How a million people a year and 0% construction financing can still mean nothing being built.

apartmentblocks marketinsights april30

Common sense would dictate that an increasing population means increasing incentives to build, as long as land is available to build on, which should equate to more housing built. What if you had 0% financing for new housing construction, essentially free money? Under this builders’ utopian scenario, how could the economics fail?

What it takes to get a development off the ground

There is only one thing driving new construction throughout most of the world: profit. Why is this the case? Development, whether the public or private sector is building new housing, involves significant risk. Housing requires much capital and is subject to uncertainty in where the project lands in the economic cycle because of lengthy approval and construction timelines, interest rate and construction cost risk, escalating fees to build, and fluctuating rents or end unit pricing.

How can there not be enough profit with an increasing population and 0% financing?

The formula is a lot more simple than you may realize:

If Costs > Revenue = No building.

Costs: materials, labour, sales, marketing, management fees, financing, municipal taxes and fees.

Revenues: total purchase prices of all the condominium units added up or the cash flow of a rental building (total rental revenue – costs for financing, operations, and capital improvements)

Population growth and a housing shortage will continue driving the cost of purchasing housing up in a free market and increasing the revenue side of our equation. Conversely, if there is too much housing supply, house prices (revenues) will decrease. However, what happens if every time the revenues go up $1, the city charges one extra dollar in building fees, or the costs to build go up that dollar? You probably guessed it: no building. Cities tend to raise fees as they see revenues rise, but when they fall, they don’t lower fees, resulting in a significant revenue shortfall. What about land pricing in this scenario? Shouldn’t land come down to the point where building revenues are greater than costs? That would be the case in a city with raw land; however, Metro Vancouver doesn’t have raw land, and most developments are assemblies of single-family homes. If the underlying land value doesn’t have a benefit above the price of selling the home individually, assemblies won’t happen, and we return to Costs > Revenues.

Can we stop increasing costs?

Managing costs is a complex issue because costs are rising for many reasons. Here are a few examples:

  1. Population growth requires more infrastructure (parks, highways, water and storm drains, power plants), community amenities, and staffing such as fire, police, and schools, which are expensive to increase and maintain.
  2. The Provincial Government is pushing towards carbon neutral housing, which adds significant skilled labour and material costs.
  3. Many projects require affordable housing, but the costs are significantly higher than the revenues to build, operate, and maintain it.
So how do we flip the script and keep Revenues > Costs to incentivize more construction?

If the ultimate goal is to make Vancouver more affordable, then increasing revenues will not help, so the solution must be in terms of costs. To reduce costs, the provincial government turned the entire province into a land assembly attempting to increase the available land for building. However, it doesn’t matter how much available land exists if Costs (to build) > Revenue. Going back to our list that is driving up costs, population growth and financing are determined federally, which is out of the provincial control, leaving us with Affordable Housing and building code requirements. Removing affordable housing would immediately make any projects requiring it feasible and spur development. Relaxing strict building codes and allowing developers more flexibility in their projects would also lower material costs and the amount of skilled labour needed to complete a project.

We all want Vancouver to be somewhere everyone can afford to live. However, that requires prioritizing and incentivizing building instead of trying to maximize the costs extracted from each development.

 

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