A Reality Check for Pricing

Published on 6th November 2019

During my day-to-day trading, I’d like to think that I don’t get surprised by things anymore. I’d like to believe that I’ve seen and experienced it all, but that’s just not reality. There are always surprises, both good and bad, especially when it comes to pricing. Good surprises are the ones that come in the form of a buyer paying a lot more money than you would have expected. A bad surprise comes in the form of a property that you’re trying to buy that ends up selling for far more than you expected.

To say the least, the ongoing surprises keep me on my toes. Imagine what surprises you would be getting if you didn’t actively trade real estate on a daily basis. Yes, I’m talking about the buyers and sellers with unrealistic expectations.

Pricing Shock and Awe – The toughest thing about unrealistic expectations is giving the buyers and sellers a reality check – somebody has to be the bearer of bad news. The most common reality checks that I see right now are sellers who still believe their detached house is worth what it was back in 2017. Sorry, but that’s just not happening right now unless you’re in Toronto. The other common reality checks are buyers who want to buy a condo or freehold in downtown Toronto thinking the prices are still circa 2017. This is true for those looking at the pre-construction prices and haven’t come to terms with the price per square foot being over $1,000 yet. Both of those situations are bad surprises that the real estate market has given us because prices are not what they used to be anymore.

SOLD… at Market Value – With surprises comes a reality check for all of us. The market value is what a buyer is willing to pay. Reality check – are the buyers actually willing to pay this market price? The short answer is unfortunately, yes – the buyers are actually willing to pay the market price. Condo prices have increased; every sale that happens in the same building pushes the limit on prices until the next one is sold, which pushes the limit even higher. The demand is there, and people are willing to overreach for it.

In the case of pre-construction condos, the builder sets the starting price in the hopes that the entire project will be purchased and absorbed. The buyers will dictate whether or not the builder’s prices are acceptable and whether those units will be purchased. If a project is successfully sold, then all of the other builders will see that a new limit has been set and a new reality at a higher price has been created.

Pre-construction vs. Resale – Throughout the years, the pre-construction to resale prices have fluctuated in a weird way. I was explaining this to a client the other night and created this graph that I believe depicts how the prices have changed relative to each other. Take a look at the graph below.

In early 2010, pre-construction was less than resale. In mid-2016 and 2017, pre-construction and resale prices were on par with one another. Now in 2019, the story has reversed and pre-construction prices are now higher than resale prices. As buyers continue to absorb pre-construction inventory, it only pushes the prices higher and higher. Initially, pre-construction was thought to be a risky undertaking because you’re essentially buying something that doesn’t exist (hence these prices were lower than resale prices back in the day). Nowadays, the narrative is such that you’re buying a brand new product so of course you’re going to pay more than an older resale unit.

Reality Check Conundrum – A reality check question that you should ask yourself is whether the current pricing from builders in today’s market is going to be a reality in 5 years time? Will resale prices eventually catch back up to pre-construction prices? Is this … continue reading by clicking here>>>> going to be a good surprise or a bad surprise? Are the builders pricing their new projects unrealistically? Do builders need a reality check?

Pricing Matrix – Under the assumption that pre-construction prices are going to be on par with resale prices when they finish, I mapped out a model for you to see below.

In early 2010, pre-construction was less than resale. In mid-2016 and 2017, pre-construction and resale prices were on par with one another. Now in 2019, the story has reversed and pre-construction prices are now higher than resale prices. As buyers continue to absorb pre-construction inventory, it only pushes the prices higher and higher. Initially, pre-construction was thought to be a risky undertaking because you’re essentially buying something that doesn’t exist (hence these prices were lower than resale prices back in the day). Nowadays, the narrative is such that you’re buying a brand new product so of course you’re going to pay more than an older resale unit.

A reality check question that you should ask yourself is whether the current pricing from builders in today’s market is going to be a reality in 5 years time? Is this going to be a good surprise or a bad surprise? Are the builders pricing their new projects unrealistically? Do they need a reality check?

Using the narrative of the pre-construction prices are going to be on par with resale when they finish, I mapped out a model for you to see below.

Pre-construction condos that have sold this year were priced at $1,350 per square foot. That’s a delta of $250 per square foot or 22%. That’s a pretty substantial difference. However, based on the 4% appreciation model scenario above, if the condo completes in 2024, then the market value will be the same as resale value, as per the yellow highlighted cell above. If the condo appreciates at 8%, then we’re looking at parity in 2022.

In the last few years, condos have appreciated approximately 8%, however, one would argue that type of growth is “unsustainable”. Regardless, in most instances, the condos sold in this area have an initial occupancy of 2022 with an expected closing in 2023. This means that if we continue to see the same growth that we’ve seen from the previous few years, and the fundamentals suggest so, then the builder’s expectations could be a reality.

What Does This All Mean? So does this mean that pre-construction is still a worthwhile investment? Given all of the changing dynamics, my answer to that is maybe, but it really depends on what your strategy and goals are. Two years ago, I was confident that we would break the $1,000 PSF mark. I am also confident that we’ll break the $1,200 PSF mark next year, but are we going to break $1,350 PSF over the next 5 years? I’m less confident about that latter mark since this level of growth is quite out of the norm, but the stats and fundamentals indicate that the answer may possibly be yes to all of the above.

The Wrap – For me, I would love to be pleasantly surprised that we hit $1,350 PSF in 5 years. For investors, this means that we would see substantial growth in our portfolios. If you’re on the outside looking in or sitting on the fence, and are also pondering this reality check, there are other strategies that I’m utilizing to profit from this potential pleasant surprise. If you’re interested in knowing this strategy, please reach out to me, Zhen at Zhen@PrimePropertiesTO.com.

Until Next Time, Happy Real Estate-ing,
Zhen

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