Tag: developer dirt

• The long and narrow of property affordability

  

  Lots sizes and dimensions vary from city to city, as well as from neighborhood to neighborhood. They come in many different shapes and sizes from long and narrow (common in Toronto) to rectangular or even wide and shallow. Charlie Gardner wrote a terrific post on this last year where he used Bing Maps to illustrate some of these differences. Tokyo, for instance, is shown as having more rectangular lots (32′ x 38′), whereas Buffalo is shown as having more long and narrow lots (30′ x 175′). Charlie then asks: why the prevalence of inefficient long and narrow lots? These dimensions obviously produce long and skinny houses.

  As he rightly points out in his post, there are economic reasons for this. Assuming you’re starting with deep blocks and lots, then there’s going to be a natural tendency toward subdividing and going long and skinny. That’s because the key dimension is frontage onto the street. The more frontages you create, the more front doors can be built, the more lots with access to the Mississippi can be created, etc. And that’s how you end up with 10-12′ wide row homes, which also helps to address overall housing affordability. This is not a new phenomenon.

  To further demonstrate this point, let’s look at how this phenomenon has translated into the condo market – specifically the mid-rise condo market here in Toronto. In this case street frontage morphs into window frontage (access to light). That’s now the guiding dimension. In a 1 bedroom apartment, that dimension might be something around 6-7m. That allows you to have both a bedroom and a living room with a window. So it makes for a great 1 bedroom or 1 bedroom + den apartment. (I’m ignoring corner suites for this thought exercise.)

  However, a tension often arises when you begin to look at larger suites, such as 2 bedrooms and 3 bedrooms. The obvious response would be to simply give over more window frontage. So instead of 6-7m, the suite may get 10m. This would allow you to create a split 2 bedroom apartment (both rooms get windows) with a living room in the middle. This would be considered a highly desirable floor plan.

  But up until now we’ve been ignoring the depth of the apartment. And as is the case with lot dimensions, this can have an impact on the amount of street/window frontage that gets designed. We’ve talked a lot about mid-rise buildings before on this blog and one of the challenges here in Toronto is that the 45 degree angular plane guideline produces deep floors on the bottom of the building and narrow floors on the top. Given this, it would not be unheard of to end up with 12m apartment depths on some of the lower floors.

  The counter argument would be that nobody is forcing these larger floor plates. Simply carve the building back. But the economic reality is that the margins are so thin on mid-rise buildings, that it would be inconceivable to give up this floor area. You have to max out the envelope.

  Why does this matter? Well let’s assume that the average downtown Toronto condo will cost you $857 per square foot. Using back of the envelope math, that means that the above 6m x 12m apartment (1 bedroom) could cost around $663,000 (774 square feet x $857 psf). And that the above 10m x 12m apartment (2 bedroom) could cost around $1,106,000 (1,291 square feet x $857). 

  These are obviously big numbers. Question becomes: Who will be able to afford these?

  So naturally the design exercise becomes about reducing the size of the apartments and often this means reducing the amount of window frontage. Of course when you do this, it means that one or more of the bedrooms will need to be pulled back from the front windows, which is how you end up with inset / recessed bedrooms (indirect light) and long and narrow apartments. These are often pejoratively referred to as “bowling alley suites”, but they are driven by a push for greater affordability.

  Again, this is not a new phenomenon. It is simply a trade-off that gets made. It’s the long and narrow of property affordability.

  2017.01.08

• What is this a building for ants?

  One of the things you’ll often hear people deride at cocktail parties is the trend toward smaller urban dwellings. They get called “shoeboxes” and “cubby holes in the sky.” So let’s unpack that a bit today and try and better understand the economics behind it all.

  When a new building is being developed, pretty much everything gets normalized to a per square foot (or square meter) number. 

  This is important because saying that building X cost $50 million to build and building Y cost $100 million to build doesn’t tell you much if the buildings are completely different. 

  However, saying that building X cost $500 per square foot to build and building Y cost $475 per square foot to build, tells you that building Y, despite being more expensive in absolute terms, was actually cheaper and/or more efficient.

  The same is true on the revenue side. And typically, developers are looking (struggling) to meet a certain per square foot number in order to make the project financially feasible. 

  For instance, let’s say you’re building a 100,000 sf condo building. Once you subtract the non revenue generating spaces, you might determine that you need 85,000 sf x $600 per square foot in revenue in order to make the project feasible.

  But there’s a back and forth game that needs to be played here. You have to ask yourself: for the product that I’m hoping to build, does $600 psf translate into something that people can actually afford?

  You might think: everyone keeps telling me at cocktail parties that condos in this city are too small. So I’m going to build a bunch of 1,800 sf, 3 bedroom condos. Based on the above, these homes would be priced at around $1.08 million (1,800 sf x $600 psf). Your on-site signage would read: “Condos coming soon. From the low $1 millions.”

  But wait a minute, how many families can afford a condo north of $1 million? Some could, but definitely not the majority. So then you determine through rigorous market analysis that $600,000 would be a better number. That is something that is within reach of more families.

  But then you look at the math and realize that if you build that same 1,800 sf home, your per square foot revenue number now drops to $333 psf ($600,000 / 1,800 sf). 

  Given that you bought the land for $100 psf buildable (market price in the area) and that your construction costs alone are going to be $250 psf, you realize that you’re now underwater ($100 + $250 psf > $333 psf) without even adding in any soft costs (consultant fees, city fees, and so on). If you showed this to your investors on the project, they would throw you out of the room.

  So instead of building that 3 bedroom condo at 1,800 sf, you say to yourself: what if I made it 1,000 sf? You’re confident that your architect could lay out a terrific condo at that size and it now magically gets your per square foot revenue number back up to $600 psf. 

  This solves two problems: it returns the project to positive feasibility and it keeps the total sale price within reach of more people. It promotes greater affordability. So you go ahead and do it. Boom – shrinking urban dwelling.

  All of this is not to say that this is fair or unfair, good or bad. It is simply to say that this is the way it often is.

  2016.04.24

• What tax policy could be doing to home sizes in Ontario

  

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

  In yesterday’s post I made a remark that we have antiquated tax policies here in Ontario that encourage the building of smaller new construction condominiums. There seemed to be a lot of interest in that comment, and so I’d like to talk about that today.

  Some people thought I was referring to development charges, but I was actually thinking of the GST/HST New Housing Rebate in Ontario. 

  The way it typically works in Ontario is that when buy a new construction home, the price you pay is inclusive of HST (harmonized sales tax) and net of any applicable rebates, such as the rebate program mentioned above. 

  This means that the price you see on your agreement is usually the price you pay. I say usually only because there are ways that you could disqualify yourself from the New Housing Rebate program. But that’s a different post.

  So what does this mean in practice?

  Let’s say you went out and bought a new construction condo for $368,200 (there is a reason I’m picking what seems like an arbitrary number). If there was no such thing as the New Housing Rebate program, then the sales tax owing on this home would be the full 13%. And that would mean that the price paid before any taxes is actually $325,841 (x 13% = $368,200). This is an important number because it represents revenue to the developer.

  But since there is a New Housing Rebate program, the effective tax rate actually works out to be 5.20% for this particular sale price, which means that the price paid before any taxes is now $350,000 (a nice whole number). And so because of rebates and because they are now paying less HST, the developer’s revenue number has increased. It has gone from $325,841 to $350,000.

  The way this logistically works is that purchasers usually assign the New Housing Rebate benefits to the developer who then processes all the paperwork. This is what I mean when I say that the “sticker price” is inclusive of HST and net of any rebates – it already factors in the possible deductions.

  So far things are looking good. And I want to be clear that I don’t have concerns with the New Housing Rebate program in its entirety. In fact, it’s a hugely important part of the new home industry. Without it, many projects would simply not be feasible to build.

  However, as the price of the new home increases (which typically happens as the home gets bigger), the rebates start to fall off. The federal portion of the rebate maxes out at a base purchase price of $350,000 (which is why I chose that number) and the Ontario portion maxes out at a base purchase price of $400,000.

  What all this means is that as the unit sizes get bigger and more expensive, the effective tax rate is no longer at 5.20%, as was the case in the example I gave above. It increases. And if you hold prices constant for the purchaser, it means that the developer’s revenues now start to drop.

  To illustrate why this matters, consider the following chart:

  

  In the first scenario, the developer builds and sells 2 units for a price of $368,2000. This translates into revenue of $700,000. However, if the developer instead decides to combine those 2 units and sell the larger single unit for $733,100 (roughly double the price) then the effective rate of HST goes up and revenue drops by $30,000.

  The second scenario is similar to the first one except that instead of 2 units, it’s 3 units which then get combined into one. Here revenue drops even further – by $50,000.

  Now, you could argue that there are some cost savings associated with building fewer suites, but I don’t think it would offset the differentials shown above, especially if you multiply those revenue numbers across an entire project. So what this all means is that it can be more profitable for developers to build smaller units priced below the thresholds mentioned above, as opposed to a smaller number of larger units. 

  Again, I’m not saying that HST rebates are bad. They’re critical to the industry. I love them. But I do believe we should be thinking about the possible implications that the current set up could be having on what we’re building and in particular on unit sizes.

  If you’d like to learn more about how the rebates work, check out this PDF from the Canada Revenue Agency. I tried to keep things simple in this post.

  2015.10.18

• Building on optimism

  To be a real estate developer, or at least to be a good real estate developer, I think you need to have a certain kind of personality. Specifically, I think you need to be an optimist.

  Because if you’re going to take big risks and deal with lots of uncertainty – which is how most development projects work – then you have to believe that you’re going to be able to figure it all out and make it happen.

  That is not to say that you’re not worried about risk and you’re not thinking critically about what you’re doing. Managing risk is a hugely important part of the business.

  Rather it’s accepting that unexpected things will come up, whether it’s a small construction hiccup or a huge black swan event. And knowing that if and when that happens, you’re going to do whatever it takes to get through it.

  As an example, I remember a developer telling me a story about one of his projects in South Florida. This was back when I was in grad school so some of the details are a bit fuzzy.

  But basically he had excavated a site for an underground parking garage and they had just finished pouring the foundations and first underground level. (Because of its high water table, underground parking garages are rare and expensive to build in South Florida.)

  It’s then 2 ’clock in the morning and he gets a call from his engineer telling him that a hurricane is coming through. And that once it comes through the water is going to lift up his foundation from below and basically destroy it.

  They immediately start brainstorming solutions and the engineer ultimately decides that if they fill up the hole with water before the hurricane comes through that it will weigh down the built structure and keep it intact.

  So in the middle of the night, before a storm was about to hit, they’re all on-site pumping water into a big hole.

  The storm eventually came and went and the engineer was right: the water-filled hole kept everything in place. So instead of spending what could have been millions, the developer probably spent tens of thousands on a water bill. That’s a much easier pill to swallow.

  This, of course, wasn’t in the development pro forma or in the construction schedule. But it happened, as stuff invariably does. And for future projects, I’m sure it’ll be something he thinks about it. 

  But it’s all part of the game. And to be good at the game, I believe you need to be an optimist.

  2015.07.08

• 3 risks that real estate developers face

  

  ‘Jailhouse Rock’ by Michael Hill on 500px

  Real estate development is a risky game. So much so that some people in the business like to say that their primary function is to mitigate risk. 

  Today I’m going to focus on 3 risks that developers face. There are, of course, others risks, but these are some of the biggest. Some people might also categorize them differently, but this is my simplified way of thinking about it.

  The first risk is approvals. Oftentimes in development you need some sort of special permissions to build what you hope to build. These permissions come in many different forms, but whatever the case may be, there is risk associated with this part of the process. 

  What happens if you’re not able to build what you were hoping to build? Is the project still feasible? Do you have a viable plan B? Did you budget for a redesign? Have you now overpaid for the land? There’s a lot of uncertainty in this phase and uncertainty generally means risk.

  Assuming you’re able to obtain your entitlements (this is more of an American term), the next big risk factor is the market. Can you sell or lease out the space that you’re about to build and can you do it at the rates you were assuming when you acquired the site? 

  In a bull market this isn’t usually a problem. In fact, prices and rents may actually exceed your early assumptions. But what if you bought the site in 2006 and now it’s 2008 and you’re hoping to go to market. Now you might be in trouble. In business school I learned to do sensitivity analyses and stress tests. How far does the market need to drop before I lose my shirt? Those are good exercises to do in development.

  Assuming though that the market holds up and you’re able to pre-sell and/or pre-lease your new project and obtain financing, you would then be ready for construction – another big risk. This is why many developers bring construction in-house. It’s them trying to exercise more control over the process and mitigate risk.

  Construction is messy both literally and figuratively. There’s a lot to consider. 

  Are the drawings that you’re using to buy construction properly coordinated? Because if they’re not, you’re going to pay for it later. Is that Chinese curtain wall a great bargain or are you going to end up on a flight to China when it never shows up on your construction site? Are the trades hungry for work or are they busy? If it’s the latter, you’re going to get higher prices. And oftentimes there’s nothing you can do about it. You’re just buying construction at the wrong time.

  But we all know that with risk there’s reward. So if weren’t for all these risks, real estate development just wouldn’t be the same. 

  If you’re in the business, what keeps you up at night? Did I miss something? Let us all know in the comment section below.

  2015.03.19

• More on the real estate development process

  

  A few weeks ago I received the following comment from a reader:

  Really enjoyed reading this post about being a real estate developer. I was just wondering if you could do a write up on the various jobs and functions in a typical real estate development company so that people like me, who intend to work for a developer can roughly know what kind of skills are required or demanded in order to work there.

  It’s a great question and so I will try and answer it today. The first thing I should say though is that real estate developers are typically very lean on people. I’ve worked for big publicly traded real estate companies and small boutique ones, and the development teams are always fairly small.

  It’s that way because development projects can be messy and intermittent. The industry itself is also prone to regular market cycles and so the strategy is generally to remain fairly lean and outsource a lot of the work. You ramp up consultants and suppliers on a per project basis – as you need them.

  With that said, let’s talk about the typical development process and some of the key skill sets required. A simplified process might look like this:

  1. Buy development site (Acquisitions)
  2. Design a project (Consultant Coordination)
  3. Make sure project is feasible (Finance)
  4. Obtain approvals for said project (Planning & Approvals)
  5. Sell/lease space (Sales, Leasing & Marketing)
  6. Build project (Construction)
  7. Make money (The goal)

  Depending on the size of the firm, one person may be responsible for managing many if not all of these steps, or they may be split up into different departments. So you could end up with a department list like this:

  1. Acquisitions
  2. Development/Project Management
  3. Finance
  4. Sales, Leasing & Marketing
  5. Construction

  From my experience as a developer, you’re going to be involved in all aspects. And that’s part of what makes development so exciting. But let’s talk about some of the key areas:

  Planning & Approvals

  After tying up a winning development site, securing your approvals (commonly referred to as “entitlements” in the US) is usually the first major step. The reason this step exists is because oftentimes what you want or hope to build isn’t what you’re actually allowed to build as-of-right.

  So you have to go through a process to make that happen. It can take years depending on where you might be doing business, but there’s typically a significant amount of value creation at this stage. Some developers only focus on this stage and don’t actually build.

  City planning is a good background for this function. You need to understand the local planning policies and frameworks.

  Consultant Coordination

  As I mentioned before, development teams are often small. And that’s because all developers rely on outside consultants to make a project happen (architects, engineers, and so on). So a big part of being a strong developer is just being a strong project manager. The expression often thrown around the industry is that development is like herding cats.

  Having some sort of a technical background helps for this function. You end up dealing with a lot of technical details (which I find super interesting), and so it helps to have a bit of a background or an interest. If you’re not inclined in this way, you might find this area boring.

  Financial Modeling

  Building project pro formas and managing budgets is obviously a key component of the development process. From the moment you first look at a site up until project completion, you’ll be building financial models and constantly refining them as you get more information. The first version might be on the back of a napkin and the last version might be a complex Excel spreadsheet.

  Banking and finance is obviously a good background for this function. But you also need to understand the real estate business. Models are only as good as the information you feed it, so your assumptions have to be sound. 

  Sales, Leasing & Marketing

  I cannot over emphasize the importance of this function. If you are not selling units or leasing space, then you do not have a project. So no matter how amazing you might be at all the other functions (even fundraising from investors), if your firm is not bringing in money from your customers (purchasers or tenants), then you are dead.

  When I was at Penn, a lot of the real estate professors used to tell us that leasing is the best way to get started in the industry. And I don’t disagree with that – even though I didn’t start there. This is often handled by a separate department and/or outside team, but you’ll need to be intimately involved.

  Construction

  If you’re at this stage, that’s usually a good sign. It usually means you’ve managed to sell a bunch of units and/or lease a bunch of space. Some developers (with enough scale) will have a construction team in-house, but many others will just outsource it to a 3rd party. Regardless of the setup, it once again helps to have a technical background.

  If I missed anything or you want to add more detail, please let me know in the comment section below. I’m always happy to receive questions and post ideas, so feel free to tweet or email me. Tweets will almost always get a faster response.

  Image: Flickr

  2014.12.29

• Should I have just become an architect?

  

  I say “just”, not to belittle the profession in any way, but rather because that was my original plan–to become an architect. That’s what I was studying to become and I was loving the ride.

  But along the way, as I’ve mentioned before, I became somewhat disillusioned with the profession and I became a real estate developer. It’s not that I didn’t and don’t love architecture. I still do. It’s that I felt the profession had been marginalized. Architects were no longer the “master builders.”

  But I’m often asked by people if I miss architecture and design. And to be perfectly honest, I do sometimes. Every now and then I’ll read something about architecture or I’ll come across an interesting design and think to myself: “Should I have just become an architect?” This morning was one of those moments. I opened up my phone while still in bed and, for whatever reason, I just wanted to look at cool architecture in my inbox.

  But I never regret the deliberate decision I made. Developers are very much entrepreneurs and I believe wholeheartedly in the power of entrepreneurship to disrupt, improve, and move the world forward. I just love architecture. And that will never change.

  Image: REX

  2014.05.14

• Studying to become a real estate developer

  Earlier this week I received a message from an undergraduate architecture student interested in moving into real estate development after school. That was his 10 year plan. And he had clearly read my blog post, “Transitioning from architecture to development.”

  In his message, he asked me if there were any books I would recommend he read to improve his real estate and finance knowledge, and, if I could have a “redo”, if I would still do a M.Arch (Master of Architecture) or just go straight to the MBA?

  After responding to his message, I thought: “This would make a good blog post, as well as an opportunity to talk about the current state of real estate education in Canada.” So here goes.

  If you’re looking for a good real estate book to get you started, I recommend checking out “Real Estate Finance and Investments: Risks and Opportunities" by Peter Linneman. It’s a much easier read and way more casual compared to most textbooks. When I was in grad school, people referred to this book as the "blue bible.” The cover on the previous edition was less purple and more blue. Unfortunately, he has also changed his glasses since the photo below.

  

  To his second question, if I were to do it all over again, I wouldn’t change a thing about my education. I loved architecture school and combining it with business school classes and a real estate concentration was the best thing for me. I never wanted to be just a “numbers guy”, but I also never wanted to be a fanciful artist type who didn’t know how to build and manage a pro forma.

  Now, let’s talk about real estate education in Canada.

  I think we’re way behind. In the US, you can do a Master of Science in Real Estate Development, a Master of Real Estate Development, and all sorts of other real estate degrees. In Canada, you’re probably doing a MBA with a few elective real estate classes. Real estate is the largest asset class in the world. Does that not justify a dedicated degree?

  Part of the reason for this, I think, is because real estate development is still very much an entrepreneur’s business–though it has become more institutionalized in recent years. Because of this, people get into development from a variety of different professions. They just need that entrepreneurial hutzpah. And that’s all fine, but I still think that the profession, the economy and our cities would benefit from University trained developers.

  So if you’re reading this University of Toronto, I think–and I’ve thought this for awhile now–that The John H. Daniels Faculty of Architecture, Landscape and Design and The Rotman School of Management should get together and collectively form a real estate program. Who’s with me?

  2014.05.02

• Developer Dirt: Site selection and acquisition

  I’ve already spoken about why I became a developer and offered some insights into how you might be able to transition from architecture into development. So now I’d like to start focusing more on the day-to-day of what it means to be a real estate developer.

  And since I seem to be getting a lot of questions from readers on career and development related topics, I’ve decided that I’m going to turn these posts into a regular blog series. Right now the working name is “Developer Dirt”, but if you have a better name I’m all ears (let me know in the comments below).

  So let’s start with step 1.

  You’re ready to develop a new project and you’re now in the market for some land (also known as a site). It could be a greenfield site (meaning it’s virgin land that hasn’t yet been tainted by humans) or, on the other end of the spectrum, it could a brownfield site (meaning it probably once housed industry, it’s contaminated as all hell, and you’re going to need to clean that puppy up before you build).

  Without going into further detail about all the different kinds of sites you could potentially buy (which is a post in itself), here are 3 high level things to keep in mind as you move forward.

  Land is the residual claimant

  What this means is that you want to start with your top line. You want to start with revenue. What can I build on this site (use and square feet) and how much can I ultimately sell or lease that space for?

  Let’s say, for example, that you think you can build 100,000 square feet. If it were office space, you’d want to know that rents in your area are $30 per square feet and that that’s going to render you $3M a year in rental income. If it were residential condos, you’d want to know that the market is absorbing $500 per square foot and that if you sold 100,000 square feet worth of condo, that your revenue would be $50M. But remember this is top line.

  Once you know your top line, you then need to figure out what it’s going to cost to bring you that revenue stream. In other words, what are the hard costs (construction costs), the soft costs (consultant fees and other non-construction costs), the return my investors are going to demand, the money I need to keep the lights on in my business, and so on.

  Hopefully, once you’ve calculated all of these numbers, you’ll have some money left over from that original top line number. That residual money is what you can reasonably afford to pay for the land, which is why it’s often referred to as the residual claimant. But even though it comes last in this example, it comes first in development. If you overpay at the onset, it’ll be an uphill battle the rest of the way.

  You often don’t know what you can build

  But here’s the rub: You often don’t know exactly what you can build. When developers buy land they often consider what they can build “as-of-right” and what they think they can build as a result of variances, rezoning and other discretionary actions.

  As-of-right basically refers to what the current zoning permits. It’s what you could go out tomorrow and build (after you get the requisite permits of course). Unfortunately though, as-of-right uses and densities are not often inline with what’s actually happening in a neighborhood. So you need to go into the city for things like a zoning by-law amendment.

  Similarly, vendors want the most for their land and so they’re going to be aggressive on this front. As a developer, this is the point where you surround yourself with a team of smart people who can help you figure out what’s reasonably attainable for the site in question. And sometimes you have to worry about the politics as much as the planning.

  Approvals are uncertain

  During the due diligence phase, the goal is obviously to mitigate as much of your risk as possible. Nobody wants to get stuck with a piece of land that they overpaid for that they now can’t (profitably) develop. But sometimes shit happens.

  It may seem like a no brainer. You could have a site that’s surrounded by transit with lots of great precedences (this matters) for the height and density that you’re hoping to obtain and that you feel will be appropriate for the neighborhood. But sometimes the stars don’t align.

  And that’s why development is a risky game.

  2014.02.21