This is the second of a series of articles about Seattle-area housing shortages and prices. The first one, on middle-housing, is here.
Bellevue’s Lake Hills neighborhood is a classic post-war suburb. It was built out rapidly in the mid-1950s, as the Seattle area emerged from a severe post-war slump, and thousands of homes went up in just a few years. These are modest homes—1,200 square foot ramblers, 1,700 square foot split levels—aimed at the expanding Boeing workforce. With the bridge across Lake Washington, the Bellevue area had become the most accessible part of the region with substantial development potential.
By the mid-1980s, these homes were assessed at around $65,000, at a time when the median household income in the county was about $25,000. Today, when median household income in the county is about $110,000, the unimproved versions of these homes are assessed at over $1 million. In other words, the values went from about 2.5 times incomes to 9 times median incomes, even as the homes themselves deteriorated.
Why is a tired, small, outdated house in a pleasant but ordinary neighborhood valued at $1 million? It’s the land values, of course. The Assessor’s office makes this pretty easy to see. For one of these original-condition ramblers in Lake Hills, the house itself is assessed at just $100,000 but the land is assessed at $900,000. And, sure enough, when these are sold today, they are typically torn down and replaced with a home that will sell for between $2 million and $3 million.
That same rambler, in the Dallas suburb of Plano–a Bellevue-like city–might sell for $350,000.
It’s all about entitled land
To understand the high prices of single family homes in our region we need to break the package out into the two pieces: land and improvements. For this discussion we can dismiss the improvements piece pretty quickly. Over time, buildings tend to stay flat or lose value (hence all those articles about how you will never get your money back out of an elaborate interior remodel). Styles and floor plans change, and structures deteriorate with normal wear and tear. Meanwhile, hard construction costs—materials and labor—don’t vary much over time, or across the country. The structures are simply not the issue, driving prices up.
On the other hand, land is the big factor. In an expensive market, what counts is the value of the parcel underneath the house. But it must be emphasized that the real value is not the dirt itself, but the entitlement that comes along with the dirt, namely the permission by a local government to have a house on that lot and to connect to local utilities. Land without an entitlement only has value for the next best use (agriculture?) which, in an urban area, is pretty close to zero.
Moreover, the size of the entitled lot does not matter a great deal, as long as the setbacks and other features of the zoning code allow an appropriately sized building envelope. A 5,000 square foot lot just inside the urban growth boundary (UGB) will have a similar value to a five-acre lot just outside the UGB, where the zoning requires a five-acre minimum. Within a subdivision, curving streets and cul de sacs will yield varying lot sizes, and this also has minimal impact on total home values.
Here’s another way to think about lot sizes. Imagine your backyard neighbor has an oversized lot and offers to sell you part of their back yard and move the fence closer to their house. How much would you pay for that land? Unless you are trying to put in a sport court or a swimming pool or another house, you probably would not pay much, if you entertained the idea at all.
The other thing to understand about the value of these “entitled lots” is that in a given market area, all lots that do not have some special amenity (views, golf course) or disamenity (adjacent to a wrecking yard) have roughly the same value. Similarly-situated lots will have similar values whether they are under a brand new home, a nice older home, a tear-down, or are vacant.
The value of the entitled lot is the starting point for understanding the value of a home, and that will vary by place, of course. Put that Lake Hills rambler in Kent, and the structure will still be worth $100,000, but the lot under it will be worth maybe $400,000. In Yelm the lot might be worth $250,000. Home prices then climb from the lot price based on the usual factors of home size, condition, age, school districts, etc.
Why entitled land is so expensive
The price of an entitled lot in a given market area is mostly a simple question of supply and demand for houses.
An entitled building lot without any significant amenities or disamenities is a commodity, and basic economic theory tells us that the value of a commodity is tied to the marginal cost of producing a new unit of that commodity. So, lot prices will reflect the cost of land plus the cost of going through the permitting process to get that land carved into legal, entitled lots with utility access.
Both of these factors, land and permitting, drive up the cost of developing new lots, and that is reflected in the prices paid for all lots that are included in home purchases. In other words, as the cost of developing new lots on the edge of Sammamish goes up, the price of existing homes in Sammamish goes up as well.
Here’s the main reason our housing prices are so high. The price of new lots drives the prices of new homes. The old rule of thumb still holds, especially where bank financing is involved: the sales price target for a new home should be at least three times the cost of the finished building lot (the entitled lot plus infrastructure). The “highest and best use” of a new building lot is a home that is higher quality than anything comparable in the existing used home market in the area.
New construction builders never want to compete directly with the used home market, so they will always build the most expensive home in an area. So, if the lot ends up costing $1 million, a builder will not likely get bank financing to build anything that will be priced at less than $3 million.
What to do about it
If entitled lots are a commodity, then the obvious way to lower their price is to lower the cost of bringing new lots onto the market. That means lowering the cost of raw land and lowering the cost of turning that land into individual entitled lots.
Urban Growth Boundaries (UGBs) have scarcely moved in King County since they were first drawn in the 1990s, so the supply of land that can be subdivided into normal building lots has been steadily shrinking. Much of that land is controlled by large development and home building companies who are banking it for future use and will never put it on the market for other developers to work with. Other land has fallen into the hands of speculative investors who are watching their land holdings increase in value as land prices rise. High demand and short supply drive up prices.
One way we will lower the value of entitled lots, and thereby lower the cost of single family homes, will be to add new land by moving outward the UGBs. The UGBs were never intended to be frozen in time as they have become. They were meant as a tool to ensure contiguous growth and to avoid leap-frog development, which is an inefficient use of infrastructure. It is time to honor the original intent of the GMA and expand the UGBs to accommodate the housing we need for families of all income levels.
If you think this means promoting the dreaded “sprawl,” a few things to keep in mind. First, sprawl depends on where you stand, and most current thinking is based on standing at the corner of Fourth and James Street, home of Seattle’s City Hall. But with hundreds of thousands of jobs far from Downtown Seattle, it does not make sense to keep thinking of the evolution of the region in those terms. Second, most areas outside the UGB are settled and hardly pristine, with pre-GMA subdivisions and individual lots, five-acre mini-estates and oddball commercial uses. Third, if we can afford $70 billion for a light rail system, we should be able to build roads and transit to much-needed new residential communities.
The UGB has become a sacred cow and (to mix metaphors) a political third rail. But so was single-family zoning, and look at what’s happening to upzoning single-family neighborhoods in state capitals around the country.