If you’re building a purpose-built rental building, you spend nearly all of your money up front and then you start earning revenue (i.e. collecting rent). On the other hand, if you’re building a condominium building in a market that generally relies on pre-sales for construction financing, which is the case here in Toronto, you spend a bit of your money up front, lock in (but not collect) most, if not all, of your project revenue, and then you spend the majority of your money.
(This is obviously a simplification and when I say “spend all of your money” I’m speaking on an unlevered gross basis and not based on equity in. But this nuance doesn’t change the point of this post.)
I have written about the above difference before on the blog, but I think it’s particularly relevant in today’s cost environment. Looking at the construction cost chart that I posted a few days ago, it is clear that a lot of us, myself included, have never had to work and build in an environment like this.
In the past 30 some years, we have never had to deal with construction costs rising as quickly as they are right now. Though I recognize that things did also suck in the early 80s when we had high inflation and double-digit interest rates, and in the early 90s when the real estate sector was particularly hard hit.
In any event, what does this current environment mean for development projects? Well for one, and this is a big one, it means that spending a bit of your money up front and then locking in most of your revenue (i.e. pre-selling condominiums), can present a lot of risks if you don’t have a good handle on how much it’s going to cost you to finish the project. And the reality is that nobody has a crystal ball, especially in this kind of environment.
So in my humble opinion, I think you need to spend a bit more of your money up front. I think it makes sense to spend the time and money on solid working drawings and on running a tight construction procurement process — all before you begin selling.
It used to be the case that many developers would start selling before they even had their zoning in place. That is far less common today (from what I can tell) for reasons like what I’m describing here. Of course, this means it’s going to take you longer to get to market. And time equals more money. But it feels like a necessary move in this environment.
Photo by Matías Santana on Unsplash