California is a beautiful place to live — if you can accept burning half your paycheck on housing.
The high cost of rent and homes for sale is directly tied to construction costs. Specifically, builders spend significantly more to build in California than in other states. The high cost of building reduces the number of housing units available. The supply-demand imbalance is only getting worse, causing housing costs to escalate rapidly.
Problem number one: land costs
An acre of land in coastal California — where the majority of jobs are — costs about eight times the U.S. average, according to the state Legislative Analyst’s Office. The average acre of undeveloped land costs $20,000 nationwide, compared to over $150,000 per acre in California’s coastal communities as of 2015. This average cost soars to twenty times the U.S. average in San Francisco, where an acre of land cost $400,000 in 2015.
When the cost of land is high, developers typically cram as many housing units as they are able into their plots. This allows them to maximize their profits.
But in California, this rarely happens.
California’s Legislative Analyst’s Office examined California’s major coastal cities — leaving out San Francisco, due to its outlier status — and their increase in multi-family units built during the last construction boom, during the 2000s. California’s coastal cities saw housing density increase 4% during the 2000s, compared to an 11% increase in other major U.S. cities.
What’s more, the type of multi-family housing built in California during the latest construction boom was less dense than in most U.S. cities. Here in California, the new multi-family units built during the 2000s averaged 10 units per acre, compared to 14 units per acre built in other major U.S. cities.
The challenges facing builders
Since the cost of land is extreme in California, and more units ought to translate to more profit, why don’t builders build denser multi-family buildings in California?
There are two major obstacles builders face:
- zoning laws which require minimum parking standards and limit building height and density; and
- high building costs, which require a larger upfront investment in California than almost every other state.
Zoning laws are easily changed, and the good news is California is seeing sweeping changes across the state to allow more density and free up restrictions to encourage more housing to be built. These types of changes are called graduated zoning changes, meaning laws are changed to open the door for builders funded by private money to do their thing. But these are soft changes — they’re not the same as direct state intervention. Zoning changes don’t address every issue holding back construction.
For instance, graduated zoning changes do not address the state’s high building costs.
Building costs are high in California due to:
- local permitting fees;
- building materials, and the various taxes included; and
- the cost of labor.
Labor is not cheap in California. In fact, due to the state’s high cost of living, contractors are forced to pay laborers higher than average pay. The Legislative Analyst’s Office report finds construction labor is 20% more expensive in California than the U.S. average.
Building materials are also more expensive here, due primarily to the higher construction standards the state mandates. Using energy-efficient building materials and meeting building codes designed to withstand earthquakes both add up to higher costs, which require a bigger investment from builders. These costs won’t see a decrease anytime soon, especially in light of the recent Trump tariffs on imported lumber.
Finally, permitting fees vary by location, but tend to be extremely high in California, nearly four times the U.S. average. Extended environmental reviews in California — instated to preserve the state’s natural resources — delay the construction process, wasting time and money.
The end result is a new home premium of 40%-50% on top of the cost of a home resale. In other words, homebuyers considering a newly constructed home for sale for $700,000-$750,000 could purchase a home in the same location, the same size and with similar amenities for just $500,000.
But builders aren’t seeing huge profits like homebuyers probably imagine. In fact, a builder’s typical profit margin is just 6.4%, according to the National Association of Home Builders.
The solution: state subsidies
Some progress toward easing the construction shortage and increasing density has been made in the past year. The passage of a package of affordable housing bills in 2017 promises more housing for low- and moderate-income families. It’s a start.
Greater intervention is needed from state and local governments to reduce the cost of building new housing. For example, the local government could grant subsidies to builders when they purchase land with the intent to build housing to be sold to low- and moderate-income homebuyers.
The government could find a way to make its highly-regulated building materials cheaper to obtain, by reducing taxes or granting subsidies.
It could also reduce environmental reviews, which extend the building process and waste money.
These are all ways the government could step in to reduce the cost of building and make it easier for builders to increase housing density in California’s desirable coastal cities. Further, when the government starts making these types of direct changes, we won’t just see more housing.
As the housing stock increases, our out-of-control prices will cool. Homeownership will be more attainable. We’ll see a more invigorated economy, as the state will attract workers from other states who currently shun the Golden State due to high housing costs (we currently see more residents leave California for other states than enter). Residents will spend less of their paycheck on housing and more on goods and services. Use of public transit will increase, as suburban sprawl subsides and more housing is built near transit corridors.
Increased density in California’s coastal cities will lead to an increased quality of life. At least it could — if the government takes action.