Why did you decide to build?
It’s perhaps the most common question and it has a very nuanced answer, but I’ll do my best to explain here.
First, let’s explore a couple of important premises:
Land appreciates, houses inflate and depreciate
Generally speaking, an increase in a house’s value comes from an increase in land value or improvements to the structure. A decrease happens due to a drop in the value of the land and the structure becoming worn and outdated over time.
To value a particular property, you can start with the market value of the lot itself with the house cleanly plucked off of it. Add to that the cost of building a new house with comparable features and finish. Subtract out an allowance for wear and tear, neglect, and dated materials. There may be additional variations for unique construction, but any value add or reduction due to location is actually tied to the land.
Once you break a house’s value into the structure and land components and understand their relationship, you have an easier time imagining cost breakdowns of building or even replacing an existing structure.
Houses wouldn’t get built if they went to market at a loss
There’s a reason spec homes exist. It may surprise you to learn that the majority of city and suburban houses are built speculatively. The builder/investors didn’t have specific buyers in mind during construction but they anticipated being able to sell the house at a profit nonetheless. If there’s new construction going up for sale in an area, that means the market is at least somewhat conducive to building a house for cheaper than it would be to buy a comparable pre-existing structure.
Okay… So, why?
In the 2013 Seattle area market, you can expect to find buildable lots (short-plats and demolitions, mostly) for $150K-$300K, depending on slope, condition, location, size, and restrictions. A modern middle-class family house can be constructed for $150K-$300K depending on size, amenities, and finish quality. The low-end on both scales yields a nice house whose comps have sold for $350K to $380K in today’s market. The high-end gets you a large house with very nice finish whose comps have sold for $600K to $780K in recent months.
In a nutshell, you get instant equity if you don’t spend too much on the lot.
A $400K house built in 1955 which was last updated in the 90s is a very different thing from a $400K new construction. Due to structure devaluation, the value is largely in the land and the raw square footage of the older house. You may get a nice big older home for your money, but you may also get dated finish, non-grounded wiring, single-pane windows, and deferred maintenance. Since one of my basic requirements for our next house was that there be no major projects, many older homes were ruled out.
We were fortunate enough to have found our ideal home design early on and decided we loved almost every aspect of the finish work. However, some of the things that we did want to change required early planning (several window additions, skylights, bathroom layout changes) so we needed to be involved before framing went up. Applying these sorts of changes to a pre-built home would have meant time consuming and expensive remodels which would cost many times more than having them in place from the beginning.
Perhaps the biggest part of all this is that we are willing to accept the risks. We found very nice and accommodating temporary housing (huge thanks to D&T!) and have agreed that the value added by getting exactly what we want (or can afford at least) is worth the potential downsides.
The risks are manifold, but most if not all can be mitigated (or at least wished away). A real estate lawyer pointed out to me that all housing purchases are leaps of faith. You can write yourself the perfect buyer’s contract, but there’s little chance anyone will sign it if they have any better options. You can hedge your bets, but the Cypriot economy could unzip the entire EU causing an economic bloodbath that sends the US economy back to 2008.
Some things are just out of your control. For the rest, mitigate and come to terms.
Construction could run long. This could be the rainiest summer ever causing epic delays that push us past our 9 month construction loan term. Fortunately, the bank is happy to extend the term if given proper notice and the added costs of going overdue are just the extra interest payments on the outstanding balance.
Our builder could go under. Hit by a bus or skipped town is always a risk. Fortunately, our construction company is owned and operated by three brothers who have been in business building nice homes since the late 1980s. Their reviews are sterling and they have a great reputation. It’s fairly safe to extrapolate on their performance pattern.
I could lose my job. It’s a right to work state and things could hit the fan. I have and would recommend people have personal reserves available no matter what. I am readily employable and could recover fairly quickly.
The loan could fall through. We’re still working on closing the loan, so perhaps it appraises low or maybe something else goes wrong. Our contract with the builder specifically handles this case and allows us to either re-apply our down payment for construction on another (cheaper) lot, or to be refunded all but consumed costs.
We won’t like the finished product. I have another post in the works about imagining the finished work, but this is always a risk. In fact, I’m certain there will be a couple of things I wish I’d realized sooner that will rub me the wrong way until I fix them. However, we were fortunate to get to know our house design first and even got to tour the completed product after one of the owners had moved in. We have tangible experience with the design and are highly confident it will work for us.
The final equation
The answer to the build vs buy question is different for every potential homeowner. Building is not for everyone. Many people are more risk averse, and many others aren’t in an equity or cash position to be able to make a full 20% down payment. It’s easier for the majority of folks to buy something that is complete or nearly complete. There’s certainly no such thing as a 3% down construction loan and you couldn’t care less if the builder went out of business if you’re buying a seven year old house.
For us, the stars happened to align. We can accept the risks, we had equity, we found the perfect plan, we found an ideal builder, and we found a lot that is an amazing deal.
We decided to build.