Are SD’s Land Values Going Up Or Down?

Posted by on Mar 1, 2017 in Blog | No Comments
Are SD’s Land Values Going Up Or Down?

SAN DIEGO—It appears we are at the peak of the market, but before assuming that land values will go down, it’s important to consider many other factors and where we live, Lee & Associates’ Matt Weaver tells How hard is it to predict where land values will head?

Weaver: Buy low, sell high. What a concept; it’s so simple. The basic premise to real estate wealth is defined by these four words, yet few people or real estate “land experts” can demonstrate that they know where we are in the real estate cycle. Even less have actually bought low and sold high.

In 14 years of selling land for residential and mixed-use development, I would like to imagine that I am as qualified as anybody to educate people on where we are in the cycle and where land values are heading. Then, my subconscious reminds me that I bought my house in January 2006. The day after I closed escrow the Union Tribune headline should have said, “Matt Weaver buys home; market drops 200% immediately.” It took me eight years to recuperate the paper value of my house just to break even. Surely, I can’t make this mistake again. What are some current factors and trends affecting land values?

Weaver: There are several. First, there’s supply and demand. San Diego County had 17,306 residential permits approved in 2004 during the housing boom. In 2016, there were approximately 8,000 permits granted. As a result, supply is low. And remember, only a portion of these permits actually resulted in new housing stock. Economists have said the current pace of new construction will not provide enough supply to meet market demands for population growth. What happens? Low inventory equals increased housing values, which should result in higher residual land values.

Another factor is increased costs and fees. I recently attended the NMHC Convention in San Diego. One of the leading contractors/developers of multifamily construction, Wermers Construction, said that hard costs for vertical construction have gone up 45% in the last two years. Do you know who has to pay for that in the long run? The land owner. We have seen “sticks and bricks” costs go up for single-family housing as well. For example, Shea Homes used to build a 3,200-square-foot to 3,500-square-foot home in Carlsbad for $80 per square foot to $82 per square foot three years ago. That same house now costs $92 per square foot to $93 per square foot to build. Most of this is due to labor costs. There simply is a lack of skilled labor available.

During the downturn, many people had to find new industries to work in, and now that there is a shortage, general contractors can get away with charging more for their labor. In addition, city and county fees are going up dramatically. For example, in the City of San Jacinto, impact fees are now almost $42,000 per lot for a 5,000-square-foot single-family lot. A “finished” lot is worth $85,000 per lot today, so after impact fees, that leaves $43,000 per lot to grade a subdivision, put in all wet and dry utilities, roads, etc. Plus, there is supposed to profit in that figure. There isn’t enough room. This is the case throughout cities in Southern California. It’s one major factor why some cities such as San Jacinto have not recovered from the downturn. If costs and fees don’t go down, logic would suggest land values will more than likely decrease. What about the political environment?

Weaver: Leading up to the election, there was a tremendous amount of trepidation in the development world. People were nervous about everything. When people are talking about World War III, they tend to get more conservative with everything in life, and certainly that includes pulling back the reins in the development business. This leads to inactivity and forces land values lower in order to move property. The new administration has certainly sparked much social-media debate. The controversy related to this administration has caused fear and paralysis in some camps; however, it has sparked optimism in others. One thing you can count on is change. Regardless of your political affiliation, most would agree that values have increased dramatically and we are at or near a peak in the market. What other challenges is the market facing?

Weaver: There have been entitlement challenges. Earning approvals on a development project has never been more difficult, regardless of in what jurisdiction the property sits. Despite efforts to “fast track” entitlements by the state through local jurisdictions, it has never been more difficult to get a project approved to build. Hydromodification and storm-water requirements on property have completely changed the game; you now have to clean or filter all water on-site before it leaves the property. Tentative maps that were approved under “old” standards have to be updated to the new standards if grading has not commenced within a certain time frame. This usually results in a loss of lots or units because of on-site detention basins. This also leads to higher site-improvement costs. In addition, the CEQA process has never been more difficult to navigate. Environmental groups including the California Coastal Commission have more power and say-so than ever before. They make the entitlement process drag out, and at the end of the day, can and do completely kill projects. The state also requires every city to provide a certain number of “affordable” units annually. These units generally result in a loss, thereby hurting the value of the overall project. This negatively affects land values, and there doesn’t appear to be any hope this will get easier to manage.

In addition, the United States is strapped with $20 trillion in debt. There are rumors that capital-gains taxes will inevitably increase and 1031 tax-deferred exchanges are in jeopardy, if not going to be abolished. Most of us believe interest rates have nowhere to go but up. These factors indicate that by the end of the year or into 2018, values will adjust downward in all asset classes and cap rates will go up. This causes land values to go down. How are rental and sales-price increases affecting land values?

Weaver: Over the last two years, rents have increased almost 10% in the rental market throughout Southern California. In addition, house prices have risen anywhere from 10% to as much as 30% in coastal markets over the last few years. This has helped to offset the aforementioned negative factors and trends and has helped to maintain, or even increase, land values. The median rental rate in San Diego is now $2,365, and the median price of homes currently listed in San Diego is $615,000. These are both higher than ever before. So, what are the takeaways from all of this on land values?

Weaver: Overall, it appears we are at the peak of the market; however, before assuming that land values go down, it’s important to consider all the aforementioned information and where we live. San Diego is less affected than other tertiary markets. People simply want to be in San Diego. Values are rising exponentially on the coast, yet in rural areas land values are still less than they were 12 years ago. It is my opinion land values will not go down and should stay steady, if not increase in some asset classes, for at least the next 18 to 24 months.