Despite a slow housing market, the cost of land and developed lots is still higher than expected. That is because lot prices are driven by several factors—home prices, existing lot supply, the cost of land development, builder demand, and the availability of capital—each of which has been pushed beyond predicted needs.
For years, prevailing thought in the construction industry was that land costs should represent 20% to 25% of total home price. In times of economic growth and retraction, significant fluctuations in the land to home cost ratio are experienced. For example, prior to the Great Recession in 2008, the lot-to-home ratio in America’s hottest MSA’s climbed to over 30% of a home’s value. In 2010 the lot-to-home price ratio plummeted as low as 10% in the same MSA’s due to a saturated building industry that produced a surplus of developed lots. Lots that fetched $50,000 in 2006 were lucky to bring $20,000 in 2010 as prices reset and remained flat for years to come. According to the National Association of Home Builders*, lot values finally exceeded pre-Great Recession values in 2016, a full decade after they began a precipitous decline. Builders rode the tailwinds of stagnant lot prices, while material cost and home price appreciation escalated during the same period.
*Graph courtesy of the National Association of Home Builders
Until 2020, low lot prices and corresponding low lot-to-home price ratios prevailed. COVID shutdowns triggered pent up demand. Housing material and labor shortages ensued, and home prices skyrocketed with demand. For the first time in many years, builders experienced significant lot price increases that caught them off guard. Lot-to-home price ratios soared to heights not seen since 2006.
An abrupt end to relatively inexpensive lots left many scratching their heads, but it is merely a decade of stagnant lot prices being corrected by market demand. Existing lot supply remains low, and though somewhat tempered compared to twelve months ago, demand remains high. Builders hoping to find basement bargains are largely disappointed as the economic adage of supply and demand continues to rule the day.