After seeing this beautiful 6-storey and 21-unit social housing project in Lyon, I decided to retweet it and share the fact that we recently had a site under contract in Toronto with the intention of doing a very similar build. We wouldn't have been able to do the same outdoor spaces at the corner, but it was going to be 6 storeys and without any setbacks. The overall dimensions appear to be similar.
However, in the end, we had to drop the site because the margins were simply too thin. I was disappointed. Of course, some people responded to my quote retweet by calling this an example of developer greed. But once again, I don't think most people understand how development economics work. If the margins are too thin it, among other things, means:
It's going to be hard/impossible to raise capital and finance the project
You might be better off buying a "risk-free" government bond instead
That unexpected situations could sink the project (i.e. you lose money)
To give a specific example, let's assume that your expected base case rent at the time of occupancy is $4.75 psf. This would mean that if your average suite size is around 600 sf (which ours was), you would need a face rent of about $2,850 per month.
But what happens if you're off by only $0.25 and your face rent for this same 600 sf apartment is now $2,700 per month at initial lease up? $150 per month may not seem like a big deal, but it is. If you capitalize this income at something like a 4% rate, you will find that it becomes material.
This is what I mean by "the margins are too thin." And it's similar to any other professional not wanting to take on a job because they might lose money or because it's "not worth their time." It's about managing risk and understanding the opportunity cost of taking on such a project.
Salt Lake City has two recently completed luxury multi-family developments. Or perhaps I should say, at least two.
The first is The Worthington by Chicago-based developer Convexity Properties. It has 31 floors and 359 apartments. Leasing started last summer and seems to be going well.
The second is the Astra Tower by Kensington Investment Company, which is being managed by Greystar. It has 41 floors, 377 apartments, and is 451 feet tall, making it the tallest building in the state of Utah. Construction was completed at the beginning of this year and, according to Building Salt Lake, it's already about 30% occupied with full stabilization forecasted for summer 2026.
It's interesting to compare these projects to multi-family developments here in Toronto.
First of all, the reported average rent for Astra is US$3 per square foot, which works out to ~C$4.19 psf for us Canadians at today's exchange rate. I would say that this is at least ~15% lower compared to where I would expect most Toronto developers are underwriting new projects. This suggests to me that it's more cost effective to build in SLC.
The product is also different. On Astra's website, they have two virtual tours.
The first is for a studio apartment at 554 sf and the second is for a one bedroom at 788 sf. These are meaningfully larger than new apartments in Toronto. Here, the first would have to be a one bedroom and the second would be at a minimum a one bedroom plus den, though probably a two bedroom.
Every market has its nuances. In the case of SLC, the model suites appear to be very clearly competing with low-rise housing. The one bedroom has a dedicated entrance foyer, there's a separate dining area, and the bedroom has carpet, among other things. It reminds me of earlier multi-family vintages in Toronto.
Of course, one really unique feature you get here is views of the Wasatch mountain range (see cover photo above). It's a special feeling being in an urban center where you have mountains all around you, and it's one of the primary reasons why an increasing number of people are being drawn to Utah.
Congratulations to the team on successfully completing such an ambitious project. It's exciting to see SLC continue to grow and urbanize.
Cover photo via the Astra Tower
Over the years on this blog, we have spoken about at least two ways to think about development pro formas. In the purest academic sense, you could say that pro formas are a way to determine the value of development land. You start with your forecasted revenues, deduct all of your expected costs, and then at the end you're left with some amount of money that can be spent on land. Said differently, land becomes the "residual claimant" in your financial model.
This is an important exercise, but in practice, pro formas sometimes (oftentimes?) need to be worked in the opposite direction. Meaning, the land price is what it is, development charges just increased, and now you're trying to figure out a way to make the math work. In this direction, you could say that you're undergoing a "cost-plus exercise." The costs are the costs and now you're trying to figure out some justifiable revenue figure that will make everything work.
If you do this latter exercise for a new rental apartment in Toronto today, you will end up with a rental rate that is likely hovering somewhere around $5 per square foot. This is a broad generalization and every site is of course different, but for the purposes of this post, let's assume it's $5. What that means is that a 500 square foot one-bedroom apartment will rent for $2,500 per month and a 1,000 square foot three-bedroom will rent for $5,000 per month.
A lot of people like to look at rental rates and say, "oh my, greedy developers are charging too much." But the reality is that this is what the cost-plus exercise is telling developers. There isn't the option of just charging less because there's only so much you can do about costs.
In fact, because development happens on the margin, some degree of optimism is often required to make new projects feasible. What I mean by this is that $5 psf may be what you need to make the project feasible, but there may be zero market comps in your submarket to actually support it. So in order to move forward, you just have to believe that in the future this will be the market rent.
This is harder to do in Toronto today because rents are not growing, they are declining. I personally believe that will quickly reverse once new housing completions fall off a cliff, but it doesn't change the fact that it's harder to underwrite rental growth in this kind of market environment. And because it's harder to underwrite rental growth, it's harder to make projects work.
The other consideration is that pushing rental rates higher is naturally going to slow down absorption. The Law of Demand tells us that as the price of something increases, the quantity demanded decreases. So you take on more risk in multiple ways when you push rates. As a developer, I'd rather be in a position where I could underwrite lower rents and feel more confident about leasing up the building quickly.
One way this could obviously be done is to lower costs. So as an exercise, I opened up one of our rental pro formas and removed just two cost items: development charges and parkland dedication. The result, in this particular instance, is that we could lower our average rent by almost $300 per month and still have a more or less equally feasible project. That's meaningful.
A cynic would say that developers will still charge the higher rent, but again, I would argue this isn't necessarily true, especially in this market. A cheaper cost structure means that more sites / projects become feasible and that developers should now face lower market risk. I'll take that. I'll take a full building with minimal vacancy and lower turnover.
Cover photo by taufiq triadi on Unsplash