COSTS AND EQUITY - PART 2: DOES BUILDING A HOME GIVE YOU INSTANT EQUITY?
Is building a custom home better for your bank account and your equity position than buying a newly built home off the market?
In Part 1 to this cost and equity review, we investigated how much it would cost to build a fully customized home from the beginning with a turnkey builder in Toronto. We used a reference property for our baseline calculations:
Approximately 2,500 square foot, 2-storey single-family home in Toronto, and particularly in our neighborhood of Mimico in South Etobicoke, on a roughly 25x125 foot lot. Some of the standard features are a finished basement and a garage.
Our analysis determined that with some significant custom features (but not over-the-top luxury) to such as build, you could estimate a cost of roughly $1,900,000 for your custom home.
At the same time, we established that a similar sized home being sold as a newly built, never lived in home, will currently sell around $1,650,000 to $1,800,000, albeit not with the same features as your fully customized home.
The Myth of Instant Equity
Before we get into the details of the equity situation, we first need to debunk an urban myth called "instant equity". People like to believe that when they get a good deal on a property, they have gained additional equity in that property, known as instant equity.
For example, you purchase a house for $50,000 below list price, there is an inherent perception that this value is your additional equity that you gained instantly. However, this is not true. Buying for less than list price just means that the current market value is $50,000 less than what the property was listed for. If you were to resell the property immediately, you could not find a buyer that will pay $50,000 more than you did (with rare exceptions). Just because the property was listed at a higher price or was previously sold for a higher value, doesn't mean that the current market value reflects that.
Instead, the real equity in the house is your down payment and any increase in market value is unlikely to happen instantaneously but rather over years.
Building versus Buying
Now let's get back to our reference property! We have established by now that a custom built home in Toronto will most likely cost you more money than buying a new home off the market. As a consequence:
Gaining equity by building your new custom home is actually unlikely!
This seems to build a case against building a custom house then, doesn't it? When looking at the immediate financials only, this is correct. The only exception to this would be if you built the house for less than what it would sell for. Now this would probably require that you are an experienced builder and investor and that you do this for a living, but now you are just building a house for yourself. For the majority of the population, this is not a realistic scenario.
So does this mean you should not build a custom home?
Where Equity Hides
As is usually the case in real estate, actual investment gains take place over time:
During your property ownership, your mortgage or debt on the property will diminish and the property value will increase which improves your equity position slowly but continuously.
Between the time when you sign the contract with your builder to purchase the land and build your new dream home and the time you take possession and move in, property values will also have increased. Granted this period is probably a year or less and property values may not increase sharply, but this will help close the gap of paying a premium for your custom home.
Let's also not forget that compared to a newly built home that is finished for mass appeal and your custom home, there is a difference in features and finishes that you will have chosen. Similar to home improvement or renovations of your current home, there are features of a house that will increase its market value. By specifying features that you think will be attractive to future buyers, you can ensure that your home will be worth more than other houses on the market to date.
For example, our main additional feature is the super energy efficient Passive House specification, which we feel is not just great for the environment and living comfort, but will also become more prevalent in the market in the coming years and appeal to more and more buyers down the road (if and when we are ready to sell, of course).
There can be plenty of reasons why you will want to get into a custom home as it lets you define what it is you want out of the home. Some reasons may be more personal, like styling, some are more practical, but all of them are yours. For the most common reasons and our Top 10 benefits of building a custom home, please check out one of our earlier blog posts.
Costs and Equity Take-Aways
What we have gathered now is that:
Building a custom home in Toronto is (hugely) expensive;
Buying a new, ready home is less expensive than building a custom home;
Instant equity does not really exist;
There are several ways to gain more equity with a custom home over time;
At an initial premium cost, a custom home gets you what you want.
As always, the decision is a very personal one, and it’s yours!
On our journey, we have come to find that only a custom home can provide us with some of the features we are looking for in a home, so we have taken the plunge into this adventure. It may not be for everyone, but it's good to explore the pros and cons...
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