I asked this question on Twitter this morning because I am planning to write more development-related posts. It's a topic that seems to be of interest to a lot of people. One question that I received was about the kind of profit margins that Toronto developers have been making over the past few decades. More specifically: How much have they increased? My response was that they haven't increased. In fact, if anything, they've been compressing as a result of rising/additional costs. (I've touched on this before in posts like this one about cost-plus pricing.) I think a lot of developers are actually wondering how much elasticity is left in the market to continue absorbing these cost increases.
I asked this question on Twitter this morning because I am planning to write more development-related posts. It's a topic that seems to be of interest to a lot of people. One question that I received was about the kind of profit margins that Toronto developers have been making over the past few decades. More specifically: How much have they increased? My response was that they haven't increased. In fact, if anything, they've been compressing as a result of rising/additional costs. (I've touched on this before in posts like this one about cost-plus pricing.) I think a lot of developers are actually wondering how much elasticity is left in the market to continue absorbing these cost increases.
Follow-up question to my response: Why then does
this report by Steve Pomeroy
claim that developers could still make a 15% margin even if they earmarked 30-40% of their units as affordable? Well, this was news to me so I went through the report and committed to responding on this blog. To be more precise, the report finds that there's room in as-of-right developments to dedicate 10% affordable in medium-cost areas and 25% affordable in high-cost areas. For rezoned sites, the numbers are 30% affordable in high-cost areas and 15% affordable in medium-cost areas. These are a potentially dangerous set of takeaways for a few reasons.
Very little mid-rise and high-rise development happens as-of-right in the City of Toronto. I don't know what the exact percentage is, but I suspect it's low. It would be very difficult to buy land if you were valuing it on this basis. And when you are valuing it -- that is, running a development pro forma -- it's not enough to pull averages from a cost guide and run high-level numbers. You can start there, but ultimately you're going to have to get more granular. Are you factoring the hundreds of thousands of dollars (more for bigger projects) that the City will charge you to occupy any public right-of-ways? What about your public contribution monies? This has historically been hard to estimate because the math that is used is akin to a secret recipe.
In this particular report, they assume a 100-unit building with 88,750 square feet of gross floor area. Since GFA typically factors some allowable deductions, the gross construction area for the project is going to be greater. Let's assume it's 5% more -- so about 93,190 square feet. This is how your construction manager will think about and do take-offs for the project. In the report, they peg total construction costs at $23,208,480. That works out to just shy of $250 per square foot (costs divided by above grade GCA). You cannot build a reinforced concrete residential building with below-grade parking for this number in Toronto. In today's market, and at this small of a scale, you might be looking at $350 to 400 psf.
On the low end of this range, that would mean your costs have just gone up by $9.4 million -- which just so happens to be the expected developer/builder profit in this model. Except now you're underwater and you won't be able to finance and build your project. It's probably time to look at your revenues and see if you can increase your projected rents at all. This is what I was getting at with cost-plus pricing. I would also add that I/we typically shy away from projects of this scale. There isn't a lot of margin for error. One or two surprises and you might be cooked. So with or without inclusionary zoning, these can be challenging projects that many developers won't even look at.
My point with all of this is twofold: development pro formas are delicate and margins aren't as generous and locked-in as most people seem to think. More often than not we end up passing on sites because we simply can't make the numbers work. The land is just too expensive. Development happens on the margin. So talking about developers "absorbing" the costs of inclusionary zoning is perhaps the wrong way to frame this discussion. A more appropriate set of questions might be: Who is going to pay for the cost of inclusionary zoning? Are landowners going to suddenly drop their prices? Is the City going to reduce their development charges/impact fees? Or will developers wait until market prices and rents increase so that they can cover these new costs? This latter scenario is how it has worked so far.
If you have other questions about development that you would like me to take a stab at answering, please leave a comment below or tweet at me.
There's a narrative out there that all developers are uncreative and greedy, and if only they would start being more creative and generous, we could solve the housing affordability problem that is plaguing many (if not all) global cities. In other words, the solution to increasing the supply of low and middle incoming housing is simply a psychological reframing on the part of developers.
The problem with this mental model is that it ignores reality. Development happens on the margin. The market is competitive. It's difficult to find developable sites. And it's a challenge to make projects work. More often than not, you have to say no as a developer. No I can't buy this land. No I can't build housing here. And no the market will not support new office space here. Sorry, but no. (See cost-plus pricing.)
Development needs to give back. On the blog we usually call this city building. And that's because it implies a greater sense of civic responsibility. Developers aren't just building one-off buildings, they're building a city. I believe wholeheartedly in this. But the belief that projects can be saddled with an endless array of government fees and civic contributions is a problematic one. There are limits -- because markets have limits.
This past weekend I was in a condo building here in Toronto with large signs in the elevator saying, "No Short-Term Rentals Including Airbnb Are Permitted. Trespassers Will be Prosecuted." It was the first time I had seen anything like this, but it immediately signaled to me that the building must be having a problem with short-term rentals. Why else would you deface the elevators? There are some buildings that allow short-term rentals, but most don't.
However, over the last few years we have started to see purpose-built short-term rental buildings. In some cases, existing apartments buildings were "converted", as was the case with Niido's two properties in Nashville and Orlando. Here tenants in the building can rent both unfurnished and furnished apartments and then rent them out on Airbnb up to a maximum of 180 days per year. To date, I think these are the only two properties to use the "Powered by Airbnb" moniker, but more are on the way.
The developer behind Niido -- Newgard Development Group -- recently launched a new Powered by Airbnb brand called, Natiivo. This one looks to be focused on for sale product, with two upcoming projects in Austin and Miami. Both projects will have hotel licenses in order to avoid any regulatory risk going forward. But this makes me wonder how materially different this model is from the condo-hotels we're already familiar with.
For landlords and developers, the goal is obviously to maximize rents and prices. Allowing (or explicitly encouraging) residents to rent out their place and earn some extra cash, should help with that. And given the way I started this post, we also know there's a desire to do this, particularly in places with strong tourist demand like in Nashville and Miami. But the reviews are mixed. Not everyone wants to live in a hotel. But then again, not everyone wants to co-live. To each their own.
this report by Steve Pomeroy
claim that developers could still make a 15% margin even if they earmarked 30-40% of their units as affordable? Well, this was news to me so I went through the report and committed to responding on this blog. To be more precise, the report finds that there's room in as-of-right developments to dedicate 10% affordable in medium-cost areas and 25% affordable in high-cost areas. For rezoned sites, the numbers are 30% affordable in high-cost areas and 15% affordable in medium-cost areas. These are a potentially dangerous set of takeaways for a few reasons.
Very little mid-rise and high-rise development happens as-of-right in the City of Toronto. I don't know what the exact percentage is, but I suspect it's low. It would be very difficult to buy land if you were valuing it on this basis. And when you are valuing it -- that is, running a development pro forma -- it's not enough to pull averages from a cost guide and run high-level numbers. You can start there, but ultimately you're going to have to get more granular. Are you factoring the hundreds of thousands of dollars (more for bigger projects) that the City will charge you to occupy any public right-of-ways? What about your public contribution monies? This has historically been hard to estimate because the math that is used is akin to a secret recipe.
In this particular report, they assume a 100-unit building with 88,750 square feet of gross floor area. Since GFA typically factors some allowable deductions, the gross construction area for the project is going to be greater. Let's assume it's 5% more -- so about 93,190 square feet. This is how your construction manager will think about and do take-offs for the project. In the report, they peg total construction costs at $23,208,480. That works out to just shy of $250 per square foot (costs divided by above grade GCA). You cannot build a reinforced concrete residential building with below-grade parking for this number in Toronto. In today's market, and at this small of a scale, you might be looking at $350 to 400 psf.
On the low end of this range, that would mean your costs have just gone up by $9.4 million -- which just so happens to be the expected developer/builder profit in this model. Except now you're underwater and you won't be able to finance and build your project. It's probably time to look at your revenues and see if you can increase your projected rents at all. This is what I was getting at with cost-plus pricing. I would also add that I/we typically shy away from projects of this scale. There isn't a lot of margin for error. One or two surprises and you might be cooked. So with or without inclusionary zoning, these can be challenging projects that many developers won't even look at.
My point with all of this is twofold: development pro formas are delicate and margins aren't as generous and locked-in as most people seem to think. More often than not we end up passing on sites because we simply can't make the numbers work. The land is just too expensive. Development happens on the margin. So talking about developers "absorbing" the costs of inclusionary zoning is perhaps the wrong way to frame this discussion. A more appropriate set of questions might be: Who is going to pay for the cost of inclusionary zoning? Are landowners going to suddenly drop their prices? Is the City going to reduce their development charges/impact fees? Or will developers wait until market prices and rents increase so that they can cover these new costs? This latter scenario is how it has worked so far.
If you have other questions about development that you would like me to take a stab at answering, please leave a comment below or tweet at me.
There's a narrative out there that all developers are uncreative and greedy, and if only they would start being more creative and generous, we could solve the housing affordability problem that is plaguing many (if not all) global cities. In other words, the solution to increasing the supply of low and middle incoming housing is simply a psychological reframing on the part of developers.
The problem with this mental model is that it ignores reality. Development happens on the margin. The market is competitive. It's difficult to find developable sites. And it's a challenge to make projects work. More often than not, you have to say no as a developer. No I can't buy this land. No I can't build housing here. And no the market will not support new office space here. Sorry, but no. (See cost-plus pricing.)
Development needs to give back. On the blog we usually call this city building. And that's because it implies a greater sense of civic responsibility. Developers aren't just building one-off buildings, they're building a city. I believe wholeheartedly in this. But the belief that projects can be saddled with an endless array of government fees and civic contributions is a problematic one. There are limits -- because markets have limits.
This past weekend I was in a condo building here in Toronto with large signs in the elevator saying, "No Short-Term Rentals Including Airbnb Are Permitted. Trespassers Will be Prosecuted." It was the first time I had seen anything like this, but it immediately signaled to me that the building must be having a problem with short-term rentals. Why else would you deface the elevators? There are some buildings that allow short-term rentals, but most don't.
However, over the last few years we have started to see purpose-built short-term rental buildings. In some cases, existing apartments buildings were "converted", as was the case with Niido's two properties in Nashville and Orlando. Here tenants in the building can rent both unfurnished and furnished apartments and then rent them out on Airbnb up to a maximum of 180 days per year. To date, I think these are the only two properties to use the "Powered by Airbnb" moniker, but more are on the way.
The developer behind Niido -- Newgard Development Group -- recently launched a new Powered by Airbnb brand called, Natiivo. This one looks to be focused on for sale product, with two upcoming projects in Austin and Miami. Both projects will have hotel licenses in order to avoid any regulatory risk going forward. But this makes me wonder how materially different this model is from the condo-hotels we're already familiar with.
For landlords and developers, the goal is obviously to maximize rents and prices. Allowing (or explicitly encouraging) residents to rent out their place and earn some extra cash, should help with that. And given the way I started this post, we also know there's a desire to do this, particularly in places with strong tourist demand like in Nashville and Miami. But the reviews are mixed. Not everyone wants to live in a hotel. But then again, not everyone wants to co-live. To each their own.
