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14 June 2012

Keeping It Victorian: Part I

This is part 1 of a series that will take a look at what I percieve as problems with the way housing is dealt with in the US.

It bothers me that the vast majority of people buy large cheaply built homes that are neither beautiful nor thermally efficient. If your house is going to be ugly at least make it energy efficient, and if it's going to be energy intensive then make is beautiful. Yet people choose the third option, big, over all others. Research shows that large houses do not make you happy (source - interesting paper by the way). The purpose of this post is to explain, mostly to myself and in a very mechanistic manner, why houses are a certain size, cost, and quality. I'll be looking at the Midwest since that's where I live.
My argument is this:

1 - Housing is generally the most expensive thing most people ever buy.
2 - Most people are not well informed as to what they are buying.
3 - Banks/financiers have a large influence on what is built.
4 - Our cultural values in the US specify a certain housing type.
5 - Money is the biggest constraint in the housing industry (and probably everything).

The median square footage of a home completed in 2010 was 2,200 square feet (SF), in the midwest it was 2,000 SF, and 30 years ago the median for the US was 1,600 SF (source).

Note: the average in 2010 was 2,390 SF but I'm not going to use that. My logic is that housing typically can only get so small, whereas the very wealthy often build huge homes which skews the data. Hence, I'm using the median.

Note 2: how closely correlated is home size to GDP per capita? This is a fun idea for a stats based blog post in the near future. For now though I took GDP in 1980 ($2,778 billion) divided by 1980 population (226.6 million) adjusted for inflation ($12,300 becomes $32,100), then compared to 2010 GDP per capita ($47,100) which is a growth of 46.6% in real terms (actual goods you can purchase). In that same 30 year period (1980-2010) the median home size went from 1,595 SF to 2169 SF, a growth of 36.0%. That's pretty close. If I were running a regression analysis I'd work in a Gini coefficient (change in level of inequality). I have a feeling that'd explain a decent amount of the difference. You would then be able to extrapolate how much larger houses should be if the level of economic equality had remained at 1980 levels. Conversely, you could estimate how much more energy efficient homes could have been with the added money and then translate that into any number of things like possible savings in carbon emmisions, barrels of oil, square miles of coal etc.

The vast majority of people take out a loan when purchasing a home and increasingly that loan tends to be of the 30 year variety, which corresponds roughly to most people's working careers (if you buy a home/loan it makes it harder to leave your job and the region, which decreases your bargaining power over wages, which makes your firm more profitable/competative, which gives local banks more business -- surely they have no vested interest in helping people secure loans for housing right? This is why companies pay you more money initially if you move to their city and buy a home in the area). Typically it is recommended that most people do not take out a loan that is more than 28% of their gross income (why do people rarely live below their means?) or 36% of their total income after other debt obligations. The median income in the Midwest in 2010 was $48,500 (source). Using the 28% figure on a median income of $48,500 we get $13,580/year or $1,130/month. Using an amortization table that comes out to about a $190,000 loan over 30 years at 6.00% interest. Interest rates are currently around 4% but I'm not sure who you have to kill or what god you have to dance to during a full moon to actually get that rate.

I'm going to assume a 20% down payment because it's conservative and you can avoid paying loan insurance at this rate. This comes to $47,500 + $190,000 = $237,500 and we'll round to $240,000. That's what the typical family in the Midwest can afford; a $240K home that is 2,000 SF and who pays a little over $1,100 per month on thier mortgage.

$240,000/2000 SF = $120 a square foot in total cost. That's what people pay, not what it actually costs to construct, but construction profit margins are razor thin so it's probably close to that minus land costs and what not. This is why no one is building right now. Construction costs in Chicago right now will probably run you in the $150/SF range which makes sense given that it's a major metropolitan area and the cost of living is higher. It costs more to build a new building than it does to buy an existing building, hence the current housing situation. This is a fairly fundamental reason why buying housing right now may not be a bad idea. You can not physically build new things cheaper. I think #1 on the list is well established so let's look at #2.

Most people do not know how a building is built, and that's fine, why should they? The problem is that the person selling you the building doesn't know either, and the bank only cares in so much as they have confidence that the building will make them money. They accomplish this by doing the same thing repeatedly. This is why the construction industry is so conservative; construction costs a lot and no one wants to "lose their ass" so to speak. The only person who does truly understand what's happening is the architect and contractor. Most market rate housing doesn't have an architect so now it's down to the contractor. This gets interesting because one doesn't need anything particularly to become a contractor. If you have tools, know how to build things, have financial backing, and sometimes insurance, you can be a contractor. Not to say that there aren't excellent contractors out there. I'm just saying that it varies greatly and these people are not always well versed in things like thermal heat bridges, structural calculations, etc. Their main goal is to stay in business, make money, and not get sued -- much like anyone I suppose. They're not exactly trying to buck the system and do something extraordinary. Let's take a closer look at the banks role, #3 on the list.

Banks are (or should be) in the business of taking deposits, providing money (liquidity) to those who need it, and managing the risk in between by charging a competative interest rate. In short, they want to be assured they will be paid back. Since the bank is typically providing 70-90% of the money in a project they get a lot of say. As in, if they don't like what you're building they won't give you any money, so unless you have all your own money to build whatever you want you're going to have to build fairly conservatively or be excellent at selling ideas to bankers. This is a large part of the reason why most buildings in the US look pretty much the same. In all fairness this is beneficial as it keeps people from doing unproven things that fail. On the other hand it keeps people from taking risks that advance the industry. None the less, this situation leads us to build homes much in the same way as people did in the Victorian era.

This brings us to #4. Simply stated, bigger is better. If you spend some time researching properties you find that housing in a general area tends to be the same price. Buildings are a lot like cars. There are class sizes, standard features, upgrades, and general price ranges. They're just not that unique for the most part. It also means that some features do not make sense at certain price points. I insist that certain things should be standard on all housing. Good windows, thick insulation, good structure, etc. I think that should be standard, but it doesn't work that way. Cheap housing gets cheap windows, expensive housing gets decent windows, and everyone gets thin insulation. You wouldn't expect wood grain in a Ford so why should the average person expect thick walls... or so goes the logic.

While researching for a project last spring I found that the price for new market rate condos in the South Loop of Chicago tended to be around $199/SF. From building to building this varied very little. We're talking $2-3 tops. Everyone had the same counter tops, same cabinets, same square footage etc. The thing that would set one place apart from another would be something like a really nice appliance or a computer nook. Maybe they spend an extra $1,000 on a big refrigerator and over a 1,000 SF apartment that raises the cost $1 SF, or maybe you get a balcony you rarely use. That's how tight construction budgets are. Buildings differentiate themselves with small perks generally in the 0.5%-2% of total price range. Why would anyone pay 10% more for a well built home? You would price yourself out of the market. The alternative is to build smaller but higher quality... think that's going to happen in America? That's #5.

In summary, people tend to buy the most expensive house they can afford, the construction type is determined by what banks and contractors are comfortable building, since banks and contractors do not have to live in the houses themselves they build cheaply, since buyers are not well educated on construction they tend not to value well built homes, add to this American's inherant preference for size over quality and you get the ubiquitous 2,000 square foot  $240,000 home with 30-year loan. This is how our incentives are aligned and this is the result they produce; huge homes with a corresponding loan for all.

Why is Europe different? They charge more for energy, pass laws and codes regarding energy useage, their code officials tend to be less stringent, they have less land, and tend to prefer well built over size. I would also argue that they have better taste in general but that's probably just my personal bias.

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