#developer dirt

A bunch of people have asked me lately about what they should do if they want to get smarter on land use planning and on the entitlement process for development projects. It was specific to Toronto, but I don’t think my answer is specific to only this city.

I took a few planning classes in graduate school when I was in the US. But I was more focused on architecture and real estate, and so I did not leave school an expert by any means.

I learned about the failures of euclidian zoning and about things like the Low-Income Housing Tax Credit, which always seemed like a sensible supply-side tool to get the private sector to invest in affordable housing.

But what I have found most useful is to just read planning staff reports. These are the responses to actual development proposals and they show you how staff interpret the policies that are in place and how staff apply them to real buildings.

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.

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.

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.

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.