Affordability Pie

Our default scenario involves a small developer who buys a (60′ x 120′) plot of land for $72k. Sure it might be a subdivision of 200 plots of land, but for the sake of the ultimate buyer, we consider the single plot as the basis of our subsequent layering of costs. The developer isn’t going to use their own money, so the carrying costs of financing the purchase should be profitable terms so that ultimately appreciation exceeds carrying costs. We assume 8% appreciation over a 20 year term, and financing at 2%. The Developer has soft costs to develop this plot, or subdivision, which we set at 30% of the cost of the land, and then there are Development Cost Charges, which we set at $40k per plot. Then the Developer has to pay Capital Gains on the appreciation, and Land Transfer Tax (LTT) at the point of sale to a Builder (or owner), we’ll see the tax man visit us all along the chain. Ultimately the homebuyer pays a cascading series of taxes and taxes on taxes, borne by others, but ultimately passed down to them in the sale price of the home. In our example, our $72k property is sold for just over $250k to the Builder. (In many cases the Builder is Also the Developer, or sometimes the Owner, but not in our example).

So our builder purchases this $250k ‘improved lot’, but still needs to service it, design the home, get permits, and build the thing. We assume a 2,500sf home (you can make it any size you like). The build quality is set at $450/sf. That may sound crazy, but this is the average rate in Q4 of 2023* and it includes soft costs like drafting/architecture fees, building permits, utility hookups and builder Profit and Overhead costs (Builder P&O). Generally Construction Costs can be roughly divided into three ‘buckets’, namely; Materials, Labour and P&O. We also add a slider for Energy Performance, because while small improvements have a low capital cost, they can save tens and even hundreds of thousands of dollars over the term of any owner’s ownership ($350k in energy costs alone in our example over 30 years). So the cost of our 2,500sf home, offered for sale by the buyer, is now ~$1.56mln. It adds up quick, but we’re nowhere near done.

*Average Construction Costs taken from RLB Q2, 2023 Index for the GTA market for SFR housing.

Canadians love moving houses. Or maybe they don’t, but stats show that we do this at least every 7 years*. That means we incur the transactional costs of buying and selling real estate at least a few times in our lives. Retired lawyer Tim Hyde has estimated these ‘transactional costs’ at over $100k for the average home in Canada. Remember, these costs don’t add any value to the asset, they are simply the cost of transacting. We set the realtor commission at 5%. Then there are all of the other little transaction-related costs, but they sum up to nearly $105k per transaction – and yes, this same group of costs occur at every sale of almost every house.

*https://www.theglobeandmail.com/investing/personal-finance/household-finances/article-do-canadian-home-owners-really-move-every-seven-years/

Here’s where things get crazy. Financing the purchase of a home is a necessary evil for most Canadians. So if we take our $1.5mln, perfectly ‘average’ 2,500sf home, and we make a 20% downpayment on it, that leaves us to finance about $1.2mln at a rate of 4% over 30 years. Good luck getting that rate in 2024 by the way. And we don’t have ‘fixed’ 30 yr terms in Canada, you have to be an American to get that kind of deal from a Canadian Bank. We have stated terms of 30 years but every mortgage renews after 5yrs, so really, we should be talking about 5yr mortgages. The cost of interest we pay, and Mortgage Insurance, and Realtor fees (generally paid from the mortgage), and we can see we’re nearly doubling the costs of our $1.5mln home, with roughly $1.4mln in finance and finance related costs. Eventually, when the homeowner sells, many of the same capital gains and LT taxes apply again – exemptions notwithstanding.

Depending on the TEUI or the level of efficiency the Builder targeted in section B above, the owner may be saddled with considerable energy costs over he 30yr. term of the mortgage. Combined with annual maintenance costs of 2-4% (recommended), and a property tax rate set at 0.66% of 60% of the value of the home (a rough approximation of an MPAC evaluation, we won’t even attempt that voodoo math beyond guessing) and you see the annual burden of costs we all need to pay. Our scenario here paints a bleak picture, where after a mortgage is fully paid, we own a home, having spent a grand total of $4,566,909.65. Will this home every represent an equity value of this much money, when re-sold again? When one considers continued inflation, it is hard to imagine a home built in 2054 will const anywhere near as little as $4.5mln. It may well be 10 to 100x as much – who can know for sure?

Costs to the owner or landlord in terms of annual maintenance costs are rising, and many owner/landlords newer to the business see this as negatively impacting their ‘profit’ and so many are opting out of maintenance altogether. The effect of this is that buildings become run down and fail prematurely. This can result in a series of cascading failures, ie. a roof that leaks, causes rot in a wall, undermining the whole house while creating a mold problem, requiring remediation/evacuation and possibly demolition. The term ‘slumlord’ is well-deserved, but a similar term could to a homeowner that neglects maintenance also. This is a tragic waste of resources because the cost of building new both in dollars and in carbon and energy impacts is so much higher than simply maintaining what has already been built. This initial perceived ‘savings’ of maintenance costs, over the long term, can bankrupt an owner or landlord who then has to sell their property at a loss or for the value of the land only without a building. This makes a strong case for designing for enhanced durability and reduced maintenance from the outset, as well as considering routine maintenance as a fundamental measure of asset and value protection.

We have colour coded the pie chart sections corresponding to where the costs increase equity (Green), where the costs are just the price of doing business (Blue) and where costs are related to Taxes (Red). What is surprising is that Taxes are not as high as we had expected. The Blue sections are the areas that do not directly add value to the Homeowner/Landlord, but generally represents services that tend to enrich others, the most pronounced cost is mortgage interest, where every fraction of a percent adds significant cost over time. To be fair to the banks, we have not included a 30yr. appreciation of the asset itself, but we plan to add that in a future calculation (links to BoC investment calculators are provided below). The problem is, if a building is designed with a service life of 30 years, and this building is not maintained, it may not appreciate as expected and the residual value after the mortgage is amortized may be substantially lower than the value of a new building. This is what we term ‘demolition by neglect’ and should serve to emphasize the importance and necessity of regular and thorough maintenance, or the value of the asset can be lost.

Commentary pending. Over 1,000MTCO2e is emitted from the ‘average’ (StatsCan) home, with electricity as the primary energy source (gas or oil would be on the order of 6x worse) with a TEUI rating of 203kWh/m3/yr. This equates to the death of one human being per 1,000MT over the service life of the asset per: https://news.westernu.ca/2023/08/climate-change-human-deaths/. It is possible to reduce CO2e operational emissions to zero over the life of the building with on-site renewable energy production and storage, however First or Embodied Carbon emitted from the extraction, manufacture and transport of construction materials remains on the order of 150-600MTCO2e per 2,500sf of area built, and this will not mitigate until we see embodied carbon targets embedded into our building codes, such as in the codes of most EU member nations as of January 2023 (ie. Denmark’s BR18).