Understanding Developer Pricing Strategy: Why New Launches grow higher in value as compared to resale
As we’ve learned in the previous article of new launches vs resale, a study of the profit margin, new projects seem to grow high in value as compared to resale properties. We gave plenty of evidences and case studies that point to this finding. But if you’re curious, which you should be, you should be asking why.
That’s exactly the purpose of this article. We’ll explain why new developments sold by developers always grow at a quicker rate that resale units. In doing so, we will be diving in deep to understand Developer Pricing Strategy and how it works so that you’re better able to understand the topic.
Understanding Bank & Developer Relationship
To begin, we’ll have to understand the relationship between banks and developers. There are three facts that you’ll need to know with regards to this.
1. Developers will always borrow money from banks
Typically, Developers borrow money from banks to:
– Buy land from the government through Government Land Sales (GLS) or En Bloc
– Top the lease back up to 99 years for En Bloc
– Pay for construction
Let me let you in on a secret. When looking at such data, 2 data that agents, have access to, but you wouldn’t. They are: cost of land and construction cost. With this information, you can add them up together to get the estimated breakeven price. From there, you’ll be able to calculate their estimated selling price, as seen below. This expected average selling price would usually be in the form of a range, because it wholly depends on the developer’s profit margin. Typically, developers have a profit margin of 20% to 30%.
2. Banks will always have safety measures in place in their contract
Banks have some safety measures and margins put into place to prevent market crashes like what happened with the Lehman Brothers back in 2008. These safety measures will be packed into the contracts that banks make with developers. These measures are meant to protect the banks. Should developers fail to meet these criteria, banks may fine them or impose a penalty.
Here is an example that illustrates how these measures may play out:
– For the first 6 months, banks would expect developers to sell at least 30% of the development
– Within the first year, banks would expect developers to sell more than 50% of the development
– Within second year, banks may expect developers to sell at least 70% of the development
Now, let’s look at the implications of such measure. For one it will affect how developers price their properties. For example, let’s assume that Developer XYZ bought a land and after performing their cost analysis, they realised that their breakeven price is $1,500 psf. And as mentioned earlier, developers tend to price their properties with a profit margin of 20% to 30%. In that case, that would be $1,800 psf (based on 20%).
Developer XYZ will now be faced with two options. The first option is to sell at $1800 psf and give discounts along the way. This strategy is honestly a pretty bad one for developers. Why? Because when they sell it at $1,800 psf and give discounts along the way, early buyers will feel that they were unfairly treated. They will then announce on their Facebook and Instagram accounts to share with everyone that they had actually paid more when the development first launched.
This would directly affect the reputation of Developer XYZ. In the future, should they launch any projects, customers will know that early birds have nothing to gain and Developer XYZ will have difficulty selling units and hitting their sales targets in the beginning of their launch.
The other strategy that developers can go for is to slowly increase their price. At the beginning of the launch, the aim should be to hit and clear their 30% sales target to avoid any penalties from the bank. They should start to sell at close to breakeven price, at $1,600 psf.
Thereafter, after they hit the 30% sales target, they should increase their price to $1,700 psf, after they hit the 50% sales target, they should increase it to $1,800, when they hit the 70% sales target, price should be $1,900, and finally, after TOP, they can price it above the profit margin at $2,000. Even though they earn lesser at the start, the above profit margin price at the end of the launch would more than cover what was lost.
Let’s look at a real-life example—Kingsford Waterbay. As you can see from the data below, the green circles represent the units that were bought by early birds in 2017. These early buyers, on average, paid $1,159 psf. Since 2017, Kingsford Waterbay’s developer has been increasing the price of the development. Those who bought a unit in late 2018, on the other hand, paid about $1,350 psf for a smaller unit!
What does this say? Well, this reflects the First Mover Advantage—that the early bird catches the worm. And in this case, the worm is a profit of about $191 psf, which in 1.5 years amounts to about $187,180.
Now let’s compare it to resale properties. As seen from below, in 2015, when we compare new launches to resale new launches can make more profit because of the simple fact that developers increase the price over time. During launch, developer priced it at $1,111 psf and at the end of four to five years, it was priced at $1,269 psf. This translates to a 14.2% return of investment for buyers who bought early.
But when we look at resale pricing, you’ll notice that prices remain stagnant. Why? That’s related to the third fact you need to know to understand the relationship between banks and developers.
3. Banks can match valuation for new development on sales price, but not for resale
To understand this, you’ll have to know what is Loan-to-value Ratio or LTV. According to MAS, the bank can maximally lend 75% of the valuation price (NOT sales price) to the buyer to take a mortgage.
For example, if a 1000 sqft property is selling at $1,600 psf, the launch price might be $1.6m. Along the way, the price might increase the price to $1.7m, $1.8m, $1.9m, and $2m. When the TOP sales price reaches $2m, the bank is able to match this valuation. The maximum loan that buyers can take, according to LTV is $1.5m. The cash that the buyer needs would be $500,000.
On the other hand, when we talk about resale units, the bank can only match the valuation that is based on past transactions. Assuming the valuation is at $1.6m but the seller wants to sell at $2m, the max loan will be based on the $1.6m valuation, and will be only $1.2m. The buyer would therefore need $800,000 cash to make up $2m.
Given the above, it makes more sense to buy the new launch from the developer. Although they are of the same price, a buyer can take a higher bank loan to finance the property. In order for resale price valuation to go up, each seller has to progressively increase the selling price so that the next valuation—based on past transactions—would increase. This increase, however, would definitely be at a slower pace as compared to new launches!
There you have it: the three facts that define the relationship between banks and developers and the implications that this relationship has on developer’s pricing strategy and subsequently affect buyers like yourself. You now know why new launches will grow in value quicker than resale units!