For many, the way that housing is built can be mysterious: a developer acquires the land and wins city approval, then at some point construction workers break ground, and eventually the new housing becomes a reality. But what about all of the steps in between? What factors go into whether or not something gets built? And what does it even mean to make a project “pencil”?
If you’ve ever found yourself wondering about these and other real estate finance questions, then our latest Terner Center publication is for you. In our new brief “Making It Pencil: The Math Behind Housing Development”, we walk through the calculations that a conventional, market-rate housing developer goes through to determine the financial feasibility of a typical multifamily rental project, and how different policy decisions impact this equation.
While developers spearhead the creation of new homes, they generally do not use their own money. Rather, they leverage capital from institutions and investors. A developer must demonstrate to these financial partners that their housing development can achieve threshold return requirements, or else housing does not get built. But meeting investor thresholds is easier said than done, especially in the face of escalating costs and growing development complexity.
To illustrate the relationship between the cost to build and what financial partners require, we created a “prototype” housing development and “put it out to bid” in three Northern California markets—Oakland, San Jose, and Sacramento. These case studies allow us to examine what makes up the full cost of a new home—from land costs to consultant fees to parking requirements to operating expenses—and how these costs are reflected in eventual monthly rents for tenants. Our brief goes beyond these baseline pro formas as well, examining how common requirements such as inclusionary zoning, impact fees, and extra parking change the development equation.
The relationship between policy priorities, development costs, and project financing is often not well understood. Our goal with this brief is to demystify the development process so that those engaged in discussions on housing broadly—from policy makers to the general public—can understand how new housing gets built, and how different variables impact this process. As we grapple with the need to construct more homes in a manner that aligns with affordability, sustainability, and other goals, understanding how homes gets financed and built in the first place has never been more important. While this brief does not cover all forms of development (e.g., subsidized affordable housing, for-sale housing, single-family development) the overarching theme is universal: building a nuanced, accessible understanding of the challenges is essential to forming thoughtful approaches to reform.
As California continues to grapple with the devastating effects of the housing crisis, more attention is being paid to the rising cost of building new homes. The median home value in California has almost reached $550,000,(1) reflecting both the limited supply of homes as well as the high cost of development. In some cases, the cost of building affordable housing in California has topped $600,000 per unit, or more. Strapped for revenue, localities are increasingly turning to development fees to fund vital public services. In an effort to uncover paths to lower the cost of housing, the Terner Center has…
The Terner Center for Housing Innovation first became involved in discussions around rent control policy in California leading up to Proposition 10, the ballot initiative in 2018 (ultimately defeated) that would have repealed the Costa-Hawkins Rental Housing Act, the statewide framework put in place by the state legislature in 1995 to set limitations on local rent control ordinances. History tells us that the debate over Costa-Hawkins itself was a divisive and hard-fought battle. It’s no surprise that stakeholders and policymakers are having a difficult time finding a path forward today. In May 2018, after research and meetings with a variety…