Owning a home has long been a cornerstone of the American Dream, and for decades the building of new, entry-level homes has helped to make homeownership possible. As the country grew, construction of smallish houses with basic features met rising demand and kept such homes affordable for first-time buyers. But for many people across the country and in the Ninth District, aspirations of owning a new “starter” home are butting up against hard market reality: escalating prices for that cozy bungalow, no-frills rambler or modestly appointed townhouse.
Two to three years ago, newly built homes priced under $200,000 were fairly common in the Flathead Valley of western Montana, said Jim Kelley, a property appraiser in Kalispell. Today such homes are a “vanishing species” in the region, he said. In September, the median list price for both new and existing single-family homes in the Kalispell metro area was almost $400,000—far beyond the means of households with incomes at or near the median for the area. “My personal opinion is that we’re in the process of pricing people out of housing,” Kelly said.
Other communities in the district where rising prices for new homes are putting stress on affordability include Missoula, Mont.; Minneapolis-St. Paul, Rochester, Minn.; and Rapid City, S.D. In many areas, high prices for new homes are contributing to price increases for existing homes, leaving renting or publicly subsidized housing as the sole options for residents whose incomes no longer qualify them for homeownership.
A number of factors have converged over the past few years to increase the price of newly built, single-family housing, including homes at the lower end of the market.
In some communities, strong demand for new homes isn’t being met due to scarce buildable land and other constraints, bidding up home prices. More generally, an array of forces is driving up the cost of building houses, among them rising labor and materials costs and, in some parts of the district, increasingly stringent building codes and high development impact fees. Many homebuilders in the district are struggling to keep down the costs of even the most basic single-family housing.
“The cost of building has gotten so high that a fairly significant number of consumers simply cannot afford a home,” said Dale Wills, president of Centra Homes, one of the largest homebuilders in Minnesota.
Affordable single-family housing is key to the economic and social well-being of communities. Homes priced to fit the budgets of households earning moderate incomes help employers recruit workers and foster a diverse residential mix that includes people at different income levels (see “Houses are where jobs sleep at night”).
Homebuilders and local governments are exploring a number of ways to cut the cost of developing entry-level homes, or at least hold the line on rising prices. Potential avenues to greater affordability include modular home construction and the relaxation of land-use regulations to permit lower-cost, innovative housing development.
No direction home
Last year, Lawrence Yun, chief economist for the National Association of Realtors (NAR), succinctly stated the fundamental problem confronting prospective homeowners: “Home prices are still rising above incomes and way too fast in many markets.”
Nationally, incomes have grown very slowly since 2012, after adjusting for inflation (Chart 1). Over the same period, single-family homes have appreciated at a faster pace, according to NAR figures. (While nationwide income growth has picked up over the past two years—the U.S. Census estimated that median U.S. income increased 3.2 percent in real terms in 2016—income growth in district states was more muted, and in North Dakota median household income fell slightly that year.)
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The consequence is that many people who in years past had the wherewithal to buy a home find themselves shut out of the market today.
Comparing the median price of a home to median household income is a widely accepted measure of affordability in housing markets. Newly built smaller houses with modest amenities and finishes—a typical first or starter home—are usually priced near the median for all homes, and this price is quite close to what middle-income households can afford. Households with incomes less than about 80 percent of the median are likely to rent instead of own. The higher the ratio of median home price to income, the more likely a household is cost-burdened, spending more than 30 percent of its annual income on housing.
A fedgazette analysis shows that in some district metro areas—Duluth, Minn., and Marquette, Mich., for example—homes are relatively affordable by this measure, and prices haven’t increased much relative to household income in recent years. In other markets (Chart 2), home price increases have outstripped income gains. In a few metro areas, such as Missoula and Rapid City, elevated home price-to-income ratios have risen even higher since 2014.
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Analyses by Realtor organizations in a number of district communities have also found that rising home prices are eroding affordability. Monthly reports by Southeast Minnesota Realtors, which represents real estate agents in Rochester and surrounding communities, show a decline since 2014 in the ability of a middle-income household to buy a median-priced house, assuming standard financing at prevailing interest rates. SEMR’s “affordability index” fell 12 percent in the first 10 months of this year compared with the same period in 2016.
A 2017 housing report by the Missoula Organization of Realtors found that affordability had progressively declined in the urban area since 2012. In 2016, the median area income needed by a family of four to buy a median-priced home with a minimal down payment (4 percent) was almost $90,000—46 percent higher than the actual median income. “The affordability of homes in Missoula is probably our biggest challenge in the market,” said Brint Wahlberg, an area real estate agent who contributed to the report.
This picture of waning affordability comes into even sharper relief for newly constructed homes. Nationwide, median prices of new homes have tracked about 15 percent above prices for existing homes for much of the past 25 years (Chart 3). But since the recession, the two trend lines have diverged, with consistently higher prices for new homes during the economic recovery.
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Comprehensive data on new-home sales at the state and local level aren’t available, although figures compiled by Realtor groups in some district markets mirror the national trend. In Missoula, the median sales price of a new detached, single-family home rose 8 percent annually from 2013 to 2016, to $311,000, according to the Organization of Realtors.
In markets with high demand, increasing prices of new homes drive up those of existing homes in two ways. Because an existing home is the alternative to a new home, higher-priced new construction increases demand for occupied homes offered for sale, bidding up prices. And once sold, new homes become existing homes, raising the market value of a community’s housing stock over time.
If I had a hammer (and someone to swing it)
Some of the factors driving up the price of new homes are national or regional in scope, while others are being felt at the local level.
Labor expense is a key cost driver for pretty much every homebuilder in the country. Higher wages due to a shortage of construction workers, especially skilled trade contractors like carpenters, electricians, plumbers and bricklayers, have driven up the cost of all types of construction, builders say.
The housing crash and subsequent recession drove thousands of construction workers out of the industry in the district. Demand for labor has surged with the recovery of the housing market, but older workers are retiring, while few young people are entering the construction trades to replace them. A daily challenge on any project is, “Where am I going to find the subcontractors, where am I going to find the laborers and how much am I going to have to pay them?” said Remi Stone, executive vice president of the Builders Association of Minnesota.
It’s difficult to quantify homebuilding wage increases in district states because wage data aren’t available for residential construction. Wage growth for workers in general construction (including commercial) has fluctuated in recent years, with some states such as Minnesota and Wisconsin posting bigger overall gains than the rest of the district.
But skilled construction workers in Minnesota have seen sizable pay gains, according to wage data for specialty trade contractors available for that state. Through the first 10 months of this year, their earnings increased 4 percent in constant dollars over the same period last year. Specialty trade wages increased even more from 2015 to 2016.
Higher prices of construction materials have also strained home construction budgets nationwide. “Lumber is going through the roof,” said Wills of Centra Homes, adding that price hikes for dimensional lumber this year have added between $3,000 and $6,000 to the cost of a modest home.
The Random Lengths Framing Lumber Composite, a broad measure of U.S. framing lumber prices, rose 23 percent in October compared with the same month in 2016. Industry analysts blame a simmering trade dispute with Canada over softwood imports and increased demand for lumber to rebuild neighborhoods in Texas and Florida damaged by hurricanes Harvey and Irma.
A September report by the Associated General Contractors of America, an industry trade group, noted price increases over the past two years for other homebuilding materials such as sheetrock, flat glass and concrete products. The wholesale price of sheetrock increased 9 percent from 2016.
To the highest bidder
Nationwide cost pressures on home prices are compounded in some parts of the district by a supply and demand imbalance. In markets with high demand for housing and constraints on supply, buyers bid up prices of housing lots and new homes.
The poster child for this phenomenon is western Montana. A renewed influx of people into the region since the recession has boosted demand for homes in cities such as Kalispell, Missoula and Bozeman, where rugged terrain, small construction industries and other factors restrict homebuilding. “The ingredients for rapid price growth are pretty much all in place here in western Montana,” said Patrick Barkey, chief economist at the University of Montana’s Bureau of Business and Economic Research.
A scarcity of buildable land has driven up residential lot prices in many communities. Two or three years ago, developers could buy quarter-acre lots in Kalispell for $30,000. Today, said Kelley, the appraiser, “lower-priced building lots have virtually gone away,” and it’s hard to find lots of any size for less than $50,000. A city planning official in Bozeman, where most large tracts on the edge of town suitable for housing development are already subdivided, said that lots in one development were selling for $120,000—40 percent more than the lot price two years ago.
A lack of construction capacity—small custom builders and subcontractors dominate the homebuilding industry in the region—limits the production of homes. And builders in western Montana often have trouble financing new housing developments, especially subdivisions built on raw land.
Ten years after the housing crisis, banks in the Flathead Valley are still leery of lending for large single-family projects, said Dennis Beams, executive vice president of Kalispell-based Glacier Bank. Mindful of losses incurred when home values collapsed, the bank requires housing developers to put more money down on a loan and pledge more collateral than was customary during the housing boom.
“Our underwriting right now is really focused on a [financing plan] that is well supported by something other than just selling lots,” Beams said. For loans to develop open land without streets, sewers and other infrastructure, Glacier may require borrowers to cover almost half the project cost—a deal breaker for many local homebuilders.
Expensive land, tight lending standards and other constraints on home production have resulted in few single-family homes coming to market. According to the Missoula housing report, only 170 new homes were sold in Missoula in 2016—fewer than half the number Wahlberg estimates is needed annually to meet demand in the area.
Robust demand for developable land and new homes has also put pressure on supply in other fast-growing district communities such as Rapid City, Minneapolis-St. Paul, Rochester and Fargo. A Realtor in Rapid City, where the scenic Black Hills both draw new residents and hem in development, said residential lots had consistently appreciated faster than inflation since the recession.
Rochester has experienced heightened demand for raw land and new homes over the past year, as commercial development associated with a $5.6 billion expansion of Mayo Clinic has taken off. “Rochester is where the Twin Cities was 20 years ago,” Stone said; increased economic activity is expected to keep pushing up prices of new homes and other real estate.
Regulation: benefits versus costs
State and local housing regulators also have had a hand in driving up the price of new homes; stringent building codes and land-use rules in some jurisdictions increase the cost of developing land and building houses.
Minnesota’s state building code is widely regarded by homebuilders as tougher than building standards in other district states such North Dakota and Montana. Successive revisions to the code have raised standards for energy efficiency and safety in residential construction; for example, code changes over the past five years have mandated better-insulated walls and windows, radon protection and redesigned windows to prevent childhood falls.
Homebuilders complain that some code upgrades yield minimal benefits while adding costs borne disproportionately by buyers of lower-priced homes. “One of the things we stress with policymakers all the time is that regulation can be very regressive on lower-income or entry-level buyers,” said Stone of the state Builders Association.
State building officials allow that changes to the code have raised the cost of home construction. The Minnesota Department of Labor and Industry estimates that the radon mitigation requirement, adopted in 2015, tacks about $1,500 onto the price of an average home. But Scott McLellan, director of construction codes and licensing for the department, points out that building regulations protect lives and the environment, and are just one of numerous factors increasing home prices. “Building codes might be the easier target, or at least the one builders have chosen to focus on,” he said.
Land use, including zoning and subdivision design, is regulated for the most part by local government. Regulations and the fees associated with them vary considerably among communities. More often than not, they discourage higher-density neighborhoods and modestly scaled, less-expensive houses.
In the Minneapolis suburb of Shakopee, for example, most land available for new housing development is zoned for detached, single-family homes; townhomes and new duplexes are disallowed. And in new subdivisions, houses are spaced more widely on larger lots than is permitted in the city’s historic core.
Shakopee also bans mobile homes citywide—a common prohibition in communities across the country. Local ordinances often require houses to be built on permanent foundations, effectively banning manufactured homes, which cost much less than site-built housing. Recent research by James Schmitz, a senior research economist at the Minneapolis Fed, details how zoning regulations combined with federal laws dictating how mobile homes are manufactured and financed have discouraged this type of housing.
Then there are impact fees—charges levied by cities or counties to cover all or a portion of the costs of providing public services to a new housing development. Impact (or platting) fees can amount to thousands of dollars per home. Since the recession, many communities have increased such fees to pay for roads, sewers, storm water drainage and other improvements. In 2016, the city of Sioux Falls, S.D., hiked its platting fees by 130 percent, citing infrastructure needs created by rapid growth.
Back to the basics
Taken together, the costs of labor, land, regulation and other aspects of housing development have driven up the cost of building new homes to the point where some builders are abandoning the lower end of the market.
Residential contractor Eid Co., has built modestly priced homes in the Fargo area since the 1950s. But no more: “Unfortunately, where prices have gotten to … I’m not building very much in that true first-time homebuyer market range right now,” said President Jason Eid. Instead, he’s focused on the middle-income market, building homes with an average price of about $270,000—well above the median home sales price in the Fargo-Moorhead area.
High development costs give builders an incentive to build larger houses with more amenities. A higher sales price helps cover expenditures for land, impact fees and other fixed costs, generating more profit.
But some district homebuilders continue to strive for affordability by taking the opposite approach: designing and erecting smaller, simpler houses that fit the budgets of middle-income households.
An increasingly popular lower-cost option is the “patio home,” or slab-on-grade home—a house built on a ground-level concrete foundation, with no basement. Skipping the basement can save up to $40,000, depending on the size of the house.
“We’re seeing a greater demand for slab-on-grade homes from the price-sensitive consumer,” said Wills of Centra Homes. About 10 percent of the 125 homes Centra built in 2017 were slab-on-grade homes. Wills said the firm would have built more if land had been available and expects to increase its output of such homes this year.
Modular construction is another cost-cutting strategy. Modular homes are built in a factory, and then delivered to the building site in several sections, or modules, to be assembled on a conventional foundation. Modular manufacturers claim that the method can trim 25 percent or more from the cost of a house.
Workers with Dynamic Homes of Detroit Lakes, Minn., guide a modular home into place on a formerly vacant lot in St. Paul.Photo by Phil Davies
Smart Homes, a startup associated with Twin Cities contractor Thor Construction, has installed six factory-built houses in the metro area and plans to complete another 40 by the fall. The bungalow-style houses, about 1,770 square feet including a finished basement, sell for $220,000 to $250,000, depending on the neighborhood—affordable to middle-wage earners such as teachers, factory workers and firefighters. (So far, sales have been restricted to buyers earning slightly more than the median area income because Smart Homes purchased vacant lots from city governments and nonprofit organizations that receive federal funding.)
“The modular process allows us to lower our costs,” said Smart Homes co-owner Gary Findell, adding that it also roughly halves the time needed to complete a house to about two months. The houses are built and trucked to the home site by Dynamic Homes of Detroit Lakes, Minn.
Other homebuilders that sell modular houses in district states include Wisconsin Homes in Marshfield, Wis., Schult of Redwood Falls, Minn., and Nebraska-based BonnaVilla.
What does a neighborhood look like?
Some district communities are doing their part to make homes more affordable by relaxing long-established zoning regulations and neighborhood design standards.
In Rapid City, 28 new single-family homes have sprung up on former pastureland on the east side of town, the first phase of what is slated to become one of the largest subdivisions developed in the city in recent years. Home prices in the Johnson Ranch development range from $160,000 to $185,000—a bargain in a community where hardly any new homes cost less than $200,000. “It’s an opportunity for us, and [we also hope that it will] attract working people to the area, because our housing cost compared to income is very high,” said local developer Hani Shafai.
Special zoning for Johnson Ranch that permitted denser development was crucial to its affordability. The lots in the subdivision, designated a “planned development,” are 30 percent smaller than the standard city lot, reducing land costs by about $20,000 per house, Additional savings on infrastructure came from allowing narrower lots and shallow “rollover” curbs.
Rapid City Mayor Steve Allender said that the use of planned developments provides a framework for city planners to “really make exceptions to a bunch of our own rules as far as density and approaches and all those type of things,” helping to make single-family homes more affordable.
Last year, the city of Bozeman passed an ordinance making it easier to build relatively small homes in clustered developments. Several “cottage housing” developments subject to distinct zoning rules have been proposed in the city. Small lots and reduced property line setbacks let developers build at twice the density allowed for traditional housing subdivisions, helping to reduce costs. In return for flexible regulation, the city requires cottage developers to provide some units considered affordable for lower- and middle-income buyers.
Other district communities have just begun to consider ways in which single-family homes could be developed more efficiently and at less cost.
In Missoula, the Organization of Realtors is involved in a market study to identify ways to increase the supply of market-rate, affordable homes, including fostering public-private partnerships, opening up underutilized land on the city’s perimeter and modifying zoning and other regulations.
Mayo Clinic is part of an initiative in Rochester to develop houses that can be brought to market quickly and sold for about $200,000. Options being weighed by a housing affordability task force that also has representatives from the Rochester Area Foundation and the local builders association include small split-level houses, townhouses and accessory dwelling units (“granny flats”), which currently don’t meet city code.
“We’re not just looking at the individual home,” said John Eischen, executive director of Rochester Area Builders. “We’re also looking at what does a new neighborhood look like, to keep costs down.”
The initiative can be viewed as a bid to revive the notion of the starter home—for generations a means for people to improve their quality of life and begin to accumulate wealth by investing in a long-term asset. Such homes “need to exist,” Eischen said.
“I think back to when I bought my first house, in the ’90s. We had two kids, and it had a backyard—that was the impetus for getting out of the apartment into a single-family home. I bought it because it was what we could afford, not because it had a fancy kitchen and everything I wanted in a house. It was what I could afford, and I don’t think that’s changed. Young people today still want to get into a house at some point.”
Research Analyst Ashwini Sankar contributed to this article.