Building Prices Vs. Buying Prices
Concept
The idea behind this concept is that the cost of building a new house or apartment should exceed the cost of buying an existing apartment or house. Should it become cheaper to build a property then an opportunity exists for developers to build new houses and add them to the market while claiming the difference in profit. The addition of these properties to the market will help to satisfy demand and induce the decline of prices to a reasonable level. However, by nature of the construction process, there is an inherent lag time (from 6 months for a small house to several years for an apartment complex) before these properties are able to be occupied, and it is during this time that property prices can be considered in a ‘bubble’.
In actual conditions, it is not necessary for existing house prices to exceed new-build prices for this process to happen - depreciation of older existing structures and the preference for new, undeteriorated buildings, economies of scale when building apartments and the release of government land for housing all mean that this building process kick-starts even before the new-build price reaches the price of existing houses, with some experts considering existing housing to start being over-valued at when it passes 80% of the new-build price.
Method
The average R/m2 price of a new-build is compared to the R/m2 price of existing property, allowing an appreciation of the developer’s incentive to build new properties to be gained. To develop the price of a new-build property two elements need to be considered: the price of the underlying land, and the cost of construction.
To establish the price of land, the sale price for vacant plots in the last year for each area has been used to establish an average per-square-meter rate, as illustrated in the table below. The number of plots sold in the period and the sum of the plot area size has been provided to give an indication of the data-sufficiency in establishing an ‘appropriate’ average.
The idea behind this concept is that the cost of building a new house or apartment should exceed the cost of buying an existing apartment or house. Should it become cheaper to build a property then an opportunity exists for developers to build new houses and add them to the market while claiming the difference in profit. The addition of these properties to the market will help to satisfy demand and induce the decline of prices to a reasonable level. However, by nature of the construction process, there is an inherent lag time (from 6 months for a small house to several years for an apartment complex) before these properties are able to be occupied, and it is during this time that property prices can be considered in a ‘bubble’.
In actual conditions, it is not necessary for existing house prices to exceed new-build prices for this process to happen - depreciation of older existing structures and the preference for new, undeteriorated buildings, economies of scale when building apartments and the release of government land for housing all mean that this building process kick-starts even before the new-build price reaches the price of existing houses, with some experts considering existing housing to start being over-valued at when it passes 80% of the new-build price.
Method
The average R/m2 price of a new-build is compared to the R/m2 price of existing property, allowing an appreciation of the developer’s incentive to build new properties to be gained. To develop the price of a new-build property two elements need to be considered: the price of the underlying land, and the cost of construction.
To establish the price of land, the sale price for vacant plots in the last year for each area has been used to establish an average per-square-meter rate, as illustrated in the table below. The number of plots sold in the period and the sum of the plot area size has been provided to give an indication of the data-sufficiency in establishing an ‘appropriate’ average.
Estimating the construction cost is considerably more difficult: the price of construction can vary dramatically according to style and taste: High ceilings, imported ceramic tiles and granite counter-tops all result in higher building costs in comparison to vinyl flooring, plasterboard walls and plastic window frames. After consulting several architects, we have decided to base our analysis on the following building price bands:
- R3000 / m2 - Lower quality housing (Timber frame construction, basic fittings and finishes)
- R8000 / m2– Medium quality housing (Brick and mortar walls, ceramic tiles, high quality fittings and finishes)
- R12000 / m2– High quality housing (Brick and mortar walls with high ceilings, luxury carpeting, ‘named’ style fitting and finishes)
While these prices are approximate at best, they do allow a fair level of appreciation to be gained. These prices have then been added to the land price to provide a per-square-meter price estimate of a lower, medium and higher quality new-build home.
Analysis
The table below shows the comparative Rand values of prices for existing property to new-build property prices. In areas where the price of vacant land is a high portion of the building cost, such as the Atlantic Seaboard and City Bowl, there is a strong drive towards building apartment blocks. Of course, this is dependent on zoning laws, so despite a high land cost, Clifton remains free from high-rise apartments while a walk through nearby Seapoint will illustrate the dominance of high-density housing.
- R3000 / m2 - Lower quality housing (Timber frame construction, basic fittings and finishes)
- R8000 / m2– Medium quality housing (Brick and mortar walls, ceramic tiles, high quality fittings and finishes)
- R12000 / m2– High quality housing (Brick and mortar walls with high ceilings, luxury carpeting, ‘named’ style fitting and finishes)
While these prices are approximate at best, they do allow a fair level of appreciation to be gained. These prices have then been added to the land price to provide a per-square-meter price estimate of a lower, medium and higher quality new-build home.
Analysis
The table below shows the comparative Rand values of prices for existing property to new-build property prices. In areas where the price of vacant land is a high portion of the building cost, such as the Atlantic Seaboard and City Bowl, there is a strong drive towards building apartment blocks. Of course, this is dependent on zoning laws, so despite a high land cost, Clifton remains free from high-rise apartments while a walk through nearby Seapoint will illustrate the dominance of high-density housing.
Considering the ratio of existing property prices to new-build property prices, The table below provides significant insight, but needs to be balanced with choosing an appropriate building price for the area. For instance developers in the Atlantic Seaboard, having purchased expensive land, are more likely to aim for medium to high quality finishes (where greater revenue can be made) than in the South East Suburbs where housing will usually range somewhere between lower and medium quality. In the table below, the ‘area-appropriate’ to-build quality has been highlighted, but this is highly subjective and should be considered as a rough guide-line, useful primarily for those unfamiliar with the Cape Town area.
By comparing the existing property price with the new-build housing price (within the quality ranges as suggested by the highlighting in the table above), the most over-priced area appears to be the City Bowl, with an existing property selling for more than 18.6% of the cost of a new-build home. Looking deeper into the data, it appears that the suburb within the City Bowl area with the highest existing-build price is De Waterkant (R20,763 /m2).
While it would be fair to note that this suburb is adjacent to the Atlantic Seaboard area and the Atlantic Seaboards vacant land price (R10,754 /m2) was used, this still results in a medium quality ratio of 110.7%, suggesting that there is a strong incentive for developers to build. It should also be pointed out that this suburb already has significant construction activity underway, with several cranes dominating the suburb’s skyline - indicating that developers have foreseen significant profit potential in the area and as a consequence, more housing will become available in the near future.
Lowest in the ratios are the Northern Suburbs, where an existing building is sold for almost half the price of the estimated new-build cost. Several suburbs in this area (Tableview, Milnerton and Blouberg Strand) all had a residential construction boom during the late 1990’s lasting into the early millennium. It appears that this boom has ‘satisfied’ demand, resulting in seemingly little financial incentive for property developers to add to existing housing, with the exception of the niche market of beachfront property. Indeed, a drive through this area does seem to show that the majority of construction in the area is commercial rather than residential.
Overall, The Atlantic Seaboard, City Bowl and Constantiaberg all appear to provide developers with strong incentive to construct housing in these areas, which should in the long term result in the decline of house-prices but could at this point be considered ‘in a bubble’ and overpriced. Hout Bay and the Southern Suburbs also appear to provide potential incentive, but the level of incentive will be dependent on quality of housing required. In contrast, False Bay, Northern Suburbs and the Western Seaboard are unlikely to see significant residential development at these prices and could be considered accurately valued, or possibly even undervalued.
While it would be fair to note that this suburb is adjacent to the Atlantic Seaboard area and the Atlantic Seaboards vacant land price (R10,754 /m2) was used, this still results in a medium quality ratio of 110.7%, suggesting that there is a strong incentive for developers to build. It should also be pointed out that this suburb already has significant construction activity underway, with several cranes dominating the suburb’s skyline - indicating that developers have foreseen significant profit potential in the area and as a consequence, more housing will become available in the near future.
Lowest in the ratios are the Northern Suburbs, where an existing building is sold for almost half the price of the estimated new-build cost. Several suburbs in this area (Tableview, Milnerton and Blouberg Strand) all had a residential construction boom during the late 1990’s lasting into the early millennium. It appears that this boom has ‘satisfied’ demand, resulting in seemingly little financial incentive for property developers to add to existing housing, with the exception of the niche market of beachfront property. Indeed, a drive through this area does seem to show that the majority of construction in the area is commercial rather than residential.
Overall, The Atlantic Seaboard, City Bowl and Constantiaberg all appear to provide developers with strong incentive to construct housing in these areas, which should in the long term result in the decline of house-prices but could at this point be considered ‘in a bubble’ and overpriced. Hout Bay and the Southern Suburbs also appear to provide potential incentive, but the level of incentive will be dependent on quality of housing required. In contrast, False Bay, Northern Suburbs and the Western Seaboard are unlikely to see significant residential development at these prices and could be considered accurately valued, or possibly even undervalued.