The Development Process: Pre-Development

What follows is a brief sketch of the development process in the United States. In general, the process to deliver a unit of housing to the market is lengthy, fraught with financial risk, and can be quite costly. What makes it easier to overcome these barriers to entering the market? Not surprisingly, the answer is inflation. When housing is scarce, prices rise and rationalize the risks and the costs of investing in housing. This dynamic often locks housing inflation into an upward spiral. Regulation which adds risk and costs only aggravates this dynamic. Housing inflation can be managed more effectively by government if it consciously seeks to reduce the time and costs to deliver housing to consumers who need it.

It’s important to note that usually, many the steps I describe happen at the same time. That is, development is often not a stepwise process; many parts of the process are concomitant. A parcel of land might feasibly sustain dense development, but if the zoning is wrong it won’t work. So, housing producers must measure a broad range of quantitative variables from the general to specific before a project can start into entitlement and permitting.

What Happens First: Pre-Development

Assessing the Market

Like any other producer, a housing developer has to assess the market for her product. Is there demand for new housing? Where is that demand and when will it peak? What kind of housing do people need and want? What are they willing and able to pay for it? Are the rents and selling prices in the market enough to offset the costs of financing, land purchase, construction, and operating? And what is the regulatory environment like? How long will it take to get entitlements and permits? Before any new development can start, a housing producer needs to understand and answer these questions.

Assessing Demand: Employment and Job Growth

Housing producers need to know whether a market has enough demand to sustain investment in more housing. If available jobs are increasing, that trend is likely to increase population increase as new people arrive to fill job vacancies. A new job growth rate that is outpacing the rate everywhere else is likely to be experiencing a higher demand for housing.

The Opportunity of Rising Demand

As demand begins to outpace supply, prices for housing begins to rise. This is an opportunity not for gouging, but to offer a competitive price for people seeking housing in an increasingly crowded market. When job growth begins to soar, housing producers usually will begin investing in building new housing.

The Problem of High Demand and Low Rents

In a perfect world, as demand for new housing went up, producers would see that as an opportunity to buy land and build housing. In the hypothetical example above, But in some markets, especially rural markets or areas recovering from economic downturns, wages lag behind regional and global drivers of costs. Lumber and labor costs, for example, might be on the rise and while land is available, scarce materials and labor mean selling prices and rents go up as well. This creates a dynamic in which poorer communities can see housing prices grow rapidly and the gap between what people can pay for housing gets wider. Meanwhile, housing producers can’t build because they won’t see income to cover their costs.

Typology

What kind of housing do people need and want? In a bustling downtown neighborhood, smaller apartments might be in demand while in exurban areas demand for larger single-family housing might be on the rise. Each typology comes with different cost structures and regulations. Housing producers will have to persuade investors that they’ll get better returns building one typology over another, perhaps more reliable investment. In the early days of microhousing in Seattle, for example, finding financing was difficult because it was a newer product. Investors liked larger apartments. After some success, that trend shifted as investors saw less risk and higher returns.

Finding Land

Many people think that wealthy developers driving convertibles and wearing tasseled loafers drive around town snatching up property with cash. It doesn’t work like that. When job and population growth pick up, land markets become very competitive. If consumers prefer certain neighborhoods, money begins to flow into those land markets and prices for land go up. It’s essential for housing producers to find land before it goes into the open market and gets bid up, making projects more costly and perhaps infeasible for smaller builders. And the biggest problem is zoning; if demand for a particular kind of housing in a certain area is high but land is scarce, prices will “skyrocket” in those neighborhoods.

Zoning

In the context of pre-development, a housing developer will have to determine whether a specific parcel is “as of right;” that is, if the project makes financial sense, can it be built without any changes to use or variances from existing requirements. If it does require these kinds of changes, risk increases and so will costs to the consumer.

Financing

Once a potential project can solve for all these variables, it will have to find investors or borrow money. The vast majority of all new housing development for the market is financed, that is, it has money that has to be paid back over time. Before a project can even begin to enter the next phase, entitlement it will have to have money in place to pay for costs.

Next up: Entitlement