How are housing prices set? No, it's not arbitrary

Demand will depend on the developer's brand value and the amenities offered in the project. Even with good brand backing, the right location and appropriateness of the project, a developer must set the ticket sizes of his homes reasonably so as not to be 'priced out of the market' - meaning that prices must be in line with similar projects by other developers in the area

The Indian housing market is in continuous boom mode, with more people than ever aspiring to own homes and developers vying for their attention. However, there is one detail that still tends to haunt many buyers, the lack of clarity when it comes to prices of homes. While homes by good developers are selling at a fast rate, many buyers feel that the prices are set arbitrarily.

Let's explore how real estate developers arrive at the prices for their properties. For this, we first need to understand a concept and process called 'price discovery'.

What is price discovery?

Price discovery is the process by which the market determines the value of a particular product. It applies to almost all products, including smart phones, costlier household items like air conditioners, refrigerators and television sets, and so on. You would have noticed that the prices of some of these items tend to fluctuate according to their demand, the state of the economy, time of year, and even the weather. Gold items, where the price of the basic raw material is determined by its market value, also experiences price hikes during the festive season. But if the economy is in doldrums and disposable income is low, gold items will also sell at a lower price because of lower demand.

In the context of real estate, price discovery determines the prices at which properties sell reasonably. In India, the process of price discovery for residential real estate is complex, as it involves several factors. One of the most important factors is the cost of land.

The Cost of Land

Land is a finite resource, and its availability is limited. The cost of land can vary widely depending on its location, the availability of basic infrastructure, and the kind of developments the area has already seen. For all intents and purposes, there is no such thing as basic cost of land - while there may be certain basic benchmarks, the prices of different plots even in the same area can vary widely.

Developers do influence the cost of land through development activities. Announcing new projects can increase land demand in nearby areas, especially if the development enhances the area with amenities and infrastructure. Less directly, the demand from developers for land in a certain area tends to drive up the price quoted by the landowners.

More influential developers, such as those who build massive townships and industrial projects, can also influence zoning and land use changes. This increases land value by enabling more profitable developments for other developers. Large-scale developments can bring about broader economic growth, which attracts businesses and residents, thereby increasing demand and therefore land costs.

In markets where some developers hold large land parcels, they control the supply, and this will also influence pricing. And, of course, government policies also play a key role.

But whether they are responsible for the current land prices or not, developers must factor in the cost of this finite resource when setting the price for their properties.

Construction Costs

Another important factor that influences the price of homes is construction costs. The amount of money a developer spends on construction materials, labour, and other expenses can vary widely depending on the city, location, nature of the project, and the quality of the materials used.

The third factor will again vary depending on whether the project being developed falls into the luxury, mid-range, or affordable housing category. The cost of relevant labor hinges on its ready availability in the area.If the project's location is remote and the developer is breaking new ground, construction labour needs to be brought in from far and needs to be accommodated. In the case of high-density development areas, labour tends to be more readily available.

Demand

The third factor that affects the price of housing is its demand. This can vary significantly depending on the location of the project and whether the project addresses the actual requirements of the target clientele. For example, a luxury development in an area largely defined by low-cost housing is unlikely to see much organic demand.

Also, demand will depend on the developer's brand value and the amenities offered in the project. Even with good brand backing, the right location and appropriateness of the project, a developer must set the ticket sizes of his homes reasonably so as not to be 'priced out of the market' - meaning that prices must be in line with similar projects by other developers in the area.

To summarise

Given the complexity of these factors, it is not surprising that the process of price discovery in the Indian housing sector can often seem arbitrary and opaque. Developers must consider multiple factors to set the price for their properties.

One common strategy used by many - but no means all - developers set a base price for their properties and are open to negotiation with individual buyers. There is usually more scope for negotiation in the case of projects which do not see much sales volumes.

Finally, developers often provide discounts or incentives to buyers who purchase in the initial stage of the project's development cycle. This encourages buyers to commit to purchasing homes before construction is complete, helping developers to improve cash flows and reduce their financial risk.

Each developer must consider unique factors that affect the price of their properties and come up with a pricing strategy that is appropriate for that particular project. But conveying these various factors to every single customer is not feasible - home buyers are not interested in the challenges that a developer faces.

It is also pertinent to note that the market tends to be self-correcting. If developers set excessively high prices, the demand for their properties will be lower than they expected. On the other hand, if a developer sets the prices too low, he may miss out on a good profit margin.

But few home buyers today are willing to be patient to see if prices in a particular project will correct. In fact, most buyers are looking for ready-to-move homes precisely because they're not willing to wait. This means that the developer must come up with the right pricing strategy right off the bat. If you've found a good home option in the right location, in the right project by the right developer, and the price corresponds to your budget, it is safe to assume that the developer has done his homework and that 'the price is right'.

(Akash Pharande is Managing Director - Pharande Spaces, a leading real estate construction and development firm famous for its township projects in West Pune and beyond. Pharande Promoters & Builders, the flagship company of Pharande Spaces, is a pioneer of townships in West Pune)