Why is Your House So Expensive? You’ll Be Surprised

Even though in many areas the cost of a house has plummeted over the last 12 months or so, it is still a huge stretch to afford a decent house, especially for first time homebuyers in many major metro areas. Why are houses so very expensive? Are the developers overcharging? Are the homebuilders all sending their children to Harvard and driving Porsches? Are homes now, filled with expensive standard features that used to be options a decade ago? Perhaps, but in some areas that’s not the largest reason for the increase. What is the single largest reason that a house costs so much in these locations?

In these areas, the single largest component in the increased cost of housing is the cost of government regulation. You read that right. The more “progressive” an area, such as Seattle, or San Francisco, the more expensive these government regulations seem to be for the average citizen looking for a home. Does your friendly state and local government respond to their constituency’s concern by reducing the level of government regulation, restriction and red tape?
Hardly, they’d get little credit for that. They wouldn’t want to reduce the cost of regulation and compliance for the guy just trying to get the house built. There would be nothing concrete local pols could point their finger at and say “See how I reduced the cost of housing for the little guy/gal”. Obviously most politicians are concerned with things they can point to during their next campaign. Now, if they can come up with some money to help Joe/sephine homebuyer in their quest for affordable housing, that’s something that can help them get elected next time around.

Are you having trouble believing me about all this? Well, I can understand that. After all houses are so very expensive, it’s hard to imagine that the cost of government is higher than the cost of wood, labor, or windows. Well, sad to say, it is. It’s not only me saying this either, although decades of involvement in the building industry has provided me with ample anecdotal evidence that it’s true. No, greater minds than mine have actually done real research on the problem of expensive housing, and gotten concrete data to back these theories up.

Government regulations, from land use regulations and environmental laws, to extremely complex and expensive building permit processes have piled on a huge amount of additional costs. They reduce the supply of buildable land, and economic law dictates that when you reduce the supply of something that is demanded, its price will increase. They have also increased the cost of compliance through such regulations as restricting the times of the year when work can be done on building projects. In addition some areas are notorious for the cost of building permits and the lengthy and complicated process one must go through to obtain them and keep them open.

I said that greater minds than mine have concluded that all this is true, and one such mind is University of Washington professor Theo Eicher, founding director of the University’s Economic Policy Research Center. He has released the results of a study, itself derived in part from the Wharton Residential Land Use Index, a detailed analysis of the cost of regulation and its contribution to the cost of housing in MSIs (Mean Statistical Areas) throughout the country. Professor Eicher’s study has concluded that in Seattle, fully $200,000 is of the average home price is attributable directly to the effects of government regulation. When you stop and consider that the average home price in Seattle is $447,800, and that $200,000 of that is due to government regulation, it’s amazing that the citizens of Seattle and King County (Seattle’s county) haven’t risen in revolt. The ironic thing is that it is these very same citizens lamenting the increased housing costs that voted in the politicians that enacted the laws, and in a few notable cases, the laws themselves.

The United States Economy - The Ferrari Effect

07 F430F1 Spider, Russo Corsa, Beige Lthr, 721 mi, $339,995’07 F430F1 Spider, Russo Corsa, Beige Lthr, 1,321mi, $324,995’06 F430F1 Spider, Nero, Cuoioe Lthr, 4,545mi, $314,995’05 F430F1 Spider, Grigio Silverstone, Girgio Lthr, 3,444mi, $289,995

These Ferrari ads are straight from yesterday’s business section. What can be gleaned from this, vis-à-vis the U.S. economy? Well, when you consider the base price of a 2007 Ferrari F430F1 Spider is $211,000 before any (extremely high priced) options are added, it means that there is tremendous demand for a car that costs upwards of a quarter of a million dollars. Now the price of admission to enjoy the wonderful shriek of a Ferrari power plant at full boil has never been cheap, but this makes that $1,995 2nd sticker your local Mitsubishi dealer has on a new Evo X look positively tame.

This indicates that certain segments of the U.S. economy are humming along nicely indeed. I call this the “Ferrari effect”. When there is such pent-up demand for extremely expensive goods, it indicates that there is an extreme amount of wealth floating around, and those that hold it aren’t afraid to spend it. That propensity for the wealthy to continue their unabashed spending on luxury goods is a great thing for the rest of the economy.

Ferrari must agree that those that have money will continue to spend it, as they just announced that carbon ceramic brakes, formerly a (are you firmly seated) $16,800 option on the F430, will be made standard equipment for 2008. Rest assured, they will not just give those beautiful discs of carbon away, a large portion of the $16,800 will be rolled into the base price of this year’s cars.
It is really quite astounding the level of demand of such an expensive vehicle. A client of mine recently took a journey to the local Ferrari dealer to buy Ferrari’s latest masterpiece, the 12 cylinder 599. The 599 lists for over $250,000, but that hasn’t discouraged a lengthy queue of buyers from forming. My client actually returned from the dealership with a 2005 F430F1 that he paid who knows how much for, after putting down the requisite deposit to secure his place in line for the 599. Sometime in the next 24 – 30 months, he’ll actually take deliver of it.
Something else that indicates the propensity of those that have money to spend it when they really want something
(As an aside, many of the very wealthy people I’ve known, and I've known quite a few (never been one of them, though), are extremely cheap. They won’t spend one extra penny if they don’t see the value in it. It’s an extremely common trait in those that have generated their own wealth. From that you can draw your own conclusions. Consider this, however; the major cause of the massive level of credit card debt exhibited by Americans today is a pattern of consistently spending beyond one’s means. Anecdotal evidence from those people I’ve seen that have accumulated a large amount of wealth do not have that trait.)
is the price structure of luxury vehicles, such as Porsches and Ferraris. Many would expect cars in this price stratum to have a very high level of standard equipment. Actually quite the opposite is true. Many things you’d expect to be standard are actually options, and very expensive options at that. For example, consider the Bose sound system (including 3-way component front door speakers with 10-inch subwoofers) on a new Infiniti G35, by all accounts a very nice car, is a $2,500. For good measure, Infiniti has also thrown in a power sliding tinted glass moonroof, heated front seats, a power tilt and telescoping steering column, automatic anti-glare rearview mirror with HomeLink® Universal Transceiver and compass, heated mirrors and a Bluetooth phone interface.
On the Ferrari F430, the Bose sound system option, all by itself, never mind such niceties as a Bluetooth interface, is a robust $7,250. Ouch! So, maybe you really don’t care all that much about a better sound system. You’d rather listen to the engine anyway. Well, you’d think a car that retails for as much as a house in Cleveland would at least include power seats, but no. In the Ferrari they will set you back an additional $2,653. The ones in my Jeep were only ¼ that much.
The point is that the Ferrari effect is still alive and well in many areas, although the economy looks like it’s poised for a slowdown. When the Ferrari effect goes away, we’re in for some rough sailing ahead. So, take a look at the business section. When the ads for overpriced Ferrari’s disappear, you’ll know we’re really in a lot of trouble.
Have a great, Debt Free weekend.

- Debt to Income Ratio – How to Calculate Your Debt to Income and Why

Your debt to income ratio is one your most important financial statistics. If you've ever bought a home you'll remember that was one of the pieces of financial information your lender wanted. If they were concerned about getting you the best mortgage, they showed you how you could improve it.

Just how do you calculate debt to income ratios anyway? For that matter, after you calculated it, what is an acceptable debt to income ratio? Calculating your debt to income ratio is fairly simple, You merely divide your monthly gross income by your outstanding debt. To calculate the ratio, you have to take your annual gross income and divide by twelve. I know, you were told there would be no math, but it's pretty darn simple, really. This calculation gives you your average monthly gross income. Here's where you wish you'd claimed all those tips and side jobs you've been gloating about. If you haven't reported them, you'll have a harder time getting your lender to believe you really have that level of income.
After you figure out your average monthly income, you'll need to look at two different percentages. If you are going to get a conventional mortgage, you'll use 28% and 36%. If you are getting an FHA or VA mortgage, you'll use slightly higher percentages; 29% and 41%. What do those percentages mean? The first is the percentage of your gross income you can use for housing expenses. That will include your house payment, all your housing associated insurance, and interest. These expenses are abbreviated PITI, for Principle, Interest, Taxes, and Insurance.
If, for example, your W-2 income was $55,291 last year, you'd divide that by 12. The result of that calculation is your average monthly income: $4,607.58. Depending upon the type of mortgage you'll be getting, that will give you the amount of house payment you can be approved for, all else being equal. In this example, you'd be able to afford a house payment of $4,607.58 x .28 for a conforming mortgage. $4,607.58 x .28 = $1,290.12. As you can see, that's not too much house in many metro areas. For example that house payment will allow you to technically afford, at this week's average 30 year fixed mortgage rate of 5.52%, a mortgage with a balance after your down payment of $227,000. You might want to avoid the mistake made by too many people leading up to our recent credit problems, and finance less than that.
Wait a minute, what about that second percentage? What does it mean? That 36% or 41% is the amount of house you can afford according to the standard debt to income calculation, after you include all your other recurring debt. This is where you include your credit card bills, car payments and store charge card payments. This is why your loan officer is telling you to pay down some of this type of debt. You can qualify for a larger mortgage if your recurring debt is lower.
Let's look at the above example, but assume you have only one car, a 2005 Honda Accord LX. That's a nice, sensible, family sedan with a price when it was new of about $22,000, depending upon the option level. Say out the door, with taxes an license, you're into it for $24,000. If you financed this car when it was new, and got 4.9% financing, your monthly payments would be about $450 per month. Let's also assume that you have the national average credit card debt of about $8,500, depending on whose statistics you look at. If you are also paying the national average gold card interest rate of 11.73%, your monthly minimum credit card payment amounts to somewhere around $260. (You can take heart in knowing that if you make only the minimum monthly payment on your cards that it will take only about 15 years to pay off the $8,500 and you'll pay about $4,000 in interest on the $8,500 principle amount!).
If you include your car payment of $450, and your credit card payment of $260, your recurring monthly expenses are $710. $710 added to $1,290.12 gives you a nice, round $2,000. Your mortgage lender will let you have 36% of your monthly gross income be consumed by PITI and recurring monthly expenses. Your current gross monthly income in this example is $4,607.58. 36% of your monthly gross is only $1,658. In this example, you're way too high after adding in your monthly expenses, to qualify for your house. Now you see why you see so many used car ads that read “Must sell, buying house”. With this level of monthly recurring expenses, you can only qualify for a house that's $948/ month. You'll be staying above the garage.

Your Other Largest Household Expense

A few days a go I did a couple of posts on lowering household expenses and how you can attack some of the largest expense to save yourself some money. In case you missed it, here are the largest expense categories of the typical American family from 2005, courtesy of US Department of Labor statistics.

1 - Shelter and associated expenses $15,167 (32.7%)

2 – Transportation $ 8,344 (18.0%)

3 – Food $ 5,931 (12.8%)

4 – Pensions and Social Security $ 4,823 (10.4%)

5 – Health care $ 2,664 ( 5.7%)

6 – Entertainment $ 2,388 ( 5.1%)

7 – Clothing $ 1,886 ( 4.1%)

Something's missing. What is it? Give up. Well for many people it is the largest expense category, for most of the rest, its in the top 3, yet for many people it gets completely overlooked much of the time. What is this major expense? Well, of course, it is taxes. You may just look at you paycheck to see what is taken out every month, but you'd be woefully underestimating how much the “Average American” pays in taxes every year.
Many taxes are hidden. Think about how much is really paid. There is employer matching of Social Security. You think the employer just takes that straight out of their bottom line? Guess again; they pass it on to their customers (you and me). There are gas, fuel and utility taxes, at the local, state and federal levels. Property taxes, which are borne by both renter and property owners. Sales taxes, B&O taxes on businesses, state income taxes, and capital gains taxes; it boggles the mind! There are just so many taxes. All the taxes paid by business are passed on to the consumer in some way or another, so don't be fooled into thinking that this tax or that doesn't, in some way, affect you. They affect all of us to some extent.
The upshot of all this is that there a about a million different tax reform organization, foundations and groups out there. Together they give some kind of picture about how much is paid by the “Average American” in taxes every year. The Tax Foundation has their Tax Freedom Day, the day when you stop working for the government and begin to line your own pocket. In 2007, it was April 30th. That works out to 32.8%. Hey, that's expense number1! Even if you give our taxing authorities the benefit of the doubt and this number is 20% too high, it would still come in at 26%, and fall neatly into slot number 2.
That's why I tend to rail a bit about taxes. The other expenses you can do something about. You can control taxes too, albeit to a lesser extent. but it requires much more effort and planning, in addition to a trip to your local polling place (or post office for a growing number of communities, where absentee is the new voting method of choice). I wouldn't care so much. After all the government provides many essential services that we desperately need, and should pay for. The problem is that they also provide many that we don't and shouldn't, in addition to being the model of inefficiency in many of the things they do.
Have a great, Debt Free weekend.