Difficult to acquire a home at a "good price”

The Truth as it is... the factors affecting the cost of housing on the island.

Difícil adquirir una vivienda a buen precio

"There is no inventory of affordable housing due to displacement caused by the entry of Act 60 beneficiaries into the market." FALSE

Some political sectors point out that the influx of capital to the island because of the tax benefits related to Law 60 has triggered an upward spiral in property costs and an inventory shortage. This offers a simple explanation that alludes more to provoking a "class war" than to identifying causes and solutions to the challenge of facilitating access to decent housing for working families. First, property costs are the result of a variety of factors, not just one element.

When corroborating the data, property sales on the island suffered a decline for the year 2023 of approximately 6% compared to the year 2022. The year 2022 also experienced a reduction in sales of 18% compared to 2021. The causes for this reduction could be associated with the fact that, during the pandemic shutdown, no property sales were made on a regular basis. Once banking functions resumed, the transactions that were pending were completed. So much so that in 2021 sales reached more than 13,200 closings in a real estate market that averaged about 10,000 sales annually.

As in other industries, the upward price spiral in housing costs is a global behavior, primarily seen in the United States over the past few years. In the United States, high construction material costs, supply chain challenges, and labor shortages have resulted in rising home prices. In fact, these high construction costs are one of the main reasons housing affordability in the U.S. is near a 10-year low.

Argument: Average property prices have increased 60% in the last decade. FALSE

Economic data for the last 10 years show that the only municipality where property values have increased significantly has been the Municipality of Dorado. All other markets have remained stable or with weighted increases. An example of this stability is the leading residential property sales markets on the island. The municipalities of San Juan, Bayamón, Caguas, Carolina, and Ponce have presented some minimal fluctuations typical of this industry, but in general terms, prices per square foot have offered minimal increases.

Considering that for 2021 and 2022, almost 70% of the residential properties sold averaged less than $200,000, it can be inferred that the disproportionate increase in sales value may have been experienced only in some limited pockets of the market. A review of some industry lines shows that the price of existing homes increased by 2.2% in 2023, increasing their average value to $183,604. The other segment, which includes new homes, showed an increase in value of 19.0% at the end of 2023. This narrow market segment achieved a record-high median value of $310,619.

Further segmenting the real estate market, 17% of the properties have maintained a value between $200,000 and $299,000, and approximately 10% exceed $300,000. Although these segments have shown some increase, in conceptual terms, they have remained relatively constant for the last decade.

Therefore, the assertion that properties have increased by 60% is a falsehood in general terms and an exaggeration when considering the luxury housing market. The increase experienced in the real estate market has been low to moderate, except in a few demographic sub-segments of the market. The following sections discuss the reasons for these increases.

Rationale: Bureaucracy and government rules increase the cost of new housing. TRUE

The government has a responsibility to ensure that the homes it builds provide the buyer with assurances that the structure is adequate. Through the imposition of regulations, inspections, and permits, the state facilitates the protection of consumers so that their property can be assured that it will withstand the elements, that the investment is protected, and that the buyer can enjoy it for the long term. Achieving this while keeping construction costs under control is a great challenge for the legislative and executive branches. In this process, it is not uncommon to see how the government regulates and even exceeds the requirements of the minimum elements that adequate housing must have. The approval of excessive requirements that delay the completion of construction and statutes that impose additional costs in the development may protect the buyer but cause an increase in the price and delay the delivery of the projects. Striking the right balance between buyer protection and housing affordability is an exercise that is not always taken into account in legislation.

In any industry, a delay in the execution of development work has the effect of increasing the cost of the final product. In the case of construction projects, it is even more impactful since a delay in the completion of the project carries the risk of exposing the developer to having to pay thousands of dollars in bank interest and exposed to changes in the cost of materials, among other incidental risks that are difficult to predict. Since property prices are set before the start of construction, the developer may consider this variable and add it to the sale value of the property, thus impacting the buyer.

Rationale: Government tariff impositions cause an increase in property values. TRUE

Between 26% and 31% of the cost of building a new home is earmarked for compliance with tax obligations, permit fees, government-mandated insurance, and impact fees. The state legislative branch and municipal legislatures, sometimes without proper validation of all the elements that impact the cost of a property, impose new fees to subsidize a government program or to make up for a shortfall in state or municipal finances.

The construction tax levied pursuant to the provisions of Act No. 81 of August 30, 1991, and the municipal ordinances that require the collection of this tax are examples of these interventions that result in an increase in cost. For years, municipalities have increased this tax in response to their respective financial conditions. This tax is considered part of the development costs and will eventually impact the buyer.

Impact fees are charges imposed by the government on new developments to assist in financing the construction of government infrastructure or the expansion of necessary public services and areas near where new housing is built. These fees are implemented to help reduce the economic burden on the government as it attempts to deal with the population growth caused by new developments. Revenues generated from impact fees are typically used to improve sidewalks, curbs, roads, lighting, water treatment plants, electrical facilities, and community parks among others. These government fees end up increasing the price of housing as well since, inevitably, that cost will be passed on to the buyer.

Housing developers must also pay SUT for the rendering of certain professional services. In the case of services rendered to other construction tradesmen, the developer must pay 4% of these services, including, in some cases, those provided by subcontractors.

In addition to these examples, the developer must pay inventory taxes, pay permitting fees, submit to the jurisdiction of the State Insurance Fund and pay those fees that are imposed, purchase a driver's insurance policy, and, in some cases, pay a construction bond. All these fees end up impacting the cost of the property at the time of sale.

Rationale: If there is little housing inventory and many people are looking to buy, sales prices increase. TRUE

The housing market, like other industries, is primarily composed of the elements of demand and supply, both subordinated to price, which is the component that gives them balance. In Puerto Rico's real estate market, we see that there is currently a lot of demand to acquire properties and little inventory to satisfy the market. The answer to this equation is an increase in the price of properties available for sale.

Critics of Law 60 argue that those who benefit from these decrees are impacting the market in such a way that they are consuming much of the available inventory, which has significantly reduced supply. Anecdotally, it is alleged that these investors are making extremely high offers, thus affecting comparables when appraising nearby properties. The data do not necessarily support this assumption..

Act 60 consolidated dozens of decrees, reimbursements, incentives and tax benefits into a single law. This consolidation included the provisions found in Law 22 approved in 2012. From that year to now, close to 5,200 decrees have been granted that have as one of their requirements residencies in Puerto Rico. From the passage of Act 22 to the present, a total of nearly 110,000 homes have been sold on the island. The effect that the acquisitions of high-cost properties during the last 10 years have had on the increase in the valuation of all properties is unlikely, although it should be studied. The truth is that these high-cost sales represent only 1% to 3% of total sales per year in a particular economic segment and location. Therefore, to conclude that the sale of one extremely expensive property in a specific location has the effect of increasing the value of all properties in the market is incorrect.

Rationale: The cost of materials and labor impacts the cost of housing. TRUE

The increase in the cost of construction materials is a worldwide trend that significantly affects Puerto Rico due to its island status. Recently, the Amsterdam Chamber of Commerce published its annual report entitled "International Construction Costs 2023 Report". In essence, the report concludes that the tough conditions facing the global construction sector persisted throughout 2023. The report on international construction costs reveals how inflation, construction material costs, transportation, and energy prices have continued to rise, resulting in fewer transactions and increased housing costs, making housing less affordable.

According to the National Association of Home Builders (NAHB), building material costs increased 20.3% in early 2022 compared to the previous year. Harvard University's Joint Center for Housing Studies recently concluded that the costs of building materials and labor doubled between 2001 and 2019. This was followed by a 9% increase between the years 2020 and 2021. These high costs have been exacerbated by the limited supply of housing. In Puerto Rico, the process of building a new home has increased by about 30%. This could be the result of the fact that in Puerto Rico, the United States, and globally, materials such as concrete, steel, aluminum, and wood have increased significantly in price.

Although Puerto Rico has been facing a construction labor shortage for nearly 10 years, the rebuilding after Hurricane Maria has generated greater demand for construction workers. The shortage of construction workers has increased construction costs and extended development times, which has contributed to higher housing costs. Without sufficient labor, housing costs will continue to rise, and potentially rise even more as construction timelines are extended.

Rationale: The reduction in the number of companies dedicated to developing home construction projects increases the cost of housing. TRUE

Currently, less than 800 new homes are being delivered each year, and between 1998 and 2004, between 12,000 and 15,000 were being built and sold each year. In fact, during the year 2023, 770 new homes were built on the island, which corresponds to the delivery of about 60 homes per month. The lack of housing inventory and the slow planning process for new projects have a real impact on the cost of existing and available-for-sale properties.

There are few local homebuilders on the island compared to the years 2000 to 2010. In 2008 many of these companies stopped building in response to the island's mortgage crisis, an adversarial public policy, the local recession, and a market contraction. In recent years, once the economy has stabilized and labor participation has increased to support the development of new housing, the industry has been limited in its ability to supply the inventories required by the island.

Between 2000 and 2010, developers faced major challenges. During this period, social movements occurred in the form of protests that objected to and prevented the development of virtually any construction, including new housing. In the face of public pressure, the government attempted to cancel permits granted for housing construction without considering the investment of hundreds of millions of dollars in these projects and the risk that such cancellations imposed on local banks. An example of this is the case of the developer of the project called "Paseo Caribe" in Condado, who had to go to court to force the state to honor the permits granted by the government itself. A year later, the government made a recommendation to demolish the "Millenium" residential project in San Juan even though, at the time, it already had apartments sold and occupied. Developers faced similar challenges in more than 100 construction projects throughout the island. Some projects were halted, others were canceled, and in some cases, permits were revoked by the government. This public policy, coupled with the fiscal crisis of 2008, caused a large number of developers on the island to decide not to build new housing because of the high risk of facing an unstable public policy and a difficult financial system.

Currently, both the government and civil society are calling for the construction of new housing. However, developers continue to face challenges for which the government has not provided clear solutions. In order to stimulate the new housing development industry, it is imperative to develop strategies to address an economy that since 2005 has experienced a 20% economic contraction, a labor market that from 2008 to the present has lost over 165,000 jobs, a declining population due to the drop in births and emigration, a scarce and unskilled labor force, the limited use of land for construction, a conservative banking system, and a slow and deficient permitting system.

Rationale: Short-term rentals reduce inventory and increase the value of nearby properties. TRUE

The Center for the New Economy conducted research on the short-term rental property market in Puerto Rico. These properties are generally being managed through digital platforms that market these rentals in international markets. The results of the study have shown that short-term rentals affect housing affordability as this type of business occupies a significant amount of the total housing units, which reduces the available inventory and affects supply in the face of a growing demand.

The study concluded that the island has already surpassed 30,000 short-term rental properties in all economic sectors. Short-term rentals have the potential to be considerably lucrative by imposing a much higher rental fee than a long-term rental. This has the effect of turning housing into a high income-generating asset, thereby increasing its value.

According to a report published by Noticel in December 2022, one of the findings of the Center for the New Economy's report is that a 10% increase in the density of short-term rental properties has the effect of causing an increase in the unit price of housing.

Argument: Mortgage rates increase the cost of ownership. FALSE

Generally speaking, high mortgage rates do not affect the value of the property in a transaction. Mortgage rates strongly affect affordability on the part of the buyer. A combination of high mortgage rates and a shortage of housing has the effect of making properties unaffordable for an economic segment.

The average interest rate on a 30-year fixed-rate mortgage was 2.65% in 2021, according to Freddie Mac. That was the lowest level in the nearly 50 years of the record Freddie Mac publishes. In this year 2024, interest rates have remained around 6.8%, the highest in the past 20 years. Therefore, all of the elements that impact the value of a property, coupled with high-interest rates, adversely affect the consumer's ability to purchase a home, but little affect the sales price.

Estudios Técnicos has prepared the "Affordable Housing Index", which measures the ability to qualify for a mortgage loan of a buyer who contributes a down payment of 20% towards the purchase of a home. A value equal to 100% means that the buyer has the necessary income to qualify for a mortgage loan based on the average price prevailing in the market. A value below that threshold reflects that the buyer does not have the ability to repay the loan. The value of this index has been falling consistently, reflecting that more and more home seekers are less and less able to afford a mortgage loan. Again, this could have a long-term effect on property values. However, with a low inventory market, and a low absorption time, sellers of properties will not be forced to lower prices.

Conclusion

According to a report presented to the Chamber of Commerce by Ivan Zavala Steidel, in 2011 the inventory of properties for sale exceeded 40,000 properties with an absorption time of 21 months. By 2022 the inventory had been reduced to 5,100 properties, with an absorption time of only 3 months. This indicates that the island has an active and healthy real estate market, with high demand and a low inventory of properties that sell quickly. This added to the other elements that impact the value of a property, are the real causes of the increase in the value of the real estate market.

The elements that adversely impact the prices of properties in Puerto Rico are:

  • Inflation: Construction materials cost inflation now nearly a decade old, bursting across most of the global economy in 2021 and 2022. Even when inflation at the local level is below other jurisdictions, increases in building material prices accelerated sharply in 2021 and 2022.
  • Low inventories: Low property inventories in all economic segments, associated with strong demand, promote an increase in the selling price of the scarce units available.
  • Cost of materials: Recurring supply chain disruptions, whether due to environmental causes, pandemics, war, accidents, or poor public policy at the federal level.
  • Taxes and government intervention: The imposition of tariffs, fees, taxes and other charges by the government, which represents at least 25% of the cost of a new home.
  • Slow Permitting: The permitting model that delays the approval and completion of development projects. Delays in being able to complete a home are caused by extensive government regulation, bureaucracy, and slowness in the permitting process.
  • Energy cost: high energy costs and uncertainty about energy stability.
  • Land Use Constraints: Restrictions and limitations on land use that limit the options for physical space to develop.
  • Few development companies: The reduction in the number of developers willing to face the challenges of a volatile market has an adverse effect on the number of homes that can be built each year and, therefore, directly affects supply.
  • Short-term rentals: These businesses have the effect of increasing the value of the property by becoming assets that generate significant income.

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Explanatory Note

NotiCel reviewed several presentations on the property market in Puerto Rico, including those made by the Puerto Rico Chamber of Commerce, Estudios Técnicos, and the Center for the New Economy. The report "International Construction Costs 2023 Report" and its possible impact on the island, the report of the National Association of Home Builders, and the "Primary Mortgage Market Survey" published by Freddie Mac, were also studied.

This article was originally published in Spanish in Noticel.

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