Every single real estate development project I have worked on has generally gone something like this:
Design the project.
Budget the project.
Realize: "Oh shit, this is way too expensive and will never work."
Cut out some of the parking (a loss leader on most projects).
Look for value engineering and other creative opportunities.
Repeat the cycle until the project works (hopefully).
This is so typical that if I went through this process and everything just magically worked, I would be immediately suspicious. This can't be. We must be overlooking something! The expectation is that the project isn't going to work until we, as developers, figure out a way to make it work.
This is what we mean around here when we say that "development happens on the margin." Projects are sensitive to even slight changes in market conditions. If rents soften, costs go up, and/or interest rates move in the wrong direction, that could be the end.
Current market conditions have only heightened this dynamic. More than ever, developers need to be both creative problem-solvers and disciplined managers because there's very little elasticity on the revenue side to help cover up any mistakes (if the revenue side even exists at all!).
Development is hard. But working through challenges is a big part of what makes it so rewarding. On that happy note, enjoy the long weekend, everyone.
Cover photo by Shivendu Shukla on Unsplash
In the olden days here in Toronto, approved development land used to sell for a premium compared to unapproved land. This was true because approved land meant you could start construction much sooner. And since time has value, this was worth something.
Today, this is far less valuable to developers (if at all) because, in most cases, the market does not support new construction. So, the land may be approved, but what does one do with it?
Rather than speed, I would say that the most valuable feature right now is the ability to be patient. Developers need to be able to stay solvent long enough for the market to return. But this does not mean that there isn't a cost to permitting, approvals, and lengthy pre-construction periods.
Here is a recent paper (that I discovered via Thesis Driven) by economists Evan Soltas (Princeton) and Jonathan Gruber (MIT) that asks: "How Costly Is Permitting in Housing Development?" What they discovered in the Los Angeles market is the following:
Developers have been willing to pay roughly 50% more for pre-approved development land (averaging about $48 per square foot).
The permitting process in Los Angeles accounts for about 40% of the time required to develop and construct a new housing project.
Approximately one-third of the gap between home prices and construction costs can be explained by permitting costs and delays.
This last point is an interesting one to focus on because it tells you how much regulatory fat there is in the system. In a perfectly free and efficient market, the market price of a home should, in theory, be roughly equal to the cost of the land, construction costs, and the developer's margin.
When you have a massive gap between the cost of the physical materials and labour required to build the home and the price of the home, it means that there are other costs being shouldered. The paper refers to some of these as "pure wait" (time) and "capitalized hassle" (dealing with bullshit).
This is an important way to think about the efficiency of housing markets, because minimizing the gap is a clear way to make housing more affordable.
Cover photo by Josh Miller on Unsplash
One of the reasons why we are seeing more multiplexes in Toronto (smaller infill buildings with less than seven homes) is that the city has waived development charges and parkland dedication fees on this scale of new housing.
This has helped enormously; without these changes, we'd be seeing far fewer of these housing projects being built.
But here's the odd thing about this exemption: if you build even one more home in the same building, the project is now subject to development charges on all of the homes (minus any credits you might receive for existing homes on the site).
Adding a seventh unit shouldn't suddenly trigger hundreds of thousands of dollars in fees for the first six. This makes zero sense:
It creates a disincentive to build incrementally more homes on sites that can accommodate them.
It creates a bias toward multiplexes (also known as "houseplexes") and away from apartments. The housing type shouldn't matter. We're talking about homes.
It perpetuates the "missing middle" problem. Build small or build big enough to shoulder the additional costs and regulatory burden.
If we're waiving DCs on sixplexes, why not at least waive them for the first six homes on every site? Better yet, waive them on even more homes. This is just one specific example of the hurdles I was talking about yesterday.
Note: My understanding is that the City of Toronto is currently looking to remove this DC cliff and implement a universal first-six-free rule.