By Property Soul (guest contributor)
Have you ever wondered why new projects from developers are able to command a large premium in asking price, sometimes up to fifty percent higher than recently completed nearby projects?
An interview with a VIP property buyer
Below is an abstract from my interview with a VIP property buyer (as compared to the usual retail buyers).
Me: How do you manage to buy before everyone else does?
VIP: After developers set the prices, easily twenty to forty percent higher than nearby projects, they need to test the water. They will invite us to a project preview where we can pick our preferred units. Whatever price we are willing to pay, the developers can use it to convince the market that it is a reasonable market price.
Me: How do you make a profit?
VIP: Say, if we buy at $1,000 per square foot, developers can sell at $1,100 during actual launch. Phase two comes a few weeks later with prices increased to $1,200, and so on and so forth. Since we’ve chosen the best units, we can offload with at least twenty percent profit.
Me: And the developer has just successfully set a new high for property prices in the district!
There are three major factors that set the stage for developers to market uncompleted projects at high “future” prices (i.e. prices that already account for future price appreciation expectations):
1. The advantages of market domination
The property developer industry is an oligopoly. It is dominated by a few big players which are often large conglomerates.
The entry barrier for new players in this industry is exceptionally high. With limited supply and high cost of land, it is not easy for small developers to raise sufficient funds or obtain financing from the bank. They also cannot compete with the big guys in terms of branding and their track record in past projects.
Bigger players have stronger financial muscle to build their own land bank. They can drive construction of projects in time to capture a booming market. They enjoy the benefits of economies of scale or cost leadership from a large number of ongoing projects. They have a handsome budget for marketing and for leverage to hire a good marketing agent. They have enough cash reserves to hedge against poor sales during bad times.
It is therefore not surprising to see a high percentage of private housing projects all supplied by the top few developers. The advantages of market domination allow them to set their list prices at the highest possible level and to reap a huge profit.
2. Collaboration among big players
The big players have good connections amongst themselves to make the most of a mutually beneficial partnership. They can collaborate with each other by forming joint ventures to bid for land parcels, to secure borrowings from banks, or to diversify their investment.
Among the top property developers, they can seek consensus and alignment on many decisions, for instance:
• When to launch or re-launch in a quiet or recovering market;
• Which type of projects to launch in different locations; and
• What projects to hold back to avoid unnecessary competitions for similar projects.
When they are setting prices for a new launch, they don’t have to make reference to the average transacted prices of existing developments in the same district. They can benchmark against each other’s list prices in other districts in order to set their prices at a new high in a hot market.
Of course, no developer can move new properties off the shelves without the support of local banks to provide buyers the necessary financing. It is not uncommon to see developers tying up with a few banks to offer housing mortgage packages to buyers at the sales galleries.
In order to secure business from home buyers, banks work with their valuers to ensure that the valuation of the uncompleted property matches with the selling price, so that they can disburse the exact amount of housing loan required by the buyers.
3. Willing sellers, willing buyers
In the past few years, property developers have paid a high price for land parcels sold by the government or from en bloc sales. Likewise, the tight supply and spiraling costs of construction manpower and building materials have taken a toll on the bottom line of developers.
It is arguable that developers have no choice but to markup considerably to ensure their profitability, although how big a safety margin is reasonable is entirely up to their discretion. After all, if they don’t make hay while the sun shines, who can tell what will happen when market direction changes?
In the end, the matter boils down to market response and customer acceptance. Developers can’t sell new flats at future prices if buyers are unwillingly to pay a premium price.
It doesn’t matter whether the selling price is twenty or fifty percent higher than the most recent transacted price of a resale flat in the same area, so long as everyone believes that the market price will be even higher by the time the new flats are ready for occupation.
Believing in the future – that is the magic pill of getting buyers to pay future prices in a booming property market!
By Property Soul, a successful property investor and enthusiast who shares her experiences and knowledge on her blog.