Local governing bodies face a real dilemma. Budget-constrained, they often seek to raise revenue by imposing new taxes and business fees. Taxes are visible and unpopular and harder to get past a public still not recovered from the Great Recession. Fees, however, often sneak through since they are not universal, more often than not directed at businesses and applied selectively.
One kind of fees, those applied to new housing development and construction, have been rising. And viscerally, you might think, "OK, not that important. Somebody has to pay for services, and it doesn’t really affect me.’"
But, you would be wrong.
According to the National Association of Home Builders (NAHB), which monitors these kinds of data points, estimates show that, on average, regulations imposed by governments at all levels account for 25 percent of the final price of a new single-family home built for sale.
Nearly two-thirds of this number — 16.4 percent of the final house price — is due to a higher price for a finished lot resulting from regulations imposed during the lot’s development. A little over one-third — 8.6 percent of the house-price increase — is the result of costs incurred by the builder after purchasing the finished lot.
Now here’s where increased regulation and impact fees become counterproductive for local governments. Cities need population growth and, to some extent, new housing to thrive, but whenever governments increase the cost of a new home through fees, they are actually reducing the universe of potential buyers. This is known as the "price-out effect."
I checked in with Natalia Siniavskaia, NAHB’s economist and recent author of a study on the price-out effect, to see what’s going on.
As Siniavskaia computes the numbers, a $1,000 increase in home cost has the effect of pricing out 232,447 U.S. households; the size of the impacts varies across metros and largely depends on population and income distribution.
"The basic mortgage underwrites your home, and that should not exceed 25 percent of your income," Siniavskaia said. "We looked at household distribution across the United States to see who could afford homes in certain price ranges. Definitely, (when) you add on $1,000 to a house price, it translates to a higher monthly housing cost, so we can calculate how many people would be disqualified by mortgage underwriters; 232,447 households would not be able to enter that market for new homes because the household income is not enough to qualify for a mortgage."
That $1,000 is not difficult to get to because of another economic metric, the add-on. If, for example, a builder pays out for a permit, that additional fee will be applied to the construction costs of the house. If the builder takes a loan to finance construction, the loans would be accrued on the permit value as well. In other words, that permit value plus the finance charges are going into the cost of house, and the same would apply to all kinds other taxes and fees.
Local governments typically impose two types of fees on new housing developments: fees to cover the cost of permit processing, and impact fees that are intended to make sure developements "pay their way," for the cost of providing services like water and sewer, police and fire, and parks to new residents. Impact fees may also be levied to help cities cope with additional demands on roads and schools.
Some states, including California, require that cities collecting impact fees conduct "nexus studies," demonstrating a "reasonable relationship" between the specific amounts of the fees imposed and the costs of building or expanding public facilities. But critics say developers are often reluctant to challenge fees that might not be justified because they don’t want to jeopardize approval of their projects.
Not all fees have a price-out effect; it depends on when they are applied.
"Some builders buy impact fees before they start developing a lot, and some buy impact fees before the house goes on the market," Siniavskaia said. "Some builders pay a lot of regulation costs before they develop a lot, some during construction, some when the building permit is acquired. It all varies, so the cost of add-on charges varies depending on when the builders actually have to pay the fee."
As can be expected, governments continue to introduce new fees and raise old ones.
"Fees are getting higher," Siniavskaia said.
To which she adds, "When I started working at the NAHB 15 years ago, impact fees weren’t so common, but they were starting to be introduced by more and more localities. An impact fee is a kind of regulation and can include the cost to meet building code necessities, environmental rules or fees builders have to pay so the community can construct schools."
One of the newest fees being considered today is mandatory fire sprinklers in new homes. That could add at minimum another $5,000 to the cost a home.
As noted, increasing the cost of a home by $1,000 would have a different price-out effect on different metros.
The top five cities where $1,000 would affect the market the most are Chicago, New York, Los Angeles, Dallas and Houston. Even here there are discrepancies, Siniavskaia said.
Increasing the price of a new home in the Chicago metro by $1,000 disqualifies more than 6,000 households from buying a home. This is by far the largest price-out effect in the nation, partially because it is a relatively affordable metro area where 43 percent of households can afford a new home, and partially because it is a populous area with almost 3.5 million households residing there.
The second-largest number of price-out households is the New York metro where more than 5,000 households will be priced out. Even though this metro is double the size of the Chicago area, the price-out effect is smaller, simply because the area is less affordable to begin with.
At the bottom of the rankings, the markets where $1,000 would have the least price-out effect are the communities where homes are very high-priced and unaffordable to most Americans. These metros are: Napa, Calif.; Ocean City, N.J., Carson City, Nev.; and Sebastian-Vero Beach, Fla.
In Napa, where half of all new homes sell for more than $700,000, adding another $1,000 to the price would affect a total of 14 households since only 13 percent of the households can afford such an expensive new home in the first place.
If the price of a new home in Napa or Ocean City goes up by $1,000, who cares? So few of us can buy in those communities anyway!