grants and crowdfunding.
Unfortunately, it’s not likely that many builders will be able to acquire funding in this way for larger projects. Single sources simply don’t have the money, or don’t want to risk it, for a large project. The lasagna system has the benefit that no single source is incurring much risk, since they are each able to finance a smaller portion of the costs.
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Populous cities are generally considered to be higher density areas, but in some of the largest cities in California, about 75% of the land is zoned for single-family residences. The history of the overabundance of SFRs can be traced back to segregation. It was a tool designed to price out lower-income Black people from predominantly white neighborhoods, something which cities hope to rectify with new zoning laws.
Though many people aren’t aware of the racist roots, and rezoning isn’t going to completely eliminate racism, SFRs are outdated in more ways than one. California desperately needs more affordable housing, but building large apartment complexes is expensive for construction companies. The middle ground is medium-density housing, such as triplexes and fourplexes. To that end, San Francisco has drafted plans to allow fourplexes in every district considered a residential district. A few other Bay Area cities are considering similar plans.
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The first 3D-printed house was put on the market last month, and already multiple other companies are following suit in other states. SQ4D is the company that started it all in New York, and Texas was the first to get on the bandwagon, with ICON completing four 3D-printed homes in East Austin. 3Strands followed suit in Kansas City, and Mighty Buildings in California is also working on a project.
3D printing buildings didn’t just start out, though. ICON actually built several a year ago. They just never went on the market, because they were built as homeless housing, not for-sale properties. ICON has the most experience, but they are no longer without competition. Their biggest competition currently is thought to be Mighty Buildings, which actually started back in 2017 but has taken the time to develop what they hope to be more cost-effective and energy-efficient building materials.
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During the 2000s, California’s population increased by 2 per new housing unit constructed. With an average varying between 2 and 3 people per household, this was a fairly sustainable rate of construction. Unfortunately, construction has slowed at the same time that population is still increasing. The ratio is now an increase of 4 per new housing unit constructed. The state has passed laws to combat the housing shortage, but it’s not enough.
UC Berkeley’s Terner Center may have cracked the code. They’ve done a case study of one San Francisco project that was completed 30% faster and 25% cheaper than similar projects, and identified the key factors that led to its success. According to the Terner Center, they are 1. an upfront commitment to low costs and a quick construction, 2. flexible funding, 3. streamlining the approval process, and 4. taking advantage of modular construction, so that some parts of the construction can be done in parallel with others. This is going to require the aid of local governments to make flexible funding more available and modify the approval process.
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New York construction company SQ4D may have the latest and greatest in construction technology. They’ve used a giant 3D printer to print houses from the bottom up out of concrete, right on the site. Their first demo house, as a proof of ability, was in Calverston, New York. The next one is already up for sale, despite not having been built yet. The 1400 square foot house will be located in Riverhead, New York and is listed at $299,000.
This isn’t just some publicity stunt. 3D printing has some real benefits. Most notably, construction is significantly shorter. SQ4D’s first house took just eight days to build — and that includes the planning process. The actual construction? 48 hours. Making the process this quick must incur significant expenses, right? Well, no, it was actually cheaper according to SQ4D. The transportation and labor costs associated with traditional construction mean that 3D printing is about 30% less expensive. The new method has been met with some skepticism, though. No one is sure exactly how this will affect the construction industry, as skilled tradesmen may suddenly find themselves replaced with printers.
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Low mortgage rates have resulted in increased buyer demand, and shifting preferences in home features are specifically increasing the demand for new constructions. With sellers waiting out the pandemic, there aren’t many existing homes available for sale. In addition, they don’t always have the features that the new generation of buyers is looking for, such as home offices, larger spaces, and outdoor amenities.
Chief economist Robert Dietz of the National Association of Home Builders (NAHB) predicts a 5% increase in construction starts by the end of 2021. Even so, buyer demand is expected to continue to outpace construction, so sales of existing homes will likely also increase. Builders are going to have trouble keeping up, not only due to lack of time or labor, but also because of increasing costs. The cost of lumber has gone up 169% since April 2020, the month after lockdowns started. Construction companies also report significant issues with obtaining timely approval and navigating new construction ordinances.
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In many cases, high-profile construction companies will purchase large areas of land and build many homes at once. In theory, this ensures that once this project is finished, they will already have homes available to purchase while they start their next project. This theory has started to break down in the current market, as demand has far outpaced construction in the wake of the pandemic lockdowns.
In fact, many buyers not able to find what they’re looking for among the low inventory of homes are actually purchasing homes that haven’t even been built yet. New residential construction sales went up 20% between November 2019 and November 2020. In some cases, buyers will contract builders to build new homes on a plot of land they have bought, but this isn’t the norm and doesn’t explain the surge in new construction sales.
A big part of the problem is that builders aren’t building. During the past year, they simply couldn’t, as lockdowns and rising costs of business made it near impossible to finish construction projects. But the issue started long before then. California’s most recent peak in SFR construction starts was in 2018 at 62,600, but this pales in comparison to the 2005 number of 154,700. And this is just SFRs — multi-family construction is also dropping. Meanwhile, more and more homes are needed, as California’s population increased by 17% between 2000 and 2018.
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Residential construction of both single-family residences (SFRs) and multi-family housing has been on a downturn since the most recent peak in 2018. SFR construction in particular is a long way down from the 2005 numbers when they started to nosedive, while multi-family housing construction has been relatively stable since the 1980s, albeit much lower than it should be.
The number of SFR starts in 2020 is projected to be about 53,000, 10% lower than in 2019 and less than a third of the 2005 number of 154,700. Multi-family housing construction has rebounded from the 2009 trough, but at an expected 48,000, is still down 5% from last year. For multi-family housing, the 50,300 value in 2005 was actually lower than the 2017 and 2018 peak of 53,800 both years.
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