Brandon Donnelly — Daily insights for city builders. Published since 2013 by Toronto-based real estate developer Brandon Donnelly. — Page 1506

Earlier this week my father sent me this article containing an excerpt of Warren Buffet’s upcoming shareholder letter. His annual letter— which started in 1965 —is well known in the investment community. And in many ways, it’s like his own annual blog, started well before anybody knew what a blog was. His letters are personal, genuine and engaging—just like a good blog should be.

But for me, what was really interesting about the letter  is that it provided a number of lessons about investing in real estate. Lessons which, in my view, really represent the fundamentals of the business. The way I think about it is that there are really 2 ways in which to make money as a real estate investor over the long term. You can develop/reposition real estate and/or you can collect rent.

Develop/Reposition

If you’re developing or repositioning real estate, it means you’re doing something to increase the value of the property. It could be by rezoning, building new, or through an aggressive leasing strategy. It’s whatever you believe will unlock additional value. Once you’ve done this, you then either sell the property or you move onto the 2nd way of making money in real estate.

Collect Rent

By collecting rent, I really mean that you’re buying yield. This means you’re saying to yourself:

I can buy this property for $1,000,000 and the net operating income on it is $100,000 (per year). So that means I’m buying at a 10% cap rate (or return). 

Or maybe you’re saying:

I can buy this property for $1,000,000, but the net operating income is only $25,000. However, the rents are well below market and I think I can easily get this thing up to a “10 cap.”

Either way, you’re buying a stream of cash flows and you have an understanding of where that cash is going to come from.

Speculate

If on the other hand, you’re buying solely on the expectation that prices are destined to rise, you are— as Buffet points out in his letter —speculating. You’re not doing anything to create value and so you’re not developing. And if you’re counting on price growth to generate your investment returns, then you aren’t buying yield either.

While many people have made large sums of money by speculating on real estate, I don’t consider myself capable of doing that in any sort of sustainable way. Hell, if Warren Buffet doesn’t think he can do that, why should I think I’m special.

But some of you may disagree with this framework. If so, I’d love to hear from you in the comment section at the bottom of this post.

Yesterday evening I moderated a panel on innovation in real estate at the Rotman School . The panelists included Subhi Alsayed (Innovation Manager at Tridel); Michael Lio (President of buildABILITY Corporation); Alison Minato (VP of Sustainability at The Minto Group); and Tad Putyra (President and COO, Low Rise Development at Great Gulf).

Though the general consensus was that the real estate industry is terrible at innovation, it was comforting to hear that a number of both low-rise and high-rise developers are working on and/or towards building “net zero” homes. A net zero home is a home with no net energy consumption. What this means is that the home produces as much as energy as it consumes.

The general strategy with these homes is to design the building so that it’s as energy efficient as possible (as in R-40 walls and triple-pane glazing) and then use renewable energy sources (such as solar) to fulfill any remaining energy needs. Of course, the next step would be homes that actually produce more energy than they consume so that they become net contributors to a city’s energy grid. But let’s not put the cart before the horse.

There are a number of challenges to achieving this goal—one of which is on the consumer side. Many of the panelists mentioned that consumers simply don’t care enough about building performance and energy efficiency. Instead of worrying about air tightness, they’re worried about cosmetic things, like granite countertops and hardwood floors. That’s not to say that these pieces aren’t important, but they’re only one aspect of a home.

So what’s the solution? Do developers and home builders need to get better at consumer education? Or should utility companies be the ones shouldering this responsibility? After all, improving energy performance means lower utility costs.

One thought that came to mind (and I’m testing this for the first time with the Architect This City community), is that maybe homes need to become more of a product. Today, developers often market projects and communities ahead of themselves. But maybe that’s not the best way to drive innovation within the real estate industry.

For example, think about how car brands segment the market. When you buy a Mercedes, you expect a certain level of performance and quality. You probably don’t know about every little technological innovation in the car, but you assume that they’re pretty damn good.

With a new home on the other hand, you’re buying (insert generic name) on the Park or the Residences of (something regal sounding). The developer’s brand is secondary. And maybe that’s the wrong approach. Maybe it’s making consumers believe that the only thing that matters is whether you’re getting stainless steel appliances and granite countertops.

Maybe consumers need to know whether or not they’re buying from the Mercedes developer or from the Ford Pinto developer. After all, consumers make decisions based on heuristics. They need to be able to say to themselves:

"This home is $50,000 more, but it’s from the Mercedes developer so I can justify it. I’ll have less problems in the future, I’m sure."

Instead, consumers are saying to themselves:

"This home is $50,000 more. Why is that? They both have stainless steel appliances and granite countertops. I’ll just go for the cheaper one."

I refuse to believe that the real estate industry can’t be as innovative as other industries. There’s always a way. We just need to figure it out.

What are your thoughts?

Yesterday I was at brunch for a good friend’s birthday and a few of us started talking about politics and the future of Toronto. We immediately became depressed by the fact that Rob Ford, could actually, get in again. For those of you outside of Toronto, I know this sounds like pure lunacy.

We then speculated as to whether John Tory would ultimately run again. Though it would split the conservative vote (between Ford and  Karen Stinz ), I was hoping he would. Then, just like magic, Tory announced his candidacy. Here’s the video:

While some would call it an oxymoron, John Tory is often painted as a “ Red Tory ”. He’s fiscally conservative, but then holds socially liberal views on issues such as same-sex marriages.

But perhaps more importantly for the Architect This City audience, Tory is also a city builder. He’s  Chair of the Greater Toronto CivicAction Alliance , which is non-profit group focused on transportation and economic development in the region. And this comes through in his clear support of the Yonge relief subway line (see above video).

So even though this risks splitting the conservative vote, I will be supporting John Tory’s candidacy during this year’s mayoral election in Toronto.