Increasing For-Sale Housing Supply Is Not Profitable

Our last post challenged the common wisdom that the construction of more housing will aid affordability. The wisdom relies on the simplistic notion drawn inaccurately from basic economics that supply is the only or even a dominant driver of housing cost. The wisdom also assumes that housing suppliers (builders, investors, and existing homeowners) will ignore or at least suppress their own financial interest and serve instead the common good of more affordable housing.

We argue in this post that expanding housing supply is not financially viable for homebuilders. We explore the cost components of home creation and the thin profitability of homebuilders. The post urges that we recognize the powerful influence of capitalism in housing creation and sets the stage for a future post that argues that housing cannot become consistently more affordable without substantial changes in household expectations.

Interest Rates and Catastrophes

Before we explore some of the factors other than supply that influence housing affordability, we should take off the itinerary certain potential affordability drivers. The first among these is interest rates. The role of interest rates in the cost of housing is not debatable whether the rate is for a construction loan, an investment return to financiers of multi-family construction, or a 30-year mortgage. Lower rates likely (but not certainly) would lower rents and mortgage payments.

For the most part, interest rates are exogenous to the housing market. Borrowing rates and investor yield expectations are dictated by the Federal Reserve, the ballooning federal government deficit, and the ever-upward direction of U.S. equities. Given persistent inflation and scarce fiscal discipline among politicians, interest rates are likely to remain elevated for years absent a crisis that opens a fissure in the bedrock of the American economy.

As the enormous monetary stimulus during Covid has proven, catastrophes may provide short-term interest rate relief at the cost of enduring inflation and high interest rates. If sustainable, low rates are in our future, they are invisible beyond the curve of the horizon.

A corollary of lower rates is easy money. Teaser rate mortgages and other monkeying with home loan terms could ease the affordability problem for some aspiring homebuyers in the short-term. As we learned from the Great Financial Crisis, the fallout of such manipulation can be a toxically radioactive housing market with skyrocketing defaults and millions of displaced households. We assume in this post that the GFC history is still remembered well by enough housing market and lending decision-makers to prevent a swing of the lending pendulum too far toward easy money.

With imminent lower interest rates and risky lending removed from the affordability solutions universe, we turn to exploring the cost and profit reality of home builders.

The Homebuilder and Investor Mandate for Profit

As Shovel To Keys has written since its inception, the creation of housing whether for rent or for sale is a profit-driven endeavor. At this moment in American history, housing is not a public good nor an output of government at any level, although some argue that the federal government inappropriately and excessively subsidizes home ownership through mortgage insurance and purchases. Housing is created when investors, developers, and builders believe that the product can be rented or sold at an acceptable profit margin. Given that housing creation is the enterprise of non-governmental companies and investors, the path to more housing must reflect the profit interest of these players.

Outcries for a burst of housing production ignore the fundamental role of profit in the rise and fall of housing supply. Advocacy for a flood of housing supply also disregards the inflexible and usually rising costs of the land, materials, labor, and governmental fees that are essential inputs to the creation of housing. The reality of profit motivation and cost complicate and probably undermine the common wisdom that housing affordability can or would be solved simply by building more housing.

Let’s break down the thinking of investors and builders:

• Geography. Whether building for rent or sale, the money and muscle that creates housing must identify locations in which housing demand exists. Demand may be identified by the trajectory of prices, the scarcity of homes for rent or sale, the influx of population, climate desirability, and more. Higher demand almost always predicts a greater probability of profit. Declining prices, a slow pace of sales, and net outbound migration almost always mean improving affordability but also low housing demand and a poor investment opportunity. Builders and investors logically choose locations with the best opportunity for profit at the lowest risk. Most of us make personal financial choices applying the same principles.
• Buildable lot availability. If a geography presents a reasonable profit opportunity based simply on apparent demand, the geography must also offer land on which to build. In desirable markets, the competition for land is intense. As land is developed, the inventory of available land shrinks and becomes more expensive, driving down affordability. Builders and investors then must look outward to nascent suburbs and even rural communities where land is available and more affordable but where distance, inadequate infrastructure, anti-growth sentiment, and scarce amenities diminish appeal and create greater profitability risk.
• Buildable lot or land cost. The cost of the land must be reasonably proportionate to the market price of new housing in the location. The median contribution of land cost to home price across the U.S. is about 17%, according to the Federal Housing Finance Agency. In expensive housing markets, land can be as much as 50% of the total price of a home. Because material, labor, and governmental costs are fairly fixed in a given geography, a higher land price compels a proportionally higher home price. As a result, the best opportunities for affordable home construction are in geographies with low land cost, but low land cost is a strong indicator that housing demand and, therefore profit opportunity, are relatively low.
• Development time. If the available land is not immediately ready for construction, time becomes a crucial component of the investment analysis. Land development (turning land into buildable lots) is almost always expensive, but in many geographies the time cost is disqualifying. Countless governmental requirements require applications, studies, hearings, and other regulatory and administrative action that increase cost but more importantly development delay. Publicly traded home builders are especially sensitive to the cost and time burdens of land development because Wall Street investors and analysts disfavor the builders that carry more than minimal land cost on their balance sheet.
• Development responsibility. Before the 2008 residential real estate fiasco, much land development was the bailiwick of local investors and developers. Local banks financed land acquisition and development, and the financing was readily available without enormous balance sheet support. Builders bought finished lots without carrying large land positions on their balance sheets. The GFC brought a tectonic and so far permanent shift away from the local developer model to a land development structure based much more on land banks financed by large financial institutions in partnership with large builders. The land banks demand low-teens return on their land and development investment, which adds a layer of cost to the homebuilding business that may exceed the profit previously earned by local developers.
• Material and labor costs. If buildable lots are immediately available or can be developed in a reasonable time at a reasonable cost through a land bank, the prospect for homebuilder profitability often is good. Material costs are fairly consistent nationwide. Labor costs and availability vary more and can be an impediment in some geographies. The important point for our discussion in this post is that the scale of the large builders makes them proficient at recruiting local labor. Scale and years of focus also have made the large builders very cost efficient already. The opportunities for material and labor cost reduction are few, smaller, and harder to achieve.
• Inflation. If builders and investors attempt to grow rapidly the volume of construction, demand for materials (most of which is imported) and labor (much of which has been deported or frightened away from visible work) would rise. If demand rises too rapidly, costs will rise dramatically, defeating the purported purpose of expanding housing supply. Even if demand climbed gradually (which would not satisfy the current clamor for more housing supply), the demand-and-supply economics that undergirds the common wisdom would also push material and labor costs higher. If costs rise, housing cannot become more affordable.
• Political uncertainty. Even if a builder can forecast a reasonable profit, unpredictable trade policy can undermine affordability. The overwhelming majority of material used in home construction is imported (e.g., lumber from Canada, appliances and HVAC systems from China or Mexico). Tariffs have driven upward the cost of most materials (even just in the anticipation of tariffs) and relief from the inflation and uncertainty is uncertain, at best.

And, Then There Is Profit

As publicly traded companies, the largest home builders share detailed revenue, cost, and profit information. To close the loop on our analysis of home building cost and the viability of expanding home supply as a solution to affordability, we examined the financial statements of the five largest, publicly traded home builders: DR Horton, Pulte Group, Lennar, NVR, and Toll Brothers. The range of home sales price of these builders with the exception of Toll Brothers puts these companies squarely in the low and middle pricing tiers of the market (i.e., between $300,000 and $500,000).

If these companies are wildly profitable, a reasonable argument can be made that building more homes could address affordability by depressing new home prices. The builders might experience net margin compression, but lower profit from a high level would not be unreasonable, even if not endorsed by Wall Street. On the other hand, if these companies deliver modest or even thin net profit, lower home prices (given the essentially fixed or rising costs of land, materials, labor, and governmental fees) would not be viable because the home builders would earn little, if any, profit. The companies simply would not build the homes to increase supply because doing so would deliver inadequate profit or even a loss.

Although each company reports different business segments and may not disclose the same set of data with equal detail, the net income percentage of the publicly traded builders can be reliably calculated. For each company’s respective fiscal year ending in 2025, the net profit margin of the five largest home builders was 13.8% for DR Horton, 12.8% for Pulte Group, 6.0% for Lennar, 15.9% for NVR, and 12.3% for Toll Brothers.

Putting aside Lennar’s weak operating result for 2025 (largely attributable to sales incentives), the five largest home builders achieved net profit in a narrow range. The average net profit excluding Lennar was 13.7%, hardly exorbitant. Not only would lower net margin push these companies into the lowest echelon of publicly traded firms, investors would punish the companies with lower share prices. No executive would choose to increase housing supply at the risk of depressing her company’s share price.

Even if a homebuilder were adventurous and increased its production of homes, the financial results feedback would be rapid and painful feedback.

• The increased supply would do nothing to mitigate the factors keeping homebuyers on the sidelines. More supply would not lower mortgage interest rates, alleviate anxiety over employment in the the low-hire / no-fire job market, reduce inflation from above 3%, or diminish political unpredictability.
• As inventory rose and became stale, the builder would enhance sales incentives and reduce prices, which would clear inventory but drive downward profitability. The recent results of the publicly traded builders illustrates exactly this dynamic.
• The builder’s share price would decline.

More housing supply would diminish the builder’s profitability, likely into the single digits. Even if the adventurous executive team survived the adventure, the feedback would compel an abrupt change of course to reduce output and restore higher prices. The Census Bureau new home starts data and publicly traded builder executive team commentary on recent earnings calls suggests that builders already are carefully controlling the pace of new construction.

The consistency of the profit margin among the large public homebuilders suggests that the range is representative of the most efficient, mass-market homebuilders. If homebuilders could increase or at least maintain their profitability by increasing supply, the common wisdom, which urges more housing supply, would be rational. As we illustrate in this post, the opposite is true, and the common wisdom seems ill-conceived. We reasonably can conclude that homebuilders have little financial room to absorb lower home prices that the common wisdom asserts would result from greater housing supply.

The Cost And Profit Components Of Rental Housing Are Analogous

All that we wrote above about for-sale housing applies equally to rental housing. The cost components of rental housing creation do not differ materially from for-sale housing. Land acquisition and development, materials and labor, and governmental fees are stable, if not rising, costs of rental housing construction. Profit is the motivation, although the profit is measured as a yield on the invested cost of the rental housing not as a profit margin on the sale of the housing.

The last six years of rental housing history illustrate well the crucial role of profit in rental housing construction expansion and decline. When demand exploded during the Covid pandemic, investors pumped enormous capital into rental housing construction. The supply growth overshot demand, leading to undesirably high vacancy rates and declining rents. The volume of rental housing starts collapsed. The investors acted rationally to preserve profitability.

There Is More To Say

Regarding the common wisdom, there is more to say, not to be redundantly contrary but to bring new ideas to the conversation. As we will discuss in future posts, housing affordability is not a supply problem. It is a demand problem that likely can be addressed only by changes in consumer expectations.

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With respect to zoning, environmental, and other regulatory burdens, advocates for housing affordability action are correct. Local and state governments erect many hurdles to land development and home construction, usually to serve the desires of existing homeowners who often oppose increased housing density.