Price Trap One – ‘Big Brand’ Builders.

We have already established that for profitable investments in Real Estate, an investor must ‘Price the market’ and not attempt to ‘time the market’. The purchase (or entry) price of a product then becomes a key factor in establishing the potential returns on investment in Real Estate. It must, therefore, be thoroughly and accurately ascertained before taking the investment decision. 

Determining a Project’s cost.

The development cost of a project depends on seven key input factors:

  1. Land/Location
  2. Government approvals
  3. Construction cost
  4. Cost of money
  5. Sales and Marketing
  6. Administrative costs
  7. Builder profit

A prudent investor must analyze these input costs with thoroughness to be able to compare the project’s cost viz a viz its offer price. For projects in a given location, the first three input cost factors are usually similar for all developers. The variance in the project’s cost can therefore be attributed mainly to inputs 4 through 7.

For the sake of this discussion, if we were to assume the construction cost, sales/marketing and administrative costs to be at par for a few projects at a particular location, then the cost variance between them would narrow down to Builder’s Profit.

Builder’s Profit.

A builder claims profits based on either Market Sentiments or his Brand Image.

People in general are hesitant (or even scared) to invest in Real Estate because of the money involved, opaqueness of processes in the industry, apathetic administration and a slow/expensive judicial process. With such an investor-unfriendly scenario, the ‘Big Brand’ builders charge a higher price for an offering similar to ones being developed by lesser known and medium/small builders.

The all-important question then is: are we paying too high a premium for just the brand name or is the higher offer price justified?

I explain this with the help of a simple example.

Let’s assume there are two projects in Sector 83 of Gurugram – one being developed by ‘Mr. Big Brand’ and the other by ‘Mr. Upcoming Lesser Known’. If these two projects are similar on all the other input cost factors, yet have a substantial offer-price differential in favor of ‘Mr. Big Brand’, then an investor is being asked to throw away money by paying a higher price for the perceived brand value of ‘Mr. Big Brand’.

If on careful analysis one finds that ‘Mr. Upcoming Lesser Known’ is providing a reasonable product then an obvious choice for an investor is to invest in the project and improve expected returns on investment. Because over a period of time, the market will equalize the perceptive value. At that point, the return on investments and equity would be better for the project by ‘Mr. Upcoming Lesser Known’.

The only exception I would apply is for projects that are still under construction, where additional risk criterion should be studied and analyzed before taking an investment decision.

Lastly, I must confess that the example I have used above is not hypothetical but of two actual projects in sector 82/83 of Gurugram.