The Market Seen From The Street: How much does it cost to build house?
Today I´m "coming back" to the housing subject, with the objective of presenting an exercise that demonstrates (approximately) the current cost of building a house. But befor that, let me make a brief note. The Real Estate Industry (where I`m including myself) has a huge difficulty communicating with people who do not "live the day-to-day" of the Industry. We communicate a lot with commercial objectives (Sales, Investment Volumes, Developments, etc) but very little with the objective of informing.
There is a lot of Marketing but lack of Information. I believe that many people “don't like” Real Estate because they don't know it. It is our obligation, as professionals from the different activities that constitute the sector, to change this reality. It is true that we have notice some good progress in recent years but we still have a lot to improve. Quoting the WONDERFULL LEADER Rui Nabeiro, “if we all wanted to, the world would be extraordinary!”
If we apply this quote to the real estate market, if we all do our part, we can greatly improve our Industry and the way it is perceived.
Returning to the main subject of this reflection, much has been said and written about housing prices and rents in Portugal. There is a clear mismatch between the average income of people and the price/rent of houses, especially in the locations where people want to live and where “urban infrastructure” (Employment, Education, Health, Transport, Leisure, etc.) supports most of their needs.
The question is: WHY? Why are house prices high?
The answer is very simple. Because the cost of producing a house is high.
Let's "imagine" a plot of land located in a high-density urban area, with an area of about 24,000 square meters, where it will be possible to build about 16,800 square meters of Gross Construction Area Above Ground (excluding balconies and terraces).
According to the defined urban rules, it will be possible to build 6 floors above ground and about 180 housing units (apartments). Needless to say, the rules require a certain number of parking spaces for each house, which will be built on 2 floors below ground.
With these assumptions in mind, let's do an exercise in “creating the development and choosing typologies”.
First, we will divide the development into 5 allotments. Each one will give life to 35 apartments and about 41 parking places with.
Assumptions:
Construction Area (Implantation Area): 560 sqm
Gross Construction Area Above the Ground: 3360 sqm
- Gross Private Area (“Apartments area”, measured by the perimeter of the exterior walls, excluding balconies): 2632 sqm
- Common Areas (Circulation Areas/Staircases and elevators): 728 sqm
Balconies & Terraces Areas: 526 sqm
Now the most interesting part, the typologies!
It was not an “easy choice”, I must confess. The methodology used was “ common sense”, trying to understand what are the main needs of the demand. Remember that I am not defining a specific location and the intention is to build houses that most people can afford. No luxuries. “Standard” construction with quality.
I remind you that the birth rate in Portugal is extremely low and, therefore, it doesn't make much sense to have many large-sized Typologies.
This being said, for each Building Developed we have 35 houses with the following typologies:
T0 (Studios) – 6 Units, with one parking place each & balconies
T1 (One Bedroom Apartment) – 5 Units, with one parking place each & balconies
T2 (Two Bedroom Apartment) – 18 Units, with one parking place each & balconies
T3 (Three Bedroom Apartments) – 6 Units, with two parking places each & balconies
Typologies Number of Units Parking Places Gross Private Area Balconies
T0 6 6 37 7
T1 5 5 56 11
T2 18 18 80 16
T3 6 12 115 23
Total 35 41 288 57
We can discuss whether the areas are large or small and whether the typologies make sense or not. But does that really matter? No! What matters is understanding how much each house will cost. Remember that we have not define a specific location.
The goal is to calculate the production cost of a house, excluding the value of the land & acquisition taxes, the Developer/Investor Profit/Return on Investment and Marketing & Sales costs.
What are the costs involved in a Development with the characteristics we are analyzing?
1) Acquisition/Land Costs: As explained above, we left this cost at 0;
- Acquisition Costs
- Taxes
- Technical and Legal Due Diligence
2) Project costs, including VAT: €118,760.60
- Previous Studies
- Licensing Projects (Architecture and Engineering)
- Execution Projects (Architecture and Engineering)
- Energetic certification
- Acoustic Certification
- Other Certifications
3) Urban Taxes (Municipality Taxes): €349,415.17
- TRIU (Fee for Realization, Maintenance and Reinforcement of Urban Infrastructures)
- Occupations of Public Roads
- Submission Fees for “Projects and Orders”
- IMI (Municipal Property Tax) and AIMI (Additional Municipal Property Tax)
4 ) Construction costs, including VAT: €4,351,354.00
- Contracts for Civil Construction and Materials
- Infrastructure (Water, Electricity, Sanitation, Gas, Telecommunications)
- Inspection
- Insurance
- Impredictables
- Policing / Security
5) Project Management and Administration Costs, Including Taxes: €202,370.08
- Operational Costs
- Outsourcing costs
6) Financing Costs: €384,865.13
- “Opening”/Process fees
- Stamp Duty on Capital Used
- Interest
7) Marketing & Brokerage Costs: For the sake of simplicity, we will leave this cost at 0, as we did with the land costs.
- Marketing Materials
- Brokerage
In summary, developing a residential project with 35 houses (with balconies) and 41 parking places can cost around €5,404,853.08, more or less.
Translating this number to cost per typology, we have:
T0 75 980,08 €
T1 114 996,87 €
T2 164 281,25 €
T3 236 154,30 €
Do not want to focus on the discussion around Real Estate Development Profit Margins but, I would like to rephrase the question.If any one of us invests €5,404,853.08, how much do we intend to profit from it? 1%, 5%, 10%, 20%, 40%, 100%?
Add that margin to presented costs. Now choose a Location you like and try to understand the cost of the land.
Then add that land cost and try to understand how much you would have to sell the apartments for the project to be viable and obtain the desired profit.
"Imagine” that the development of a project with these characteristics takes an average of 48 months and more than half of the time is pure bureaucracy. 48 months is 4 years!
The cycle that goes through between the moment when the project starts to be created and the moment when the houses are delivered is too long. There is a lot of risk associated with it. Just think of what has happened in recent months with rising interest rates. People´s ability to take on debt has “worsened” a lot. In theory, 1000€ in mortgage monthly payments allowed to buy a house worth of 300 000€.
Currently, the same €1000 will buy a house worth 240 000€.
We spend a lot of time criticizing the price and rent of houses but we rarely talk about their cost and process.
In my point of view, Cost and Process are the main causes of the housing shortage for the middle class, or rather, for most people. Unfortunately, their income it´s “inelastic”. If the Developer/Investor's cost already reaches the user's purchasing capacity, the decision is simple: Do not proceed with the Development and bet on another type of market segment with less “sensitivity” to price and need for financing.
And what is the solution? Continue to discuss the “Sex of Angels”? Thus, certainly won´t change anything.
Can we reduce production costs?
Yes, everything is possible. Especially if there is Large Scale Development and consequent verticalization of the Development Process. In this case, the risk increases considerably, with a significant increase on operational fixed costs, but it allows for economies of scale.
To build on a large scale it is imperative to reduce the Development Cycle, especially regarding bureaucracy. Regarding the more practical part, Construction Execution, the Industry has evolved in terms of construction methods. Technology is allowing for a significant reduction in construction time. We have the problem of labor to solve but that is another story.
By reducing the Licensing/Bureaucracy time and construction time in half (from 4 to 2 years), the perception of risk changes completely. It would be a very beneficial transformation for the sector and all its stakeholders. The risk associated with the Real Estate Development process would decrease considerably.
Regarding new construction, the issue of VAT and its possible reduction to 6% has been discussed. Can it help? Yes, undoubtedly. But I don't think it is the "Only Solution".
To have a more accurate idea, the VAT (23%) of the Construction Item in the exercise I present represents about 14% of the Total Cost. If we change the VAT to 6%, we have a savings of about 4% in Total Cost.
Can we cut costs more? Yes, we can. But we will obviously impact the incomes of professionals who are part of the Real Estate Development process. I am sure that the "problem" of Production Costs is not in the salaries of designers, construction workers, and all other participants. At least in Portugal.
Are there other alternatives?
Well, actually, I believe so. Especially at the level of Urban Planning.
Urban rules for Residential Properties should take into account the "type of Housing".
Developing homes for the Purchase and Sale Market should not be the same as developing Projects for the Long-Term Rental Market. The needs are different. The "user" is different. The project should also have different specificities and different obligations.
In particular, regarding the number of units and minimum areas per typology. Depending on the locations, the issue of mandatory parking spaces should also be reviewed.
Summary:
Developing/building 175 new houses, with parking spaces and balconies, without any luxury, could cost around €27,024,265.41 (excluding land value, development profit margin/capital investment remuneration, and marketing and sales costs) and should take about 4 years if everything goes well.
To develop 175 new houses with the aforementioned characteristics, we need to build 16,800 square meters above ground, 5600 square meters below ground, and 2632 square meters of balconies and terraces. In total, we have 25,032 square meters of gross construction area, with the sum of the private area and balconies and terraces of each unit amounting to 15,792 square meters. The effectively "saleable" area represents approximately 63% of the total area.
I venture to say that reducing the development cycle of real estate projects, especially bureaucracy, is more important than reducing VAT on new construction because at moment zero, we know the value of the tax, but we don't know how long it will take to license the project.
Analyzing the cost per typology, it is evident that from the T3 typology, the cost significantly exceeds the average financing value in Portugal (€180,000). This indicator presents the reason why most new developments associated with the middle class develop "shorter" typologies.
Reducing the average area per typology can be an interesting response to the need to reduce the cost per typology. I don't think the habitability of the houses will worsen. We have to analyze how people live in their homes nowadays. We can't stick to urbanistic rules created 50 years ago that tried to respond to different needs.
Residential projects with different specificities (e.g., buying and selling versus leasing) should not have the same type of urbanistic criteria.
In conclusion, I would like to make it clear that I don't know what is the most effective solution to this housing problem, but I am sure that the solution is not "everyone pulling their own chestnuts out of the fire" according to their interest or convenience.
The housing problem is serious and, above all, needs to be analyzed with common sense and without excessive extremism.
On the other hand, it is evident that the way of "living" in houses has changed significantly in recent years. The transformation was significant and will continue. If urbanistic rules and our theory of "complication" do not adapt to new realities, we will lag behind in solving this global problem.
See you soon,
André Casaca
