[The Economics of Controlling Home Prices] Pre-sale Cost Has Nothing to Do with Market Prices

Suppose you inherit a 50-pyeong residential lot from your parents. Let us say the land has a market value of 5 million won per pyeong. By the way people calculate things these days, the cost basis of that land to you is 0 won, because you received it for free.

If you spend 100 million won to build a house on that land and then sell it to someone else, how much would you ask for it? They say the newly built house would have a market value of about 400 million won. Would you ask for 100 million won by adding 0 won for the land cost and 100 million won in construction costs, or would you ask for the market price of 400 million won? The answer is obvious. Not only you but anyone would naturally—and rightly—charge the market price.

The same logic applies to the original cost of a newly built apartment offered for sale. In deciding whether or not to buy your house, the buyer has little use for information about its cost. If the value the buyer perceives in the house is greater than the price, he buys it; if it is less, he does not. That is the principle of the market. The most important information for evaluating the value of a house includes its size, location, school district, transportation conditions, surrounding environment, interior layout, and the quality of the finishing materials. Buyers generally already have most of this information.

More importantly, knowing the cost does not help in evaluating the value of a house. At most, cost information might help one judge whether cheap building materials were used. But in most cases, the quality of building materials can be confirmed with the naked eye as well. Cost is only a very minor factor in assessing the value of a house.

Whether it is an apartment or a detached house, the basic principle is that homes are bought and sold at market prices. Here, market price means the price at which they actually sell. There is no reason apartments should be sold at cost.

Those demanding disclosure of costs want apartment presale prices lowered below market levels so that they can buy them cheaply. As a result, the initial winners of the allocation would gain a premium equal to the difference between the presale price and the market price. To that extent, construction companies’ profits would decline, and the construction of new housing would also fall. In the long run, this could actually increase housing prices.

The goal of housing policy should not be to force presale prices down, but to increase the supply of housing sites so abundantly that homes will not sell if developers try to charge excessively high presale prices.

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Original title: [집값잡기의 경제학 ] 분양원가는 시장가격과 무관하다

Author: Center for Free Enterprise (CFE)

Date: 2006-12-14

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=column&pn=20&idx=10681