Brandon Donnelly — Daily insights for city builders. Published since 2013 by Toronto-based real estate developer Brandon Donnelly. — Page 151

One perverse way to think about development is that it is a tool to transfer costs away from people who don't want to pay for stuff to people who don't know they're paying for stuff. Two good examples of this are development levies and inclusionary zoning. Inclusionary zoning is a popular policy tool to create affordable housing because nobody feels like they're directly paying for the requisite subsidies (i.e. no public money) and it does, to varying degrees, result in affordable housing.

Cambridge, Massachusetts, for instance, enacted IZ policy in 1998 and, up until the market turned in 2022, it created just shy of 1,600 affordable homes . This only works out to ~66 units per year, but Cambridge doesn't build that many new homes. Starts over the last five years have hovered somewhere around 500 new homes per year. But now starts are falling and new projects simply aren't penciling (as is the case in many cities).

Here's a specific example from the Boston Globe:

The project at 2400 Mass. Ave. helps explain why. With 60 condominium units, North Cambridge Partners figured their project would generate about $108 million in sales if all the units were sold at market prices, said Tim Rowe, the developer’s lead investor, who is also the founder and CEO of the Cambridge Innovation Center. But with 12 of those units sold at far-lower “affordable” prices under the city’s inclusionary rule, that amount drops to about $90 million.

The developers figure they’ll sell the market rate units at somewhere around $1,500 per square foot, or perhaps a bit less. That’s a very steep figure, one that’s partially driven by high construction costs and the need to offset the discount on the affordable units. The price for affordable units, under the city’s rules, would come in closer to $275 per square foot.

Rowe estimates the six-story, 72,000-square-foot building would cost $85 million to build, leaving the developers with $5 million in profit. But to come up with that $85 million to begin with, they’d need to find an equity investor willing to put up about 35 percent of the money — $30 million — and then borrow the rest. The investors the developers have talked with about financing the project are seeking such a high rate of return that the project would need to net roughly $16 million, Rowe said, $11 million more than what the developers currently project to make.

I'm impressed the developer shared this much about their economics.

What is clear is that the affordable units don't come close to covering the close to $1,200 psf it would cost to build the building. And so somebody has to cover this shortfall. Nobody wants to spend public money on this and so it gets passed onto the market-rate buyers who don't exactly know what they're paying for, but frankly don't have a choice either way if they need a new home.

When the market is robust, this can clearly work. But when the market softens, it can shut off development. Today, there's debate in Cambridge about whether the 20% requirement should be lowered to spur more supply. This would certainly help but it gets at the real conundrum of inclusionary zoning. Lowering the burden will create more market-rate housing. And so what is the most equitable and ideal percentage of affordable housing that should be mandated in IZ policies?

In other words, exactly how much cost should we transfer from the people who don't want to pay for stuff to the people who don't know they're paying for stuff? In my view, it shouldn't just be new homebuyers who pay to subsidize the creation of new affordable housing. Why only them? If there's collective agreement that more affordable housing is a good thing for our cities, then there should be a more broad-based solution.

Cover photo by Henry Dixon on Unsplash

Over the weekend, Warren Buffett and his team hosted some 40,000 people in Omaha for Berkshire Hathaway's annual shareholder meeting. And during the event the 94-year-old announced that he would be retiring at the end of the year. This is after 55 years as CEO, which makes him the longest-serving chief executive of an S&P 500 company.

What a run. Thanks for all the wisdom that you have shared over the years, Warren. In honor of this milestone, I decided to go back and reread his last shareholder letter (which was published back in February). His comments on the insurance industry are particularly interesting, and naturally relevant to real estate.

Over the decades, Warren has talked a lot about the benefits of owning insurance companies, namely the "money-up-front, loss-payments-later" model. It creates a "float" of cash that can be invested in the interim. But the flip side of this benefit is that it can sometimes conceal a shitty business.

As a business, if you have to pay your costs up front before you sell your products or services, then it's pretty easy to determine if you're not making any money. But in insurance, there's a long-tail of liabilities that can be far more insidious and that may not appear for many years, or even decades according to Warren.

There's also climate change bringing more uncertainty:

In general, property-casualty (“P/C”) insurance pricing strengthened during 2024, reflecting a major increase in damage from convective storms. Climate change may have been announcing its arrival. However, no “monster” event occurred during 2024. Someday, any day, a truly staggering insurance loss will occur – and there is no guarantee that there will be only one per annum.

Think back only 135 years when the world had no autos, trucks or airplanes. Now there are 300 million vehicles in the U.S. alone, a massive fleet causing huge damage daily. Property damage arising from hurricanes, tornadoes and wildfires is massive, growing and increasingly unpredictable in their patterns and eventual costs.

In a perverse way, all of this is good for the insurance business. More economic risk means higher premiums and a greater overall need for insurance products. But you have to accurately underwrite this risk:

Properly pricing P/C insurance is part art, part science and is definitely not a business for optimists. Mike Goldberg, the Berkshire executive who recruited Ajit, said it best: “We want our underwriters to daily come to work nervous, but not paralyzed.”

This reminds me. I was speaking with one of our insurance advisors a few years ago and he made a comment that he was going to be " on risk for the project." I responded by half-jokingly saying "it's funny, you see only risk, and I see an opportunity to create something special for the city." Both of us then laughed, but there's obviously some truth to these two perspectives.

I guess I chose the right profession.

Cover photo by Chris Nguyen on Unsplash

Andermatt is a small mountain village in the Swiss Alps. It's a few hours from Zurich, it's known for its skiing and snowboarding, and it's surely really beautiful. But right now it has two other important things going for it: one, it does not restrict property purchases by foreign nationals and, two, it does not limit the construction of second homes to 20% of the village's housing stock, which is a rule in other places. This is expected to come into force in Andermatt in 2040.

Because of these features, Andermatt is being viewed as a barometer for foreign demand and, over the last six weeks in particular, local developers and agencies are reporting "hockey stick growth" in terms of sales volume and inquiries ( according to FT ). As of April 10, new development projects in the village reported selling SFr14.2mn worth of apartments, which is nearly 2x the amount of transactions for all of 2024. And nearly a third of these deals were signed by "nervous Americans" following April 2.

Here's one buyer testimonial:

One Andermatt buyer, a New York-based tech entrepreneur in his early fifties who asked to remain anonymous, said Trump was one of the “main factors” in his decision to buy. He and his partner purchased a two-bedroom unit for SFr2.2mn in November. Switzerland, he said, was stable and secure at a time when the US was less so under Trump. “It is not only financial uncertainty — it is not liking what [the US] is turning into and what it has become,” he said.

It is not uncommon for people to say, "if X happens, then I'm going to leave and move to Y." That doesn't always, or even oftentimes, materialize. But wealthy people have the means to make it happen, if they want, and we're seeing signs of it all across Europe. In some cases, putting down a deposit on a new Swiss apartment might just be an option, should things get worse. And in other cases it may be a firm commitment to relocate.

But either way, it's a strong indicator and a demonstration of people voting with their feet.