Paying for the free lunch

Paying for the free lunch

The greedy rich continue to force middle America to its knees; Fatcats get rich while middle America goes bankrupt; insert misleading hyperbolic statement here.

 

This is a topic I’ve wanted to write about for some time, but it’s seemingly never a top story. It’s always in the background, a false assumption that everyone accepts as fact. So today I will take the personal liberty of shining a light on the free lunches that Americans have been enjoying, and paying for, for years.

 

If you ask most Americans about finances and the cost of living, a long string of blame and complaints will follow, and will likely include the cost of home purchase as proof of whatever accusation they are making. I mean, just look at the cost of housing. From 1994 to 2004, the median cost of a new home steadily rose from 130,000 to over 220,000. And that was before prices really skyrocketed in the boom(It jumped another 20k in just one year)! Clearly that means that the richest 1% are making $100,000 more on every house they sell. They are stealing from Americans and keeping all the profits for themselves, probably in some account in the Grand Caymans where they don’t even pay taxes!

 

I am a structural engineer, and my career is deep within the homebuilding industry, so please allow me to pull back the curtain. Every industry has been hit with increased government regulation over the last several decades, and mine is no exception.

 

Building Codes:

If you bought a home twenty years ago, chances are an engineer never even touched the plans. A builder just built a house following rules of thumb that had been developed for decades and centuries. An architect was likely not involved in the process either. And many cities didn’t even have a building code that had to be followed. You showed up to the city office with a front elevation and a floor plan and walked out with a permit.

Today, there are teams of college educated, government registered architects, engineers, and designers that certify every plan that breaks ground. They have to be familiar with thousands of pages of code that reference tens of thousands of pages more. Everything is governed by a code.

These requirements make our houses immeasurably safer and better, but it isn’t free. The cost of my time and training is not free, and the cost of building a house that meets these stringent codes is even higher.

Design Guidelines:

Every city has requirements for anyone to pull a permit and build a house. They have certain codes that builders must follow, and they have “Design Guidelines”. If you’ve ever driven through a neighborhood from the 80’s or 90’s, you see a lot of rectangular houses with gable roofs. They are ugly, and boring, and amazingly cheap to build. You do not see many new neighborhoods with this level of simplicity, and every year you see less and less. This is the result of design guidelines. Cities require that the outside appearance of a house meet certain minimums – a set percentage of stone/brick, a subjective use of design elements to provide variety, certain size requirements for front porches, and on and on. This is to reduce the cookie cutter stigma that has long dominated my industry. Well here’s how much it costs you:

One of my clients is a builder who constructs the exact same house in multiple cities. Each city has different design guidelines, so the builder changes the exterior appearance for every city. The cost to add stone, fake dormers, mass breaks and other design elements is nearly 15% of the cost of the home! In this specific case, the cost of building the house rises nearly 30 thousand dollars for the exact same floor plan. The builder doesn’t make any of that $30 thousand, that’s purely in the amount of materials and labor that each homeowner is buying with their house.

Of course the base house, the one that’s $30 thousand cheaper, is a complex house to start with, one that is already far more expensive than any 80’s cookie cutter beauty.

 

I can continue on, to highlight the permit fees, plan check fees, impact fees, etc. that builders must pay to the city government for every house they build (this can easily exceed $20,000 in many cities). I can highlight the increased liability that these companies face. I can discuss the worker’s compensation payment increases. What I can’t do is show you the extra profit that these homebuilders are making – because it isn’t there. Do they still get rich? Yes, some of them do, the same as they always have. But it’s time that people stop blaming the increasing costs on the 1% and greed. It is the homeowners, the communities, the cities that are getting the return on the higher costs of home investment.

 

Now this is just one example of many. The automotive industry suffers from the same issues. Increasing regulations, increased safety requirements, increasing fuel economy requirements, more expensive and extensive testing – they all add to the cost of a car. The automaker still makes profit like they always have, but with all those extra dollars the buyer is getting a car that is safer, nicer, and much more fuel efficient.

Pick an industry with rising prices, and similar examples can be found. There’s no increase in the greed of the 1% driving this new economy. No secret conspiracy to steal from the common man. It is the greed of Middle America, with its demands for bigger, better and safer, that is the true source of the increased cost of living.

Yes, that is correct.  The greed of MIDDLE AMERICA is to blame.

As I see it, we have two choices:

-Go back to the good old days. The days when houses fell over in earthquakes. The days when cars weren’t required to have silly things like airbags or crash testing. The days when cancer was a death sentence. You know, the good old days.

-Accept that better things cost more and enjoy the highest quality of living that has existed in the history of the world.

It will always remain true, there’s no such thing as a free lunch. So let’s not complain when the check comes.

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Jacob Morgan

Jacob Morgan

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8 Responses to Paying for the free lunch

  1. Am I right in understanding that you’re accepting of much of this government regulation then, at least to the extent that it really does promote health and safety? Even while you are frustrated by the cosmetic local differences that add to cost without doing much in terms of quality?

    I especially appreciated your point that much of this extra cost is actually going to pay white collar, middle-class professionals – the kind of jobs we say we want more of. Worth considering whenever we talk about regulation. (For instance, while I would welcome a much-simplified tax code and streamlined filing process, that’s also a LOT of accountants suddenly out of work.)

    • Jason – Yes I absolutely think there is some room for government regulation. Specifically, the building codes section of this topic. The average homebuyer doesn’t have enough education to understand the difference between a safe home and a dangerous one. Just as auto makers must crash test their cars, I think it’s important that new homes submit to a set of criteria that professionals determine to be safe.
      It’s my opinion that safety should be regulated – as I believe that the governments role is to protect citizens from eachother.

      I have issues with design guidelines. While it is done at a local level, which I think is the right way to do it, I think random design requirements are forced on builders and buyers when no one understands the cost. A local government will tell builders they have to design it a certain way, than the citizens of that locale will complain that prices are too expensive. I don’t think that looks should be regulated – I think that the public should determine that with their wallets.

      In a future writing, I’ll discuss my opinions of regulation on a more global scale.

  2. I find this information about the cost of actually building a home very interesting. I had previously assumed that the increase in home prices over that past 20 years was due mostly to increased demand on the part of homeowners to live in desirable areas near city centers and in the suburbs. More and more dual-income households in the middle class may tend to increase the amount a family is willing to pay for a plot of land, thus pushing up prices; this may be just one of a wide range of causes for the increase in home prices. I am not an economist and don’t have data to back up that theory.

    Generally speaking, I think that many people in our generation define the “American Dream” quite differently than our parents did. Some are frustrated that the American Dream appears harder to attain than ever. For some groups, this may be true. Generally speaking, however, I think that increased expectations give rise to a lot of these frustrations. Your example of homes now vs. then is perhaps a case in point.

    • Andrew – There is no doubt that land costs have also increased – especially in the more desired communities. I didn’t include that in this discussion because it is so varied. Even today, the cost of a lot can vary by as much as 100% for a builder, so comparing it to the past becomes difficult.

      I think you nailed it – increased expectations are the biggest cause of frustration today.

  3. That is an interesting perspective to bring to the factored costs of housing. Given that fact that you are imbedded in that industry, I would be stupid not to accept your insight. I am certainly not here to disagree with you that increased government regulations through safety codes are partly to blame for the increase costs. I believe it would be silly to think that safer more efficient housing would somehow cost less. However, I think if you polled most people, you would find that they would be ok with paying 25% of their actual housing cost to ensure it was done with someone looking over the shoulder of the builder.

    My problem lies in your premise; that somehow the 1% isn’t culpable for rising costs of homes. Did you miss what happened in 2008? While many thought big government involvement was to blame, which to be fair was at least in some part true, the biggest driver of prices were a desire for increased profits from all involved. Without having to rehash the entire list of who was to blame, a solid part of it lied in the laps of private entities, specifically investment and commercial banks.
    http://www.ritholtz.com/blog/2012/10/4-year-flashback-private-sector-not-gses-triggered-crisis/

    Investment banks are designed to turn profits for their investors. So, in the case of the housing market, they created all sorts of methods to achieve this goal. They pushed sub-primes, alt-A, CDOs, CDSs, etc. All in the hopes that the bubble would just keep on getting bigger. It worked for a while, but then it didn’t anymore. In fact, it came crashing down and took some banks along with it.
    http://research.stlouisfed.org/fred2/series/MSPNHSUS

    This push to blow the bubble up with no real care, or idea that it had to come crashing down at some point, was not done by the middle class. Which by the way have become poorer as a result. This was done in order to achieve greater wealth for a very small section of people, with no intention of creating any real “value”. For all intents and purposes, it was a modern day pump and dump. Just done with a far more complex system.
    http://billmoyers.com/2013/09/20/by-the-numbers-the-incredibly-shrinking-american-middle-class/

    Either by sheer luck, or with an idea of what the future might hold when something as large as this comes crashing down, they were able risk unbelievable amounts of money and not have to suffer the consequences. This topic is a whole other can of worms for another day, so I’ll digress.

    So to sit here and lay the blame of the “free lunch” on the part of the middle class is rather pompous and naïve. This isn’t to say that the middle class wasn’t handed down some left-overs from that free lunch, but the bulk of it went to the oligarchs in our country. Sure, increased regulations cost money, so does unabashed greed. Just look to the recent Davos meeting to see what they’re concerned about this year.
    http://www.washingtonpost.com/posteverything/wp/2015/01/26/the-dark-underbelly-of-the-davos-well-being-agenda/

    • Clinton – My opinion is that the middle class is the majority factor to blame in the rising costs of homes. This opinion is based on the fact that I can track a majority of the increase to factors that are driven by the middle class (and just for the record, opposed by the greedy, horrible 1%). So I would disagree that my opinion is pompous and naïve. That my opinion disagrees with the underlying assumptions of our current societal craze, sure – guilty as charged.
      Let’s split what you discussed into 2 parts – The run up in the bust, and the overall change in home prices.
      -The overall change in homeprices.
      I would agree that people would be willing to pay more for a safe house. But this has nothing to do with the 1%. In fact, the 1% typically opposes the adoption of newer, stricter codes. They make more money when they can sell more houses. They can sell more houses when they are cheaper. They are cheaper when they are less safe. Ergo price increases due to building codes can be entirely laid at the feet of the homebuyer.
      People are also willing to pay more for a better looking house – though they have no idea just how much extra they are paying. Again, better looking houses do nothing for the 1%. And again, the 1% fight it at every turn. So the massive price increases due to design guidelines can be laid at the feet of the homebuyer.
      I did not go into it in the article, but probably the biggest single factor is home size and finish level. The square footage has tracked upwards considerable (a trend which just now might start reversing if my anecdotal experience suggests anything). And the level of finishes, hardwood floors, granite, dual HVAC systems, etc. has steadily increased. Even my clients who specialize in homes for first time buyers are putting standard granite in the kitchen. This, again, is a cost that is solely attributed to the greed of the middle class (hopefully by now you will see that ‘greed’ is always used tongue in cheek).
      So, we can safely say that 18 of the last 20 years saw price increases due in large majority to home buyers. What about those other 2 years?
      You mention that the 1% was greedy. And they were. So was the rest of America. It’s not like the middle class just went about their business as usual while the 1% went crazy. The middle class was just as greedy, trying to profit on houses without adding any value, trying to buy houses they couldn’t afford because everything was just going up up up. Oh, but it’s ok, because poor old middle class morons don’t know any better? They were lied to by the 1%, who of course should be able to predict the future. So when the 1% and the middle class act in the exact same fashion, only one of them is judged as the villain? Everyone was greedy, everyone was trying to profit without adding value. Everyone was to blame in these years.

      The fact is, people can get rich from building houses (they can also go broke). They have for a century. Nothing has changed in the last decade or 2. They aren’t all of a sudden trying to extract larger profits at the expense of the middle class. They are seeing the same profits they always have, why? Because it’s a tremendous feat to build a house. It requires a huge cash investment, coordinating the labor of hundreds of workers, and a huge risk related to the sale price of the house.
      Given all of those factors, the payoff has to be significant for anyone to go through the trouble.
      My purpose with this article was to illustrate that it’s a false argument when home prices are used to vilify the 1%. If people want to hate the rich, that’s their choice. They just need to find some real reasons for it and stop propagating ignorance with their ridiculous arguments.

  4. “But this has nothing to do with the 1%. In fact, the 1% typically opposes the adoption of newer, stricter codes. ”
    -They do? How do you know this, can you support it with evidence?

    “Ergo price increases due to building codes can be entirely laid at the feet of the homebuyer.”
    -Why is that? Did homebuyers request increased building codes? How do prospective home buyers change building codes? Was there an increased lobbying by homeowners for newer building codes? This assertion sounds as though you are putting the cart before the horse.

    “People are also willing to pay more for a better looking house – though they have no idea just how much extra they are paying.”
    -Don’t they? Are they not buying the house for a specific price? Don’t free-markets naturally trend toward equilibrium? Are you saying that buyers are paying more than they should? Or are you saying that builders are charging more than they should?

    “Again, better looking houses do nothing for the 1%. And again, the 1% fight it at every turn.”
    -Don’t better looking houses increase property value in neighborhoods? Doesn’t that help to raise investment values on things like REITs and real estate investment vehicles? How does that not benefit the the 1% given the fact that most of their income is earned from capital gains? Which likely include real estate.

    “And the level of finishes, hardwood floors, granite, dual HVAC systems, etc. has steadily increased.”
    – Couldn’t that be due to the fact that the cost of the tech. has come down over the years? So while it may cost more in total to put ALL of this into a house, you are still getting more for less?

    “So, we can safely say that 18 of the last 20 years saw price increases due in large majority to home buyers. What about those other 2 years?”
    -We can? Why? How? What about those other two years? Can you tell me?

    “You mention that the 1% was greedy. And they were. So was the rest of America. ”
    -Ok, so we have our first agreement. Everyone was greedy, but not at the same time however and that is a big stipulation.

    “The middle class was just as greedy, trying to profit on houses without adding any value, trying to buy houses they couldn’t afford because everything was just going up up up.”
    -Yes they were, however by the time most of us realized it the ones who helped facilitate the bubble had already made their money and were now adjusting to catch the wave down.

    “They were lied to by the 1%, who of course should be able to predict the future.”
    -Lied to? No, deceived, mis-lead, yes. And to think that those who have been accused(and found guilty) of manipulating every major market type out there(LIBOR, FOREX) since the recession had no way of knowing the bubble that was being blown up is either naive or ignorant of history. Investors are trained to not only spot ways to make money, they are trained to understand and attempt to forecast human behavior as it relates to economics and the markets. The market is mostly controlled by emotions, if you can begin to predict this, it could be easy to make some money

    “So when the 1% and the middle class act in the exact same fashion, only one of them is judged as the villain? Everyone was greedy, everyone was trying to profit without adding value. Everyone was to blame in these years.”
    -This is a statement which places the two groups on a level playing field. That they somehow all had access to the same information and the same knowledge base(and influence) to affect the markets. It’s just not borne out by what history tells us as it relates to the housing crisis.

    “The fact is, people can get rich from building houses (they can also go broke). They have for a century. Nothing has changed in the last decade or 2. They aren’t all of a sudden trying to extract larger profits at the expense of the middle class. They are seeing the same profits they always have, why? Because it’s a tremendous feat to build a house. It requires a huge cash investment, coordinating the labor of hundreds of workers, and a huge risk related to the sale price of the house.
    Given all of those factors, the payoff has to be significant for anyone to go through the trouble.”
    -I can agree with you here. However I am not discussing the housing price fluctuations as it relates to home builders. They play only part of the role of the cost of this commodity. You MUST factor in the role that investment plays(builders, especially large ones, do rely on investors to keep their motor humming, right?) in the housing market.

    “My purpose with this article was to illustrate that it’s a false argument when home prices are used to vilify the 1%.”
    -And my response is to show you why that is a flawed argument. The 1% have an enormous amount of control over the prices of most everything we buy, if not everything. Including houses. To think that they are somehow irrelevant to this discussion is, again, naive at best.

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