A frequent talking point among southwestern Ontario new condominium and apartment developers this year is the sharp increase in construction costs.

Ben Myers operates the boutique residential real estate advisory firm Bullpen Research & Consulting Inc.

Ronnie Mandowsky of Pelican Woodcliff Inc., whose firm offers cost consulting and quantity surveying services, notes that trades with fixed-price contracts are asking for higher prices on delayed projects, especially for metals, drywall, masonry, form-work and mechanical/electrical. After years of construction cost growth of two to three per cent a year, he anticipates that costs will increase by six or eight per cent in 2018. Others who track construction costs closely are seeing double-digit inflation.

Developers are now building those higher construction costs into their current pro formas, as well as increases in development charges, increases in the cost of borrowing due to higher interest rates, and additional costs associated with the new TOCore plan.

Many developers will have to offset these costs by achieving additional revenue, in other words launching their new condo projects at higher prices. The question then becomes, how much more demand is there at higher prices?

Are residential developers market makers, or market takers?

Comparing apples to . . .

When new product released is relatively standard, buyers can compare the asking prices to units traded in recently completed resale projects, and transactions at active new developments to determine if the value makes sense – the comparison is apples to apples. However, what if the location is unrivalled, what if the level of interior finish is the best in the city, what if the building is the tallest in the country?

The developer often sets the premium for this type of product, and the market must decide if it agrees.

With costs rising rapidly, developers need continued price escalation to attain the same level of profit, and many of these developers will be offering homogeneous product.

In many instances, standard newly completed condo units are selling for $900 to $950 per square foot (psf) in the resale market or being offered at $1,000 psf for unsold suites at active sites which launched a couple years ago. If condo developers need to sell at $1,100 to $1,200 now to realize an acceptable return, will they be able to set a new market price for pre-construction condos?

In the single-family housing market in the GTA, it is clear that developer prices are not market prices, as sales for single-detached and semi-detached new homes have been very slow for nearly a year.

New homes average $995,000 in 2018

According to CMHC, the average single and semi completed in 2018 (January to May) sold for approximately $995,000 in the Toronto CMA, an increase of five per cent year-over-year. The average asking price for a sample of new single-detached and semi-detached homes with updated 2018 pricing is $1.39 million (via BuzzBuzzHome data).

In slower sales environments, buyers are less willing to accept the latest developer prices and the new benchmark values.

Who do you think sets new home prices, the market, the developers, or both?

2018 will be an interesting year, as we see if the market will continue to accept much higher pre-construction condo launch prices, or if sales will drop off like they have in the low-rise market following the unprecedented price growth in 2017.