Early on in my career, I worked on a new office development where the decision was made to start construction having only pre-leased 25% of the building. (It may have actually been closer to 22% if my memory serves me correctly.)

Our big constraint at the time was that this first tenant had to be out of their current space by a certain date, and the only way we could meet their deadline was to immediately start construction. Otherwise, we knew we would lose them to another development or to an existing building.

To convince ourselves that this was a reasonable thing to do, we looked at all of the upcoming lease expiries in the market, and then came to the conclusion that there would be enough demand in the coming years to fill the rest of the building.

Still, we were taking a leap of faith, even if it was an informed one. And it meant running the project entirely on equity until we could secure a construction loan. Thankfully, in this particular instance, our hypothesis proved true. The lease expiries did end up creating the demand we were hoping for and so we were able to fill the rest of the building.

The project was a success.

But that was then. And in hindsight, this move feels scary. What would have happened had we made this exact same decision at the end of 2019? Things would have been very different. Not because of a fundamentally different decision on our part, but because of a black swan event that was truly impossible to predict. Our timing would have been bad.

This is just one example of the many risks associated with the building of buildings. Development never happens in a vacuum. You're always solving for a long list of constraints. And sometimes you need to solve for things that you don't even know exist yet.

When you build a new office building, the typical strategy is to pre-lease a certain portion of it. That is, you sign leases with a tenant or a few tenants so that you know for sure that X% of the building will be occupied upon completion. It’s a way to manage risk. If you don’t do this, then you are said to be building the office building “on spec.” 

When you build a new condo building, the typical strategy is to pre-sell a certain portion of it. That is, you sell suites to purchasers based on plan drawings, certain finishes, and a model suite intended to illustrate what that future suite will more or less look like. And the reason this is typical is because most construction lenders will require you to do that.

So when you see office buildings and condo buildings going up, there are usually already tenants and residents who plan to move in or investors who plan to rent out their suite and have generally transferred that risk away from the developer. 

Because really the only time that a purchaser or investor wouldn’t close on a condo suite (and walk away from their deposit) is when the market corrects so badly that it actually makes financial sense to do that. That happened in the U.S. in 2008-2009 in a number of markets.

But by contrast, when you’re building a rental apartment building you don’t have anything to pre-sell and your tenants (unlike office tenants) aren’t going to sign leases with you for some space that will be ready in 3 years. If you’re lucky, they might sign a lease with you for an apartment that will be ready in 3 months. This means that by default you are also building “on spec”.

Now rental apartments are often considered to be the safest real estate asset class and the least correlated with the macroeconomy. But as a developer and city builder, this dynamic is still something to keep in mind.

Early on in my career, I worked on a new office development where the decision was made to start construction having only pre-leased 25% of the building. (It may have actually been closer to 22% if my memory serves me correctly.)

Our big constraint at the time was that this first tenant had to be out of their current space by a certain date, and the only way we could meet their deadline was to immediately start construction. Otherwise, we knew we would lose them to another development or to an existing building.

To convince ourselves that this was a reasonable thing to do, we looked at all of the upcoming lease expiries in the market, and then came to the conclusion that there would be enough demand in the coming years to fill the rest of the building.

Still, we were taking a leap of faith, even if it was an informed one. And it meant running the project entirely on equity until we could secure a construction loan. Thankfully, in this particular instance, our hypothesis proved true. The lease expiries did end up creating the demand we were hoping for and so we were able to fill the rest of the building.

The project was a success.

But that was then. And in hindsight, this move feels scary. What would have happened had we made this exact same decision at the end of 2019? Things would have been very different. Not because of a fundamentally different decision on our part, but because of a black swan event that was truly impossible to predict. Our timing would have been bad.

This is just one example of the many risks associated with the building of buildings. Development never happens in a vacuum. You're always solving for a long list of constraints. And sometimes you need to solve for things that you don't even know exist yet.

When you build a new office building, the typical strategy is to pre-lease a certain portion of it. That is, you sign leases with a tenant or a few tenants so that you know for sure that X% of the building will be occupied upon completion. It’s a way to manage risk. If you don’t do this, then you are said to be building the office building “on spec.” 

When you build a new condo building, the typical strategy is to pre-sell a certain portion of it. That is, you sell suites to purchasers based on plan drawings, certain finishes, and a model suite intended to illustrate what that future suite will more or less look like. And the reason this is typical is because most construction lenders will require you to do that.

So when you see office buildings and condo buildings going up, there are usually already tenants and residents who plan to move in or investors who plan to rent out their suite and have generally transferred that risk away from the developer. 

Because really the only time that a purchaser or investor wouldn’t close on a condo suite (and walk away from their deposit) is when the market corrects so badly that it actually makes financial sense to do that. That happened in the U.S. in 2008-2009 in a number of markets.

But by contrast, when you’re building a rental apartment building you don’t have anything to pre-sell and your tenants (unlike office tenants) aren’t going to sign leases with you for some space that will be ready in 3 years. If you’re lucky, they might sign a lease with you for an apartment that will be ready in 3 months. This means that by default you are also building “on spec”.

Now rental apartments are often considered to be the safest real estate asset class and the least correlated with the macroeconomy. But as a developer and city builder, this dynamic is still something to keep in mind.