Builders walk a fine line between profit and loss, with you in the middle

If you are one of the thousands of men and women who look at the price of today's condominiums and suspect it is the greed of developers that is driving prices up, you would be dead wrong.

Yes prices can take the breath away. They range, on average, from $297 a square foot in Thornhill to a whopping $990 in the area's most sought-after location — Bloor-Yorkville.

Yes, developers do indeed make admirable profits if a project goes well — an educated guess suggests anything from 15 per cent of the total cost and up. But the experts argue they have to make that substantial profit in order to justify the enormous risks involved and a time frame that often extends to five years.

Developing a condominium is in many ways a crap shoot. If the market turns sour, if construction delays slow completion, if the economy slides into one of its regular troughs, you can go broke.

But if you want to identify one of the major reasons costs are certain to climb, look towards city council, suggests Niall Finnegan. He is president of operations in the cost consulting unit of The Altus Group Ltd., the company that does the number crunching for a good many of the city's top projects.

"You don't set prices by looking across the street and see what Jimmy is charging," he says. "You base them on three main factors: Land, construction and soft costs."

Soft costs, in effect, cover everything but land and construction — the money spent on marketing and sales, legal fees and especially on all those municipal levies to cover taxes, sewers, utilities hook ups, development charges, school levies, parkland fees and a host of others.

"Those soft costs can account for anything from 35 per cent to 60 per cent of the total costs of the project and the fastest rising component of them is municipal levies," he says. "The level to which they have risen is posing real concern for the whole industry.

"In fact, they are starting to impede the ability to go ahead with some projects at prices the market can bear."

So, all that said, just how do developers decide what to charge?

It is not like setting a price for most goods and services, says George Carras, president of RealNet Canada Inc. In most industries you take a bottom-up approach. You look at your costs including raw materials, labour and marketing plus a host of various factors, then tack on the profit you figure you need on your investment and arrive at a price to charge customers.

If that selling price is lower than the competition, terrific. You have a competitive advantage. If it is higher you either take another look at the costs and profit or find a way to make customers believe the premium price is justified.

"In the condo industry you do that, but at the same time you have to take a top down approach as well," Mr. Carras says.

Eve Lewis, president of Market Vision Real Estate Corp., explains it this way: "You start with the piece of land you want to build on," she says. "You look at the zoning and then work out what you can build on it — how many units of what size.

"Then you look at what else is for sale in the surrounding area. You look at things that might allow you to charge a premium for your suites such as being right on the subway line, the views, all that good stuff.

"That gives you your total revenue."

Then you number crunch to create what is known as a "pro-forma"; a balance sheet that lists all those hard and soft costs — not just what they might be now but also what they are likely to be by the time you get around to building the project as well, she continues.

Take costs away from projected revenue and you have the potential profits.

"I can tell you, given the risk involved, they have to be significant or a bank just won't give you the financing you need," she says.

In an effort to mitigate that risk and to reduce the time frame, developers offer their lowest prices right after they launch a project. The faster they can sell units, the faster they can start to build. The banks that provide the financing usually demand at least 60 per cent of the units be sold before they will provide the funds needed to break ground.

Then as construction starts the number crunchers constantly revise costs to reflect real time increases. Selling prices have to rise to cover them.

"Our accounting guys are always going nuts once we start work," says Christene DeGasperis, sales and marketing director at Aspen Ridge Homes in Concord. "They have to constantly adjust budgets to reflect increases in our cost of construction and materials."

For example, when Aspen Ridge started pre-sales at its Vü project at Jarvis and Adelaide, the selling price was $280 a foot. Now, with completion nearing and only about 10 per cent of the suites left on the market, the selling price is about $450 a square foot, she says.

Once construction starts, the risks rise considerably, points out Mr. Carras.

"Suppose you are at maximum cash draw from the bank and you run into construction delays," he says. "The meter keeps on ticking on the interest you are paying and every day there is a delay that means the ability to pay that interest — let alone repay the loan — recedes farther and farther into the future."

The same holds true if the project does not find a ready buyer audience. In the condo business, time is indeed money.

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