High Interest Rates Make New Home Construction Less Feasible

The city of San Jose just released a report titled "Residential Feasibility Analysis" that compares expected construction costs with the value of the construction. The report says the total estimated development costs have increased by approximately 12-13% over the last 18 months. Construction mortgage rates have doubled over the last 12 months and hover above 8.0%. The report analyzed the expected total construction costs of building multi-unit housing and compared it to the expected value of the completed project for housing built to be rented and housing built to be sold. For market-rate homes, the expected residual value per unit ranged from -$322,000 to -$614,000. The residual value is the expected sales price minus the total of the hard costs, soft costs, sales costs, and profit. With these strong negative residual values, a builder would not want to build.

Looking at the San Jose real estate market shows that weak sales prices are not the cause.

The average total development cost for a rental unit in San Jose was estimated to be $549,100 in 2019, $790,800 in 2022, and $890,600 in 2023. In “Attachment A – Cost of Development” the total cost of city permits and fees is estimated at $53,600 to $92,800 per unit.

With little likelihood of new construction increasing the supply of housing, it is hard to see a path for reduced home prices in a healthy economic environment.