Building housing is a business. Both non-profit or for-profit builders need to make some money to keep the operations going and get to the next project. To estimate whether a project is economically viable, they all use a document called a pro forma. It can get quite complicated, but at the simplest, it’s a spreadsheet that compares costs against revenue.
Housing Construction Site at 24 Webster Ave
There are two kinds of costs: hard costs (land, labor, and materials) and soft costs (mostly fees and interest). There is one main revenue stream: rents or sale proceeds.
To see how this works in practice, let’s take a look at the public data from the recently built 9-unit building at 115 Thurston St. The lot cost about $2.2 million. Based on the city’s Fiscal Feasibility Analysis, we estimate that construction cost about $250 per square foot, which brings hard costs to $3.2 million. Soft costs are typically about 20% of hard costs, so we can add another $0.6 million for a total cost of $6 million.
Note that those construction costs are highly variable, because they both labor and raw material costs are highly variable. Even a small percentage change in those costs can be enough to scuttle a project like this one.
Those costs are estimates, but because 115 Thurston St is a condo building, we can be more confident in the accuracy of our revenue calculations: the condos have been sold or are listed for a total of $6.4 million. That means the project could return a profit of about $400,000, or 6.7% of costs.
That may sound like a lot of money, but spread out over the 4 years from initial purchase to first sale, it comes to an annualized return of just 1.63% — worse than a money market or high-yield savings account. In other words, the Thurston Street project was probably only barely profitable.
The difference between what a builder can make in a safe investment and what they can make in construction is one of the biggest factors for lenders and developers alike. And that’s part of why today’s higher interest rate environment matters. Just like changes to the cost of labor and materials, a small increase in the cost of financing can tank a project.
You can dig endlessly into every aspect of a pro forma, from profit projections to parking demand management to shared utilities, janitorial services, and even laundry (every shared laundry room has both cost and revenue estimates). Some folks spend their entire careers just doing the nitty gritty detailed work of pro forma for home building.
Even with all these complexities, we can learn from real examples of how housing gets built and start to understand how to unstuck ourselves from our housing shortage. At the end of the day, it’s important to remember that building homes is a job, and the people who do it need to get paid just as much as you do.