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

  • Case studies on inclusionary zoning

    Back in 2017, Portland, Oregon enacted new inclusionary zoning policies mandating that all new residential projects with 20 or more units must deliver a specified amount of affordable housing. Early accounts, by people like Joe Cortright of City Observatory, suggested that the market was reacting to this new requirement as you might expect. Developers rushed to get new applications onto the books and then there was a drop off in new housing supply.

    Now that it’s been a couple more years, it is perhaps worth checking in on Portland. Cortright did that in the fall of last year and the housing numbers are continuing to fall. From 2019 to 2020, new multi-unit housing permits in Portland fell by more than 60%. I really don’t know the Portland market and so it’s hard for me to comment on whether it is solely the fault of IZ, but there was a peak in 2017 and now housing permits are down significantly. However, they were also down significantly during the financial crisis. It’ll of course be interesting to see how this plays out over a longer time horizon.

    That said, a similar market response was recently reported in another Portland — Portland, Maine. In 2020, the city implemented a “Green New Deal” that stipulated, among other things, that all new residential developments with 10+ units would be subject to their new IZ policies. It has only been just over a year, but according to the city’s planning department, there were 756 new housing units on the books in 2020 prior to the new IZ policies. And since then, that figure has dropped to 139 new housing units. This is admittedly a small market and a relatively short time horizon, but it is still a data point.

    As many of you know, I struggle with inclusionary zoning. Maybe it’s confirmation bias, but I just haven’t been able to find much data suggesting that it can meaningfully increase overall housing supply and the supply of new affordable units. So if any of you are aware of some good case studies outlining successful examples, please share them in the comment section below.

  • The future of parking is a lot less of it — at least here in Toronto

    I was having a conversation this week with a few friends in the industry about the future of parking. We were specifically talking about Toronto, but I would imagine that much of this holds true for many other cities around the world.

    Here in Toronto, it’s not uncommon to see new parking spaces in central locations selling for upwards of $200k. For those that are not in the industry and not seeing the work and immense costs that go into building parking, this often comes as a surprise.

    But as I have said many times before on the blog, parking is often a significant loss leader for new developments. Even at relatively high prices, most developers aren’t covering their costs. So developers naturally aren’t racing out to build more of it. They’re trying to build just what is absolutely necessary for the market.

    Given the strong incentives to build less parking, it’s no surprise that parking ratios continue to decline. But consider some of the other parking headwinds:

    • Parking minimums are (hopefully) set to be removed
    • Push toward watertight undergrounds across the city (higher costs)
    • Tipping fees for disposing of contaminated soil (higher costs)
    • Increasing development charges / levies (higher costs)
    • Introduction of inclusionary zoning (higher costs)
    • Inflationary construction cost environment (again, higher costs)

    There is a lag between changing cost structures and what the end consumer sees and feels. Junction House, for example, is fully tendered from a construction standpoint and so we are building with a kind of historic cost structure that would be impossible to replicate today. When the next project comes around, they’ll have higher costs and will have to price their homes accordingly.

    As rising costs and new policies (like the ones I mention above) begin to work their way through the system, I think it’s fairly obvious that parking ratios will continue to be one of the first things that gets looked at and ultimately chopped down. This will make parking even more scarce in the city and surely far more expensive.

    (Back in 2018, Hong Kong had the record for the most expensive parking spot in the world. I wouldn’t be surprised if it still holds this title.)

    But as I have argued before, I am of the opinion that building around the car is not the way to build big and well-functioning global cities. Many of us recognize that we need to focus on alternative forms of transport — everything from public transit to new micro-mobility solutions. And given where costs are going, I don’t think we’ll have much choice.

    Photo by Sven Mieke on Unsplash

  • Toronto green-lights new inclusionary zoning policy

    Toronto’s new inclusionary zoning policy went to Planning and Housing Committee this week. Agenda item, here. The recommendations were approved, which means that the item will move onto City Council next month for final approval.

    Here’s a summary of some what is being proposed (though keep in mind that I am not a planner and you should probably do your own due diligence if you’re looking to buy land and/or develop here):

    • IZ to come into force next year in 2022.
    • IZ to only apply on projects with 100 or more residential units.
    • Three distinct market areas across the City with differing set aside rates (see below charts). This strategy acknowledges the fact that you generally need submarkets with expensive housing and rising prices to be able to absorb the financial burden of the affordable housing units. I’ve written a lot about this dynamic on the blog. Relevant posts, here.
    • It’s in the chart, but it’s perhaps worth repeating: Purpose-built rental projects will not be required to deliver any affordable housing units at the outset of this policy. This is important to note because the margins on purpose-built rentals are razor thin.
    • The set aside rates are planned to increase to 8-22% by 2030.
    • The affordable units will need to remain affordable for 99 years. And the rents and prices are to be geared toward low and moderate income households, which are currently defined as those earning between $32,000 and $92,000.
    • Clear transition period for the development industry.
    • Ongoing monitoring of the policy to make sure it doesn’t suck.

    If you’re interested, the full staff recommendation report can be found here and the draft OPA and zoning by-law can be found here and here.

  • No-cost affordable housing in Toronto

    It upsets me when I read things like this (click here if you can’t see the embedded tweet above). I think it creates a false sense of a free lunch and ignores all of the nuances and complexities associated with inclusionary zoning.

    IZ is an obligation to provide a certain number of affordable units in new housing developments. There’s a lot of detail and debate around where this should apply, how much needs to be provided, and at what degree of affordability.

    But at the end of the day, it’s important to keep in mind that at meaningful levels of affordability, these IZ homes are going to be built at steep losses. More info on the economic impacts of IZ can be found here.

    The simple math is that the costs to build these homes are going to be greater than the revenues that they bring in. Which is why developers aren’t out building affordable housing everywhere. There’s no margin.

    In order to build, somebody or something needs to provide a subsidy so that this revenue-expense shortfall can be made up. How this works its way through the market is where I have tried to focus the discussion when writing about IZ. There are complexities. Some lessons from Portland, here.

    But to just assume that these costs will get magically absorbed by housing developers, with no other knock-on effects or distortions to the market, is incorrect.

  • Affordable housing for all?

    Bloomberg CityLab has a new video out talking about how Vienna has seemingly solved the housing unaffordability problem that is impacting most global cities around the world. Each year Vienna builds about 14,000 new housing units and about half of this is supply is “affordable.” Already over 60% of Viennese live in an affordable home. The title of the video suggests that their approach is radical, but is that really the case?

    What was clear to me when I watched the video is that there are perhaps two key differences in terms of how Vienna approaches this problem. One, they quite simply care about delivering high-quality affordable housing to the middle class. They think it’s culturally important and they believe that architecture and design matters. Two, they are willing to invest in it, both up front and over time (maintenance).

    In the video, the former Vice Mayor of Vienna talks about how the City will go out and buy land (or use already owned land) and then make it available (sale or lease) at discounted rates so that it makes economic sense for non-profit housing developers. If the math still doesn’t work for the private sector, then there are other subsidies available.

    I’m certainly not an expert on Vienna’s approach to housing delivery. And I’m not suggesting it’s perfect. My knowledge base comes largely from one 13 minute episode by CityLab. But I think it’s notable that I didn’t pickup anything in the video about inclusionary zoning leading the way (which I have argued before tends to shift the burden to the remaining market rate housing units). Instead, they value it and they invest in it. There’s no such thing as a free lunch.

    Image: CityLab

  • The numerical impacts of inclusionary zoning

    Our cost consultant, Finnegan Marshall, gave our team a presentation today on what’s happening with construction costs in Toronto and across Canada. I’ve said this before, but hard costs are no joke right now.

    One of the areas that they focused on was the impact that inclusionary zoning is likely to have on development economics here in Toronto. To illustrate the point, a sample high-rise condominium pro forma was used. Think something in the 30-35 storey range.

    Assuming a requirement of 10% affordable (the policy details are still TBD), there is going to be a real cost to development pro formas that will need to be somehow paid for.

    One school of thought is that land prices will simply adjust downward. In this case, the landowner would be the one paying. I don’t think this will be the case (land prices tend to be sticky), but if they were to adjust downward, it would need to drop by $44 per square foot buildable to maintain the project’s margins in this example. (That’s $13.2 million on a 300,000 sf project.)

    If, on the other hand, the price of the remaining market rate condominium suites were to increase to offset the cost of the affordable component, they would need to increase by $91 per square foot. This translates, in the above example, into a sticker price increase of approximately $60,000 per suite.

    These numbers are, of course, not exact. That is not the point of this post. Every project is different. But hopefully it gives you an idea of some of the levers that will invariably need to be pulled when inclusionary zoning comes into force.

    My sense is that this latter scenario is more likely to happen. I have yet to see land prices adjust downward in the face of rising costs. So all of this is likely to be bad for broad-based affordability, but good if you want to be bullish on market rate home prices.

  • There is no such thing as a free lunch

    Inclusionary zoning has been on my mind this week and so I thought I would revisit some of my old posts on the topic. I wrote about it here, here, here, here, here, and probably in a bunch of other places that I am forgetting right now. A number of these posts go as far back as 2015-2016.

    As well-intended as inclusionary zoning may be, I have never been able to get my head around it. There are lots of cities with inclusionary zoning polices in place and what history generally tells us is that it tends to reduce overall housing supply and increase market rents/prices.

    This makes intuitive sense when you consider that inclusionary zoning is in effect a tax on new development. And one of the only things I remember from my economics classes is that it’s generally good practice to tax the things we want less of. You know, things like cigarettes and carbon.

    This is why I have also been a strong supporter of road pricing over the years on this blog. Traffic congestion is bad (demand also happens to be relatively inelastic). So tax it and redirect the funds toward transit.

    Housing supply, on the other hand, isn’t bad. It’s pretty good and fairly useful. So in my simple mind, I don’t know why we would want to apply a tax to it instead of figuring out way to simultaneously encourage and incent the supply of new affordable housing. Here’s one idea.

  • New condo sales totaled 5,385 units last quarter

    Urbanation released its Q1-2021 quarterly condo market update for the Greater Toronto Area at the end of last month. And there’s some good stuff in it. New condo sales totaled 5,385 units in the first quarter of this year, which is higher than the 10-year average of 4,924 units and only slightly below sales from a year ago (Q1-2020). By and large, the numbers are starting to feel a bit pre-pandemic-like.

    If you remember what happened back in the second quarter of last year, there was a quick shift in demand toward the suburbs and outskirts of Toronto. Part of this was driven by affordability. But I guess part of this was also driven by the fact that some people seemed to think that our cities had never before experienced a health crisis and were going to somehow die. Or perhaps it was because Zoom is so much fun (and not at all exhausting) and that this time was destined to be different. Either way, I never understood this.

    Fast forward a year and the core is not surprisingly coming back. The oldest part of the city (former City of Toronto) saw 2,886 new condo sales in the first quarter of this year. This is actually higher than sales in Q1-2020. New condo openings in downtown Toronto sold for an average price of $1,419 per square foot. And overall absorption was about 76% in the quarter, which is the highest it has been since 2017.

    Some of you may be looking at these numbers and thinking WTF. But when developers look at the costs in their pro forma, as well as what’s on the horizon — ahem, inclusionary zoning — it’s usually that same feeling. So it’s hard to imagine average prices and rents going anywhere but up.

  • Where developers won’t build even with $0 land

    Building on yesterday’s post about inclusionary zoning, below is a telling diagram from the Urban Land Institute showing which areas of Portland can support new development and which areas cannot. To create this map, ULI looked at achievable rents in each US census block to determine, quite simply, where rents will cover the cost of new development (all types of construction).

    However, in their models they are also assuming a land value of $0. And typically people want you to pay them money when you buy their land. So in all likelihood, this map is overstating the amount of blue — that being land where new development is feasible.

    But it does tell you something about developer margins. A lot of people seem to assume that the margins on new developments are so great that things like inclusionary zoning can simply be “absorbed” without impacting overall feasibility. The reality is that there are large swaths in most cities where development is never going to happen even if you were to start handing out free land.

    This map is also helpful at illustrating some of the impacts of IZ. If you assume that rents are the highest in the center of the city and that they fall off as you move outward, then the outer edge of the above blue area is going to be where development is only marginally feasible. And so any new cost imposed on development would naturally start to uniformly eat away at the blue feasible area — that is, until rents rise enough to offset it.

    Of course, this is a simplified mapping. Land usually costs money. Land values might also be highest in the center and fall off as you move outward, or there could be pockets of high-cost land. There may be more price elasticity in certain sub-markets compared to others. So the impacts of a new development cost may not play out as neatly as I outlined above.

    Regardless, there will be impacts, which is why I find this map telling even if it isn’t fully accurate or up to date. Maybe some of you will as well.

  • What would you like to know about real estate development? (Also, inclusionary zoning)

    I asked this question on Twitter this morning because I am planning to write more development-related posts. It’s a topic that seems to be of interest to a lot of people. One question that I received was about the kind of profit margins that Toronto developers have been making over the past few decades. More specifically: How much have they increased? My response was that they haven’t increased. In fact, if anything, they’ve been compressing as a result of rising/additional costs. (I’ve touched on this before in posts like this one about cost-plus pricing.) I think a lot of developers are actually wondering how much elasticity is left in the market to continue absorbing these cost increases.

    Follow-up question to my response: Why then does this report by Steve Pomeroy claim that developers could still make a 15% margin even if they earmarked 30-40% of their units as affordable? Well, this was news to me so I went through the report and committed to responding on this blog. To be more precise, the report finds that there’s room in as-of-right developments to dedicate 10% affordable in medium-cost areas and 25% affordable in high-cost areas. For rezoned sites, the numbers are 30% affordable in high-cost areas and 15% affordable in medium-cost areas. These are a potentially dangerous set of takeaways for a few reasons.

    Very little mid-rise and high-rise development happens as-of-right in the City of Toronto. I don’t know what the exact percentage is, but I suspect it’s low. It would be very difficult to buy land if you were valuing it on this basis. And when you are valuing it — that is, running a development pro forma — it’s not enough to pull averages from a cost guide and run high-level numbers. You can start there, but ultimately you’re going to have to get more granular. Are you factoring the hundreds of thousands of dollars (more for bigger projects) that the City will charge you to occupy any public right-of-ways? What about your public contribution monies? This has historically been hard to estimate because the math that is used is akin to a secret recipe.

    In this particular report, they assume a 100-unit building with 88,750 square feet of gross floor area. Since GFA typically factors some allowable deductions, the gross construction area for the project is going to be greater. Let’s assume it’s 5% more — so about 93,190 square feet. This is how your construction manager will think about and do take-offs for the project. In the report, they peg total construction costs at $23,208,480. That works out to just shy of $250 per square foot (costs divided by above grade GCA). You cannot build a reinforced concrete residential building with below-grade parking for this number in Toronto. In today’s market, and at this small of a scale, you might be looking at $350 to 400 psf.

    On the low end of this range, that would mean your costs have just gone up by $9.4 million — which just so happens to be the expected developer/builder profit in this model. Except now you’re underwater and you won’t be able to finance and build your project. It’s probably time to look at your revenues and see if you can increase your projected rents at all. This is what I was getting at with cost-plus pricing. I would also add that I/we typically shy away from projects of this scale. There isn’t a lot of margin for error. One or two surprises and you might be cooked. So with or without inclusionary zoning, these can be challenging projects that many developers won’t even look at.

    My point with all of this is twofold: development pro formas are delicate and margins aren’t as generous and locked-in as most people seem to think. More often than not we end up passing on sites because we simply can’t make the numbers work. The land is just too expensive. Development happens on the margin. So talking about developers “absorbing” the costs of inclusionary zoning is perhaps the wrong way to frame this discussion. A more appropriate set of questions might be: Who is going to pay for the cost of inclusionary zoning? Are landowners going to suddenly drop their prices? Is the City going to reduce their development charges/impact fees? Or will developers wait until market prices and rents increase so that they can cover these new costs? This latter scenario is how it has worked so far.

    If you have other questions about development that you would like me to take a stab at answering, please leave a comment below or tweet at me.