By James F. McClister

Chicago Agent Magazine

August 22, 2016

 

Home starts are up; residential construction in the Chicagoland market has seen a massive cash injection this year; and Chicagoland new home construction is at its highest level in seven years, according to Metrostudy. But while starts are on the rise, new construction sales are down. In the 12-month period ending with Q2 2016, sales fell 4.1 percent, and quarterly sales were down 14.1 percent year over year.

Chicagoland has a lot shortage – so to speak. Builders are finding it difficult to find skilled labor, affordable materials and financing. Faced with regulatory and demand problems, replenishing affordable housing stock has become a challenge. So how do builders overcome those obstacles and thrive in a changing economy? Why are some homebuilders able to adapt while others struggle to evolve?

Not a lot of lots

“Lot supply is constraining Chicago’s ability to move upward,” says Tracy Cross, president and chief executive of real estate research firm Tracy Cross and Associates, Inc.

Lot supply in Chicago peaked about five years ago in the third quarter of 2011, when the vacant developed lot inventory was more than 250-months supply. Now it’s closer to 86 months of supply.

In terms of sheer numbers, an 86-month lot inventory is technically an oversupply. The “shortage” comes in preferred lots – otherwise known as “A” lots. It’s a problem Belgravia Group President and CEO Alan Lev says Chicagoland builders have always faced.

“Lot supply is a problem, but that’s not a new thing,” he says. “I like to think it is, but I look back to my younger years in this business: it’s always been hard to find good sites at the right price. You can always find stuff, and you can over pay for it, but the key is finding something at a number that actually works.”

Mark Gianopulos of Metrostudy claimed Chicagoland builders will look to supplement with infill locations. Cross says we need to expand, but that “it won’t happen over the next year.”

Why? Cross points to disorganization among the developer community, namely interests that come more from corporate dictums than collective agreements. “There are companies saying that builders can only go in and develop 100 lots because they don’t want to hold lot inventories,” he says. “That’s a corporate strategy.”

The hurdles Lev sees are more systemic. “I don’t know if it’s any harder to find lots in the city today than it used to be. It’s the same situation Chicago has always had,” he explains. “Every alderman has all the power in the ward, and you have to get his or her blessing to develop a lot, and the alderman won’t generally bless it unless it has the backing of all the right community groups.”

Assuming a builder can overcome corporate interests and satisfy the right community leaders to eventually land an “A” lot at a worthwhile price, there remain considerable restraints.

Labor

For one, Chicagoland is facing a shortage of skilled labor.

“Labor availability is an issue,” says Lev. “Our subs and general contractors are extremely busy, and their prices have gone up quite a bit. That’s a concern and an issue.”

A report from the Cushman & Wakefield outlined the labor loss in Chicagoland: the construction workforce in the Chicago metro area plunged from 29,600 people in 2008 to 18,100 in 2011, and while it has been slowly building back up, fewer than 22,000 people were working in the industry last year, or about 74 percent of the pre-recession level, according to data compiled by.

Materials

Lev also cites materials costs as a concern. “Pretty much the same building that we built three years ago for $140 per square foot is now $170 per square foot,” he says. “That’s partly due to materials costs.”

And it’s partly due to a building code Lev calls “antiquated.” He says: “It’s not at all in step with the model codes that are used in most other places. And that adds to the cost quite a bit.”

In Chicago, builders are held to standards that keep them operating behind norms. For instance, the city’s building code requires copper and other types of piping over CPVC, which is less prone to corrosion and costs considerably less. “The city is adding costs for things that are unique to Chicago – things you won’t find in codes elsewhere,” Lev says.

Regulations

Complaints against the city’s building code are only part of a much wider set of grievances builders have against how the city and its suburbs continue to shape the new construction market.

“In the suburbs, builders face 297 municipalities and political jurisdictions from which to get approval,” Cross says, explaining the difficulty of adhering to or even understanding the hodgepodge of regulations suburban builders have to follow. “I live in Schaumburg – if I go 1,500 yards, I’m going through three different villages. And none of those villages have the same rules.”

Chicagoland builders juggle regulations on what buildings can go on what lots, how those properties must be built, what materials they can use. Those are necessary to ensure a baseline for quality, but many builders argue the current rules and regulations are excessive. It is an opinion that extends to the national market, according to National Association of Home Builders senior economist Michael Neal.

“In a blog, we recently illustrated the regulatory burden federal, state and local governments are putting on builders,” he says, “and it puts significant upward pressure on the prices that buyers ultimately face.”

One particular Chicago regulation that Lev believes harms buyers is the city’s affordable requirements ordinance, or ARO, which our own Peter Thomas Ricci covers here.

The affordability dilemma

Currently, Chicago is a relatively affordable U.S. city. In this year’s second quarter, 60.5 percent of Chicagoland housing stock was considered affordable by the NAHB’s Housing Opportunity Index – a 100-point scale to compare local incomes against housing costs.

“Our HOI has a dividing line. If you’re above 50, you’re considered affordable, and if you’re below 50, you’re less affordable,” says Neal. “Nationwide, we’re around 50.”

The latest S&P/Case-Shiller Home Price Index reported that May home prices in Chicago increased more than any other major city in the country. And during the first quarter of this year, the supply of starter homes dropped 47.3 percent compared to 2012, according to Trulia.

Do builders have an obligation to provide affordable homes?

Lev says yes, but it’s a shared responsibility.

“I think the responsibility should land on everybody. Frankly, if you think about it, affordable housing is important for everyone,” Lev says. “It’s very hard to build affordable housing, because of land prices, because of construction cost, because of the building code, because of union labor, and because of the affordable requirements ordinance. All these things add up and make it very difficult to building anything you would think of as affordable, especially in areas closer to the city.”

But that’s not to say affordable building is not already happening. “Not all builders are building at the high end of the market. Almost 30 percent of all product produced in the new construction sector is priced under $250,000,” Cross says, noting that in the custom home sector, builders have migrated closer to the $1 million-and-up side of the market. He adds: “But that’s only a very small portion of supply chain.”

The current inventory of affordable new construction homes is not enough to satisfy the demand for entry-level homes. But Cross does not believe filling that inventory deficiency is the sole responsibility of builders.

“Is every first-time home buyer entitled to a brand new house?” he asks. “The answer is no.”

Existing in the new market

Prime lot availability is another issue for today’s builders. In 2005, 1,507 building permits were issued for single-family homes in Chicago proper, and in the suburbs the number was more than 32,000. Last year, the number of permits issued dropped to 503 and 5,905, respectively.

“Most of the construction going on in the city is rental,” Lev says. “Builders are still delivering 4,000 units annually – which is down from the high water mark of 6,000-plus units – but most of it is apartments.”

A silver lining Lev sees in the new construction market, which may come to define new construction in Chicagoland over the next decade, is the growing condo market. “What’s selling in the condo market is larger units and high price points – $700,000 and up,” he says. “We’ve been able to tap into that market.”

The reason one-bedroom condos aren’t selling is because there is no demand for them. Millennials are not buying. They’re renting, or living with their parents. As this new generation of homebuyers struggles to find ways to buy new homes, less are being built.

“We’re 75 percent below peak, and we’ve been there since 2008,” Cross says. “Every year we’ve been bouncing along the bottom. So is new construction going to increase in the short term? Yes, it almost has to.”For builders, existing in today’s local and national markets is a matter of waiting for the new generation to reach the means necessary to buy in substantial numbers. And Neal says it’s inevitable.

“The NAHB does a preference survey, and in it, we ask Millennials: do you prefer single-family homes,” he says. “Their preferences are not much different from what previous generations have expressed.”

Sixty-five percent of Millennials prefer a detached single-family home, but because of price, credit availability, student loans, stagnant wages, etc., they haven’t been able to buy. But they will, eventually.

“We’re experiencing a delay, and eventually that pent-up demand is going to be unleashed,” Neal says. “But it will take some time for young buyers to work their way through the rental market and the existing market before they can purchase a new home.”

When that wave of demand finally hits the market (in the mid 2020s), there’s unlikely to be an explosion of new single-family homes in the city proper. Builders are going to have to expand. They are going to have to subvert the lot shortage.

“Builders are going to need to move into the greenfield, so to speak, but not totally into the emerging markets where you can’t see the Chicago skyline anymore,” says Cross, referring to the under-developed areas beyond current suburban limits. “What I mean is that we’re going to see development occurring in areas along the Route 59 corridor in Plainfield, or near the Cape Farm Road Corridor near Joliet.”

Cross expects to see more development in Oswego, Elgin and Gilberts, as well.

That is what builders will have to do to survive.

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