The simple question follows: Why aren’t homebuilders building fast enough to keep up with this demand?
One answer was highlighted by John Lovallo II at Bank of America Merrill Lynch: land regulations.
Not only is the cost of land increasing at a rapid pace, but the land entitlement process, in which homebuilders get approval from the government to start building, is one of the biggest problems holding developers back from completing more houses, according to Lovallo.
“Land entitlement represents one of the greatest bottlenecks for homebuilders, with timelines extended further following the Great Recession,” wrote Lovallo in a recent note to clients.
“In addition, transforming raw land into entitled land is arguably the most value enhancing stage of the development process, with industry estimates indicating a 1X-5X multiplier. However, entitlement can be fraught with risk of procedural missteps negatively impacting a project’s value.”
The cost of entitlement can make up a substantial amount of the final cost of a home. The process includes several steps, like submitting and receiving plan approval from local governments, getting zoning changes, and even things like permits for building near wetlands.
All in all, land costs make up 23% of the final cost of a home in Lovallo’s estimation, and 8% of the total is simply from the entitlement process.
However, regulations differ in various states and cities. For instance, zoning laws may be more lax and allow for fewer re-submissions in one municipality than another.
While Lovallo said that it is hard to classify states as less- or more-developer friendly, he used a study from the University of Pennsylvania in order to place each state in the US on a spectrum called the Wharton Residential Land Use Regulatory Index.
“In general, lower WRLURI values represent states and MSAs with less restrictive housing market regulations (blue states in the map below), while those with higher values were more restrictive (red states),” said the note.
“Not surprisingly, MSAs with larger populations and states considered to be more environmentally conscious had higher values (more restrictive) than less densely populated MSAs or so-called ‘pro-business’ states.”
Check out below where your state falls on the spectrum, and how much land regulation may be driving up the cost of a home.
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