Why Do Builder’s Price New Homes So High?

BuilderHome

I mean, most of them eventually reduce the price, right?

Time and time again, we see builders of new homes, primarily those over $2,000,000, price the property far higher than anything resembling fair market value, and reduce over, and over, and over, until the property finally sells.

Why is this?

Why do builders do the complete opposite of what resellers of single-family homes do?

Let’s take a look at the reasons; both those which are logical, and those which make no sense…

BuilderHome

Unless this is your first time reading Toronto Realty Blog, and/or you haven’t transacted in the Toronto real estate market in over a decade, you all know how single-family homes are sold on the open market.

After a week, or a month, of preparation, a house is listed on the open market with everything ready to go – the staging is complete, photos/video/virtual-tour is ready, and the oranges for freshly-squeezed orange juice at the open house have been flown in from Florida.

The house his the market on a Tuesday, Wednesday, or Thursday, and “offer night” is scheduled for anywhere from 6-to-8 days later, at 7pm, at the listing brokerage.

In between the listing and the offer night, dozens of buyers flow in and out of the house, some looking to make a “bully offer” on the property and force the offer night to be moved up.

The property is under-listed, and everybody knows that the list price isn’t anything close to: a) fair market value, b) what the sellers actually want and expect, c) what the property is going to sell for.

The week of the listing is a frenzy, and the house sells on time, as expected.

We certainly don’t need a refresher on this, but there are the Coles Notes just because.

So in the case of $2 Million+ “builder homes,” why does it work the opposite way?

Forget about staging and marketing – many of these houses are missing grass on the front lawn, and you can’t even expect to find an MLS Listing print-out on the kitchen counter.

If it was possible to put less work into selling some of these builder homes, I think agents and builders would try it.

If you don’t know what I mean, take a look at the following listing – one I literally just pulled at random from MLS:

649Broadway

This is a classic example of how a “builder house” is sold.

It was first listed for $2.5M, and eventually sold for $375,000 under that initial asking price.

It was on the market for 6 1/2 months; over a HALF YEAR!  That’s an eternity in the Toronto real estate market!

It was listed three times, and with two different brokerages (that part isn’t shown).

It was listed through three seasons – summer, fall, and winter, and thus showed very differently at different times of the sale process.

It sold in a different year in which it was first listed.

And yet this is very, very common with “builder homes.”

Quite the contrast from what we’re used to seeing with $699,000, single-family homes, wouldn’t you say?

And this house – the one that sold for $2,125,000, is in a fantastic area, where houses like this are in very high demand.  So it’s not like the owner was trying to sell a lemon here, or that there was something wrong with the house.

Like everything else in real estate, this simply comes down to price.

And yet it’s not as simple as “the house is over-priced.”  The question is why is the house over-priced to begin with?

1) The builder thinks it’s worth more than anybody else.

Your child is cuter than anybody else’s child, right?

Even though your child his a gigantic head that make people on the street stop, turn, look, and then wonder, “Good GOD, why is that child’s head so big?  Is that safe?  Should I, as somebody who has never met that person and that child, go over and make sure everything is okay?  Or should I just call the fire department and see if they can put a helmet on that child’s head to stop it from shifting the earth’s gravitational pull?”

Even though your child is actually freakish in nature, you think he or she is the cutest baby in the world, and you refuse to accept otherwise.

Can it be, that perhaps what you see is different from what other people see?

Maybe it is.  But you created that child, and for some people – it can be a LOT of hard work!  It can take longer than you expected as well, and make you look back, and say, “I never thought it would take this much time, effort, and energy!”

Yeah, well, the same feelings exist when you build a house, even if this isn’t a house you’re going to raise for 18-years, and then send off to University.  Even if you just want to build it, flip it, and move on, you’re still going to think of it as “your baby,” and really, truly believe that it’s worth more than it actually is.

2) The builder isn’t from the area.

I want to puke when I hear those ads on the radio that say something like, “…….at our seminar, we’ll show you how to buy properties in the Greater Toronto Area, renovate them, flip them, make a huge profit, and do it ALL without using a penny of your own money!”

Too many people get burned in Toronto trying to buy a $600K gut-job of a house, paint it, put in a new (crappy) kitchen, and then sell it for 130% of what they paid.

But we’re talking about $2M builder homes in this blog post, so only the smartest of the smartest try their money here, right?

I wish it were so.

Anybody with money can buy a $900,000 North Toronto bungalow, build 3,500 square feet, and then try to sell it for $2.5 Million.

The problem is that the builders who regularly build in the area, who know people there, who live there, and who “get” the demographic, are the only ones who are going to make money consistently.

More often than not, the houses that sit on the market are from builders who have no clue what buyers in that area want.

A basement apartment?  In a $2.5M North Toronto home?  That’s not what the buyer wants.

12-inch ceramic tile in the basement rather than carpet, panes of glass instead of wrought-iron spindles on oak railings, and orange carpet in the formal dining room?

How about his-and-hers bidets?

Or, how about you spend $25,000 to hire an interior designer who knows the area?

No?  You don’t want to to do that?  You think you can simply GUESS at what people want in this area?  And you’re willing to risk a couple-million-bucks on it?  Great decision….

3) The builder has time.

True that.

Time is a luxury that most sellers don’t have.

Let’s face it – sellers of your typical $700,000 homes in Toronto have already bought somewhere else.  They’re probably closing in 60 days, and they need to get their house sold, not only to obtain bridge financing to close the new house, but to get on with their lives.

Waiting doesn’t usually get the seller of a typical $700K home more money.  In fact, any house in that price range that’s been on the market for 20+ days, at least in the Central core, will usually get buyers thinking about a “deal.”

With the $2,000,000 builder houses, you often simply expect that the property is going to be on the market for a while.  And the builders often think this as well.

Any builder who is dealing with cash is in a position to wait, and wait, and wait.

Sure, there’s the opportunity cost of holding the asset, and even at a modest 2% rate of interest, selling now and getting that cash out and into an interest-bearing asset is ideal.  But if there’s $100-$200K more to be made from “waiting,” then that trumps any potential gain from a quick sale.

But while we’re on the subject, what about builders that aren’t dealing with cash?

Let’s say that a builder purchased the $900,000 bungalow with 20% down, and got a conventional mortgage for the balance.  Well that’s only $1,500 in interest each month.

But what about the $800,000 in cash to build the property?  If it’s a construction loan, at upwards of 9%, that could cost the builder over $5,000 per month in interest!

At $6,000 per month in interest, holding a property for over six months, like the Broadway home we looked at above, still “only” costs the builder $36,000.  When we’re dealing with a $2.5 Million listing, where a price drop could be $100,000, what’s a paltry $36,000 as a “fee” to hold it for another half-year?

More often than not, builders will price the high borrowing cost into their projections before ever buying the raw land to begin with.  Assume it takes you six months, and $40,000 worth of interest, before you sell – and calculate your return on that.  Once you sell, anything better than six months on the market puts money into your pocket that you didn’t expect to have.

4) Buyers want what they want.

I feel like when I was growing up, there were so many stories, books, and TV shows where a character desperately wanted that toy, doll, or piece of clothing that sat in a store window, and passed by it every day for a year before finally saving up enough money for it, or obtaining it by some whimsical, romanticized series of events.

Today, buyer impulse is higher than ever.

We can buy just about anything from our phones.  Our PHONES!  Quick – look at what your wife is doing right now!  She says she’s texting her mother, but she really just blew $250 on a pair of shoes!

Builders of new homes often over-price because they know that an interested buyer, who is looking to make the biggest decision of his or her life, and buy a 25-year house, might act on emotion, just as any buyer of a $700K house does.

That buyer, looking at a $2.5 Million house, and thinking it woulda/coulda/shoulda been priced at $2.1M, might not wait for a price reduction and might enter into negotiations at $2.2M, and end up somewhere in the middle, thus paying more than he or she might have expected.

Builders often price high to test the water.  Dangle a line, and see if you get any bites.

5) Prices go UP over time.

The price of a home in Toronto has gone up every single year for almost two decades.

So if a builder holds onto a house for seven months, isn’t it worth more seven months later, than when he first listed?

Let’s say, just for argument’s sake, that prices are going up in a given neighbourhood around 6% per year.

So if you listed a $2,000,000+ house on January 1st, and still had it for sale in July, theoretically, it’s worth $60,000 more.

That $60,000 could be double what it cost you in interest to carry the property for that half-year.

The next time you see a “new” listing for a newly-built, $2,000,000+ house in North Toronto, run a history on the property, and see if that is in fact a “new” listing.

We’re not talking about ALL $2M houses here, nor are we talking about the true “luxury” homes in Rosedale, Moore Park, Forest Hill, and the like.  That’s a whole other type of seller, in a whole other situation, which is a whole other story.

But for builder houses, you almost have to expect that they’re going to come onto the market at higher-than-expected prices.

And every builder wants to break the previous high-water mark too…

11 Comments

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  1. Joe says:

    The kid metaphore is gut wrenching.

  2. Jason Voorhees says:

    There are many reasons to high budget for a new home. When I planned a new home in Anderson I faced these things. After reaches I found a local home builder service named as “Actionconstructionco”. This service made my home beautiful with affordable price. Hope this service will helps others

  3. Suzanne says:

    I enjoyed reading this — thanks. But please remove the apostrophe from the title. You’re better than that.

  4. joel says:

    Thanks for writing this, I have been driving by new builds each morning and wondered why they sit unoccupied for so long.
    Do you have any recollection of new builds being priced low for a bidding war?

  5. Marina says:

    I think there is a definite lack of appreciation for layout and finishes. On my street, five new builds have sold for around $2 million in the past 3 months. Another two have languished for the past year. One finally sold after a drastic price reduction.
    The other is basically unsellable. It’s not a good family home – too much glass, bad bedroom layouts, terrible bachelor basement. If I had 2 million to spend on a home in this neighborhood, there are much better options, and more are being built all the time.

    Actually that’s the other thing. New houses come up all the time. In the last 5 years, I have seen over 30 teardowns on my street alone. Just this street. Probably over 100 in the neighborhood. So a bad one is not going to be snapped up. More are coming from builders who know what they are doing.

  6. Kyle says:

    In the West end, there are a pair of “new” builds (though they already look really dated and gaudy) – 41 Riverside Cres and 58 Edenbridge, that keep re-listing at ridiculous prices every few months. They’ve been on and off the market for what feels like an eternity, one of them i’m certain has been listed for over a decade now. The other started out at twice the current asking price, which is still about twice the fair market. The reasons you’ve mentioned above certainly seem to be at play. At some point i wonder if the builder is going to just accept that he totally missed the mark and drop the prices to something reasonable, or hire a real Designer to replace all the tacky finishes in them.

  7. Dan says:

    Just a note on your calculation – 6% increase on a $2m home is $120,000

    1. daniel says:

      6 months, aka half a year

    2. Haussman says:

      6% over half a year is $60000

      1. Dan says:

        skipped that part -thanks

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