Daily insights for city builders, delivered every morning at 6 AM ET. I’m Brandon Donnelly — a Toronto-based real estate developer and founder of Globizen. I’ve been writing here since 2013.
The delegates insisted on one hand that “housing is for living not speculation”, but on the other, emphasised the critical importance of real estate to China’s economic growth.
In other words, things are complicated. We want housing to be affordable to more people, but at the same time, we recognize that housing appreciation is kind of useful for overall economic growth. So we’re a bit conflicted. And that may be why we tend to take contradictory actions.
Canada’s new foreign buyer ban came into effect on January 1 of this year. And for the next 2 years, it prohibits companies and people who are not Canadian citizens or permanent residents from acquiring non-recreational, residential property in Canada. (What is the definition of non-recreational?)
While this may sound good to some — finally, more homes for Canadians — we’re talking about a relatively small portion of the market, which is likely why there’s also little evidence that any of our foreign buyer taxes have been all that effective.
It’s really hard to imagine this one working much better. But it certainly sounds like something.
It asked whether developers should build more 3-bedroom apartments/condominiums. And not surprisingly, the vast majority of people voted yes. Of course, the problem with this poll is that it says nothing about the overall affordability of these larger suites. (We’ve talked about this many times before on the blog.)
So it is akin to asking: Should Mercedes put this concept car into production and make it widely available? My answer would obviously be yes. It’s a sweet car. I would like one. But I also don’t like spending money on depreciating “assets”, so in the end I probably wouldn’t buy it. That said, if you’re in the market for a sweet 3-bedroom condominium, I could sell you one right now.
My overly simplistic view of taxes is that it is generally good practice to tax the things you want less of — you know, things like cigarettes and pollution — and reduce taxes on the things you want more of — you know, things like housing and income.
The irony of this poll is that the vast majority of people voted for road tolls as the way to increase municipal funding. But in practice, this is not what we do at all! We heavily tax new housing and we are extremely reticent to even accurately price the usage of roads and highways.
Here in Toronto, I guess we kind of tried a few times, but in the end it never passes. Part of the problem, I think, is visibility. New home taxes are easy to hide from consumers. It is also easy to just vilify big bad developers. Road prices, on the other hand, are highly visible and they hit you repeatedly.
Perhaps what we ought to do is become more transparent about the charges that are levied on all new housing. I bet most people would be surprised.
Anyone who has ever worked on a development pro forma will know that the process generally works like this: You start with a bunch of assumptions. You assemble those assumptions in a way that will allow you to determine if the project in question is feasible. And then, you realize that almost everything is more costly than you initially thought and that the project may not actually work. Oh shit.
In fact, a sure-fire way to know that you’re on the right track is if the numbers sort of don’t work. If the returns look too good to be true, they almost certainly are and you’re likely missing something big and meaningful. As we have talked about before on this blog, development happens on the margin. That means that you have to work at it. You have to be creative. And often you have to find ways to increase revenues and cut costs.
The common way to find money is through something known as value engineering, which is just a fancy way of saying, “I need to cut costs, so let’s see what I can tolerate losing from this project.” That’s generally how it works. And we do it on every project. You’re trying to find high-cost items with relatively low perceived value.
This process often gets a lot of criticism because people view it as a distasteful cheapening of a project. But the reality is that it is usually an important part of maintaining project feasibility. You may really want to use that fancy material you can only get from Switzerland, but maybe development charges were just increased and now you need to offset those new costs by finding savings somewhere else.
This isn’t a perfect analogy, but imagine you were shopping for a new car. You might start out by wanting the fully-loaded version, but then you see the price and realize you can’t afford it. So you decide to start trimming features and add-ons until you get to a place where you feel more comfortable. I would imagine this happens with cars, and I’m not sure it’s right to point to that person after and say, “oh my god, I can’t believe you cheaped out and didn’t buy the fully-loaded version.”
At the same time, I think it would be perfectly reasonable to argue that you don’t need to spend a lot of money to (1) care deeply about the work that you do and (2) have taste. You can’t fight the economic realities of the world, but you can care and you can be creative. And I don’t think it’s too much to advocate for these things.
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.
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 notenough 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.
Bullpen Consulting just released its latest land insights reports for the Greater Toronto Area. For the period of Q2-2022, Ben Myers and the team identified 46 high-density residential land transactions with an average price of $95 per buildable square foot. This is down from $112 pbsf in Q1.
In the core of the city (former City of Toronto), the average price for Q2-2022 was $135 pbsf. In North York it was $103 pbsf. And in Scarborough it was $50 pbsf. Overall land prices are down about 15% from last quarter (though it’s important to note that quarterly transactions can represent a relatively small sample size).
We have spoken before about how land prices tend to be fairly sticky in the face of changing cost structures. But what we are seeing right now is a bit of a perfect storm:
Hard costs have seen double digit increases (with some inputs increasing by 30-40%)
Inclusionary zoning is on the horizon and will add another additional cost to new housing
And rising interest rates are both increasing project costs (higher interest charges) and slowing the macro economy
All of this is naturally causing developers to be more cautious when it comes buying new land. And we are seeing that in the above pricing. But at the same time, this dip in pricing is not going to be enough to absorb all of the additional costs that new housing projects now face in today’s market.
If you’d like to download a full copy of Bullpen’s report, click here.
Deeply affordable housing is mostly infeasible to build.
This is why you don’t see the market naturally building this kind of housing on its own. It, for the most part, doesn’t make any economic sense to do so. So this is also why the US has fabricated things like low-income housing tax credits. They are a way to make up the economic shortfall that exists with low-income rental housing and get the private sector building this kind of housing.
We sometimes try to convince ourselves — or maybe it is a way of shirking responsibility — that there can be such a thing as no-cost affordable housing through things like inclusionary zoning. But I think we all know that there’s no such thing as a free lunch. Somebody is ultimately going to need to pay. The big question, of course, is who should that be?
By definition, we acknowledge that the people who will ultimately live in these affordable homes cannot afford to pay market rates. So by default, the subsidies will need come from somewhere else. But again, from where and from who? Should it be specific people who pay or should it be mostly everyone who pays?
If we return to the Toronto building industry’s favorite topic right now — development charges — you’ll see that under the current rates, every new 2 bedroom or larger apartment that is constructed must pay $3,727 toward affordable housing. Under the proposed rates, this will increase to $12,545 for every new large apartment. It’s by far the largest proposed percentage increase (237%) and also one of the largest service items.
This raises two interesting philosophical questions.
One, should the buyers of new housing be responsible for contributing to affordable housing in this way? Because what we are in effect saying to these people is, “Hey, you can afford to buy a new market rate home, so we’re going to collect some additional money from you — $12,545 to be exact — so that we can try and help those that aren’t in the same position as you. We’re also going to mandate additional affordable homes within your building and we’d like you to subsidize those too.” This is one way to redistribute wealth.
But if the goal is to try and create more broad-based affordability, an alternative approach might be, “Hey, you already own a home and it has gone up a lot in value, so we’re going to collect some additional money from you over time so that we can try and help those that aren’t in the same position as you.” This would be the property tax approach. It’s probably not perfect, but might it be a more fair and equitable way to redistribute wealth?
The second interesting philosophical question has to do with whether this is consistent with the dogma that growth should pay for growth. The idea behind development charges (also known as impact fees in some parts of the world) is that they should pay for the cost of new development. This makes complete sense. When you build new housing you certainly need some additional stuff — everything from additional school capacity to emergency services.
But the question here is whether the construction of new housing in and of itself creates a direct need for more affordable housing, and therefore should be charged for it. Asked in the opposite way, if you weren’t building this new housing, would you then no longer need this affordable housing, just like you no longer need that additional school capacity?
This is definitely not the case. In fact, I would argue that the opposite is true. If you don’t build any new housing in a growing city, you actually exacerbate the problem of affordability. So here’s a provocative thought. Rather than a charge, should this affordable housing line item actually be a credit towards each new project given that it benefits affordability?
While it may not make any economic sense to build affordable housing, I think that many of us would agree that it makes a lot of social sense to build affordable housing. We know that our cities are at their best when they are both diverse and inclusive. The problem is that we can’t agree on who should pay for it.
The big news this week for Toronto city builders is that the city has put forward a proposal to substantially increase development charges. Here’s a tweet storm that I published earlier today on the topic, and here’s a summary of what the new fees might look like:
To translate this into a specific example, let’s assume that you’re building a 300 unit apartment building with 180 one bedroom suites and 120 two bedroom suites.
Under these proposed DC rates, this would translate into charges of about $9.6mm for the one bedroom suites and $9.8mm for the two bedroom suites, totaling over $19.4mm in DCs alone. But keep in mind that there would be other charges on top of this for parkland dedication, community benefits, and a bunch of other things.
When our cost consultant ran the numbers back in 2019, the estimate was that about a quarter of the price of a new condominium in Toronto was going to government fees and taxes. But with the above increase and with the introduction of policies like inclusionary zoning, I am sure that the number is higher today.
These are easy fees to hide. Most people don’t know they exist. And a lot of people don’t seem to like new development and new housing. Property taxes on the other hand are highly visible and highly sensitive. So that tax tends to be left alone, especially by comparison.
But these increases are hugely impactful. It means that developers across the city will now need to start looking at increasing rents and prices in order to try and offset it. If they can’t, they won’t build. And if they can, it will mean that the housing that does ultimately get built will be that much more expensive.
There are many development narratives that I don’t quite understand. (I’m thinking of Toronto, but you can probably replace Toronto with any number of global cities for this discussion.) One is the belief that our transit network is full and so no new development should be allowed in certain locations, next to certain transit stations. The thrust of this argument is that additional transit capacity must be added before any new development is allowed to occur. This might sound logical, except it ignores the fact that the need for new housing doesn’t magically disappear because subway cars are thought to be too busy during the morning rush.
Transit systems are also a network, and so does this mean that no more development should be allowed to happen anywhere in the city/region? Or is the goal to simply move development off of higher order transit and into lower-density areas so that the future residents in these new buildings can either take buses to the transit stations that were previously deemed to be at capacity or drive their cars everywhere? (Our highways have excess capacity during the morning rush, right?)
The second narrative that I find perplexing is that new developments don’t give back in any way. Above is a chart showing residential development charges in the City of Toronto, as of November 1, 2020. This chart outlines the fees that every developer must pay when building new residential, though it is important to keep in mind that there are many other government fees and charges that form part of almost every new development. These are things like parkland dedication and separately negotiated community benefits. But for the purposes of this post, let’s just focus on development charges (aka impact fees).
Assume you’re building a 400 unit apartment building, consisting of 240 one bedroom suites (60%) and 160 two and three bedroom suites (40%). Based on the above chart, your development charge bill would be:
240 one bedroom suites x $33,358 per unit = $8,005,920
160 two and three bedroom suites x $51,103 per unit = $8,176,480
For a total of $16,182,400.
But it’s important to keep in mind that these are the rates as of November 1, 2020. They will almost certainly go up by the time these charges become payable for your 400 unit apartment building. By how much you ask? Well according to Urban Capital’s most recent issue of Site Magazine, which compared a development pro forma from 2005 to 2020, development charges in the City of Toronto have increased by about 3,244% during this time period. (The S&P 500 was up about 220% during this same time.) These are obligatory fees that contribute to everything from transit and parks to subsidized housing and municipal services. (The line items above.)
So it strikes me that there are other more productive questions that we could and should be asking ourselves. Such as, why is it that our transit/mobility infrastructure hasn’t kept pace with new development and new housing demand? What are we going to do to fix that immediately? Why are we not taxing the things we don’t want (like traffic congestion) so that we have more resources for the things we do want (like transit and housing)? And most importantly, what is the best way for all of us to work together so that we can create the absolute greatest global city in the world?
Every year my friends at Urban Capital publish an annual magazine called Site. And every year it contains some great articles about the real estate development industry across Canada. (Some of you may also remember that I’ve written a few articles for it in previous years.)
Well this year’s issue is out and there are a few featured articles that I’d like to draw your attention to:
What happens when 175 (mostly) women get together to design a condominium?Link
Why have Toronto condos become so %@$#$! expensive?Link
This last one is a topic that we have talked about many times before on the blog. But here, UC has provided a quantitative comparison between a project they did in 2005 and a project that they’re doing today in 2020. Here’s what they found:
Average condo prices in the City of Toronto are up about 150%. But…
Land costs are up 160%.
Soft costs are up 118%.
Construction and related costs are up 91%.
Financing costs are up 93%.
Government fees, charges, and taxes are up 413%.
And development charges (a subset of the above) are up 3,244%!
At the same time, the profit margin over costs is down about 45%.
(As a point of comparison, CPI only increased by about 26.5% during this same time period.)
The point here is that condos are so %@$#$! expensive largely because of cost-plus pricing. Government fee increases are also outpacing every other cost bucket.
If you’re developing new housing in Toronto, you have no choice but to accept these rising costs. You have to pay development charges and you have to pay them when you’re told, even if that means swallowing some new massive increase.
So by necessity, end prices get continually pushed as a way to try and absorb these costs. You figure out what your costs are going to be and then you price accordingly. But of course, you also have to ask yourself: Can people actually afford this kind of pricing and can this neighborhood support it?
Sometimes the answer is yes, which is why development continues. But sometimes the answer is no. In this case, the next step is simple: you don’t build.
Currently, if you’re building an Ancillary Secondary Dwelling Unit (such as a laneway suite) in the City of Toronto, you can defer the payment of any development charges for 20 years from the date that a building permit is issued for the unit. But really what this means is that, if you don’t do anything bad for 20 years (event of default), you won’t have to pay anything. The payable charge goes to $0 at the end of the term and the agreement goes away. Cool.
So what are some of the bad things that you’re not supposed to do?
Well the main thing is that you’re not allowed to create a new lot at any point during the 20-year deferral period. This is because the laneway suite policies are designed to encourage the creation of new rental housing and not new for sale housing. So you can’t sever off the back of your lot. The other thing you need to do is make sure that if you were to ever sell your property that the new owner(s) assumes these same obligations.
This all makes sense.
There is some fine print to consider. The payable development charge amount that the City enters into these agreements is the rate for single detached dwellings. Currently that figure is $76,830. This is more than double what you would have to pay if you, well, just paid the DCs for your ancillary secondary unit instead of deferring them. The reason for this is because, if you do do something bad such as sever your property, you’ve now no longer built an ancillary secondary unit. You’ve built a detached dwelling. Rates go up.
Moral of the story: Don’t create a new lot. For more information on the program, click here.
P.S. I’m not a lawyer. Please don’t take this post as any sort of legal advice. This post was also revised from its original version to correct a misunderstanding on my part.
