October 9, 2016 by Omar Passons
On this blog, I write about San Diego issues that could use straight forward explanations. Most people don’t have time to wade through the technical differences between an enterprise fund and a general fund, or complex deferred maintenance documents related to infrastructure. If our city is to do anything meaningful about how hard it is to afford to live under a roof in San Diego, as a community we must get a better working knowledge of how homes are built. Over the next couple months, I’ll release several straightforward pieces about real estate development – the process by which companies turn land into places to live, work, or play. First up, let’s talk big picture.
Everybody loves a good diagram, right? I’m going to use a diagram that works for the type of small-to-midsize apartment and condominium construction that is likely to fit and address the issues in San Diego, specifically. The model gets a little muddy if we start talking about office buildings or industrial parks. But if we focus on residential homes and basic businesses we should be able to walk together to a deeper understanding of real estate in San Diego.
I always like to reveal my biases and background up front so readers don’t think I’m hiding the ball. I was a construction and land use attorney for just over ten years. I worked with developers, community groups, cities, architects, contractors and other related professionals for much of that time. I’ve drafted purchase and sale agreements, negotiated leases, and provided counsel to people about what they could do with their property. I’ve also litigated construction disputes in which a company who builds things and the owner of the property disagree about how much things did (or should) cost.
I’m also an unapologetic Urbanist who, despite this position, doesn’t think everyone else needs to agree (though, ya know, I wouldn’t complain). What’s an Urbanist (CLICK)? If you didn’t click that link, I’ll tell you that I have a bias in favor of making it easier to build more homes in the right places and in favor of making living in dense areas enjoyable and interesting. San Diego has plenty of room to accommodate everyone who wants to live here at a responsible price point, we just refuse to use the right spaces to do it.
We could keep virtually every single family neighborhood as it is, build only on corridors, or in already urbanized areas, and meet every bit of housing need we have in San Diego. That’s my position and I aim to show you why (and maybe even how). More on this in a future bonus post on affordability.
For now, I just want to explain the life cycle basics so that the next several posts make sense. First, a few glossary items are in order. We can’t talk about building stuff in San Diego without talking about a couple key concepts.
- Development Impact Fees (LINK) are the fees the company that wants to build something pays to cover some of the real world impacts of that development. An easy example that doesn’t happen as much as you might think is if you add 500 new homes to a street you might expect that to impact the amount of sewer systems you need. Yes, it’s a gross example, but it makes the point. More people needing, ahem, relief, might mean more or larger sewer pipes. (The truth is that many of the places to build have plenty of sewer capacity, but it’s a decent example). If you hear people talk about “DIF” (it rhymes with Jiff, the peanut butter) this is what they are talking about.
- Stormwater Permit Fees (LINK) are specific fees to ensure compliance with California’s complicated and expensive requirements to protect our oceans from stuff like dirt and chemicals coming off of a project. These are important ways to protect our environment, but they add cost and at least some of the regulations are a constant source of dispute about how much protection they actually provide.
- Bridge Financing (LINK) is another important term that describes the money that a developer must get to cover that space between the initial acquisition and a construction loan.
- Construction Financing (LINK) is just what it sounds like. It’s a bit more expensive than getting a mortgage because it’s a bit more risky to get a bank to give you money to build homes than to buy a home that is already there. The link is to a residential construction loan guide, but the concepts are similar enough to make the basic point for now.
- Zoning (LINK) is the fancy name for the often incomprehensible set of byzantine and obscure rules that govern what a city says you can do with your property. Zoning is a needlessly cumbersome process which is mostly that way because we are afraid to use better, more flexible alternatives.
- Form Based Codes (LINK) are an example of a better, more flexible alternative to zoning. In a nutshell, this is about letting the types of buildings and appropriate scale dictate what can be built rather than based strictly on uses.
I could fill up an entire passage on just definitions, but that would get old. Here’s a handy page in plain English (LINK) if you want a few more key terms.
WORD OF CAUTION – Development Cycle is not really linear: The only reasonably straight forward way to describe the real estate development life cycle is step-by-step. Any real estate professional will tell you it isn’t quite that neat. Sometimes you already have contractors you trust who are ready from the beginning. Sometimes (frequently, actually) you start designing the project early, but it undergoes many changes over the life of the project. The complex patchwork of financing options also varies quite a lot. But to help us get a basic understanding, I’ve had to do some over-simplifying. For example, you’ll see a section on “seeking permit approvals,” which actually includes a very detailed web of community interaction, building department review, and appointed and elected official approval. It can happen at several stages in the process, but I needed to put it in one place to make sense.
You will take away from this cycle both what the most common steps are and some of the challenges involved that impact the cost to build homes.
A Word About Source Material: I pretty much always want official source material that isn’t just some person’s opinion when I read items like this. I assume there are others of you reading this who feel the same way. To that end, I’ve tried to put at least one source for any major assertion I make. The links throughout these pages really are useful. In addition, for the true nerds among us, I’ll be creating a mirrored page that is just links to useful source material. You won’t have to believe me when I explain the role of capital markets in setting the rate of return a project must generate, I’ll link to those actual rates so you can see for yourselves. Stuff like that.
I absolutely DO have an agenda, such as it is, in creating this series. I want people – especially elected and appointed officials and their staff – to make more informed decisions about housing. I want my fellow San Diegans who live in our communities to understand how housing works so we can solve a huge crisis for our kids and grandkids (and teachers and police and everyone else who can’t afford to live in San Diego). But I don’t want to do it by hiding the ball or shading the truth. We ultimately will make our own decisions about what type of neighborhoods and commercial areas we want, and I’ll advocate for the vision I believe in, but I want to convince you with facts not smoke and mirrors.
Enough background, let’s get started. This page will be a handy index to the several steps in the series. Roughly each week, another of these steps will become a hyperlink to the new post. Each of the posts in the series will take a deeper look at how this particular step in the cycle works. For now, here’s a quick overview to make the point. As I update the series each step will become a hyperlink to that more detailed explanation.
Development Cycle Step #1: The first step involves getting out into communities to see what properties are available, what areas might be good investments, and what the pulse of the community is for the development you have in mind.
Development Cycle Step #2: Once a developer identifies a property, she must figure out what she can build on it, how easy or hard that building will be, and what all the rules are with as much certainty as possible for reasons that become clear later.
Development Cycle Step #3: Once the property is identified and some idea of what’s possible is known, the next step is to try and tie up the property for a certain price. This can be an outright purchase or just a contract for the option to purchase at a certain price within a certain time. Usually a property owner will want some money for the risk of not selling the property
BONUS READING – The role of market conditions and risk: This is the first post separate from the development cycle series, but is necessary for anyone who really wants to understand building homes. Like planning for a child’s future or your retirement, these factors are always on a developer’s mind throughout the life of a project – and they have serious impacts on the type of deal the developer can even consider.
Designing the project is not just about getting a fancy architect to make a drawing or a set of plans. This step is actually much more about planning the scale of the project, how it fits into the given community, and the financial numbers for how much each unit can be rented or bought for, the cost of amenities, and lots of other decisions that make up “the design” of the project – or at least the initial design. Often this step involves paying someone to help think through these pieces and also having important consultants with design, finance, and legal training to understand what a feasible design might be.
BONUS READING – The Parking Problem: What’s really going on? A separate post outside the development cycle to help understand and think about what to do with parked cars and the impact on a project.
Once the property has been tied up and designed, the money necessary to secure approvals and actually build the project must be found. A developer has a range of options for securing the money, but she must have a good sense of what will be built to provide the funding source (e.g. a lender) with confidence that the money will be repaid.
BONUS READING – Developer Profit & Pro Forma Series: A series of simple tables to understand how changes impact a project
This is the step most people have some familiarity with because it is the part where community is likely to be involved. It can include getting community input and approval, working with the City to make changes based on what zoning and building laws allow, and ultimately getting approval to start digging.
Once a developer has secured all the approvals, she has a finite amount of time to start building before those approvals go bad. Also, since the meter is running by this point on the financing (see step #5, above), getting the construction professionals in place and working is really important.
The construction portion of the project is hugely important. If it takes six months longer than expected, or the price of steel shoots up, or some other problem emerges it can blow an entire project. Getting projects completed on time and on budget matters a great deal to building homes.
As the project gets close to construction completion, all the research a developer did in the early stage must be put to work to find people to live in the homes. For those in San Diego who saw the old, run-down Pat’s at 30th and North Park Way become the North Parker, you can imagine how important it was to find people willing and able to afford the rent needed.
BONUS READING: The affordability interlude – Why does housing need to be affordable and attainable? In this separate post we’ll examine why it even matters that housing be affordable at various levels. I will also help people understand that “affordable” doesn’t necessarily mean making Clairemont the same price as Azalea Park, it means that there are homes at varying price points that are legitimately affordable based on the incomes San Diego businesses can afford to pay. And, for reasons I will explain, sometimes it means making a certain amount of homes even in luxury areas affordable for blue collar workers to live nearby.
The short-term construction financing I mentioned in the glossary has to be replaced with long-term financing. And this step explains what happens as the homes are filled up and a development project comes to a close – at least when everything works as it should.
I hope the above overview was helpful. Over the next several weeks, I’ll expand on each of the above steps in separate posts. My goal is for members of communities and staff who work for elected officials in San Diego to have a meaningful working knowledge of how housing gets built, what the cost factors really are, and to give a way to think about what’s going on with projects in your communities.
The dreaded “law” of supply and demand
The land in the City of San Diego is more expensive than the land in rural Arizona. There are several drivers, but the most important of these are:
- Boundaries. San Diego has the ocean to the west and the international border to the south. This is an immovable constraint on the amount of land on which we can build homes.
- The weather and the beach. Let’s be honest, people born here (*raising hand*) rarely want to leave or stay gone and people who move here are generally not interested in moving along. A growth rate of people that is higher than the growth rate of homes drives up prices. Relatively speaking, Tucson has much less of a problem here.
- People like having kids. Much of our growth comes from people who are already here having children. If two people have (or adopt) two children, they’ve doubled the residency without adding to the housing supply.
- BIG OVERLOOKED FACTOR: Single people with money and DINKs (Dual Income, No Kids)/Empty Nesters are a big, emerging factor in housing issues. I got in an interesting discussion with an engineer friend named Carl. He pointed out that the actual data for the North Park community shows a net decrease in population over a 10-year period but an increase in households! How can this be? My wife and I bought a house previously occupied at one time by a family with kids. And our older friends from out in suburban places like Rancho Bernardo and Scripps Ranch have raised their children and can now move back to fun neighborhoods like North Park. Plus, ya know, tech. If you don’t mind the drive, you can afford to occupy a whole house in North Park and work up in the Golden Triangle even as a single person.
Most people know that it costs more to live in San Diego than outside of Tucson, but the above is an attempt to start to explain why that is. I hope you found this enjoyable and informative and that you’ll check back from time to time to learn more that you can apply to your community or to your day job or just for your interest. Have a great day!