Many people have expressed their surprise that the increased mortgage interest rates in 2023 have not pushed home prices downward. Some home buyers have said they are waiting for interest rates to drop.
Many overlook the impact of high interest rates on new home construction while planning when to buy a home. The city of San Jose just released a report titled “Residential Feasibility Analysis” that discusses this impact. The report states “Interest rates have doubled over past 12 months. Construction interest rates are hovering above 8.0%.” The lowest cost per unit home residence to build, a low-rise condo with combustible interior and exterior structural materials that is built to become a rental complex, is now estimated to be $765,000 (900 sq.ft). The cost to build a similar residence that will be sold (1,150 sq.ft.) is now estimated to be $1,163,000. The costs were broken down into hard costs (labor and materials for construction) and soft costs (architecture, engineering, financing, city fees, insurance, property taxes, legal, accounting, and marketing). The soft costs were estimated to be 32% to 40% of the hard costs. In “Attachment A – Cost of Development” the total cost of city permits and fees is estimated at $53,600 to $92,800 per unit.
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. The residual value, which is the sales price minus the total of the hard costs, the soft costs, sales costs, and profit, is negative for all of the scenarios studied. Builders see a significant risk of losing money on new construction projects.
In an article titled “Apartment construction in Silicon Valley grinds to a halt amid cost crunch,” the San Jose Mercury reports that “no apartment projects with market-rate units broke ground in Silicon Valley during the first half of 2023”. With essentially no new construction, it is hard to see the cost of a home decreasing in a healthy economic environment.
The San Jose real estate market is so large compared to other Silicon Valley cities that it matches the average Silicon Valley real estate trends quite well.