May 12, 2024
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Cost-plus price floor

Oftentimes, it feels like there is a perception that developers price new housing with the fattest of margins. Meaning, if only developers were less greedy, housing could be more affordable. But as we have spoken about many times before, real estate development is a competitive industry; therefore, projects happen on the margin.

Ordinarily, the prices you see are the result of a cost-plus pricing strategy. Developers figure out what it will cost to build and develop, they add on a margin that they think their investors will accept, and then they determine what sticker prices they need to make the project financially feasible.

I’ve been writing about this approach for many years, but today it’s even more obvious. According to Urbanation’s Q1-2024 condominium report, new unsold condominium inventory in the GTA is currently sitting at approximately 23,815 units. This is up 30% YoY and is equal to about 23 months of supply. Two years ago in Q1-2022, this number had reached an 18-quarter low of 8,726 units.

Developers are highly motivated to sell and move their projects forward. Time is a killer, especially today. So the logical explanation for this rising inventory is simply that they can’t sell it. Their cost-plus pricing doesn’t overlap with what most buyers in the market are willing to pay. Like I said, development happens on the margin.

In theory, there is always a price where buyers would be willing to transact. If I listed a beautiful condominium for $100k today, many people would want to buy it. Supply would quickly run out. The problem is that no developer can build for this. There is always a very real price floor and, right now, that floor doesn’t seem to be low enough for many buyers.

May 11, 2024
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Housing affordability in Canada

By some measures, housing affordability is, in aggregate, the worst it has been in Canada going back to the 1980s. Below is a chart from RBC showing homeownership costs as a percentage of median household income.

The previous spike came around the early 90s, but following that, we saw 3 decades of relative affordability. In fact, for a large portion of this timeline, condo apartments look to be hovering around 1/3 of median household income. This is a common rule of thumb for measuring affordability.

Now obviously things changed pretty dramatically during the pandemic. But that time has ended and a reset is underway. New housing supply has slowed dramatically. Developers are sitting on record levels of inventory. And sellers of all shapes and sizes are clinging, as best they can, to yesterday’s prices.

With so much uncertainty, it’s challenging, if not impossible, to know exactly how all of this will play out in the coming years. But I suspect that, as time goes on, the above chart is going to start to mirror what we saw in the early and mid-90’s. In other words, affordability is going to improve.

May 10, 2024
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Facing west

I lived in my last condo for over 10 years. And since it faced east, I never got to see any sunsets while at home. Now that our new place faces south and west, I am amazed at how often there’s a beautiful sunset here in Toronto.

This was last night’s from my home office:

Naturally, this picture doesn’t come close to doing it justice.

May 9, 2024
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Toronto’s Major Streets Study approved at Planning and Housing Committee

Back in March, we spoke about how Toronto wants to allow small-scale apartments on all of its major streets. Well today, this study — known as the Major Streets Study — passed at Planning and Housing Committee.

It still has to pass at Council. And the Committee did ask for city staff to look at certain amendments, such as reducing setbacks and increasing the maximum dwelling count from 30 to 60 suites. However, all signs point to this new policy being fully approved sometime in the coming months.

There’s still work to be done. For example, I don’t know why there even needs to be a maximum number of homes. Maybe one of you can explain it to me. We are already dictating the overall built form, so why not let people just build as many homes as possible.

It feels like we’re saying: “We desperately want more homes on our major streets, but you know, we don’t want the economies of scale to be too great. We’d rather see more, smaller projects. This way each home is more expensive to build!”

In any event, this is still meaningful progress. It is what so many urbanists have been clamoring for over the years; more homes in our low-rise neighborhoods. So I think it’s important that we recognize today as such. Nice work.

May 8, 2024
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Unlearning our biases

I had coffee this morning with an engineer who is going back to business school in order to segue into real estate development. This is a fairly typical journey. Lots of people come into development from a related discipline. In my case, it was architecture (even though I never practiced architecture). It was also the case when I went to Rotman that something like a third of the class had a background in some sort of science or engineering field.

However, one thing I did mention this morning was that he will likely find that he will need to unlearn certain things as he moves forward. Every discipline tends to indoctrinate us with a certain way of thinking about the world. Lawyers tend to be a certain way. Engineers tend to be a certain way. And architects tend to be a certain way.

In my case, I found that architecture school taught me to be, among other things, an intense perfectionist. The modus operandi in design studios is that your project is never ever complete. The more you work on it, the better it will become. And as a result, you should feel a deep onus to work on it as much as humanly possible. But in business, this isn’t practical. In the vast majority of cases, speed over perfection will serve you better.

I believe wholeheartedly in multi-disciplinary backgrounds, and maybe this is one of the reasons why. It shows you what you should unlearn. What would you say your biases are?

May 7, 2024
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US mandates new higher-speed automatic braking for passenger vehicles

The US Department of Transportation has just finalized a new vehicle safety standard that will require all light-duty vehicles to be equipped with a more advanced form of automatic emergency braking (AEB) by 2029. (Light-duty vehicle = pretty much all passenger vehicles, including SUVs and trucks.)

Now, most light-duty vehicles on the road today already have some form of emergency braking. What’s noteworthy about this ruling is that it requires a more robust version. Some might say one that works. Specifically, it will need to work at much higher speeds and at night.

Most of the AEB systems in operation today don’t really work at night — basically at all — and many have shown to be ineffective when it comes to stopping for humans.

This new standard will require vehicles to automatically brake at up to 90 mph when a possible collision with a car is detected and up to 45 mph when a possible collision with a pedestrian is detected.

This seems like a very good thing, especially given the persistent problem we are having with cars killing too many people. But how do we do it?

From what I have read, this new standard will be pretty challenging to meet without the use of long-range LiDAR, especially since night vision is a requirement. I find this interesting because, even though autonomy is taking a lot longer to arrive than most people anticipated, there’s still meaningful progress being made.

Here’s to hoping it saves a lot of lives.

May 6, 2024
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Architecture as a product

Construction is generally considered to be the world’s largest industry, and yet, it is well known that its productivity levels suck. Over the last half century, the industry has experienced something in between meager and negative productivity growth.

It is for this reason that, for as long as I can remember, people have been trying to figure out how to turn development and construction into something more repeatable and less custom — something like a product.

Now, there can be a bit of a stigma associated with this moniker. Architects don’t often like to think of their work as being a product and references to modularity can sometimes evoke feelings of cheapness (think manufactured homes).

But I think all of this is quickly changing. And at the end of the day, we are going to need to start building like this if we have any hope of making housing more affordable within our cities.

Here’s an example.

Back in 2021, I wrote about a new modular housing company called Juno. They had just broken ground on their first project in Austin (a five-story 24-unit building), and they were in the media talking about how they had more or less reduced the building down to 33 standardized parts.

The multi-family space has since softened in Austin, and I don’t have any inside knowledge of how this project went, but the building is now complete and being leased up. And regardless, I think it’s an important case study to look to. This is where our industry is heading.

May 5, 2024
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Art in hospitals

Art in hospitals is such a good idea. The above photos are from Michael Garron Hospital, here in Toronto. One thing I have never understood is why so many hospitals look and feel depressing. (My mom is a nurse and so I was around them growing up.)

I fully appreciate that utility is first and foremost and that construction budgets are always tight. But it strikes me that if there’s one place where you want the opposite of depressing, it is in the places where people go when they’re already not well.

It also doesn’t necessarily need to cost more to be “not depressing.” A little creativity and caring goes a long way.

I don’t know, maybe this is so often the case because the people making the important decisions don’t believe that our environments affect our well being. So the design process naturally reduces to just getting the utilitarian parts right and not spending a penny beyond that.

Whatever the case, I do believe that our environments affect us. More than most of us probably appreciate. And so naturally, I think that art in hospitals is a very good thing.

May 4, 2024
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Unclear and unknowable

Development land, as we often talk about on this blog, should be the residual claimant in a pro forma. Meaning, start with your revenue, subtract your costs and required margin, and then see how much money is leftover to pay for the land. This is, in theory, how you should value land.

It’s also the most disciplined way to go about your underwriting. In fact, it can be beneficial to not know the asking price or broker guidance for a new site until you’ve completed this exercise. That way you won’t bias yourself.

However, in practice, it can be difficult to do all of this. In a rising market, you might find that there’s always some other developer who is willing to be more aggressive on their assumptions, which means they will be willing to pay more for the same piece of land.

And so if you want to be in the game, you might find yourself doing the exact opposite: starting with the land price and then trying to figure out how to make the rest of your model work. We’ve all been there.

During this stage of the cycle, you get punished for being conservative and disciplined — you don’t win sites. But when the market turns, discipline and conservatism get rewarded handsomely. You then become thankful for the deals you didn’t do. And I’m sure that many prudent risk managers are feeling this way right now.

It is very challenging to underwrite new sites today. Many of the assumptions that go into a pro forma are unclear and unknowable. And so the spread between what developer’s models are telling them to pay and what landowners want to sell for is often significant. That is why everyone is trying to find “creative deal structures” that can be used to close this gap.

At some point, though, the gap will actually close; things will once again feel clear and knowable. I have absolutely no idea when that will happen, but I do know that when it does, it will then be too late from a maximum opportunity standpoint.

Because that’s how risk works. Once the uncertainty is gone, it’s no longer a risk. And if it’s no longer a risk, then you’re not going to be paid for bearing it.

May 3, 2024
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Cheaper or better?

One perfectly sound approach is to just be the cheapest. This often entails lower margins, but hopefully higher volumes. However, the problem with this approach is that it can become a race to the bottom. At some point, somebody will find a new corner to cut. As Seth Godin says, “the problem with the race to the bottom is that you might win.”

On the other end of the spectrum is this approach:

This is a pamphlet describing full ripeness mangoes from the Miyazaki prefecture in Japan. These are not the cheapest mangoes around. In fact, it’s the opposite; they’re generally known to be the world’s most expensive. But they will almost certainly be the best mangoes that you’ve ever tasted. And you’ll only be able to get them between the months of April and August.

Sometimes it’s possible to be both cheaper and better. And that’s obviously an ideal position to be in. But in many, or perhaps most cases, you’ll need to choose. Cheaper, or that much better.