Why developers prefer to build luxury apartments

|

Here’s a question that’s been popping up all over the place: Why do developers only build apartments for the rich?

The answer, as with most things in our business, is in the math.

Imagine you can buy enough land to build 10 units for $1MM, or $100,000 per unit.

Let’s say you have two options:

  1. Build 10 “workforce” apartments of 800 sq ft at a cost of $200 / sq ft that will rent for $1500 each; or
  2. Build 10 luxury apartments of 1000 sq ft at $250 / sq ft which will rent at $3000.

Here is the per unit math for Option 1:

  • Buy land for $100k
  • Build apartment for 800 sq ft x $200 / sq ft = $160k
  • All-in for $260k
  • Annual rent of $1500 x 12 = $18k
  • GRM of 14.4x (eg terrible)

Here is the math for Option 2:

  • Buy land for $100k
  • Build apartment for 1000 sq ft x $250 / sq ft = $250k
  • All-in for $350k
  • Annual rent of $3000 x 12 = $36k
  • GRM of 9.7x (eg awesome)

What’s going on is that, at any fixed cost per unit of land, you’re almost always¬†better off building bigger, more expensive units. So, as long as land is hard to find and expensive, that’s what developers will do.

If you want developers to build housing for middle and lower income people without being subsidized, then you need to up-zone neighborhoods. By increasing the supply of buildable land, you decrease the per unit land cost. Then, once developers saturate the luxury market (because that’s still where the highest margin is), they will move on to saturate the middle and (possibly) lower income markets.

Share