One of the things you’ll often hear people deride at cocktail parties is the trend toward smaller urban dwellings. They get called “shoeboxes” and “cubby holes in the sky.” So let’s unpack that a bit today and try and better understand the economics behind it all.
When a new building is being developed, pretty much everything gets normalized to a per square foot (or square meter) number.
This is important because saying that building X cost $50 million to build and building Y cost $100 million to build doesn’t tell you much if the buildings are completely different.
However, saying that building X cost $500 per square foot to build and building Y cost $475 per square foot to build, tells you that building Y, despite being more expensive in absolute terms, was actually cheaper and/or more efficient.
The same is true on the revenue side. And typically, developers are looking (struggling) to meet a certain per square foot number in order to make the project financially feasible.
For instance, let’s say you’re building a 100,000 sf condo building. Once you subtract the non revenue generating spaces, you might determine that you need 85,000 sf x $600 per square foot in revenue in order to make the project feasible.
But there’s a back and forth game that needs to be played here. You have to ask yourself: for the product that I’m hoping to build, does $600 psf translate into something that people can actually afford?
You might think: everyone keeps telling me at cocktail parties that condos in this city are too small. So I’m going to build a bunch of 1,800 sf, 3 bedroom condos. Based on the above, these homes would be priced at around $1.08 million (1,800 sf x $600 psf). Your on-site signage would read: “Condos coming soon. From the low $1 millions.”
But wait a minute, how many families can afford a condo north of $1 million? Some could, but definitely not the majority. So then you determine through rigorous market analysis that $600,000 would be a better number. That is something that is within reach of more families.
But then you look at the math and realize that if you build that same 1,800 sf home, your per square foot revenue number now drops to $333 psf ($600,000 / 1,800 sf).
Given that you bought the land for $100 psf buildable (market price in the area) and that your construction costs alone are going to be $250 psf, you realize that you’re now underwater ($100 + $250 psf > $333 psf) without even adding in any soft costs (consultant fees, city fees, and so on). If you showed this to your investors on the project, they would throw you out of the room.
So instead of building that 3 bedroom condo at 1,800 sf, you say to yourself: what if I made it 1,000 sf? You’re confident that your architect could lay out a terrific condo at that size and it now magically gets your per square foot revenue number back up to $600 psf.
This solves two problems: it returns the project to positive feasibility and it keeps the total sale price within reach of more people. It promotes greater affordability. So you go ahead and do it. Boom – shrinking urban dwelling.
All of this is not to say that this is fair or unfair, good or bad. It is simply to say that this is the way it often is.