Home Prices and Land Values

At the risk of stating the obvious, San Francisco housing is expensive because San Francisco land is expensive. Take a look at the chart, below, which shows historical sale prices for single family homes and vacant residential lots in four of San Francisco's ten real estate districts.

The blue bars show average sale prices for residential lots ranging from 1,500 to 4,500 square feet. (I used the average instead of the median because the average seemed to give a truer picture of what was happening to 'typical' lot values.) The dashed purple line shows median sale prices for single family homes. The four districts represented in the chart accounted for 86% of San Francisco's residential lot sales over the last fifteen years (i.e., as far back as my data goes).

Evidently, lot prices are correlated with home prices. That's what you would expect. Construction costs don't change much from year to year, so the opportunity to build a new home becomes more valuable as home prices rise. That causes developers to bid up the price of buildable lots. (Conversely, the high price of buildable lots prevents would-be homeowners from avoiding high home prices simply by buying vacant land and building their own houses.)

Through the first eight months of 2009, the average residential lot price was $440,000, compared to a median home price of $600,000. In other words, 73% of the value of a typical home (in one of the four districts listed above) is attributable to the underlying land. At the peak of the housing market, land accounted for almost 80% of the value of a typical home.

The price difference between a home and a comparable vacant lot can be interpreted as the market value of the existing structure (i.e., the thing that we usually refer to as a 'house'). Take a look at the chart, below, which plots the difference between the median home price and the average residential lot price for the same four districts as before.

The series is volatile, but averages out to around $175,000 over the fifteen-year period represented in the chart. That's the value that the market is implicitly assigning to existing single-family structures.

$175,000 doesn’t go very far in San Francisco. Even the small, 1,250 square-foot houses that typically are found in these districts would cost more than that to rebuild. Why does the market seem to value them at less than replacement cost?

The answer is that they would not be replaced today. If it costs $300 per square foot to build a house that will sell for $600 per square foot, it’s clearly more profitable to build a big house than a small house. That’s exactly what developers have been doing. In the process, they’ve driven lot prices up to the point where building a small, old-fashioned house would be a money-losing proposition.

So how valuable is San Francisco land? It’s so valuable that you probably wouldn’t even consider rebuilding your current house if it burned down. You’d be destroying a great deal of value if you did.