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Is ‘missing middle’ financially viable?

Studio North, Gravity Architecture and Part & Parcel won a competition to construct missing middle housing in Edmonton.

Cities across Canada are exploring the missing middle as opportunities to welcome more homes and people in their communities. The term “missing middle” refers to multi-unit housing that falls between single detached homes and tall apartment buildings. It includes row housing, triplexes/fourplexes, courtyard housing and walk-up apartments. These housing forms are considered “missing” because they have been largely absent from urban streetscapes in Canada, including Winnipeg.

As planners working with the City of Edmonton, we too, are seeking to enable medium-density development in the city’s older neighbourhoods. Edmonton’s official plan, the City Plan, envisions a growth of over one million people by 2040, and will be up for public debate in fall of 2020. The City’s Infill Roadmap, which articulates a series of actions to enable medium-scale infill, is also in effect from 2018 to the end of 2021. What both of these policies and initiatives demonstrate is Edmonton’s interest in increasing housing choices, particularly in the missing middle housing range.

But does this development orientation align with industry and consumer demand? Planners and city-builders across the nation have questioned whether households prefer mid-rise housing, and if builders see these housing typologies as more profitable than single-detached or high-rise residential buildings.

Launched in 2019, Edmonton’s Missing Middle Infill Design Competition encouraged conversations around infill and helped the public and development community envision design possibilities — inspiring builders, developers, and architects to work in collaboration on medium-scale housing proposals.

The competition solicited and reviewed design proposals that considered how the missing middle (or medium-density housing) might work on a site of five lots owned by the City of Edmonton. The winning team, adjudicated by a national jury of architects, would be given the opportunity to purchase the site and build their design. The City of Edmonton, in its communications, articulated how it might support the winning team through the development process, inclusive of the rezoning, development permit, and building permit stages. The City of Edmonton envisioned the design as serving as inspiration and a prototype for further missing middle infill development throughout other parts of the city.

The winning proposal, named The Goodweather, is designed to bring together different demographics and generations with a variety of typologies grouped around a central communal courtyard.

Nearly 100 renderings and 30 pro formas, representing more than half a million dollars of architectural design work, were received from Edmonton, Calgary, Winnipeg, Vancouver, and Seattle, in addition to preliminary registrations from London (UK), Regina, Hamilton, Toronto, and Oklahoma City. The first-place winning design, The Goodweather, by developer Part & Parcel, builder Studio North, and Gravity Architecture, won because it was a good fit for the site, was considered likely to be successfully built and sold, and because its design could be reproduced on other sites. The Goodweather presented a well-conceived courtyard space, and situated its buildings close to the sidewalk — enhancing opportunities for interactions in the public realm. The Goodweather arranged existing housing typologies into a new, exciting configuration that hopes to bring together many demographics and generations into one pocket community. In total, there are 56 dwellings: 14 townhouses designed for young families, 21 single bedroom loft dwellings for students and young professionals, and 21 ground level dwellings designed for seniors. There are 14 single car garages and 6 guest parking stalls, all accessed from the alley.

Applicants to the Missing Middle Infill Design Competition were required to provide a pro forma. This is a document that shows how a development will spend, and make money. A pro forma ignores design and marketing language and gives the “brass tacks” of a project. It answers the critical question: “how much profit will this project produce?” Creating a pro forma requires a lot of assumptions about what materials and labour will cost, how people want to live, and what they will pay for real estate. The assumptions behind the numbers reveal some of the logic of real estate development.

By reviewing the thirty pro formas submitted to our design competition, we sought to answer three questions as part of an analysis on the financial viability of missing middle housing. What do the pro formas from the Missing Middle Infill Design Competition tell us about the most financially-feasible low and medium infill forms? What do the estimated profit margins tell us about the risks applicants see with building infill? What funding sources and financing structures are typical for infill development and how do these differ from greenfield?

The second-place submission by Leckie Studio Architecture + Design is a variation on the stacked townhouse typology.

What the numbers say

With land value held constant across all projects, the average profit margin for an apartment and row house is identical (11% of revenues). To test the impact of land value reductions, the land value was reduced by 25% for row house and stacked row house projects. Cheaper land makes row housing more profitable than apartments (15% vs 11% profit). Based on the data available for this study, row housing can be competitive with small apartments.

Submissions to the competition offered innovative building design and construction solutions, including mass timber prefabrication and factory assembly, and modular units that could be contracted or expanded to respond to the needs of the user and to site constraints. While these innovative techniques influenced the design of the buildings, none of them created a real edge when it came to estimates of construction costs. This means that developers are interested in innovation (at least in a public design competition), but do not expect these to cut costs.

Nine of the twenty-two projects evaluated proposed rental apartments. Three of these were among the most profitable developments (ranking first, second, and ninth). The remaining six rental projects were the least profitable of all projects. The average profit margin was lower for rental projects than for condominiums (7% vs 13%). However, maximum profit margin for rental projects was comparable to the maximum for condominiums (34% vs 32%). Overall, the financial data suggest that there is not currently a clear advantage for building rental or condominium projects, and that considerations other than pure financial return influence the developer’s choice.

Every developer will set a minimum acceptable margin that depends on what investment options they have and the risks involved. The most common margin used by policy makers, however, is 15%. The average profit margin for this site was only 11%, meaning that for most developers, it is hard to put together a successful project.

A checkerboard proposal designed by SPECTACLE with RedBrick won third place.

With profit margins so low, what can we say about project risk? We might assume it means that developers think infill is a slam dunk, and so they are willing to take a small return. However, when you look closely at project inputs like rent per square foot, construction costs, and condo sales timing in a slow Edmonton market, this does not seem reasonable. In fact, we found more evidence of aggressive targets (or wishful thinking) in the pro formas than conservative estimates. Would you pay $1,900 a month for an 800 square foot apartment in Edmonton? Or spend $380,000 on the same apartment, before condo fees? Would you spend $14 million on an apartment building that would earn you $670,000 annually?

Greenfield development can be done at scale and reproduced over and over, and with little engagement cost or risk. High-rise development is large enough to produce its own efficiencies through scale, and to attract investment from pension funds. Missing middle infill development never gets the scale, the momentum, or the attention to make it an easy win.

What the industry says

To accompany our pro forma analysis, we invited architects, builders, and developers to share their perspectives and assumptions around profit and risk for medium-density housing, and associated financial and regulatory barriers.

Applicants to the design competition perceived their participation as a worthwhile venture and investment because of the opportunity to build their proposal. In fact, the ideas that developer-architect teams explored are, in many cases, being explored for other housing projects. The Missing Middle Infill Design Competition helped to expand our knowledge of what scale of density is preferred and reasonable for the missing middle in Edmonton. Participants noted how the design competition was an opportunity to test new design concepts, and to potentially challenge the City’s current regulations with new innovations.

Our interviews also revealed that members of the industry perceive land values as a challenge to making pro formas for medium-density housing viable. Municipal government affects land value primarily through the development rights (zoning) granted to each parcel. We typically expect that adding development rights will also increase the value of land. The land in the competition was priced at for low-rise apartments, but some projects proposed lower density development, like row housing. These projects could expect to acquire land with less permitted density for lower cost in an open market, as long as upzoning is not expected.

Builders, architects, and developers cited how servicing requirements need to be made clear so that these costs can be appropriately factored into their pro formas. Some of these participants made assumptions that since the competition was put forward by the City of Edmonton, that there would be leniency on permitting timelines and additional incentives to support the winning team’s advancement through the land development process.

The interviews illuminated how design features like amenity space and public space are potentially at odds with density requirements for developments to be profitable. While developers strive to include public space so that their housing projects can entice their intended user demographics, their pro formas did not perform well with them included.

The provision of parking was also seen as a significant expense. The City of Edmonton is exploring the possibility of removing minimum parking requirements, with amendments to the Zoning Bylaw scheduled for public hearing in 2020. If these regulatory changes were factored into the design competition, would the number of parking spaces put forward by architect-developer teams be reduced, and by what measure?

Several financing models were proposed through the Missing Middle Infill Design Competition. All projects require financing for construction, but some considered interesting sources of private equity, such as co-operative housing. All participants agreed that strong design is needed to maximize access to financing.

Given the nature of the design competition, all projects expected rezoning fee reductions or waivers, timely permits, and a positive neighbourhood response. While municipal fees were not a major project cost, interviewees indicated that the success of their proposal depended on minimizing delays and project uncertainty. Part of what made the competition desirable was that there was an assembled site, and the City of Edmonton was taking on much of the community engagement work, reducing uncertainty and timelines for proponents.

Scott Graham for Unsplash

Sharpening our pencils

The development of new housing can be complex and costly in the best of circumstances. When it proposes a new form in an old neighbourhood, it can be very difficult to put together a project that can please neighbours, satisfy regulators, attract buyers or renters, and convince banks and investors to put their money in.

So what lessons can we draw from the City of Edmonton’s Missing Middle Infill Design Competition?

We learned that developers and architects are creative and interested in innovating when there is support from regulators, like city planners, to do so. We learned that different infill designs are possible, and even competitive — rental apartments, condominium rowhouses, and even modular, stacking, expandable co-op housing can be viable on paper. If cities want row housing, they need to zone land for row housing and use those zones as a commitment to communities and developers to prevent price creep from pricing out desirable projects. Cities can use their zoning tools, along with long-range planning and engagement, to set community expectations and reduce uncertainty for all involved.

The pro formas tell us that most of the factors affecting real estate development are determined by the markets for labour, investment capital, and housing, which are outside of a municipality’s hands. However, interviews with developers reveal that supportive policies, regulations and proactive engagement can make the difference between a successful infill project, and a failure to launch. Cities seeking missing middle development—like Edmonton and Winnipeg—will need to work with local developers to understand the challenges facing infill in order to find effective solutions. Cities, now more than ever, are eager to sharpen their pencils, and get moving on this type of work. We are excited for the possibilities.

 

Jason Syvixay is an urban planner currently completing his PhD in Urban and Regional Planning at the University of Alberta. He has worked as the managing director of the Downtown Winnipeg BIZ, a planner with HTFC Planning & Design, and more recently, has joined the City of Edmonton to support the implementation of its Infill Roadmap. He has a passion for people and places, and engages in city building that listens to and empowers the community, builds knowledge and capacity, and works towards equity in urban places.

Sean Bohle is an urban planner at the City of Edmonton. He discovered a love for spreadsheets and financial models while completing graduate school at the University of British Columbia, and through subsequent consulting work on affordable housing development. At the City of Edmonton, Sean has worked on policies to provide affordable housing and community amenities from rezoning, and now leads the implementation of the Infill Roadmap.

 

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