Toronto-based condo developer Brad Lamb described property developers’ challenge in a recent presentation to the Ottawa Construction Specifications Canada chapter. Although tongue-in-cheek, the excerpts here indicate the real challenges anyone encounters who decides to take on the process of building/transforming a community as a business.
After this story first appeared online, it went “viral” through Twitter, as several readers interested in the development industry shared it with thousands of colleagues on their lists. One reader observed that this story is “Probably the best article written for people to understand the development business.” Another wrote: “Best read all day, week, and year. Thank you.”
By Brad Lamb
Special to the Canadian Design and Construction Report
Development takes millions of dollars. In 2002, where did I get the money to start this enterprise? I have always been an advocate for putting money to work. I am not risk averse and I believe in growth and the positive side of life. Optimism is more profitable than pessimism. I told you how I had started a real estate investment company in 1985. I funded Lamb Development Corp. with $2 million. I sold 15 investment condos held by my investment company, a small portion of what I had bought over the previous 15 years. I paid a large tax bill and I was ready to go.
The condo development business in Toronto, it turns out, is extraordinarily difficult. It takes huge amounts of money, and is fraught with risk. By example, a typical development is a $80-$150 million business that has a four-year life and then it is over. The pressure is unbelievable but it is a fantastic challenge. Let me explain.
Opportunities to buy good development land in Toronto are few and far between. Firstly, you will buy land from either an unwilling seller with unrealistically high expectations, or by an auction-style overpriced bid process. You can choose from either terrible option. Either way, with so little land available, your price will be based on the maximum conceivable density which is only possible in a parallel universe inhabited by reasonable people. So, you will not actually achieve the density that you paid for.
Toronto is the most competitive environment in the world to design and rezone a project. Planning and design mistakes cannot be made or they could cost you the development. Good architects and consultants are difficult to find in a hyper crowded, busy landscape. As time is always of the essence in real estate, you will need to be a drill sergeant to get your consultants to focus. There will be many consultants, more than you can possibly imagine (architectural, mechanical, electrical, historic, archaeological, legal, planning, structural, soils, acoustical, energy modelling, landscape, interior designer, shoring, construction management, building code, wind study to name about half). Their focus on your project is hard to ensure. All are needed to contribute studies for a city planning application. This process is like herding cats and all of this will take far more time than you allocated.
You will have to greatly exceed the existing zoning of the land and probably have to change its use. All the easy land has long been developed, so land today is going to be difficult to develop and a guaranteed fight with city planners, councillors, and rate payers. In most cities, your development would be welcome by all. In most cities, development is rare. Not in Toronto. The planning department in Toronto will not agree to any reasonable proposal. Don’t ever attempt to alter employment land or “neighbourhood” designations. You will lose. If you go the route of working with the city planners, your project will be marginalized and decimated by untalented hands that mostly failed in private industry. Their meddlings will make your project less good, more expensive to build, smaller in scale, and far less profitable than anticipated. Podiums and setbacks, setbacks and podiums, they are the only words in a planner’s vocabulary. Of course, most councillors just pander to rate payers. They actually have less vision than their short-sighted, selfish, NIMBY constituents.
You will have to sell 65-75 per cent of the building to buyers, sight unseen, aware that they have a four-year wait ahead of them. This of course is one of the largest outlays of money they will ever make with less concrete information available to them than when buying a sandwich. With much work and patience, you may prevail.
You will likely experience a slowdown or even a recession during the overall five-year development process. You will have to figure out how to beat it. Some projects will fail. The best ones won’t. You must get buyers to give you 15-20 per cent deposits, even though most condos are for first time buyers and they usually have a minimal deposit of 5 per cent. You are selling in the most competitive environment in the free world. Everyone wants to buy at opening day VIP pricing, even 1 ½ years after you’ve opened your sales office.
And of course, don’t sell to investors because your bank believes it is “too risky,” even though investors are, logically speaking, are the most likely buyer of your product. Why? Move-up/move-down buyers don’t typically like to make decisions four years prior to their needs, and as I just stated, first-time buyers can only scratch together 5 per cent down which the funding bank won’t approve as a sale.
Most buyers believe they are more knowledgeable and talented than the actual developer, project architect and designers. They are mystified as to why certain design decisions were made as their massive abilities have allowed them to amass a small fortune of $30,000 over 35 years of saving and investing but of course they are real estate experts. They say things like, “Why are the suites so small? They’re like shoe boxes. I couldn’t live in anything that small.” Of course, when asked about their budget, you realize it’s not actually about apartment size, rather it’s about their total lack of any money. Apparently, their awesome talents do not draw awesome salaries. In some way of course, this must be our failing for not devising a way to build something for nothing. Other buyers say things like, “I think there are too many glassy towers. I hate glassy towers, why do all developers build glassy towers? Why can’t they be more original like in Paris without all the glass? Of course these same buyers don’t want to face north, because “light is very important to me” and did I say I want floor to ceiling windows because I need light or I’ll die.
Now that you have sold enough suites, you now have to actually truly design it. This is the 6-8 month odyssey known as “design drawings,” or DD, where consultants you work with try to actually deliver a reasonable replica to what was promised or sold. Your architect is resolutely holding on to his unrealistic vision while ‘value engineering’ is marginalizing the building largely because it took 12 months too long to sell and the architect is a dreamer.
Next comes your construction financing. Just as you start to talk to banks, Minister Flaherty and company have pulled the rug from under your feet. He is of the opinion, due to his years of experience working in the development business, real estate, and banking, that there is a banking problem developing in the condo construction lending business. Apparently he too is now a real estate expert. He figures he needs to slow it down. So now construction financing has vanished and you now are standing alone with a $90M project and no lenders. No problem – just put your head down, stay positive, avoid a fiscal cliff, and all will be fine in time. Time. Time in the development business, is otherwise known as ‘the devil.’ Six months later, the lenders are back and you’ve got your financing. But you are now $750,000 over budget because of the unanticipated extra costs of your extension on your land loan and some nasty new extension fees. You’re going to need some more value-engineering.
Finally, it’s time to build. God forbid that the construction market is tight or all your costing projections will be wrong. You hope that the forming contractors aren’t currently colluding. You continue away at reducing costs as your budget is still higher than your bank loan allows due to the delays and additional bank and consulting costs. Of course, now that you actually have your financing approved, so does everyone else. Construction costs just went up due to the many multiple large projects bidding for work. More value engineering ahead. Now as you start to excavate and shore, you “discover” the remnants of an old building, formerly collapsed and buried on your site. It’s funny that your high-priced soil consultant couldn’t find that.
Ouch! $500,000 in extra disposal costs, more value engineering. Oh no, now your shoring contractor has hit some large rocks, that is not part of their contract…oops, $100,000 in extras – thank goodness for that $3M in contingency. Over the next 24 months while you build the building, every one of your consultants from the designer, architect, mechanical engineer, civil engineer, surveyor, elevator company, lawyer, you name it, will screw something up. They will most certainly pass that cost on to you. Why? Their fees can’t possibly cover the extra and remember, in the development business, no one takes any responsibility for errors, except you, the developer.
Hurray! You have managed to finish the building, you have spent most of your contingency, but registration is just days away. Now you can occupy your building. Payday! Pay back for all your hard work…..but no. Not so fast.
Now you have to actually close all the sales. If you were fortunate to complete the building in March or September, you stand a good chance of selling your unsold inventory in an orderly fashion at top price, selling into a strong spring or fall market. Of course, you will have to keep all of the inevitable “friends,” consultants, and good clients that bought suites in check to prevent a flood of assignments or flipping as they try to cash in quickly on their $100,000 profit windfall, which they believe was due to their incredible skill, knowledge, and foresight, and nothing at all to do with the developers skill and hard work in creating a spectacular building with excellent design and floor plans. Even more likely, it was their dumb luck being the benefactor of a rising market. What do they say – “a rising tide lifts all boats.”
If you completed your building in November or June, tough luck. You are selling now into the slow real estate seasons, winter or summer. Your inventory will take twice as long to sell, look stale to buyers (due to the longevity of listings), and eventually wear at your bottom line. Thank goodness you didn’t sell all of your product at discounted launch pricing or you’d be really screwed.
Now comes registration. This is when the city allows you to transfer title to your buyers. You have completed everything needed to register, or so the city planner tells you. Oops – they neglected to tell you they are leaving for a three-week Safari in Africa (once in a lifetime opportunity you’re told, everyone needs to do an African safari once in their life). Registration will just have to wait.
Now you are into November. Tough luck, but the planner is back. They discover that site servicing has a small problem with one of your consultant’s letter. Apparently, your undertaking to complete a tiny, obscure task is not enough. Even though your highly paid consultant informed you it would not be a problem, well it is NOW though, because this particular city employee is a stickler, just following the rules of a non-existent rule book – tough luck. Ok, ok – two weeks later after tidying up the one small issue, and having your engineering consultant satisfied with the content of the letter to the city (which for some odd reason, takes a full week. This may have something to do with not acknowledging that consultant in a hallway a year ago), well anyway, you are now registered.
Now the closing circus starts, but you have been delayed into late November. Every buyer has an amazing reason why the closing doesn’t work for them. Nonetheless, after threatening large fines, it appears all of your deals will close over a 15-30 day period. I can live with that.
Oh no – last minute glitch. The plumber double cashed a cheque. That is to say he reported a cheque lost, pestered for a new one, then cashed both before the bank cancelled the first one. Then he has liened your building for $450,000. The plumber is unhappy because he lost money on the job and is trying to blackmail you at a perceived moment of weakness. Your bank loan is fully advanced and you need to either settle with the plumber, or pay the lien in court (plus an additional fee). Either way, closings will now be delayed.
Thank goodness for being prepared (keeping a million or two on hand for just this kind of thing) – the lien is negotiated and paid. Ok, closing time. Not so fast, buyers that are really investors hadn’t budgeted for the new HST. Thank you Mr. Flaherty, a new 13% per cent tax on new housing is appreciated, especially half way through a development. Apparently, several buyers are shy $15,000 or so to close. Ugh – you have to extend 25 buyers for a few weeks so they can source the money. Sorry bank – can’t pay you out just yet. All the delays have cost you more time. Merry Christmas! Lawyers have now gone for the holiday December 15th – January 4th. No closings till mid-January. Damn it all.
Ok. Patience is a virtue. We’ll get there. January 31st – everyone has closed. Paid the bank. Fifty per cent of profits tied up in inventory and with a tax rate of 26 per cent you can’t pay any profit dividend. Stay positive. Alright then, eight months later, it is now the end of August, the final units are all sold, we can close the books. Job well done.
Not so fast. You have some upcoming issues. Tarion warranty is still holding $500,000 of your deposits, the city won’t release a $300,000 line of credit, and you will soon have one and two year technical audits to get through.
Just then, the phone rings. It’s your favourite commercial real estate broker calling. “Hey – are you in the market for a great site?” You pause, and sigh. “Of course I am. What do you have?”
This has never been an easy business. But I love it.