Search results for: “road pricing”

• How to properly complain about development charges

  

  In the wake of Bill 23, there has been a lot of discussion and concern around development charges and parkland dedication revenues. At a high level, the concern is that the proposed changes will reduce the amount of money that cities are able to collect from developers, and that this will exacerbate any existing funding shortfalls and possibly force municipalities to do things like raise property taxes. In the case of Toronto, the estimated figure is about $230 million of lost revenue per year.

  For all intents and purposes, this is objectively true. Bill 23 includes changes that will reduce the amount of revenue that cities are able to collect when new stuff is being built. Here is one such example:

  New sections 4.1, 4.2 and 4.3 provide, respectively, for exemptions from development charges for the creation of affordable residential units and attainable residential units, for non-profit housing developments and for inclusionary zoning residential units.

  This makes for great headline fodder: “Bill 23 is bad, it is going to reduce city revenues by $X million, your property taxes may need to go up, so you should be deeply upset about this.” Hmm. We should talk about this. I’m not going to suggest that Bill 23 is entirely perfect. But I do think it is important to consider two important facts when it comes to things like development charges.

  Firstly, the above exemption (to use just one example) is specifically related to affordable and attainable housing. It is not a reduction in DCs for the sake of reducing DCs. It is an attempt to recognize that we need more affordable/attainable housing and so maybe we should do things that make it easier and less costly to build it. And this brings me back to a point that I frequently make on this blog, which is that we can talk all we want about the need for more affordable housing, but at the end of the day it comes back to this: Who is going to pay for it? There is no such thing as a free lunch.

  The common rebuttal to exemptions like this is that developers will always profit maximize and price their housing at the most the market will bear. In other words, there is no evidence that developers will pass on any cost savings to the end consumer. But this is not entirely true. For developers, pricing a project is typically a cost-plus exercise: how much is this going to cost to build and what do I need in revenue in order to hit my required returns?

  When costs go down, it reduces what you need to make a project feasible. This in turn reduces developer risk, because there is always a very real question of absorption. The more you push pricing, the more you slow market absorption. So you might actually be better off selling for less, more quickly. An example of this line of thinking is when condominium developers choose to sell 100% of their inventory upfront as opposed to holding some back with the expectation that prices will increase in the future. Doing this means that you value certainty over profit maximization.

  Secondly, this is what development charges are for (taken from the City of Toronto):

  Development charges are fees collected from developers at the time a building permit to help pay for the cost of infrastructure required to provide municipal services to new development, such as roads, transit, water and sewer infrastructure, community centres and fire and police facilities.

  Put differently, development charges are based on the idea that growth should pay for growth. When you build something new you create additional servicing demands, and so developers should pay for whatever incremental needs their projects are creating. This is, of course, fair. However, it is not the intent that growth pays for existing services. i.e. Ones that would be required regardless of whether there was the presence of development.

  So in theory, if new development were to shut off entirely and if development charge revenue were to go to $0, there shouldn’t be any issues funding the existing services. And in theory, nobody should be complaining about this lost revenue, because there is actually no need for this additional revenue. There is no growth to fund and all existing services are being adequately funded by the residents who are already there and using them.

  Of course, not all city services are self sustaining. Public transit, for instance, typically requires subsidies. Ridership fares aren’t enough to pay for operations, and this shortfall got understandably a lot worse during the pandemic. But is this a growth-related problem or is it an existing-resident problem? I mean, technically the problem is not enough riders. So isn’t that kind of the opposite of growth related? More people would be a benefit right now.

  In any event, the point I am raising today is that there is a right way and a wrong way to complain about lost development charge revenue. The wrong way is thinking, “ah, this lost revenue is going to impact my quality of life and the existing city services that I enjoy. I may have to pay higher property taxes.” The relevant points for this particular discussion should not be that there’s an operating budget shortfall or that existing taxpayers maybe can’t afford to pay.

  The more valid way to complain would be to say, “hey, these reduced development charges are going to make it difficult to fund the growth-related upgrades needed to support new and more housing in my community. And we need more housing!” Because if the concern is not actually this second one, then the headlines are a great big red herring. We have a larger financial problem on our hands that we are not speaking about.

  Photo by Scott Webb on Unsplash

  2022.11.27

• Demystifying the development pro forma

  

  Yesterday I made a comment on Twitter about most people not understanding to what extent government bureaucracy inhibits the delivery of new housing in this city. It received a number of responses, including remarks about how development charges have also recently doubled and how this statement applies to pretty much every city out there. But there was also a comment about developers not being transparent and not properly explaining the impact to the public. In other words: please demystify the development pro forma. I thought that was a fair remark, and so this post is going to be a response to that comment.

  Before I begin, it’s important to keep in mind that most developers have investors. These investors put up most of the money required for a project and in turn they take most of the profits. However, there is typically a “promote” in place, which is just an incentive structure that pays the developer more of the profits (disproportionate to the cash they invested in the project) if they perform and hit certain return benchmarks. All of this is to say that developers aren’t usually the ones holding all of the cash (which is what a lot of the public seems to think) and they are accountable to their investors to do what they said they would do.

  Now let’s run through the costs that make up a “typical” development pro forma. For this example, I am going to assume that we’re talking about a 100,000 square foot mid-rise building; the kind that you might build and find along any one of Toronto’s Avenues. If we were doing this in real life, we would get more precise with the areas and consider gross construction area, gross floor area (city definition), and the net saleable/rentable areas. But to keep the math simple, we will ignore these differences. That’s the approach I’m going to take overall in the post. What you need to know, though, is that you have to pay to build the entire building, but you only get to collect revenue on a portion of it. That’s why the “efficiency” of a building matters.

  Land

  The value of development land is a function of what you can build and the revenue you can ultimately collect. So location matters a great deal. Based on the latest high-density land report from Bullpen and Batory, the average price of an unzoned mid-rise site in the City of Toronto is about $231 psf. So let’s assume a land cost for our project of $23.1 million. Assuming we can get land financing at 60% of the value of the land (loan-to-value), that would mean we’re putting up $9.24 million of cash (plus a loan guarantee!) and borrowing $13.86 million to start our project. At 5.25% per annum (interest-only loan), our annual interest charges would be about $727,650. From now on forward, we’re going to pay ~$60k in additional interest charges for every month that our project is delayed. Buckle up.

  You should now begin to see why time is so valuable and why government bureaucracy can be so frustrating. As a developer, you’re heavily incentivized to move things forward, whereas it can often feel like everyone around you is trying to deliberately erect roadblocks in order to slow you down and make your project more expensive to build. Oftentimes, it is because it is less risky for them to punt things down the road and not make a decision. That is not the case for us and our project.

  Hard Costs

  Onto construction (or hard) costs. As many of you know, these have risen dramatically over the last 4 to 5 years. On some of our projects, we have added over $100 psf in hard costs alone. Part of this has to do with a busy construction market and part of this has to do with new building requirements: watertight undergrounds, new Green Standards, and so on. For our project, which is on the small side, let’s assume $360 psf for a total of $36 million. This would include our direct construction costs and our construction manager’s overhead (general conditions). We should also prepare for some of the trades to decline to bid on our project because it is too small and not worth their time.

  Soft Costs

  Soft costs include everything from consultant costs and interest charges to government levies and management fees. Like everything in your pro forma, these absolutely need to be broken out line by line. Don’t be lazy here. But for the purposes of this simplistic example, we’re going to use 75% of hard costs, which works out to be $27 million (or $270 psf). When I first started out in the development business, the rule of thumb was closer to 25% of hard costs. But times have changed. Government fees, alone, can make up about 1/4 of the price of a new condo in Toronto.

  Adding up all of these costs, we’re at $861 psf or $86.1 million in costs. It’s now time to consider the revenue side. $1,000 psf seems like a nice round number, so let’s start there and assume we’re going to sell our condos for that. Typically in Toronto, the price you pay is inclusive of HST, so that liability will need to be deducted from our revenue line. It’s not a straight 13% because of the new home rebate, but the rebate also hasn’t been properly indexed since it was introduced and so the liability could still be upwards of 10%. (This is worthy of a separate blog post.) The result is $900 psf in revenue and a margin on costs that is less than 5%. No sensible developer would want to do this project. One misstep (or development charge increase) and you’re dead.

  So let’s increase our condo prices to $1,100 psf. Maybe that will work. In doing that, we get to a margin on costs that is nearly 15%. Okay, now we’re in the range. But let’s say we just got delayed by 6 months (boom, interest charges) and our hard costs turned out to be off by $15. They’re actually working out to be $375 psf because of some new tariff and because the formworkers in the city are all tied up on bigger projects and couldn’t give a shit about our cute little infill project. Now we’re offside again in terms of our margin on costs. No problem, let’s try and push condo prices a bit more. Is $1,150 achievable? Perhaps. But ideally, given the above, we would want to be at $1,200 psf just to be safe.

  This is an overly simplistic example of the math that goes into a development pro forma. But hopefully it begins to show you (1) just how many moving parts there are in a development project and (2) the kind of pricing that is required in today’s cost environment. Developers are reacting to the costs that they are being thrown and it is creating upward pressure on home prices. (See related post: Cost-plus pricing.) So far there has been enough elasticity in the market to absorb these price increases, but that may not always be the case. If you have questions about this post or disagree with any of my assumptions, feel free to leave a searing comment below.

  Photo by Marcos Paulo Prado on Unsplash

  2020.03.14

• Thoughts on Autonomy Day

  This past Monday, Tesla held an event for its investors called “Autonomy Day.” It was livestreamed, but if you missed it, here’s the video. It’s almost 4 hours long, though the first hour is just footage of Tesla vehicles driving around. I’m assuming it was background content.

  I’ll be honest in that I haven’t watched it all. But there’s a lot here if you want to get into the inner workings of how their self-driving cars work. Musk also promises, at the event, that Tesla will have level 5 autonomy ready by the middle of next year (2020). At that level, you will no longer need to pay attention to the road as a driver.

  Along with this autonomy, the company plans to start rolling out “robotaxis” and a ride-hailing app that will allow owners to rent out their cars. Musk is predicting that this could generate upwards of $30,000 in profit per year for owners. Of course, at this point, nobody really believes any of these promises. Musk is notorious for overselling.

  But let’s imagine that robotaxis are the future. Maybe it won’t happen by the middle of 2020. But it will happen at some point.

  If taxis are automated machines that drive people around all day and then go and park somewhere during off-peak times, where do they want to go and park? Does autonomy all of a sudden disconnect the locations of owners and parking, because your car will simply come to you when you need it?

  And what do these feature mean for parking supply? Presumably (and we have talked about this before on this blog), you need less parking and it wants to be in locations where the real estate values are less. But because of this, I bet that we’re going to need to start — and get really good at — pricing road usage.

  What are your thoughts?

  2019.04.25

• Red tide, scooters, and civic security

  

  I am reading up on a few different things this morning.

  Southwest Florida, which is where I am right now, is in the midst of a “red tide” that began last November. These happen fairly regularly along the Gulf Coast, but this one is high up on the severity scale. There doesn’t appear to be a clear explanation for what causes them, but sustained warmer temperatures and fertilizer and other pollutant runoff are thought to stoke it. Whatever the cause, they are devastating to the environment. We are switching coasts tomorrow morning.

  Portland now has electric scooters. (Why don’t we have these in Toronto?) But to combat possible concerns around urban clutter, the company, Bird, has committed to collecting all of its scooters each night and has agreed to remit $1 per scooter per day to the city. These scooters are pissing off some cities (or maybe it’s just San Francisco), but I still believe the problem will eventually get resolved. City Observatory also has this interesting piece where it compares the above scooter pricing to car pricing. Are we underpricing cars?

  Finally, here is a short film on civic security in Paris. In an effort to mitigate terrorism, the city has, of course, been implementing and erecting fencing, barricades and other reactive security measures. But sadly, now that this has become a new reality, the capital is spending more time considering how these measures could be more thoughtfully designed. The video showcases some of them. Certainly a more deliberate approach, but are they just as reactive?

  Maybe one of these topics will be of interest to you too.

  Photo by Andreas Selter on Unsplash

  2018.08.04

• Stockholm’s congestion charge reduced car traffic by 20%

  Stockholm has a congestion charge that is used to reduce traffic volumes in the center of the city. Toronto does not. We looked at it, actually fairly recently, but then we lost our nerve.

  Stockholm’s congestion charge was first implemented on a trial basis starting in January 2006. Trials and pilots have become a common way to actually create positive change. Otherwise the status quo bias may simply be too strong.

  When Stockholm started the trial back in 2006, public support was very low. Maybe 30%. But as soon as it was implemented, car trips dropped overnight by 20%. Once people saw the benefits, support grew – hitting around 70% by 2011.

  Here is a brief Street Films video with Stockholm’s Director of Transport, Jonas Eliasson, talking about their experience with congestion pricing. If you can’t see the video below, click here.

  [vimeo 244771087 w=640 h=360]

  2017.11.29

• Thoughts on inclusionary zoning

  Ontario is looking to pass legislation that would allow municipalities in the province to implement something known as inclusionary zoning. If passed and should municipalities decide to use this tool (Toronto almost certainly would), developers would then be required and/or incentivized to include some percentage of affordable housing in their new market rate developments. 

  Politically, inclusionary zoning tends to be popular. It’s believed to be a way for governments to create new affordable housing using relatively small public subsidies. Not surprisingly though, the development industry generally hates IZ. It’s another cost that needs to be added to the development pro forma – though some municipalities rightly offset these additional costs with additional density, breaks on levies, and so on.

  What I always think about when this topic comes up is the broader economic impact of the land use policy. Because I’m suspect that it’s as simple as: mandate affordable housing; get more affordable housing for free. Generally there are always trade-offs.

  So here’s some reading material for you all this morning.

  In a classic paper (1981) by Yale Professor Robert C. Ellickson – called The Irony of Inclusionary Zoning – he argues that these practices can actually increase general house prices:

  

  As a counterargument Owen Pickford over at The Urbanist argues that IZ simply reduces land prices as a result of the new tax. Land, after all, is the residual claimant. Therefore, he believes it’s an effective affordable housing policy. (I’m not so sure I believe that land prices would decrease in practice.)

  There’s also debate about the effectiveness of inclusionary zoning to actually deliver affordable housing at a meaningful scale. City Observatory wrote a post that looked at the total number of units produced (through IZ) across a number of American cities and the results were spotty. It should, however, be noted that not all inclusionary zoning policies are mandatory.

  Finally, the Furman Center for Real Estate & Urban Policy at New York University published a housing policy brief back in 2008 that looked at this exact topic. While they admit that the data is scarce, they come to the conclusion that IZ had no meaningful impact on the prices and production of single-family housing in San Francisco, but that IZ seems to have slightly decreased production and slightly increased pricing in the suburbs of Boston.

  What this last point suggests is that inclusionary zoning policies are not all created equal. So like all difficult questions, the answer to this one is likely: it depends. If anyone can point me to better data on inclusionary zoning, I would love to see it.

  2016.03.17

• The tragedy of the commons

  

  the traffic jam by Phoebe Eve on 500px

  https://500px.com/embed.js

  In 1968, Garrett Hardin wrote an article where he coined the term: the tragedy of the commons. Hardin was an American ecologist who was obsessed and concerned with the prospect of human overpopulation.

  In his article, the term tragedy of the commons was used to describe a situation where individuals – all acting independently and in their own self-interest – actually end up behaving in a way that is detrimental to the larger group and that negatively impacts some sort of common resource.

  Just in case, here’s another definition via Investopedia:

  An economic problem in which every individual tries to reap the greatest benefit from a given resource. As the demand for the resource overwhelms the supply, every individual who consumes an additional unit directly harms others who can no longer enjoy the benefits. Generally, the resource of interest is easily available to all individuals.

  So what would be an example of a tragedy of the commons?

  You may not have thought of it in these terms, but I bet you that everybody reading this blog has experienced one.

  I will give you two examples.

  1. The first is that of electricity consumption. 

  In most condominiums, there are two types of ways that electricity gets billed and paid. Either the whole building gets one bill (master metering) or each individual resident gets a bill (submetering). 

  In the case of master mastering, each resident’s consumption isn’t tracked and so nobody knows who is consuming what. But in the case of submetering, each individual resident only pays for the electricity that they use.

  Not surprisingly, the data shows that submetering can cut electricity consumption by 10 to 30%. That’s because it creates a 1:1 relationship between usage and cost. There’s now a strong incentive to conserve.

  With master metering, there isn’t a 1:1 relationship between usage and cost. The additional burden/cost of consumption actually gets shared by everyone else in the building. And since each individual is looking to maximize their own benefit, they lose the incentive to conserve. As a whole, this makes the entire group worse off.

  2. The second example is that of congestion on public, un-tolled roads.

  In most cities, public roads are a resource that is “easily available to all individuals” (to use Investopedia’s terminology). They are basically free. The marginal cost of driving another kilometer to work on a road is basically nothing (other than a bit of gas and some time).

  What this does is create a situation where individuals – in their pursuit of maximum individual benefit – start to overload the road. Everybody just wants to get where they need to go and there’s no incentive to conserve the resource (i.e. the road). Once again, the result is that the entire group becomes worse off.

  That’s why building more road rarely/never works. You’re simply increasing a resource that is easily available to all individuals. What we should instead be doing is looking at submetering our roads (i.e. pricing our roads). It’s been proven time and time again to reduce road congestion basically overnight.

  I had never heard of the term tragedy of the commons before today, but I like it a lot. So the next time you’re stuck somewhere in traffic, you can now scream to yourself: What a tragedy of the commons!

  2015.07.14

• How much should a ride on the Union Pearson Express cost?

  When I was in Chicago a few weekends ago, one of the things we did was take the train from Midway Airport to downtown. We were a large group, but since it was only $2.25 and we figured it would be easier and faster than contending with traffic, we decided to take it.

  Since it was their local transit service (as opposed to a dedicated airport rail line), the train came within a few minutes and it took us about 25 minutes to get to the Loop. It was a great experience. And I would take it again the next time I go to Chicago.

  I mention this because there’s been a lot of debate in Toronto recently about the potential ticket price for the new Union Pearson Express train to the airport. Some are suggesting that it could cost upwards of $30 for a one way ride, which would also take 25 minutes and would leave every 15 minutes.

  The concern is that at this price, the train will only serve the business community and the rich. And indeed, it’s a lot more than the $2.25 I paid when I landed in Chicago earlier this month. But at the same time the Union Pearson Express promises to offer a more refined travel experience than your regular old subway train. So how should it be priced?

  Pricing exercises are really interesting because, as David Fitzpatrick pointed out in a recent tweet, increasing the price of the ticket will lower ridership. And at a certain point, this will cause overall revenues to also decline (the loss in ridership stops being made up by the higher ticket price). So, in theory at least, there exists a magic, profit maximizing number.  

  Of course, profit may not be the only goal. One might also be interested in reducing the number of vehicles on the road, promoting sustainability, and generally providing people with a convenient way to get to and from the city’s biggest airport. And should this be case, then those factors also need to be worked into the pricing model.

  Now, I don’t know what that magic number should be off hand, but I do think we need to be clear on our goals as that decision is made.

  I personally believe that we underprice roads in this city, which is why we have such a supply and demand imbalance (i.e. gridlock). And so if we decide that rail travel should be a premium service, then I don’t think it’ll do much to correct that imbalance.

  2014.08.27

• Closing the homeownership affordability gap

  Through TAS, I’m involved in an affordable homeownership seminar at Ryerson University. The goal of the semester is to develop a comprehensive policy document for how best to deliver affordable homeownership units in Ontario. 

  The students are still working on their final report, but I wanted share one thought that came to mind as I was reviewing the draft.

  As a first step, I think the question of affordability needs to begin with a broader look at the market rate housing market. Have we optimized for the delivery of new housing or are we operating in a state of perpetual supply deficits?

  The reason for this question is that—as I’ve written before—I subscribe to Edward Glaeser’s argument that easing housing regulation and increasing supply can go a long way to broadly improving housing affordability. It won’t make New York as affordable as suburban Houston (Glaeser says), but it will help to avoid some of the outrageous pricing that can occur in severely supply constrained markets like San Francisco.

  Once this has been addressed, it then comes down to deciding how you want to make up the shortfall. If you want to provide housing below its costs (the market rate), somebody is going to have to pay for the difference. However, if you’ve optimized around the market rate, it means that the required subsidies should be less than they otherwise would have been. This makes it more cost effective for governments, or whoever else is providing the subsidy.

  So my point is to not take the market conditions as a given when looking at affordability. Are there structural changes that could be made to improve affordability more broadly?

  There’s certainly no easy answer, but it’s an important discussion to be having. Let me know your thoughts in the comments below.

  2013.11.22
• It turns out that the average rake at Priceline Group is even higher today, as they allow merchants to voluntarily bid up their rake for better placement in the network (you can see this in the table above). This is one of my favorite marketplace business model “tweaks.” You start with a low rake to get broad-based supplier adoption, and you add in a market-driven pricing dynamic that allows those suppliers who want more volume or exposure to pay more on an opt-in basis. This way no one leaves the network due to excessive fees, yet you end up with a higher average rake over time due to the competitive dynamic. And when prices go up due to bidding and competition, the suppliers blame their competition not the platform (part of the genius of the Google AdWords business model). This also allows you to extract more dollars from those suppliers who desire to spend more to promote themselves (without raising the tax on those that don’t).

  Bill Gurley

  2013.05.23