After being almost a year into one of the worst real estate markets in last 20 years in Vancouver and the real estate prices being down across the board, the prices of new homes have started to show signs of reaching its bottom!
One of the signs that the prices of newly built single-family homes have reached its bottom is that the price level of new homes has gone below their replacement costs! This means, in most Vancouver markets, buying a new home would be less expensive than buying a similar piece of land in that neighbourhood, at current depreciated land values, and building a new house with almost the same size and quality!
The main reason for new home prices going below their replacement costs is that the price of new homes has dropped by a larger percentage than the price of land!
It is not surprising that the price of new homes has dropped quickly considering the sharp decline in demand for more expensive homes because of the tight mortgage market. The high carrying costs of new homes is also another reason that the developers have to go through sharp price declines to get their new homes sold faster.
On the other hand, the price of land hasn’t declined at the same ratio as the price of new homes. As we know, in developed urban areas, the supply of land for the development of new homes usually come from the re-development of older homes. The demand for the older homes, even in a slow market, is always higher than the demand for new homes because of its lower price levels and the larger source of buyers for this type of property. Older homes are in demand by the buyers entering the single-family market, developers, investors, renovators, and buyers who like to build a new house to their own taste.
The price of new homes going below its replacement cost would do two things to the market:
One would be a higher demand for new homes as the buyers would see great opportunities in buying new homes.
The other would be a reduction in the supply of new homes as the construction of new homes wouldn’t be economically feasible for the developers who have to purchase the land at current market prices.
The higher demand and lower supply in short term would stop the price of new homes from going down further! In long run, this imbalance in supply and demand of new homes would result in prices of new homes to up to the levels that the construction of new homes become profitable again!