The shifting landscape of home construction costs

In the span of two-and-a-half years — from March 2020 through October 2022 — as is illustrated in the year-over-year (YoY) changes in the Laspeyres Constant Quality Index above,^Footnote1 steeply rising material and labor costs nearly vanquished demand for new construction. At various points, potential buyers were told in no uncertain terms that by the time their home was move-in ready, the fast increasing prices could climb another 20%!

But a lot has changed since the fall of 2022. With inflation easing in construction costs, prospects for homebuilders are once again looking up. As we enter the fall of 2023, price growth has dropped back down to the 2% to 3% pre-pandemic level from the 17%+ price inflation we experienced a year ago.^Footnote3

While actual construction costs are significantly up from their pre-COVID levels, construction inflation has been easing since November 2022.^Footnote3 However, no one can say with any certainty whether construction prices will continue to experience lower inflationary pressures or that some other factor will again disrupt the home-building market in the future.

In terms of the impact of COVID-19 on costs, the home construction market is now establishing a new normal.

A Forbes Home article from March of this year asks, How much does it cost to build a house? The basic answer — for an average 2,000-square-foot home using builder-grade materials and including labor — is around $150 per square foot. Or $300,000.^Footnote4

This excludes the price of the plot and land development, as well as features such as a garage, deck or basement. Plus, the average price varies by state, region, proximity to metro areas and a host of other factors.^Footnote4

Furthermore, when purchase prices go up, as they dramatically did during the pandemic, market forces and self interest typically keep them high. The bottom line is that the purchase price of a newly constructed home, especially with today’s interest rates, will continue to be costly.

A July 2023 report from The Wall Street Journal announced that homebuilder stocks are booming. The primary reason cited is a shortage of existing homes for sale. This is partially due, as you’d expect, to many current homeowners staying put to enjoy the financial benefits of the low mortgage rates they locked in during the pandemic.^Footnote5

Compared to May 2019, there were 43% fewer existing homes for sale or under contract in May 2023.^Footnote5 In other words, the Federal Reserve’s aggressive rate hikes have slowed the housing market, which is dominated by the resale of existing homes.

As a result, homebuilders are the primary beneficiaries. According to the WSJ article, the top three publicly traded builders have seen their stocks rise in May by 30% to 70% since the start of this year.^Footnote5

Consider too that home building is not evenly distributed across the country, but is strongest in lower-cost states, especially in the South. Recent worker migration (based on the newfound opportunity to work from home, especially where it’s most affordable) and corporate relocation have created thriving job markets in Texas and South Florida.^Footnote5

In May 2023, although new-home sales were up 20% YoY, existing home sales were down 20% YoY.^Footnote5

Unfortunately, from the perspective of your clients, the stabilization of new-home construction costs does not translate into purchase prices dropping to anywhere near as low as what they were in early 2020. Markets will always bear the price someone is willing to pay for a product or service — and home buying is no exception.

Millennials and now the older Gen Zers are itching to buy their first homes. Baby boomers who have paid off their mortgages, or are about to, are also looking for new, downsized homes — including in 55+ communities — with little or no maintenance. But there is still a national shortage of homes on the market, and builders cannot build new homes fast enough. The closer the relationship you can establish with builders in your area, the more your clients will appreciate your services.