Many, or perhaps most, developers I know have a minimum project size that they will work on. That’s why you’ll hear people say, “No, that project is too small. I need at least X square feet or Y number of units.” Given that smaller scale development such as laneway housing and “the missing middle” are so in vogue today, I thought I would discuss some of the reasons why scale matters.
But first, it’s worth mentioning that “laneway suites,” as we have structured them here in Toronto, are intended to be built by individual homeowners and not by developers. The lots can’t be severed and most lots will yield less than 1,000 square feet. So this is a bit of a unique circumstance. As most of you know, I am a big supporter of this initiative.
When you get into larger developer-led projects, it’s a different ball game. For one, it’s hard to even find sites. And good luck if you need to deal with multiple owners as part of an assembly. Most landowners have pricing expectations that do not even remotely align with “missing middle” level densities.
But assuming you’ve been able to find land at a reasonable price, you still have to contend with the fact that projects have a lot of fixed costs, as well as diseconomies of scale. In other words, there are schedule, cost, and resourcing considerations that won’t change no matter how big or small you go. It’s still going to take this long and cost this much, and you’re still going to need a set of humans to manage it through.
This can then create a situation where there’s not enough margin for error. The project is simply too small to absorb any shocks, such as an unforeseen delay or an unforeseen groundwater concern that is now adding millions to your project budget. There’s a lot of risk with development and it’s prudent to have contingency room. That’s harder to do with smaller projects.
The other problem developers run into with smaller projects is that the construction subtrades also tend to think of them as smaller projects. They have their own set of fixed costs and margins to worry about. So unless you happen to catch them with an opening in their schedule, you run the risk of them telling you they’re too busy or them giving you a stinky price, which is just another way of them saying they don’t want the job.
On top of all this, there’s minimum project size inflation. If capital is not a constraint, there’s a tendency to want to do bigger projects (see above). And because the cost of everything keeps going up, it’s simultaneously getting harder and harder to make smaller projects pencil; unless you, maybe, go ultra luxury and ultra exclusive. But that’s kind of the opposite goal of this whole “missing middle” movement, is it not?
Photo by JOHN TOWNER on Unsplash
This is fascinating, thank you for educating us Brandon! I wonder if a developer might look to develop multiple smaller projects in one area simultaneously to make numbers work. I know of a developer in Philadelphia doing this. However, these are high-end projects and as you pointed out, ‘missing middle’ should ideally have at least some degree of affordability if they are to address a housing shortage.
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1. I’m wondering if the margins are more attractive to say, custom home builders who might be developing multiple spec properties a year. Have the capital to turn over a small scale duplex/triplex say at the scale of a single family lot, and still see a good return. One that larger operation developers wouldn’t bother with. And to other points made here, what about the idea of expanded profit based on volume of properties being developed at the same time. Say 3-4 duplexes at same time.
2. Any idea of the developer in Philadelphia referred to by Craig? Very curious.
Thanks for sharing, Brandon. I have to ask, do you feel this creates the opportunity for an entirely different kind of developer? What if, for instance, a developer were to approach multiple property owners within a specified distance (e.g. 1-2 residential blocks) with the proposition of assisting them in leveraging the equity in their properties by helping to facilitate the construction of a laneway dwelling. The issue of scale could be addressed, in part, by entering into agreements that would see the construction processes undertaken simultaneously or concurrently, once a minimum threshold of land owners agreed to participate, with the same team of contractors and sub-trades used to address cost and resource requirements. In exchange for fronting a portion or entirety of the construction costs, the developer would be entitled to (1) collect ongoing revenue, either as a portion of rental income or treated like a mortgage in the case of owner occupancy, and (2) collect a portion of equity gain at the time of sale.
I am over-simplifying the complexity of what would be required, of course. But, could something like this work from your perspective?
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