One way or another, everyone pays for housing. Yet there is little to no transparency into why buying or renting costs what it does. Understanding residential pricing starts with the cost of construction, including the hard costs (such as wood, steel, and plaster), the soft costs (such as architects, attorneys, and financing), the land, and the profits to the investors.
Here is a summary of the typical costs to develop a 30-unit, four-story apartment building. We are using economics for a property in downtown Washington, DC. For simplicity’s sake, we are only showing the costs on a per-unit basis, assuming a 1,000 gross square foot average (small 2 bedroom apartment), rather than the whole building cost for all 30 units.
1. The first thing to note is only half the costs come from physical construction (37%) and land (19%) that you can see and touch in a building. The remainder of the total are soft costs (24%) and expected equity return for the investors (25%):
2. A real estate developer loses approximately 15% of the total building’s space to inefficiencies and common areas (e.g., hallways, elevator and exhaust shafts, residential lobby, etc.). Therefore, a 1,000 gross square foot construction turns into a 850 net square foot 2-bedroom, 2-bathroom apartment. The 15% loss factor increases the price per square foot, equivalent to approximately $65,000 per unit for space everyone is using in the buidling but no one is thinking they are paying for when they purchase a condo.
3. The profit to the equity investor is the second largest driver of residential pricing. Although the real estate developer may lead and manage the project and is often the face of the development, the developer generally is not the primary capital provider in the project.
For instance, in the 30-unit apartment development described above, the developer would have to invest $4,500,000 of equity (i.e., $150,000 per unit or 35% of the total cost). Most real estate developers would not invest all of the capital themselves, especially if they have a few real estate projects underway at any one time. Instead they raise the equity capital, usually from an investment fund, and those outside investors put up 80-90% of the money (e.g., $3,600,000 to $4,050,000 of the total).
Where Fundrise comes in
Now, this is where Fundrise comes in. Why raise the money from an investment fund if a developer could raise it directly from people instead? The equity profits can be attractive, and direct investment by local residents has incredible potential to change the politics and economics concerning local development. We plan more on this topic in another blog post.
This cost breakdown also raises additional questions about how to make housing more affordable, and why prices vary so much from one location to another:
There are a lot of factors driving the price up. So there is no single “silver bullet” for making housing affordable. Typically, when government wants to encourage building new affordable housing, they provide low-cost financing and donate the land for virtually nothing, which can save a development 43% on the costs listed above. In addition, the developer will usually lower the construction costs by not building underground parking or with concrete and steel.
The costs listed above do not include the cost of inclusionary zoning, a law in Washington, DC that requires 8-10% of new housing to be affordable. This regulation lowers the pricing for certain low-income renters or purchasers and raises the costs for other purchasers. The costs can vary significantly, depending on the building.
The costs of land and construction generally drive the huge disparities in cost in different localities. For example, the price range per square foot for a comparable project in Baltimore is $15-25, while in New York it would be $1000-1500.
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