What Price Should A House Be?
That’s an easy question. It depends.
For example, I know of a building purchased, not new, in 1956 for $28,000. It is a three-level home of about 3,500 square feet in a desirable neighbourhood in Toronto. By today’s standards, it’s on a large lot. (about 7,500 square feet)
What should its price be now?
- Replacement cost is one possibility. The building itself is of fine construction, in excellent condition and close to the subway. It features materials and fixtures not easily found today. I doubt you could rebuild it for less than $500 a square foot. So about $1.8 million there. The lot is unknowable because there are none like it for sale. However, people have bought small homes on large lots in surrounding neighbourhoods and then tore them down. It is unlikely you could do that for much less than $1.5 million. Add landscaping, driveways and the like and you will reach $3.4 million.
- Replacement cost less depreciation might drop it to $3 million.
- A similar-sized house on the same street sold recently for $3.6 million.
- The original purchase price plus inflation is misleading because there have been improvements to kitchens, bathrooms, and basement finishing. Nonetheless. the original purchase price plus inflation brings it to about $300,000. The average rate of increase is 3.59%
It is safe to say that absent a special buyer or competitive offers, it would likely bring something in the $3.5 million range
How does that make sense if Inflation drove it to just $300,000? Even with upgrades over the years, maybe $500,000.
Everything in economics relies on the context and for large homes in good neighbourhoods in Toronto, the context has become quite different in the past 70 years.
Construction costs. At $500 a square foot, they are about a hundred times what they were. That seems impossible, doesn’t it? I thought so too, but there are factors relating to supply and demand.
It looks different if you see a percentage. A hundred times more in 66 years is 7.34%
- Wages are much higher now for several reasons. Construction trades pay well because not so many people are going into them. The trades generally are short of competent workers. If something is more scarce then it costs more when you want it.
- The skill level is higher. Modern materials and tools are not similar to what was available in 1956.
- Construction standards are different. More skill is needed.
- Building permits are expensive and come with considerable inspection and oversight costs.
- Materials are much more expensive. Again, labour cost in the suppliers has risen more than inflation. The materials are more highly engineered and more complex than a shipment of boards, single-pane windows, or pipes.
The lot itself. A similar lot in 1956 would have sold for something around $5,000 fully serviced. There are new lots in the neighbourhood. buying a new house in a newly developed area would take you 10 miles or more further out of the city. Maybe more. Again scarcity adds value. How much is reasonable?
- Today, the cost to provide municipal services, sewers, water, and roads is amazing. It is different in every municipality. You could count on a 6-figure number though.
- Supply and demand matter. People want to live at a convenient distance from their work and recreation and will pay extra to have that.
- No new lots can be created at 1956 lot prices plus inflation because the available land has been used already. To rebuild on an existing lot adds cost because it already has a building on it that has value. The demolition is far from cheap or easy.
- Fees related to development are significant. Legal, survey, environmental and archeological studies, and planner services add up quickly.
- There are objectors to every new development. That adds time and money costs.
The idea of social overhead
Social overhead is the cost that society adds to anything we buy. All that regulation is paid for by someone. In a house building situation, there are many factors.
- Scarcity of workers because of training requirements and promotion of white-collar jobs.
- Safety standards of materials are much higher. Fire considerations are among them.
- Bureaucracy at municipal and more senior levels makes the land more valuable because of zoning bylaws and the time it takes to develop new properties. Decades are the standard of time.
- Never forget the HST. The government enjoys 13% (in Ontario) of the price of all you spend. That was 0% in 1956.
The lessons and bits to take away
There are many factors that affect the price of the components.
Inflation factors in too. Maybe it is not the house that isn’t worth the money. Maybe the money isn’t worth the money.
In 66 years 3.59% growth becomes 10x, while 7.34% growth becomes 100x. Small changes over a long time has a bigger effect than intuition suggests. Know the rule of 72.
There is a conflict in many people. They think price must make sense. JP Morgan has opined, “A thing is worth what it will fetch.” Once a thing exists the reasons for price are absorbed and Morgan’s idea applies.
If any factors change the price of a house could change either up or down. Supply and demand dominate.
Help me, please. Please subscribe. If you have found this article helpful, forward it to others.
I build strategic, fact-based estate and income plans. The plans identify alternate ways to achieve spending and estate distribution goals. In the past, I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning. I have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, and Banks – from CIBC to the Business Development Bank.
Be in touch at 705-927-4770 or by email at email@example.com