When considering the factors that influence home prices, it’s important to understand the critical role of lot costs. Lot costs typically account for approximately 20-25% of the total cost to build a home. According to the National Home Builders Association (NHBA), the national gross profit margin for residential homebuilders is 18.2%. However, this is not the same as net profit. After accounting for significant overhead costs, the national net profit margin is only 7%.
This means that if lot costs remain high, it’s nearly impossible for home prices to decline without builders taking a hit to their already slim margins. Let’s break this down further to see how lot costs directly impact the sales price of homes.
The Formula Linking Lot Costs to Home Prices
There is a general formula used to estimate the sales price of a home based on lot costs. Ten years ago in Rutherford County, standard residential lots were priced between $60,000 and $70,000. Using the upper end of this range, we can calculate the home price:
- Lot cost ($70,000) / 20% = $350,000 (home price)
Fast forward to today, and the cost of standard lots in Rutherford County has surged to $180,000 to $220,000. Using $180,000 as an example, the estimated sales price of a home is:
- Lot cost ($180,000) / 20% = $900,000 (home price)
As you can see, when lot costs rise, home prices follow. Without a decrease in lot costs, builders have no room to reduce the price of homes while maintaining profitability.
The Role of Zoning and Yield
One potential solution to mitigate rising home prices lies in addressing zoning regulations and maximizing lot yield. For instance, consider a $250,000 three-acre tract of land. This tract might have enough soil capacity to build two homes but lack sufficient road frontage to meet current zoning ordinances. If municipalities were willing to loosen zoning restrictions—such as reducing road frontage requirements—builders could divide the three-acre tract into two lots. This would significantly reduce the cost per lot and, by extension, the price of the homes built on those lots. Here’s an example:
- Land cost ($250,000) divided into 2 lots = $125,000 per lot
- Lot cost ($125,000) / 20% = $625,000 (home price)
In this scenario, the reduced lot cost brings the home price down to $625,000, which is much more affordable than $900,000. By increasing yield through more flexible zoning ordinances, municipalities could play a vital role in creating more affordable housing.
Final Thoughts
The cost of lots is a driving force behind rising home prices, and it’s unlikely that home prices will decline as long as lot costs remain high. Municipalities have an opportunity to influence affordability by revisiting zoning regulations and allowing for greater lot yield. Until then, buyers should understand that rising lot costs, combined with builders’ slim profit margins, will keep home prices steady or climbing, not falling.
