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
High Art Capital recently announced the launch of a new fund called the Greater Toronto Area (GTA) Rental and Affordable Housing Initiative. It has been anchored by a $300 million mezzanine debt commitment (and a "nominal equity investment") from the Building Ontario Fund (BOF) and is expected to be capitalized in total with a minimum of $1.3 billion.
The objective is to acquire approximately 2,200 rental homes in blocks within newly completed, unsold condominiums across the GTA and convert them into long-term rental housing. Included within this will be approximately 550 affordable rental homes that are expected to be title-protected at rents set at the lower of 25% below local market rent or 30% of median gross household income.
This is interesting, but it's certainly not the first example of investors buying, or wanting to buy, excess condominium inventory. However, it may become the largest in Toronto and, as far as I know, it's the only one to partner with the public sector (BOF is a provincial Crown agency).
The way it is intended to work is as follows:
Condominium developers are sitting on unsold inventory and maybe on inventory they took back after purchasers defaulted (and which may be subject to legal action). What High Art will do is say to developers, "Hey, if you give me a really awesome deal, I'll take 50 of those condominium units off your hands." And if the developer is desperate enough, they will say, "Sure, that sounds good. Let's do a deal and then go for a nice closing dinner."
But at what price?
As we've talked about many times before on the blog, developer pricing is typically based on a cost-plus model. We take our costs, add a margin, and there's the final sticker price. The reason prices haven't fallen as much as one might expect on unsold units is because they're hitting the "cost floor"; developers don't want to lose money, unless they are given no other option.
But for this rental fund model to work at reasonable costs of debt, I suspect that, in many/most cases, deals will need to be struck below a developer's cost basis. So, it'll be very interesting to watch how this fund deploys capital and who the winners and losers are in this market.
Regardless, I think it is good that we are seeing this sort of activity. The faster we deal with the pain, the faster we'll get to the other side.
Cover photo by Patrick Boucher on Unsplash
It is worth reiterating that one of the main reasons the majority of people live in cities is because they would like to make money and improve their economic status. There are, of course, other reasons too, but making money is an enduring attractor. In Alain Bertaud's book, Order Without Design: How Markets Shape Cities, he famously argued that cities are, first and foremost, labour markets.
Because of this, the success of cities depends on their ability to harness talent and turn it into economic progress. New York City, for example, is the city it is today because it was the largest port of entry for immigrants. And because transportation costs were high at the time, people arrived in New York and stayed in New York to work and create businesses.
The same thing is generally true today in the San Francisco Bay Area. It is estimated that roughly 50% of all tech startups and 59 of the top 100 highest-valued unicorns have a foreign-born founder. (I'd love to know what percentage are Canadian graduates of the University of Waterloo.) These are immigrants looking for money and economic opportunity, and the local ecosystem is providing the right preconditions.
But if the preconditions for success disappear, people will start to both leave and not come in the first place. So, it's also worth reiterating that the fortunes of cities have always risen and fallen over a long enough time horizon. Here's a great excerpt from a recent Bloomberg article by Richard Frost and Mary Hui, talking about what "war-rattled Dubai can learn from Hong Kong's expat exodus."
Financial centers rise and fall with the tides of geopolitics. From the mid-1500s, the tiny Portuguese enclave of Macau served as the primary intermediary for trade between Europe, Japan and China. In the mid-1800s, it was displaced by Hong Kong, which Britain secured by defeating the Qing dynasty. Hong Kong, in turn, was overtaken by Shanghai in the 1920s, when its more glamorous though still Western-run rival became the wealthiest city in East Asia. Both were occupied by Japanese forces during World War II, and their expatriate elite were interned in camps.
Shanghai never regained its prewar status. After their 1949 victory in China’s civil war, the Communists seized foreign-owned assets, bringing an end to the dominance of one of Asia’s most prominent business dynasties — the Baghdadi-Jewish Sassoon family, known as the “Rothschilds of the East.” The exodus of wealthy Shanghainese to Hong Kong helped lay the foundations for the city’s modern-day revival as Asia’s leading financial hub.
But between the protests of the 2010s, the 2020 national security law, and the draconian pandemic lockdowns, in recent years, it did feel like Hong Kong might be at risk of losing at least some of its status as a global financial hub. According to the latest Global Financial Centres Index, Hong Kong is still ranked third, behind New York and London, respectively. But Singapore is nipping at its heels in fourth position.
Today, some are arguing that the current turmoil in the Middle East has broken the promise of Dubai as a stable, global financial capital where influencers roam freely on the beach. People are, not surprisingly, leaving in the immediate term, but will it be lasting? I think it's too early to be calling the fall of Dubai, but there's no question that this is a meaningful exogenous shock. Its real estate index fell 30% in two weeks.
History shows us that there are no guarantees. Preeminence exists until something happens, and then it doesn't. If this war becomes protracted, it will be a major problem for Dubai. Capital and talent want openness, stability, opportunity, and a favourable business environment (keep taxes reasonable and get out of the way). After all, it's arguably the main reason why people come to cities in the first place.
Cover photo by Sepehr Moradian on Unsplash
Chart via the Global Financial Centres Index