The recent rise in home building could be thwarted by an unlikely factor, a shortage of land in desirable locations.
During the housing boom, developers—the companies that pave roads and sidewalks, dig ditches for sewage pipes and power lines and bring in bulldozers to clear space for construction—prepared hundreds of thousands of lots and sold them to home builders, which in turn built subdivisions.
Today many of these lots remain empty. They often are in distant suburbs of cities and still owned by banks, builders or developers. The problem is that they are in places where few home buyers want to live. In fact, builders are running low on land in suburbs that have well-regarded school districts and reasonable commutes to city and job centers.
That is weighing on the recovery of the new-home market that in recent months has showed signs of life. Many economists are optimistic that housing starts—the number of houses and apartments on which construction has begun each year—will rise 15% to 25% in 2012, a prediction that could be bolstered by the May housing starts report due out this week.
Starts have been ticking up, sales of newly built homes are higher and, in some areas, new-home prices are rising. But in markets such as Atlanta, for example—where home prices fell 18% in the latest Case-Shiller report—there is land as far as the eye can see, but few good places to build.
The Atlanta metropolitan area has about 120,000 vacant lots ready for building, some as far as 70 miles from the city’s downtown, according to real-estate consultancy Metrostudy Inc.
“A lot of the demand during the boom was speculative demand, not real user demand, and speculative demand was blind to location,” said Brad Hunter, Metrostudy’s chief economist. “Real demand is now concentrated in those core counties.”
Bidding wars are breaking out for lots in prime locations, with some builders developing raw land themselves in Atlanta’s nearer suburbs such as Roswell, Dunwoody and Johns Creek.
One such battle unfolded at the Paddocks, a 240-acre subdivision near Cumming, a suburb near an interstate with a public school district that has a good reputation. In the past six months, four publicly traded builders bid up the price on a patch of raw land planned for about 130 houses to nearly $90,000 an acre from $40,000 an acre, according Scott McGregor, a land broker with Resource Real Estate Partners, which is handling the deal.
“Eighteen months ago no one would talk about buying undeveloped land,” Mr. McGregor said. “Today, everyone is clamoring all over each other to get these good land positions.”
Elsewhere in metropolitan Atlanta, there are plenty of cleared lots that are likely to remain vacant for another decade or more.
“Of all the lots out there, probably 95% of them are unbuildable,” said Patrick Malloy, an Atlanta-area builder. Mr. Malloy said home prices are recovering—but only in the city and nearby suburbs, starting in the established affluent neighborhood of Buckhead and going north.
Much farther outside Atlanta, “the sales prices for homes are less than what the sticks and bricks cost,” Mr. Malloy said.
That means the recovery in both home construction and new-home sales could be held back until developers replenish their supply of land, especially in areas where buyers want to live. According to data analyzed by Capital Economics, the 12 biggest publicly traded home builders controlled 632,864 land lots at the end of the first quarter of 2012, compared with 1.8 million six years ago.
Less land on hand translates into less building and fewer construction jobs. According to Capital Economics, there is a close historical correlation between housing starts and land owned by builders.
“In the short run, desirable land gets constrained when you’re in an up cycle,” says Michael Feroli, an economist with J.P. Morgan. “The new-home market is not going to turn on a dime…If there were a surge in demand, the supply response would take several months, or even a few quarters.”
Many economists predict that builders will start work on between 700,000 and 750,000 units of housing in 2012. That is up from 608,000 starts last year but well below the annual average of 1.7 million built between 1998 and 2004 and far less than the two million at the peak of the market in 2005. Of course, fewer new homes being built means a tighter supply of existing homes, which could help push up prices.
Two recent surveys from housing-research firms John Burns Real Estate Consultants and Zelman & Associates suggest that until these land inventories rise, new-home sales and construction will be constrained. As builders run out of “finished lots”—land that has been developed and is ready to be built on—in good locations, land prices in these areas are rising.
“Any kind of pop in sales volume this spring is going to deplete the builders’ land positions in their current communities, the really desirable locations…and I can really see how difficult it’s going to be to replenish these locations,” said Jody Kahn, who specializes in land issues for the Burns group. “We’re coming off of the bottom, and it’s a little bit like trying to run in a swimming pool. You can run all you want, but it’s hard to get any kind of speed or momentum.”
The builders’ response to the shortage likely will be to pay more for the most desirable, and most scarce land, or to begin developing raw land themselves. Both courses require big upfront capital commitments and both will likely require builders to pass on the additional costs to consumers in the form of new-home prices. That could make it harder for builders to compete on price with existing homes, whose values have been suppressed by foreclosures and short sales.
Corrections & Amplifications
Michael Feroli is an economist with J.P. Morgan Chase & Co. In an earlier version of this story, his surname was incorrectly spelled as Veroli.