I hope you’ve had your Monday-morning coffee, because this is going to be fun, fun, fun!
Why are pre-construction condominium prices so high? Is it because developers are greedy? Is it because land costs more these days? Is it because the city of Toronto is bleeding developers dry?
Or is it, as you would probably expect, a combination of everything above, and more?
I’ve spent some time speaking to industry contacts, and gathering tangible data on the costs involved with development. Let’s take a look…
Read it again.
That’s the answer to the question you all want to know.
“What is a developer’s profit margin, in this absolutely incredible real estate bull market?”
At this point, many of you are already shaking your heads.
You saw the number, you read the words ‘developer’s profit margin,’ and your brain quickly sent a signal to the rest of your body that made you squirm in your chair in discomfort, because I’m lying. The number can’t be that low.
You already have your minds made up, and some of you may even be thinking, “He’s finally done it; he’s sold out to the world of evil condominium developers!”
But surely you’re going to read onwards, right?
Surely you’ll give me a chance to explain?
Look, that 12% figure is more for effect than anything else, to start the blog off with a bang. I could have strung you all along, and done some big reveal, like this is a home renovation show, and the naive buyers finished their project under-budget, on time, and with no regrets.
The actual figure I was given was 12%-20%, and as will be a continuing theme in today’s blog, everything is estimated, subjective, and can change in an instant.
But where did this conversation start?
It started in the comments section, as many discussions usually do.
This is from Wednesday’s blog:
I had a feeling the “greed” comment was coming.
How can we not assume that greed is the main driver of just about any capitalistic venture in society today? The real estate market has been on fire for over a decade! Developers must be getting Sh!t-Rich off the backs of naive condo buyers!
But if you really sit down and think about it, successful, established companies are able to stay in business because they offer a product or service that meets the demands, and needs of buyers and users, at a price that they’re willing to pay.
I don’t think it’s reasonable to assume that when pre-construction condo prices were at $600/sqft, and developers’ costs were at, say, $300,/sqft, that today these developers are still paying $300/sqft in costs, and they’ve just decided to get rich or die tryin’, and charge $1,000/sqft.
In fact, I think it’s more reasonable to assume, and correct me if I’m wrong, that the reason for an increase in pre-construction condo prices is more likely to do with rising costs, than greed.
Please, tell me if you disagree.
And keep in mind, I say this even though I’ve been the most ardent opponent of pre-construction condominium purchases for the last decade. We won’t go down that road again; you’ve read my blogs for years. But what I want to do today, is hypothesize that the rise in prices is less to do with greed, and more to do with cost, and have you readers follow along, without making your minds up in advance that I’m in bed with developers.
As I told a reader who commented on Monday’s blog, I don’t know any developers. I’ve sold exactly ZERO pre-construction condos in the 14 years I have been licensed. I don’t hob-nob, or eat caviar with the principals of Tridel, Menkes, and Cresford. The only time I’ve ever interacted with developers is when their lawyers have sent me threatening letters because of things I’ve written on my blog.
So allow me to present to you my findings on the approximate cost of building new construction in downtown Toronto, and take it with a grain of salt, if you so choose.
I’ve solicited opinions from two people who work in the commercial and/or condo development space, both of whom I’ll quote, but leave anonymous.
The way we want to look at the construction cost is by breaking down the following:
- Land Cost
- Hard Costs
- Soft Costs
Let’s look at each one in detail.
One of my colleagues said the following:
“Fifteen years ago, surface-level parking lots were in abundance throughout the downtown core, and developers could have their pick of building sites, both those actually posted for sale, and those that could be solicited. Today, there are more developers, they are larger, and they have deeper pockets. But they’re all fighting for the same handful of building sites that are available each year. They’re suffering from the same lack of supply that your average 1-bedroom condo buyer or entry-level home-buyer is faced with, and they’re out-bidding each other, looking at smaller margins each and every time. Developers are getting more creative, and future-focused. They’re land-banking for a decade ahead. They’re buying existing commercial/office and trying to double or triple the denisty to make a condominium development work.”
One of the best resources for construction costs and industry trends that you’ll find available publicly is the Altus Group Construction Cost Guide.
The report states the following:
Altus Group’s annual Construction Cost Guide is the Canadian real estate industry’s leading guide to development project costing. It is trusted as a budgeting tool by public bodies, developers, lenders, contractors, consultants and various industry professionals.
Click HERE if you want to download, or read the 22-page report.
Market trends, sales figures for new construction, office leasing – this report has it all, in addition to the construction cost guide we’re interested in.
Within the construction cost guide is a reference to the cost per buildable square foot for land prices:
Toronto is on par with Vancouver at around $200/sqft.
But as far as that $200/sqft goes, we need to make two important notes:
1) This is a GTA cost. The value of land in Toronto’s downtown core is far greater.
2) This is buildable square footage, and not actual sellable square footage.
One of my contacts said the following regarding point #2:
“Buildings are typically about 85% efficient so when you sell, your sales are based on the square footage inside each unit but when you allocate the costs, it is on 100% of the building. Lobby, party room, gym, pool, fire escapes, elevators, hallways, stairwells – all common elements. So when you calculate costs, it is on 100% of the building but when calculate revenue, you can only charge on ~85% of what you have built.”
Taking into consideration both point #1 and point #2 above, that $200/sqft estimate of cost per buildable square foot would likely head into the high-$200’s rather quickly for a downtown Toronto condo.
I was also told the following:
“The cost per square foot of buildable land is highly subjective for a condo. You might be looking at a land-banked dozen freehold homes, for which zoning is residential with a 3-storey height restriction. That site could be sold with the assumption that a 30-storey tower will be approved. It cuts both ways though. If you’re able to negotiate with the city and get approval for 40-storeys then you’re ahead of the game and your cost psqft is lowered. But if a downtown sight is sold as though 70-storeys is a slam dunk and you but heads with the city councilor and get 60-storeys approved, then your cost skyrockets.”
I would conclude here that we’re looking at a floor of $200 for the acquisition of one square foot of condominium space, and that cost, with the three points above considered, could double.
Altus Group’s proprietary database of project costs includes project data from over 1,400 properties in 2017.
For the Greater Toronto Area, I’ve taken a screen-shot of the following:
It’s fair to say that most new condos in Toronto are being built higher than 40-storeys, at least when we consider the downtown core.
These figures refer to the GTA, but for our purposes, we’re not really interested in what’s happening in Halton, Peel, York, or Durham. We want to know why pre-construction prices in the downtown core are now over $1,000 per square foot!
So I would likely use the higher number in the range, and again, I think that’s fair.
We’re looking at upwards of $330 per square foot in hard costs, and note the “premium for high quality.” That could refer to Yorkville projects, but it could also refer to something as unassuming as a new Freed project in King West. Consider that Altus is using data from 1,400 condos, across Canada. And I don’t believe that the “average” features and finishes in a Calgary condo are the same as that of a downtown Toronto condo.
All three costs – land value, hard costs, and soft costs, have been increasing dramatically over the years. But with respect to the hard costs, one of my colleagues said this:
“Labour costs have never been higher. The unions feel as though after a decade of building, it’s time for them to get their ‘piece.'”
I have no hard data to support that.
But also consider that a developer must forecast increases in hard costs – labour, materials, what have you, as the project is future-based:
“When you are a developer and you sell all your units in one market, you have committed to delivering at that price. You have little control over costs of materials over the next 3-5 years of building, debt costs, delays etc.”
As we saw with the “LAND VALUE” portion, these costs can fluctuate dramatically. But if you want to be conservative, then use $330/sqft as the measure for your calculations.
What are soft costs?
Basically anything outside of the cost to acquire the site, and the cost to build it.
Sales and marketing? Check. Building a sales centre, hiring a marketing firm, public relations, sales team, etc. Commissions payable to Realtors who sell units are 2.5%-5% of the price of a unit alone.
Architectural, legal, zoning, permitting, etc. This is a big one!
And that brings us to the City of Toronto’s part in all of this, which adds a substantial cost!
A lot has been made of “development fees” but that’s only a small part of the pie.
Much of what we want to know is made public by the City of Toronto, and is a set fee.
Click HERE if you want to see the City of Toronto’s residential development charge rates, effective February 1st, 2018.
Here’s a breakdown:
Note that for a 1-bedroom apartment, the development charge is $17,644.
In the context of a 450 square foot condo, selling for, say, $900/sqft (or $405,000), this represents 4.4% of that price.
4.4% might not sound like a lot, but it is. It’s a large chunk, and it’s passed directly on to the consumer.
But also consider that this is far from the only cost the developer incur from the City of Toronto.
A note on this from my colleague:
“In addition to those development charges, there are also education DC’s, cash in lieu of parkland (which can be 5-10% of the value of your land at the time of building permit), City permitting fees and many more. That is on top of Section 37 cost, which is arbitrarily negotiated with the city for “public improvements” which could be millions of dollars. You need to negotiate this in order to get final approvals to build. The conversation now is around DC’s going up by double in Toronto, and no one knows exactly when that will happen.”
The education charges are also available on the city’s website, check HERE.
They’re about $1,500 per unit, which, again, doesn’t sound like much. But trust me – this all adds up.
“Cash in lieu of parkland” is 5-10% of the value of the land at the time the building permit is issued, which is usually more than the amount which was paid for it. So you could conceivably add another 5-10% of that $200-$400/sqft from our first section on “LAND VALUE,” or another $10-$40/sqft.
Then comes those pesky Section 37 fees, which I wrote about in a January blog you can read HERE.
That’s 1% of the “gross construction costs.”
When all is said and done, how much of the purchase price of a condominium – say that $405,000, 1-bedroom condo we used as an example above, goes to the city of Toronto in one form or another? 10%? 12%? 15%?
How much does that drive up the price?
I understand that the city needs money. And clearly, given the political climate we’re in now – with FREE STUFF FOR EVERYBODY, the city, province, and country all need to come up with creative taxation measures. But I think it’s prudent to identify how much of a hand the government has had in driving up the price.
As for the rest of the soft costs, use your imagination.
I don’t have any way of estimating the total soft costs, but my contact in commercial real estate has said these are roughly $150/sqft for your “typical” Toronto condo.
So where does that leave us?
Cost to acquire land: $200/sqft
Hard costs: $330/sqft
Soft costs: $150/sqft
That’s $680 per square foot.
And that’s using conservative numbers.
The cost to acquire the land, looking at downtown condos, and looking at actual sellable square footage, would probably be closer to $300/sqft.
The cost of building something with above-average finishes might be closer to $400/sqft.
That’s now $850/sqft.
And what are pre-construction condos selling for, on average, in downtown Toronto right now? About $1,000/sqft.
So what is the developer really making?
One of my colleagues sums it up nicely:
“I would suspect that on a typical project (if the market stays the same from when you buy it to when it is sold), developers are typically in a 12-20% profit margin range. Do you think it’s worth the risk??? This is of course increased by the ability to leverage their capital with land loans and construction financing, but that comes along with significant risk.”
This was a fun project to work on.
Keep in mind that I am a residential real estate agent, and this is an estimate; an exercise, if you will.
I wish I could find exact numbers on this, but I think it’s fair to say that Tridel, Menkes, Freed, et al aren’t going to let me publish their financial statements on Toronto Realty Blog.
I welcome your thoughts below.