Brandon Donnelly

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.

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Tag: inclusionary zoning

  • No more foreign buyers

    Here’s the thing about housing:

    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.

    Broadly speaking, the current playbook in Canada seems to be as follows: heavily tax new housing, force those who can afford new market-rate housing to subsidize those who can’t, and then tax/ban foreign buyers.

    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.

  • Housing supply in low-cost and high-cost municipalities

    Here is a housing study that looked at housing supply — in the US from 2000 to 2020 — relative to median housing values. And here is the key takeaway:

    What this chart is saying is that new housing is rarely added in cities with the lowest-value homes. The bar on the left represents municipalities whose median housing values are less than 50% of the metropolitan average. And this makes sense. If values are low there is likely little to no incentive to build. The math just doesn’t work.

    However, as home values increase, the incentive to build and the ability to finance new projects also increases, and that is what we see in the above chart. This also makes sense.

    But something interesting happens in the highest-value cities — housing supply once again starts to fall off. And it turns out that there is a bit of a sweet spot. Municipalities whose relative housing values are 110 to 130% of the metropolitan average actually produce the most overall housing. Any higher than that and things start to decline.

    Why is that? The answer likely has to do with restrictive land-use regulations. The highest-value cities (and wealthiest suburbs) often have a lot of large single-family lots, as well as policies to ensure that this kind of built form doesn’t change. This has the effect of both limiting supply and enshrining values.

    So when it comes to housing supply, what you don’t want are low-cost areas. But you also don’t want the highest-value areas. What you want are areas that are doing well, but no so well that they start really restricting new entrants. This is what our industry often refers to as exclusionary zoning.

    Now, one of the most common ways to respond to this problem is to develop an opposing policy, namely inclusionary zoning. But usually what this policy doesn’t do is direct more supply to these high-value and low-density areas. Instead what it typically does is force the segment that is producing the most housing — let’s call it the 110 to 130% band — to deliver more affordable housing.

    It’s a neat trick that sounds pretty cool, but it is not at no cost.

  • Q2-2022 land prices in the Greater Toronto Area

    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:

    • Development charges (here in Toronto) are set to increase by 49%
    • 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.

  • Artificially low property taxes

    A blog reader responded to yesterday’s post about rent controls (and inclusionary zoning) with an excellent point: If you’re against rent controls, then you must also be against artificially low property taxes for homeowners. And I would agree with this.

    One of the points I was trying to make yesterday was that if you’re in a situation where your revenue is capped but your operating expenses are free to grow based on the market, then you are likely heading down an unsustainable financial path.

    This is true if the revenue is in the form of rent and this is true if the revenue is in the form of property taxes. A good example of this is California’s Proposition 13, which is the principal thing that keeps property taxes artificially low over on that coast.

    Similar to what I argued yesterday with rent controls, it too creates a misallocation of housing. If you’re sitting on historic and artificially low property taxes, then you are now highly incentivized to stay put where you are. Why would you move only to have your taxes mark to market?

    So this line of thinking cuts both ways, whether we’re talking about renters or homeowners.

  • Rent control and inclusionary zoning

    I received an email from a reader over the weekend saying that my comments around rent control have been too critical, and that they are not doing proper justice to the challenges that renters face in today’s cities. I thought this was a fair comment and so I’d like to respond to it publicly on the blog.

    But before I get into that, it’s worth saying that housing issues are incredibly complex. And I am certainly not professing to have all of the answers. In fact, part of the reason I write this blog is so that I can think critically about these topics and hear what other people have to say.

    It is obvious that wages have not kept pace with home prices in many cities around the world. This is a problem. And so we can all agree that we need more economic opportunities, we need more housing, and we need more attainable housing. The question is how best to go about this.

    Mechanisms like rent control and inclusionary zoning might seem like obvious solutions. Just cap rents and force developers to build affordable housing. Problem solved at no cost to anyone, right? It’s not that simple. Every intervention creates distortions in the market.

    To give just one example, studies suggest that rent controls end up creating a misallocation of housing. Because if you are living in a rent controlled home and your rent is well below market, you are now heavily incentivized never to move. Even if you have an empty nest with 5 bedrooms, why would you?

    Of course, there are other possible repercussions. Residential contracts are typically gross leases (though some utilities might be sub-metered and paid for by the tenant). This is in contrast to commercial leases where net leases are common and most, if not all, of the operating costs are passed through to the tenant.

    Why this matters is that if your rents are capped but your utility costs, taxes, and other operating expenses are continuing to rise, you may run into a situation as a landlord where you can no longer afford to upkeep your building. And you’re certainly not going to invest in any new improvements if this is your situation.

    Rent controls could also impact the supply of new housing by making it no longer feasible to build. This is similar to what we have seen with policies like inclusionary zoning. Just last month San Francisco went on the record saying that it’s going to rethink its inclusionary zoning policies because of a view that it is now choking off new housing supply.

    And so herein lies one of our great housing challenges. We want more housing and we want more affordable housing. But depending on how we approach the latter, it could hurt the former, which ends up creating a viscous cycle.

    Building new rental housing is very challenging in Toronto (and elsewhere). Typically the way the process goes for a developer is that you start by preparing a detailed development pro forma. This pro forma will then tell you that your new rental development is infeasible. And so you go back, convert it to a condominium development, and then it magically becomes feasible.

    I am exaggerating, but only slightly. The point is that there are lots of developers out there who would love to build more rental housing — they just can’t make the math worth.

    My goal with this post was to explain where I have been coming from with some of my past comments. I also used the opportunity to link to a number of my related posts. But I haven’t really put forward any possible solutions. I plan to do that in a follow-up post, and I think I’m going to call it “the definitive but crazy guide to creating more affordable housing.”

    So if any of you have any crazy ideas, please send them over.

  • Disease-breeding tenements

    What do you think of this beautiful low-rise apartment building? It is called Spadina Gardens and it was built (allegedly illegally) on Toronto’s Spadina Avenue in 1906, shortly before the City enacted an outright ban on “disease-breeding tenements” (i.e. apartment buildings) in all residential neighborhoods.

    This, of course, is a form of exclusionary zoning. Our predecessors had decided that apartments were bad, they promoted disease and immorality, and that they were likely to destroy or at least corrupt Toronto by making it, you know, less waspy.

    Important studies are underway here in Toronto, and across North America, to determine whether we should do something about this longstanding city building tradition. Should we allow a mixture of different housing types in our residential neighborhoods, or should we keep things just the way that they are? That being low-rise and single-family.

    In the meantime, we are implementing things like inclusionary zoning, which I guess makes some people feel better about themselves and the current state of affairs. But in the end, it sits very much on top of our exclusionary past.

    Low-rise single-family home neighborhoods remain off limits. Apartments should only go in select locations (provided they don’t bother the single-family homes). And any efforts to create greater affordability and diversity should only impact the new apartments and not the low-rise single-family homes that already exist.

    I would encourage all of you to have a listen to 99% Percent Invisible’s recent episode about Toronto’s “missing middle.” It does a great job explaining why Toronto looks and performs the way that it does today, and why it’s time that we do something about it. It’s also highly relevant to not just Toronto, but many cities across North America.

  • Weekend link roundup — Ukraine and gas supply to Warren Buffet and Canadian housing supply

    I spent much of this morning reading about and listening to discussions about what’s happening in Ukraine and so, instead of a typical post this morning, I’m just going to share a mélange of links.

    • Monocle 24 Foreign Desk episode talking about Russia’s invasion of Ukraine. Speakers are Ukrainian MP Lesia Vasylenko, former NATO chief Richard Shirreff, Russian journalist Ekaterina Kotrikadze, and Russia expert Mark Galeotti. I found this helpful in better understanding some of the dynamics at play here and what might happen going forward — though, of course, who knows. All of this is both deeply sad and frustrating. [Link]
    • Discussion in Bloomberg Green about the feasibility of the EU shutting off Russian gas right now, as opposed to through a protracted transition. Currently, the EU satisfies about 20% of its total energy needs through gas and about 40% of it comes from Russia. [Link] Also, a chart showing Russian natural gas exports, by destination. [Link]
    • Warren Buffet published his widely read annual letter to Berkshire Hathaway shareholders this weekend. He likes to deliver news like this on a Saturday so that people have time to digest it before the markets reopen on Monday. The overall message was one that we have heard before: BH has a lot of cash (~$144 billion to be exact) and they’re not finding very many compelling opportunities in which to deploy it. [Link]
    • To add to the above, here is a longish Q&A session with Buffet’s partner, Charlie Munger. He continues to be worried about excess money in the system and high inflation. [Link]
    • Construction has been recently completed on a Mies van der Rohe design from 1952 that had been forgotten and buried in some archives. Originally commissioned to be a fraternity house at Indiana University, the building is now the Eskenazi School of Art, Architecture + Design. This is a supremely cool story, particularly for an architecture school. [Link]
    • Yet another simple example by Bobby Fijan on how highly restrictive zoning codes and design guidelines don’t always produce the end results that we might want. Different times and different contexts in this example. But it’s interesting to think about how best to promote design excellence in our cites. Is more creative market freedom the answer? [Link]
    • My friend Randy Gladman, who is senior vice-president of development advisory at Colliers here in Toronto, published an opinion piece in the Financial Post last week about the hidden costs of inclusionary zoning. It is consistent with the ad nauseam discussions that we have been having on this blog for the past few years, but it of course remains an important read. [Link]
    • Steve Pomeroy of Focus Consulting makes an argument in the Globe and Mail that elevated home prices in Canada isn’t primarily the result of a supply deficit. Using recent census data that allegedly shows that housing supply in Vancouver actually kept pace with demand (over how long of a period?), Pomeroy instead points to the other typical culprits: strong demand, low interest rates, unused homes owned by non-residents, and so on. This one likely deserves a dedicated post at some point. [Link]

    Ironically, the post turned out to be wordier than my usual ones.

  • Philadelphia readies new inclusionary zoning policy

    When I was living in Philadelphia as a graduate student, new development was seen as a bit of a gift. I remember developers telling me that it costs the same to build in Philly as it does in New York, except that the rents are obviously a fraction in the former relative to the latter. So it was tough to make projects pencil.

    At the same time, Philadelphia had a 10-year residential tax abatement program in place. I think it’s still in place, but it may have been modified since I was there. Either way, it was essentially an incentive to develop or redevelop existing residential properties. In the case of a renovation, the taxes associated with any improvements were what got abated for the 10 years.

    Put differently, it was an invitation to gentrify. Come buy an old row home, fix it up, and then don’t pay any additional property taxes on those improvements. This was the way things felt at the time. So it was interesting to learn today that Philly’s current development boom is about to get throttled down with a new mandatory inclusionary zoning policy that will take effect later this year. Gentrification, it would now seem, is a problem.

    The policy requires that 20% of the units in any new housing development (with 10 or more units) must be affordable for at least a 50-year period. For rental households, affordability means 40% of the area median income (AMI). And for owner-occupied households, it means 60% of AMI.

    I have already said pretty much everything I can say about inclusionary zoning. But one of the unique things about Philly’s policy is that it is only going to apply to two of its Council Districts. It is not a citywide policy. This is going to create a strong disincentive to develop in these areas, and will likely force new development into surrounding ones. But maybe that’s part of the point.

    Photo by Dan Mall on Unsplash

  • Density bonus as inclusionary zoning offset

    Somebody on Twitter responded to my recent post about inclusionary zoning and asked: Aren’t all the upzonings that the City is already doing a kind of density bonus? In other words, and this is me elaborating here, why is there an economic “shortfall?” Why does there need to be any other sort of subsidy in order to mitigate the economic impacts of inclusionary zoning?

    A density bonus can mean and can be used in a number of different contexts. Sometimes it is used as an incentive with landowners, whereby they get a bonus on top of their sale price if the developer manages to achieve a certain amount of density on the site. But in this particular case — IZ subsidies — we’re talking about something else.

    We’re talking about density above and beyond what you might normally achieve on a particular site in order to directly offset — maybe partially or maybe entirely — the economic shortfall brought about by inclusionary zoning. The fact that upzonings are happening all over the city doesn’t necessarily qualify them as bonuses. In the case of Toronto, the market is just responding to out-of-date zoning.

    Here’s a specific example.

    Let’s say you have a development site with in-place zoning that would allow you to build 20,000 sf of density. This is the as-of-right or by-right density. No need to rezone the site. Just file your building permits and you’re off making things. If this is the most you could build, then the market would value the land based on this density. As we have talked about before, land is the residual claimant in a development pro forma.

    However, if the zoning was out of date and it was fairly clear that one could rezone the site and build up to 100,000 sf, then the market would no longer value the site based on its in-place zoning. It would instead value it based on its future expected density. Again, because land is the residual claimant, more density = higher land value.

    In this second scenario, the additional 80,000 sf is, in my view, not a density bonus. Give or take a bit here and there, it is the density that everyone is generally expecting. The market has already priced it in. A true bonus / subsidy, would be something above and beyond the base of 100,000 sf. Something that is only available to developers if they do X — which could be build affordable housing.

    Maybe the bonus is perfectly tuned to exactly offset the economic drag of doing X, or maybe the bonus is designed to serve as an incentive to do X. In this latter case, the bonus would more than offset the drag and be accretive to the pro forma, which would mean that every sensible developer would now want to do X. More carrot, less stick.

    One of the challenges with this hypothetical scenario is that, for such a bonus structure to work, you need to know the baseline that you’re bonusing against and you need to ensure that nobody gets the bonus unless they do the thing — the X. Using the above example, that means that the 100,000 sf needs to be fairly firm and that anything above that number only happens with the delivery of affordable housing.

  • The inclusionary zoning shortfall

    Colliers recently hosted a webinar about inclusionary zoning here in Toronto. On the panel was Jeremiah Shamess (SVP at Colliers / moderator), David Bronskill (partner at Goodmans), Giulio Cescato (senior planner at IBI Group), and Richard Witt (principal at BDP Quadrangle). I wasn’t able to attend (either because of a critical meeting or because I was off attending to a gluttonous lunch burrito), but the slides are now available online. I was going through them this morning and I came across this chart from NBLC:

    What you are seeing here is a comparison between a typical market development before IZ and a development after IZ. As you can see, soft costs remain the same, hard costs remain the same, and the profit margin remains the same. What changes is the overall revenue. Market revenue goes down because you now have fewer market-rate units and a new IZ revenue is added, which is the revenue generated from the addition of affordable units to the project.

    But when you add up the market revenue and the IZ revenue, you don’t get back to the same economic equilibrium. In other words, there has been a destruction of value, and so something is going to have to give in order for this project to pencil and remain financeable. Otherwise, no development will take place. This shortfall is the red box area in the above graph that says, “impact of inclusionary zoning.”

    We have discussed this red box gap a lot on the blog, because how you think this gap gets filled might determine how you think of inclusionary zoning as a policy tool. In this particular instance/graph, the gap is filled by a reduction in the value of the land. Everything else remains static. So what is effectively happening in this model is that the landowner, who has decided to sell their land to the above developer, is now the one who has to indirectly pay for this new affordable housing.

    This may seem like a sensible way to go about it. I mean, people who own land must be rich. Let’s make them pay. But is this actually what is going to happen in practice and over extended periods of time? Soft costs — things like development charges — are always going up. Why aren’t land values perpetually declining in order to offset these additional costs? It is largely because market revenues have also been increasing. Housing keeps getting more expensive. And that is what has been keeping the market going.

    I suspect that over an extended period of time, the same thing will happen here.