As demand drops to more normalized levels, lot pricing becomes more common.
By Greg Vogel
2021 has been a very active land and lot market for builders, developers and those who advise them. It has been a vibrant, edge of your seat situation where all participants are transacting with a level of fear (of missing out). This is resulting in record-setting completions of land and lot transactions closing as scheduled at contracted prices. At the Land Advisors Organization, we have seen transaction completion rates soar from 66% to over 90% in our markets across the nation.
The surge in activity and dollar volume raises many questions and has led to comparisons of the current land and lot market to the bubble era of 2004-2007. The critical primary difference is housing supply. The current lack of housing supply compared to the wild surplus of housing built between 2004-2007, combined with the current and ongoing lack of ability to create a bubble of excess inventory, play a significant role in the differences in eras.
Recently, waiting lists for new homes have lessened, and demand has dropped to more normalized levels in some regions and price points. The national resale market has 2.6 months of supply, up from 2.3 months at the beginning of 2021, according to the National Association of Realtors®. However, resale supply is still 35% below 2019, and the supply shortage is a massive driver of new housing demand.
Markets have begun to outprice the consumer’s ability and the willingness to buy a home. This outpricing will not cause massive deflation in value as we experienced in the Great Recession but will lead to stabilization from hyper to normalized inflation, which we are beginning to see.
Inflation is present in relation to housing. Fortunately for builders and developers, the rise in costs versus pricing power has been a net benefit. Even with cost inflation, builders’ pricing power is still quite present in most markets across the US.
The national new median home price of $383,000 has escalated 16.2 percent over the past 12 months, according to John Burns Real Estate Consulting. The escalation in house price disproportionately rewards the underlying land and raw lot value as the gap between home prices and lot finishing costs grows wider.
This is not a “static” analysis as building product inputs, and lot finishing costs have also increased, weighing down a portion of the “hockey stick” rise of underlying land value. Land value “is the residual of all costs and a reasonable profit.”
The recent House Price Appreciation (HPA) has allowed for there to be renewed attractive risk adjusted returns and substantial margins for land developers, financiers and especially land investors.
Scarcity of inventory of entitled and finished lots is a growing factor in lot pricing as well. The typical lot is priced by a ratio of 20-30% against the projected final selling price of the house. A $450,000 house at a 25% ratio equates to $112,500 for a finished lot. Today, a builder in the same area is paying $140,000 per lot, resulting in a 31% lot ratio. To maintain a 25% lot ratio, the same $450,000 house would need to be priced at $560,000.
Finished lot scarcity pricing is beginning to be the new calculator for house price rather than current new home price driving what can be paid for a finished lot. Tension to solve to a 20% gross margin requires a reasonable lot ratio to be maintained, and HPA is the current resolver.
Lot scarcity continues to rise with cities, engineers and contractors being backed up and supply chains for certain horizontal materials being stressed. Lot entitlement, development and major infrastructure will take at least 3-5 years to meet the demand of the nation’s growing population, massive migration, along with the rising wealth of millennials looking to achieve the American dream of homeownership.
The outlook calls for stabilization of the land, lot and housing market as the industry rises to the occasion to get to a fair balance of supply and demand. Don’t look for ugly deflation of house price, therefore lot price, and therefore land price in the several years ahead as no formula exists among all these ingredients to cause the effect.
Greg Vogel is CEO of Land Advisors Organization based in Scottsdale, Arizona and serving 26 markets across the United States.