Brandon Donnelly

Daily insights for city builders, delivered every morning at 6 AM ET. I’m Brandon Donnelly — a Toronto-based real estate developer and founder of Globizen. I’ve been writing here since 2013.

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Category: Finance

  • Customer-centricity reduces risk

    Real estate can be an abstract concept. If you’re a capital allocator, it might be a line item in one of your spreadsheets. Or, if you’re a developer primarily focused on zoning and entitlements, you might think in terms of gross floor area. How much density do I have, and what is it going to be worth?

    This is not to disparage any one component or participant within the development supply chain; it is simply to say that development is long and complicated, participants will naturally specialize, and everyone will have a lens through which they see things.

    But at the end of the day, these activities ultimately come back to fundamentals: the real estate needs to house people and things, and do something. Gross floor area has value on a spreadsheet because it can be turned into something. And it is ultimately that something that determines how much it is worth.

    If you’re a developer selling entitled land, your direct customer is the next developer, the one who will ultimately build out the site. Then, that developer’s customers are the people who will ultimately buy, rent, and occupy the space. And in some cases, those customers will also have their own customers, if, for instance, they choose to buy a space and then rent it out to somebody else.

    So there are layers to this. But regardless of where you might sit within the chain, I think it’s always helpful to focus on the customer, or customers. It’s harder to be wrong with your assumptions if you drill all the way down and consider the end use cases.

    Cover photo by Israel Andrade

  • How to think about a development pro forma

    One common mistake that people make when it comes to development pro forma is assuming that feasibility is easily attainable. It’s not. In fact, it’s best to think of a pro forma as a fragile object that is liable to break if not handled properly. So to that end, here’s a non-exhaustive list of things you may want to keep in mind when trying to both forecast and create the future as a developer:

    • As a starting point, you’re safer assuming that your pro forma isn’t going to work. If the numbers look too good to be true or even just really promising — especially at the outset — then there’s a good chance they’re wrong. You’ve likely missed things. Be weary if it feels too easy, especially in our current market, where very little works.
    • Cheap land isn’t enough. Just because your land cost feels cheap, it doesn’t mean that your development project will end up being feasible. There are instances and entire markets where even free land isn’t enough. You might actually need a negative land value. Meaning, a subsidy is required to reach feasibility. This is the case with affordable housing.
    • Drill down into as many line items as possible. Back-of-the-envelope math — where you just plug in a few cost per square foot assumptions — is fine for an initial screening. But if you’re really serious, you need to get deep into the weeds. Run through the entire process in your mind and think about what might happen, and go wrong. Even with this, you will still miss things.
    • Stress test your assumptions. What happens if the city asks you to do X? What happens if the local councillor comes at you with Y? Can your fragile object support them, or will it shatter to pieces? The sensitivity of your fragile object to various stimuli will help you decide whether you want to do the project or whether there’s simply too much risk.
    • Ultimately, real estate development is a creative act. You’ll need to come up with creative solutions, and then you’ll need to will your project to life. This is one way to tell that you’re on the right path. It needs to feel really hard. So if your pro forma also feels this way, then there’s a higher probability that you’re narrowing in on something close to reality.

  • Equitable Bank launches construction financing product for laneway houses

    A few weeks ago, Equitable Bank launched a new construction financing product for laneway homes and garden suites in Canada. Here is the announcement. This is generally good news. When we completed Mackay Laneway House back in 2021, the banks hadn’t yet gotten their head around this housing type. I remember RBC getting tripped up on the fact that there were two detached dwellings on the same residential lot.

    That said, there are some important conditions around this new mortgage product:

    “The Laneway House Mortgage is offered on properties that are free and clear, or in combination with new or existing mortgages where Equitable Bank holds, or will hold, the first position.”

    In other words, they want no debt on the property or they want sufficient equity in the property — but Equitable Bank needs to hold the mortgage. I suspect that most of the people who have built laneway and garden suites have done so by leveraging the equity in their main house; so I’m not sure how “innovative” this product will end being in practice. You’ll also need to switch to Equitable Bank if you have your mortgage with another lender.

    Still, if you’re looking to build one of these homes — and I continue to believe that they make a ton of sense both financially and from a city-building standpoint — it wouldn’t hurt to see what Equitable Bank can offer.

  • Development charge litmus test

    Development charges are a topic that is near and dear to this blog.

    In theory, development charges are supposed to be “growth paying for growth.” In other words, they are intended to pay for the incremental services and infrastructure required strictly because of new development. This, of course, sounds right. More people will equal more demand on city services.

    However, development charges also increase the cost of new homes and there is a growing concern that development charges now pay for more than they should. Meaning, they have become a “housing tax”, which is more or less the opposite of what you want if you think there’s a shortage of new homes.

    Frances Bula recently wrote about this in the Globe and Mail.

    Part of the challenge, I think, is that city budgets are complicated. As far as I know, it’s largely impossible for the average person to try and figure out which municipal costs are associated with growth and which are associated with ongoing operations (i.e. they should be paid for through things like property taxes).

    That said, I think this current market environment could create a bit of a litmus test for development charges. As most of you know, new home sales in Toronto have fallen to levels not seen since the global financial crisis and the early 90s.

    This means that construction activity has now also fallen and that, in turn, fewer developers are paying development charges. I haven’t seen the exact numbers, but intuitively the drop in development charges paid should be precipitous.

    Now, if these charges are strictly paying for growth, then in theory, cities should be completely agnostic to this decline. Sure, they’re collecting less revenue, but they also don’t have the new growth. Any growth that is still in the pipeline (i.e. under construction) would have already paid for their impacts.

    However, if this is not the case, and municipal budgets start getting negatively impacted by this drop in development charge revenue, then it suggests that one of two things could be going on.

    Either development charges aren’t enough to cover the true cost of growth and the whole thing is a bit of a Ponzi scheme. That is, we need a constant flow of new developments to pay for the shortfalls of the last. Or, we’re overtaxing new homebuyers for the benefit of incumbent ratepayers.

    I’m sure it’s more complicated than I’m making it seem right now. But this is the crux of this debate: Are we equitably levying development charges on new homes? This current market could offer a clue. If cities start running out of money, it might suggest the answer is no.

  • The risk of not taking risk

    One simple definition of risk is that it’s the “possibility of loss or injury.” And that’s generally how most of us think about it — it’s a bad thing that needs to be managed, minimized, and sometimes avoided all together.

    While true, this recent memo by Howard Marks is a good reminder that risk is also indispensable. Or, put differently, there’s risk in not taking enough risk. This is true in business and finance, but it’s also true — as Howard argues — in chess, in sports, and in many other aspects of life:

    The paradox of risk-taking is inescapable. You have to take it to be successful in competitive, high-aspiration arenas. But taking it doesn’t mean you’ll be successful; that’s why they call it risk.

    By definition, it means that you will be wrong sometimes. Because if you couldn’t possibly be wrong, then it wouldn’t be a risk. It would be a known. And known things exist in our world in a very different way than uncertain things. Superior performance, as a gross generalization, demands uncertainty.

    So what’s the solution? Calculated risks:

    You shouldn’t expect to make money without bearing risk, but you shouldn’t expect to make money just for taking risk. You have to sacrifice certainty, but it has to be done skillfully and intelligently, and with emotion under control.

  • Fundamental and enduring

    I admire Warren Buffet’s humility:

    In the physical world, great buildings are linked to their architect while those who had poured the concrete or installed the windows are soon forgotten. Berkshire has become a great company. Though I have long been in charge of the construction crew; Charlie [Munger] should forever be credited with being the architect.

    This is an excerpt from his recent letter to Berkshire Hathaway shareholders, which, this year, he opens up with an obituary to his late partner, Charlie Munger.

    I don’t agree with everything Warren says and writes. He, for instance, doesn’t seem to like crypto and streetcars. Though, surely, he’d really dig my CryptoParisian.

    That said, I never miss his letters and his thinking has been broadly instrumental in how I tend to think about real estate.

    If you take his description (same letter) of what Berkshire does, and replace businesses with properties, this is what you get:

    Our goal at Berkshire is simple: We want to own either all or a portion of [properties] that enjoy good economics that are fundamental and enduring. Within capitalism, some [properties] will flourish for a very long time while others will prove to be sinkholes. It’s harder than you would think to predict which will be the winners and losers.

    This is a good way to think about real estate.

  • What might happen in 2024

    Yesterday we looked in the rear-view mirror. Today we’re looking forward:

    • The market consensus right now is that this cycle of interest rate increases has come to an end, and that we should see rates start to come down next year. Having confidence that rates won’t go any higher in the near future is what markets need in order to start making more decisions. So this is, of course, positive. At the same time, I don’t think anyone should expect a return to ultra-low rates. Rates today are still low when viewed historically.
    • Lower rates are good for levered assets such as real estate, but I don’t think that our industry has fully felt and processed the impacts of higher rates. Unfortunately, I think that things will get worse (in 2024) before they get better (maybe toward the end of 2024 or perhaps in 2025). This is when a “risk-on” approach will return in commercial real estate. A year ago today, I thought 2023 would be the year for this, but as I said yesterday, I was overly optimistic in terms of my timing.
    • On the residential resale side, I think we will see greater optimism sooner, certainly for the most in-demand cities and areas. There is pent up demand waiting on the sidelines and, once we can get past the current bid-ask spreads and deadlock, I believe we’ll return to a more balanced market in 2024. To be clear, I’m not expecting bidding wars and the like. And because of our housing affordability crisis, I also think the Bank of Canada will be more resistant to lowering rates compared to other central banks. This will help the Canadian dollar.
    • If you’re a buyer of real estate, I generally believe that 2024 will turn out to be a pivotal year for you. Roughly speaking, you win acquisitions in one of two ways: either (1) you pay the most or (2) you believe in something that most other people in the market don’t. This second approach is harder to achieve in bull markets. But in slower markets, the door is open and history has taught us that it can be the foundation in which great fortunes are made.
    • As I mentioned yesterday, I agree with the prognostications that hard costs will soften further next year (perhaps even more than 5% on average). Obviously every market is different. But here in Toronto, I just don’t see us returning to the level of construction starts that we have seen over the last number of years.
    • Since 2021, I have used my hyper scientific Jimmy the Greek Reopening Index to keep tabs on office utilization and the overall return to office. And based on this, 2023 was a positive year. Initially, souvlaki consumption appeared dramatically lower on days like Monday. But I noticed discernible increases as the year went on. However, if you look at actual data, such as what we have from swipe cards, the great return to office seems to have stalled out at around 50%. I don’t think this will hold, though. I continue to believe that of the people who work in offices, most will spend > 50% of each week there. And we will see that in 2024.
    • 2023 was the year of AI. But Fred Wilson makes an excellent point, here. AI is 40+ years in the making. Last year only became the year of AI because a consumer-facing app — ChatGPT — was revealed that captured everyone’s attention. Crypto will eventually have this moment, but it will likely need to marinate a bit longer. Instead, I think 2024 will be the year of augmented reality (AR) and a further blurring of our offline and online worlds. Think digital art, fashion, and other collectibles (such as NFTs).
    • Right now, autonomous vehicles feel like they’re in the trough of disillusionment (within the hype cycle). There were moments last year where it felt like we were finally moving beyond this phase. But then some very suboptimal things happened. I think AVs are our reality in the next 5+ years, which means that for next year we likely want to be focused on the inputs: vision/LIDAR, battery tech, etc.
    • Zooming out, we should be thinking about the above two trends in the context of a broader shift toward greater automation. I think it will feel more insidious than immediate (certainly in 2024), but the longer-term impacts are going to be profound for our society. The so-called gig economy is likely to be impacted first. Eventually the overall economy will create new jobs, but we are still going to need to manage this transition toward more automation.
    • TikTok Shop is where to look for the future of shopping. I think the platform will continue to see strong adoption and ultimately prove to be a dominant e-commerce platform throughout 2024. Amazon, Meta, and others will see this, and try their best to catch up and copy it.
    • At the time of writing this post, the total crypto market capitalization is about $1.74 trillion. This is down from nearly $3 trillion at the peak of the market in 2021. The recent gains suggest that the so-called “crypto winter” might be over, and so combined with lower interest rates and more real-world use cases, I think that 2024 will be another strong year for crypto. Total crypto market cap at the end of the year will exceed its 2021 peak.

    And there you have it. My current thoughts for this upcoming year. I should note that I’m not an economist, analyst, or an expert on souvlaki demand for that matter. But I enjoy writing this post as an annual discipline. It forces me to think critically about the topics that interest me. And in the paraphrased words of Howard Lindzon, it gives me an archive that I can go back to and either cringe at or think to myself, “hey, I could have been a somebody!”

    And with that, a big thanks to everyone who has read this daily blog over the last year. This year marked its 10th anniversary. I wish you much success and happiness in 2024. Happy new year!

  • What happened in 2023

    As per tradition around here, I like to bookend the new year with two posts: a post that revisits my random predictions for the year and a post that talks about what might happen in the year to follow. Today’s post is the former. So let’s see how I did:

    • I thought the interest rate hikes would come to an end in Q1-2023. But that didn’t happen until the summer. I also thought this would lead to a mild recession in Canada. Technically, we are not actually in one, but according to some, we kind of are.
    • I thought the real estate sector would start seeing some distress in the first half of the year, and that a new equilibrium would be found in the second half. This proved to be overly optimistic in terms of timing. A lot ended up being on pause for the entire year, and I now think that my forecast was at least a year too early. The sea change is still underway.
    • Given the overall slowdown in real estate, I felt that construction costs had to see some softening. This did, in fact, happen with some of the “earlier trades”, such as shoring and excavation, and we did see some specific trade pricing, such as concrete formwork, come down by as much as 30%. The smart cost consultants we work with now expect to see overall hard costs come down by a further 5-6% next year in Toronto. This makes sense given construction starts are way down.
    • With me expecting the interest rate increases to stop in Q1, I thought that pre-construction condominium sales would return in a meaningful way by the spring. While we did see some buoyancy around that time, it was short lived. Sales remained nearly shutoff for the entire year, but for maybe a handful of projects. The more successful projects tended to be outside of the Toronto core and at lower price points.
    • With respect to home prices in more tertiary/fringe markets, my sense then, as it is now, was that these prices would remain below the peaks for many years. In addition to the upward momentum created by low rates, my view was/is that some of this pricing was the result of a bet on urban decentralization. I don’t think that has played out as many expected it to, so that’s why I think it will be many years before the pricing we saw in early 2022 returns.
    • The momentum around “expanding housing options” in our low-rise neighborhoods is many years in the making. And a lot of progress was made in 2023. Here in Toronto, we adopted new multiplex policies that now allow fourplexes plus an accessory dwelling (so 5 homes in total) on an as-of-right basis. I continue to believe that this momentum is only going to grow. I also think we will see the arrival of more mixed-use opportunities.
    • I believed that, broadly speaking, urban transit ridership would remain below pre-pandemic levels for all of 2023. This proved to be the case for most US and Canadian cities. But things are improving. For Canada as a whole, it looks like we’ll see full recovery sometime in 2024 based on this trend line.
    • I thought 2023 was going to be the year I took my inaugural ride in an autonomous vehicle. Sadly, this didn’t happen. The sector as a whole also saw some setbacks. Hopefully I’ll get a chance next year.
    • I assumed that Apple would finally release its augmented reality device. And though they didn’t technically release Vision Pro, they did announce it. So I guess that counts for something. I also thought that 2023 would be a big year for “phygital” goods. Maybe it was. Or maybe it was more of a building year. A lot of people are curious to see how Vision Pro does in 2024. It’s not set up for the mass market, just yet, but I think it will do exactly what it is supposed to once it’s out in the wild.
    • Finally, crypto. I know that a lot of you like to skip over these posts, but it is something that I feel strongly about. A year ago, though, I was pretty bearish on Solana. Boy was I wrong. Solana ended the year as the best performing major crypto asset — up 933% at the time of writing this. Oops! However, Ether is also +91%, and I continued to dollar-cost average in all throughout the year.

    Next up: What will, or more accurately, what might happen in 2024.

  • These are not unprecedented interest rates

    BlogTO recently asked: Is it a good time or a bad time to buy a condo in Toronto right now? My unsolicited opinion is that if you are someone who would like a home in Toronto, now is an excellent time to buy it. But that’s not actually what I want to talk about today.

    If you read the post, you’ll come across this line: “She emphasized that these are unprecedented interest rates…” Hmm. I think it’s important to point out that these are not unprecedented rates. Rates today are certainly higher than they have been for about two decades. But they’ve been even higher before and, if you go back to say the 1980s, rates today still look historically low.

    We just got used to ultra low rates and now we need to adjust to them being higher. And we will. The first step is feeling confident that rates won’t go even higher in the short term. Because if you think you know where rates are going to hang out, you can then make decisions around that.

  • Billionaire minimum tax

    If you’re looking for a rough overview of how US business income taxation works — and who isn’t really — this is an interesting article by Matt Levine. He has a knack for making this stuff a lot more interesting. The real purpose of the article, though, is as a lead up to talking about Biden’s proposed “billionaire minimum tax”. At the highest level, here’s the idea:

    His most recent budget would require taxpayers worth more than $100 million to pay a minimum of 25% on their capital gains each year, whether they sold assets for a profit or continue to hold them.

    The way things work today is that unrealized capital gains are not taxed. Meaning you can own something like a stock for a really long time and not pay any capital gains on it, until of course you sell or realize the gains. So this is a philosophical kind of change. And in Matt’s words, it is both “jarring” and “possibly unconstitutional”.

    But I guess it doesn’t affect that many people. There are, according to CNBC, somewhere around 10,660 centi-millionaires in the US. I wonder why it’s not called a centi-millionaire minimum tax, though. (I know why.)