Lead Story… Ivy Zelman of Zelman and Associates started some industry chatter last week by posting a video about how difficult it is to build affordable homes, particularly in CA. It focused primarily on two areas: FHA loan limits and impact fees. Nick Timiraos from the Wall Street Journal did an excellent write up if you don’t want to watch the video. Today we are going to focus on the FHA issue. Friday we will spend some more time talking about impact fees and why they are so high in California.
For many entry level home buyers. FHA is the only option. The loans are easier to qualify for than GSE conforming loans and can have down payment requirements as low as 3%. The FHA sets it’s loan limits based on the county that a home is located in. Zelman’s critique of FHA is that it’s a clunky, one size fits all product that covers some very large geographical areas that have vastly different home markets. She used California’s Inland Empire, Southern California’s primary growth market and the neck and sleeve tattoo capital of the US as an example. The Inland Empire is 4,850 square miles. If it were it’s own state, it would be the 11th largest in the US. Parts of the Inland Empire are adjacent to Orange County and Los Angeles and are quite expensive. Other parts are in the middle of a vast desert and not very expensive. Yet the FHA set their loan limit at $356,500 for that entire massive area, even while surrounding counties to the south and west have loan limits of between $580k and $625k right over the county line. This makes it much, much harder for buyers to purchase entry level homes in the interior (LA/OC commuter) Inland Empire Markets:
For entry-level buyers, financing is also an issue. Many builders rely on loans backed by the Federal Housing Administration, which allows buyers to make down payments of just 3%. Ms. Zelman says as fees rise, builders are struggling to build homes that they can sell for prices below those FHA limits, which vary from county to county. This leaves builders with very little margin to take the risk of building and selling entry-level homes.
For example, consider the typical starter home in California’s Inland Empire, about an hour east of Los Angeles. The FHA loan limit there is $355,350. A typical home might require $70,000 in raw land cost, another $60,000 to develop the land, $100,000 in direct construction costs, and $63,850 in other overhead and selling costs. That brings the total cost to around $294,000.
Ms. Zelman says impact fees in the Inland Empire now average around $50,000 per home, up from $11,000 in 2005. If this home is going to sell at the FHA limit, the profit—that is, the incentive to build this home—has essentially been washed out by the impact fee.
“Builders won’t build it, and they won’t build it for a good reason,” says Ms. Zelman.
Ironically, this is a problem that could be solved incredibly easily were it not for the fact that government bureaucracy is involved. The simple solution is that the FHA should be based on zip code rather than county and should reflect the entry level market in a given zip code but include a cap so it doesn’t lead to abuses in zip codes in Newport Beach, Beverly Hills, etc. Years ago, this would have been a tedious mess to sort out. However, the data is already out there and easier to access due to advances in technology. In fact, it’s the very data used to come up with the county numbers, just sorted differently. Basing FHA loan limits by zip code would help the commuter markets like the western Inland Empire by providing access to financing that simply isn’t available today and has helped keep these markets from recovering. At the same time, it wouldn’t add fuel to the fire along the coasts where median home prices are running over $1MM so long as the absolute cap remained at a reasonable level. Perhaps I’m missing something here but this seems like a common sense approach that’s a win-win: builders can sell more entry level units because buyers can qualify for mortgages, cities and counties collect more fees from home starts and we create more jobs. What am I missing?
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