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In years past, it was relatively simple for Toronto condominium developers to underwrite pre-construction sales (which, as most of you know, is a requirement for construction financing). Notwithstanding the temporary blips, like at the start of the pandemic, it was easy to feel generally confident that the sales would be there when you needed them. It was just a question of 1) pricing and 2) how quickly could you get there (i.e. get through the zoning and entitlement process).
This is not the case today. And it's happening in many (most?) markets, not just Toronto.
Today, the market clearing price for new condominiums is below the cost of actually building them. So no developer knows what the pricing should be, because no developer can price there and still have a feasible project. In addition, the question of timing is no longer dependent on approval timelines (though please don't take this to mean that approval timelines don't impact projects). At this point in the cycle, there are lots of zoned sites available. The question is now: When will the pre-construction condo market return?
It is impossible to know the answer to this. If you have a truly differentiated product catering to a specific buyer pool, then it is possible the answer could still be today. But if you look at the number of condominium suites under construction in the region (more than 85k) and the number of suites expected to finish construction this year (around 27k the last time I checked), most people are broadly assuming the answer is, at the very least, a few years from now.
Not surprisingly, this is having a meaningful impact on high-density land values. If you don't know when and for how much you can sell for at the back end, then it's pretty challenging to run a residual land value model today. Because it's a lot harder to have conviction in your assumptions. What this also means is that, if your assumption is the market will take years to return, then you need to add in this additional cost of time into your model.
To provide an indicative example, let's say that you're buying land today for $75 per buildable square foot, but that you don't anticipate being able to launch condominium sales for a few years. The result could be that once you add in interest charges and other carry on the land, your effective land basis could end up being somewhere closer to $125 pbsf. (Again, these are just indicative numbers.) The end result is that you have to pay that much less today.
In today's market, you need to have the flexibility of patience. So this is one of the ways that developers are thinking about new acquisitions, assuming they're still active. And it represents a significant discount on land (>50% in many cases) compared to where we were a few years ago.
Pat Hanson of gh3* is absolutely right with her comment, here, about why we are seeing more windowless bedrooms being built in Toronto:
In much the same way, some of Toronto’s development policies encourage windowless bedrooms. “I don’t think it’s driven by cost,” says architect Pat Hanson, a founding principal of gh3* and a member of Waterfront Toronto’s Design Review Panel. “It’s driven a lot by building forms. Where you find a lot of these inboard bedrooms is in the mid-rise type.” The requirements to step back mid-rises on an angular plane, she adds, forces the developers to populate their projects with very deep units.
This condition is being driven by building forms and by overall housing affordability. Here is a post that I wrote on this exact topic back in 2017. The numbers are dated. I cited $857 per square foot as the average price of a downtown Toronto condo. But the forces at work remain the same.
And they are not entirely unique to apartments and condominiums. One of the reasons why many condominiums are becoming long and skinny -- and getting designed with windowless bedrooms -- is the same reason that many cities, like Toronto, have long and skinny single-family lots.
You can certainly find wider lots, but it'll cost you.
Urbanation is forecasting that approximately 27,000 condominium suites will finish construction and be ready for occupancy this year in the Greater Toronto Area. This is some sort of a record, and is naturally the result of record pre-construction sales over the last cycle.
This number is going to come down given that construction starts are declining, but before that, these suites will need to get absorbed into the market. And that's why I think that one of the biggest risks for our industry this year is going to be closing risk.
In other words, you've got the pre-sales, but will the purchasers actually show up and close on their homes?
It is for this exact reason that most/all construction lenders want to see pre-construction purchasers pay at least 10% in deposits before they'll advance their loan. It is also why the most risk-averse developers won't start construction until they have even more than 10% sitting in trust. The more hard money a purchaser has paid, the more likely they are to close.
It can be easy to forget this when the market is on fire and you're more preoccupied with holding back inventory because you think that sale prices will be higher in the future. But it's prudent to remember these times. They are a naturally occurring part of real estate cycles.
The most risk adverse execution strategies will likely leave some money on the table in the best of times. You won't be profit maximizing. However, they'll leave you more protected in the worst of times. That's how risk and reward work.
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