There are many development narratives that I don't quite understand. (I'm thinking of Toronto, but you can probably replace Toronto with any number of global cities for this discussion.) One is the belief that our transit network is full and so no new development should be allowed in certain locations, next to certain transit stations. The thrust of this argument is that additional transit capacity must be added before any new development is allowed to occur. This might sound logical, except it ignores the fact that the need for new housing doesn't magically disappear because subway cars are thought to be too busy during the morning rush.
Transit systems are also a network, and so does this mean that no more development should be allowed to happen anywhere in the city/region? Or is the goal to simply move development off of higher order transit and into lower-density areas so that the future residents in these new buildings can either take buses to the transit stations that were previously deemed to be at capacity or drive their cars everywhere? (Our highways have excess capacity during the morning rush, right?)
The second narrative that I find perplexing is that new developments don't give back in any way. Above is a chart showing residential development charges in the City of Toronto, as of November 1, 2020. This chart outlines the fees that every developer must pay when building new residential, though it is important to keep in mind that there are many other government fees and charges that form part of almost every new development. These are things like parkland dedication and separately negotiated community benefits. But for the purposes of this post, let's just focus on development charges (aka impact fees).
Assume you're building a 400 unit apartment building, consisting of 240 one bedroom suites (60%) and 160 two and three bedroom suites (40%). Based on the above chart, your development charge bill would be:
240 one bedroom suites x $33,358 per unit = $8,005,920
160 two and three bedroom suites x $51,103 per unit = $8,176,480
For a total of $16,182,400.
But it's important to keep in mind that these are the rates as of November 1, 2020. They will almost certainly go up by the time these charges become payable for your 400 unit apartment building. By how much you ask? Well according to Urban Capital's most recent issue of Site Magazine, which compared a development pro forma from 2005 to 2020, development charges in the City of Toronto have increased by about 3,244% during this time period. (The S&P 500 was up about 220% during this same time.) These are obligatory fees that contribute to everything from transit and parks to subsidized housing and municipal services. (The line items above.)
So it strikes me that there are other more productive questions that we could and should be asking ourselves. Such as, why is it that our transit/mobility infrastructure hasn't kept pace with new development and new housing demand? What are we going to do to fix that immediately? Why are we not taxing the things we don't want (like traffic congestion) so that we have more resources for the things we do want (like transit and housing)? And most importantly, what is the best way for all of us to work together so that we can create the absolute greatest global city in the world?
Photo by Mimi Di Cianni on Unsplash
Every year my friends at Urban Capital publish an annual magazine called Site. And every year it contains some great articles about the real estate development industry across Canada. (Some of you may also remember that I've written a few articles for it in previous years.)
Well this year's issue is out and there are a few featured articles that I'd like to draw your attention to:
What happens when 175 (mostly) women get together to design a condominium? Link
How (not) to build a public park Link
Why have Toronto condos become so %@$#$! expensive? Link
This last one is a topic that we have talked about many times before on the blog. But here, UC has provided a quantitative comparison between a project they did in 2005 and a project that they're doing today in 2020. Here's what they found:
Condo developers are merchant builders. They build a project and then move on. Because of this, there's a belief that there's little incentive to build for durability, in comparison to say purpose-built rental buildings where the developer might continue to own over an extended period of time. While it is true that putting on an operations hat will make you hyper-focused on everything from garbage collection to how you're going to manage all of your suite keys, there are a few things to consider in this debate.
One, as developers we certainly think and care a lot about our brand and our reputation, both with our customers and with Tarion (warranty program). We ask ourselves: "What will our customers think if we do this?" Irrespective of the tenure we're building, we want our projects to be carefully considered. And in the case of condominium projects, we would like our customers to feel excited and comfortable about buying in one of our future projects. That's the goal. This is no different than any other product that you might buy that doesn't come along with some sort of ongoing subscription.
Two, there's often a spread between condominium and rental values. For example, let's consider a brand new 550 square foot condominium in a central neighborhood of Toronto and let's say it would cost you $1,300 psf to buy it today. (Obviously it could be more or it could be less depending on the area and the building.) Now let's start with a rent and back into a value, using some basic assumptions.
Unit Size (SF) | 550 |
Monthly Rent | $2,400 |
Rent PSF - Monthly | $4.36 |
Rent PSF - Annual | $52.36 |
NOI Margin | 72% |
NOI | $37.70 |
Exit Cap | 3.75% |
Value PSF | $1,005 |
Here I'm assuming that same suite would rent for $2,400 per month. I'm converting that to an annual PSF rent. And then I'm assuming that if you were managing a whole building of these kinds of units, your operating costs might be somewhere around 28%. Crude back-of-the-napkin math to get to a Net Operating Income (psf). Finally, I'm capping this NOI at 3.75%. We can debate my assumptions and if this were in a development pro forma you might "trend" the rents. But I find this comparison helpful. Here we are getting to a value of around $1,005 per square foot. Less than our $1,300 psf above.
The point is that the margins are tighter, which helps to explain why for a long time we saw very few purpose-built rentals being constructed in this city. So even though you might argue that the incentives are in place to build for durability, you do have to weigh that against the realities of what you can actually afford to build. Development is filled with all sorts of these tradeoffs. But if you and/or your investors really want a consistent yield, this strategy can work just fine. Personally, I'm a fan of the long-term approach.
Three, rent control policies can have an impact both on the feasibility of new projects and on people's ability to actually perform maintenance. If you have a scenario where your operating costs -- everything from taxes to utilities -- are rising faster than your allowable rent increases, then you're in a bad situation and you have zero incentive or financial ability to actually invest in the building, despite being a long-term owner.
Finally, there is nothing stopping a purpose-built rental developer from also being a merchant builder. i.e. Selling the entire rental building once it is done and it has been stabilized. So you could argue that we're right back at my first point. Whether you're selling to individual condominium owners or the entire building to one entity, you as the developer have to sit back and ask yourself: "What will our customer(s) think if we do this?"
There are many development narratives that I don't quite understand. (I'm thinking of Toronto, but you can probably replace Toronto with any number of global cities for this discussion.) One is the belief that our transit network is full and so no new development should be allowed in certain locations, next to certain transit stations. The thrust of this argument is that additional transit capacity must be added before any new development is allowed to occur. This might sound logical, except it ignores the fact that the need for new housing doesn't magically disappear because subway cars are thought to be too busy during the morning rush.
Transit systems are also a network, and so does this mean that no more development should be allowed to happen anywhere in the city/region? Or is the goal to simply move development off of higher order transit and into lower-density areas so that the future residents in these new buildings can either take buses to the transit stations that were previously deemed to be at capacity or drive their cars everywhere? (Our highways have excess capacity during the morning rush, right?)
The second narrative that I find perplexing is that new developments don't give back in any way. Above is a chart showing residential development charges in the City of Toronto, as of November 1, 2020. This chart outlines the fees that every developer must pay when building new residential, though it is important to keep in mind that there are many other government fees and charges that form part of almost every new development. These are things like parkland dedication and separately negotiated community benefits. But for the purposes of this post, let's just focus on development charges (aka impact fees).
Assume you're building a 400 unit apartment building, consisting of 240 one bedroom suites (60%) and 160 two and three bedroom suites (40%). Based on the above chart, your development charge bill would be:
240 one bedroom suites x $33,358 per unit = $8,005,920
160 two and three bedroom suites x $51,103 per unit = $8,176,480
For a total of $16,182,400.
But it's important to keep in mind that these are the rates as of November 1, 2020. They will almost certainly go up by the time these charges become payable for your 400 unit apartment building. By how much you ask? Well according to Urban Capital's most recent issue of Site Magazine, which compared a development pro forma from 2005 to 2020, development charges in the City of Toronto have increased by about 3,244% during this time period. (The S&P 500 was up about 220% during this same time.) These are obligatory fees that contribute to everything from transit and parks to subsidized housing and municipal services. (The line items above.)
So it strikes me that there are other more productive questions that we could and should be asking ourselves. Such as, why is it that our transit/mobility infrastructure hasn't kept pace with new development and new housing demand? What are we going to do to fix that immediately? Why are we not taxing the things we don't want (like traffic congestion) so that we have more resources for the things we do want (like transit and housing)? And most importantly, what is the best way for all of us to work together so that we can create the absolute greatest global city in the world?
Photo by Mimi Di Cianni on Unsplash
Every year my friends at Urban Capital publish an annual magazine called Site. And every year it contains some great articles about the real estate development industry across Canada. (Some of you may also remember that I've written a few articles for it in previous years.)
Well this year's issue is out and there are a few featured articles that I'd like to draw your attention to:
What happens when 175 (mostly) women get together to design a condominium? Link
How (not) to build a public park Link
Why have Toronto condos become so %@$#$! expensive? Link
This last one is a topic that we have talked about many times before on the blog. But here, UC has provided a quantitative comparison between a project they did in 2005 and a project that they're doing today in 2020. Here's what they found:
Condo developers are merchant builders. They build a project and then move on. Because of this, there's a belief that there's little incentive to build for durability, in comparison to say purpose-built rental buildings where the developer might continue to own over an extended period of time. While it is true that putting on an operations hat will make you hyper-focused on everything from garbage collection to how you're going to manage all of your suite keys, there are a few things to consider in this debate.
One, as developers we certainly think and care a lot about our brand and our reputation, both with our customers and with Tarion (warranty program). We ask ourselves: "What will our customers think if we do this?" Irrespective of the tenure we're building, we want our projects to be carefully considered. And in the case of condominium projects, we would like our customers to feel excited and comfortable about buying in one of our future projects. That's the goal. This is no different than any other product that you might buy that doesn't come along with some sort of ongoing subscription.
Two, there's often a spread between condominium and rental values. For example, let's consider a brand new 550 square foot condominium in a central neighborhood of Toronto and let's say it would cost you $1,300 psf to buy it today. (Obviously it could be more or it could be less depending on the area and the building.) Now let's start with a rent and back into a value, using some basic assumptions.
Unit Size (SF) | 550 |
Monthly Rent | $2,400 |
Rent PSF - Monthly | $4.36 |
Rent PSF - Annual | $52.36 |
NOI Margin | 72% |
NOI | $37.70 |
Exit Cap | 3.75% |
Value PSF | $1,005 |
Here I'm assuming that same suite would rent for $2,400 per month. I'm converting that to an annual PSF rent. And then I'm assuming that if you were managing a whole building of these kinds of units, your operating costs might be somewhere around 28%. Crude back-of-the-napkin math to get to a Net Operating Income (psf). Finally, I'm capping this NOI at 3.75%. We can debate my assumptions and if this were in a development pro forma you might "trend" the rents. But I find this comparison helpful. Here we are getting to a value of around $1,005 per square foot. Less than our $1,300 psf above.
The point is that the margins are tighter, which helps to explain why for a long time we saw very few purpose-built rentals being constructed in this city. So even though you might argue that the incentives are in place to build for durability, you do have to weigh that against the realities of what you can actually afford to build. Development is filled with all sorts of these tradeoffs. But if you and/or your investors really want a consistent yield, this strategy can work just fine. Personally, I'm a fan of the long-term approach.
Three, rent control policies can have an impact both on the feasibility of new projects and on people's ability to actually perform maintenance. If you have a scenario where your operating costs -- everything from taxes to utilities -- are rising faster than your allowable rent increases, then you're in a bad situation and you have zero incentive or financial ability to actually invest in the building, despite being a long-term owner.
Finally, there is nothing stopping a purpose-built rental developer from also being a merchant builder. i.e. Selling the entire rental building once it is done and it has been stabilized. So you could argue that we're right back at my first point. Whether you're selling to individual condominium owners or the entire building to one entity, you as the developer have to sit back and ask yourself: "What will our customer(s) think if we do this?"
Average condo prices in the City of Toronto are up about 150%. But...
Land costs are up 160%.
Soft costs are up 118%.
Construction and related costs are up 91%.
Financing costs are up 93%.
Government fees, charges, and taxes are up 413%.
And development charges (a subset of the above) are up 3,244%!
At the same time, the profit margin over costs is down about 45%.
(As a point of comparison, CPI only increased by about 26.5% during this same time period.)
The point here is that condos are so %@$#$! expensive largely because of cost-plus pricing. Government fee increases are also outpacing every other cost bucket.
If you're developing new housing in Toronto, you have no choice but to accept these rising costs. You have to pay development charges and you have to pay them when you're told, even if that means swallowing some new massive increase.
So by necessity, end prices get continually pushed as a way to try and absorb these costs. You figure out what your costs are going to be and then you price accordingly. But of course, you also have to ask yourself: Can people actually afford this kind of pricing and can this neighborhood support it?
Sometimes the answer is yes, which is why development continues. But sometimes the answer is no. In this case, the next step is simple: you don't build.
Average condo prices in the City of Toronto are up about 150%. But...
Land costs are up 160%.
Soft costs are up 118%.
Construction and related costs are up 91%.
Financing costs are up 93%.
Government fees, charges, and taxes are up 413%.
And development charges (a subset of the above) are up 3,244%!
At the same time, the profit margin over costs is down about 45%.
(As a point of comparison, CPI only increased by about 26.5% during this same time period.)
The point here is that condos are so %@$#$! expensive largely because of cost-plus pricing. Government fee increases are also outpacing every other cost bucket.
If you're developing new housing in Toronto, you have no choice but to accept these rising costs. You have to pay development charges and you have to pay them when you're told, even if that means swallowing some new massive increase.
So by necessity, end prices get continually pushed as a way to try and absorb these costs. You figure out what your costs are going to be and then you price accordingly. But of course, you also have to ask yourself: Can people actually afford this kind of pricing and can this neighborhood support it?
Sometimes the answer is yes, which is why development continues. But sometimes the answer is no. In this case, the next step is simple: you don't build.
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