The Inside the Rent model is built upon a simplified development and first-year operating budget and relies on a series of assumptions, which we have researched, contrasted and vetted thoroughly with a wide array of industry professionals. The model first uses these assumptions to calculate the total development cost based on the options selected by the player. It then calculates the net operating income (NOI) required for the building, and adds operating expenses in order to solve for the necessary rent required for the building to be financially sustainable through its first year of operations.
The model initially assumes that full property tax payments are required and that no government subsidies are available. If the player’s selections do not produce a financially sustainable building, options become available to bring down the development and/or operating costs of the building using direct government subsidies or property tax relief, or just to accept a higher rent.
To build the financial model, we consulted on land costs with appraisers who track land sales transactions throughout the five boroughs, and we obtained construction and operating costs from developers who build for-profit and non-profit housing in neighborhoods across the city. Architects also helped us to understand the costs associated with different construction methods, as well as the rates of net/gross square footage and what are considered standard sizes for apartments. And lenders and underwriters provided valuable insight into the necessary cash flows required for a project to be financeable, in addition to verifying that the cost assumptions made in the model are realistic. We also verified these assumptions with government agencies involved in financing housing development to ensure that they are realistic.
We recognize that in creating this model, any assumption runs the risk of quickly becoming obsolete as market conditions can evolve rapidly. We also recognize that our assumptions do not necessarily hold true for every development, as site-specific factors can impact development costs substantially.
We are nevertheless confident that these assumptions are representative of the average development in New York City in 2015 and that they do not compromise the educational value we pursue. We aim to update these assumptions periodically to keep Inside the rent current.
A spreadsheet showing all the development and operating budget assumptions can be downloaded here.
DEVELOPMENT BUDGET ASSUMPTIONS
We used neighborhood choice to determine the cost of acquiring land to build on. The selection of neighborhoods was made balancing three criteria: geographic diversity, price diversity, and available comparables.
We obtained data on prices per buildable square foot in different neighborhoods from developers who have acquired land in the past year, as well as from appraisers who provided us comparables for residential sales transactions in those neighborhoods. The number of available comparables varied widely between neighborhoods, owing to the market desirability and/or site conditions and availability of different locations.
The range of prices was also significant within some neighborhoods. This can be explained by site-specific factors such as the shape of the lot, the presence of environmental hazards, or desirability and marketability of a specific location within a neighborhood. In order to control for these price variations, we used the median price per buildable square foot in most neighborhoods and rounded it to the closest multiple of $5.
Location is the primary factor affecting the cost of land, and like any other cost developers pass it on to renters when they build rental housing. All other factors remaining equal, higher land prices will result in higher rent.
The land prices used in the model are (per buildable square foot):
- Astoria: $150
- Bedford-Stuyvesant: $125
- Bushwick: $100
- Downtown Brooklyn: $235
- East Harlem: $130
- East New York: $60
- Harlem: $140
- Jamaica: $60
- Lower East Side: $550
- Long Island City: $215
- Morrisania: $35
- Mott Haven: $50
- Stapleton: $45
- Williamsburg: $300
Hard costs include the cost of materials and the wages paid to construction workers. One important factor which determines hard costs is the height of the building, because it affects the construction techniques that can be used. Typically, buildings up to 12 stories (mid-rises) use block and plank construction. Buildings with 13 stories or more (high-rises) require poured-in-place concrete, which is more costly per square foot.
A second important factor affecting hard costs are the wages paid to construction workers. Prevailing wages are set by the government and may be required because of government regulation or paid through voluntary agreements by developers. For years prevailing wages have been a point of contention within the industry, because they increase the cost of construction.
In our interviews developers quoted hard costs in the following ranges (all values are per gross square foot):
- Block and plank (standard market wages): $220-$275; $250 median.
- Poured-in-place concrete (standard market wages): $300-$415; $313 median.
- Block and plank (prevailing wages): $300-$400; $330 median.
- Poured-in-place concrete (prevailing wages): $375-$581; $440 median.
For each source, we also calculated the additional cost of prevailing wages over standard market wages and found a range of 30%-36%, with a median of 33%. Using standard market wages as a baseline and adding the 33% differential for prevailing wages yields a cost of $332.50 for block and plank, and $416.29 for poured-in-place concrete. The first is close to the median of $330, while the second is lower than the median of $440.
Although both methodologies are equally valid, we opted for the more conservative methodology that yielded lower hard costs. The resulting values in our assumptions are:
- Block and plank (standard market wages): $250.
- Poured-in-place concrete (standard market wages): $313.
- Block and plank (prevailing wages): $332.50.
- Poured-in-place concrete (prevailing wages): $416.29.
It should be noted that construction costs are not constant and that the differential between standard market and prevailing wages can vary over time based on supply and demand.
Our assumptions do not include a hard cost contingency to cover unforeseen expenses.
Soft costs are expenses associated with development, such as fees paid to architects, lawyers and banks in order to secure government approvals and financing. They can vary widely from project to project. For example, high-end buildings typically have more expensive architecture fees, but affordable projects can also have high soft costs due to the expenses incurred as a result of more complex financing sources.
In our interviews we obtained a range of soft costs from 16%-41% of hard costs, with a median of 28%. Our model assumes soft costs at 28% of hard costs.
TOTAL DEVELOPMENT COSTS
The Total Development Costs (TDC) is the sum of the land cost, the hard costs and the soft costs.
OPERATING BUDGET ASSUMPTIONS
YIELD-ON-COST & NET OPERATING INCOME
The model assumes that, after paying all operating expenses, the building yields an annual net operating income (NOI) of 5% of the total development cost (the yield-on-cost). It is from this amount that the developer services the debt and also takes a profit.
Making assumptions about the correct yield-on-cost rate is particularly difficult. Every project is financed with a different split of debt and equity, and the rate that will be accepted depends on the interest lenders charge on the debt and the return sought on the equity. This is further complicated by each lenders’ and investors’ opportunity costs and their perceived risk of a project.
The perception of risk between different neighborhoods is one particularly strong factor affecting the necessary yield-on-cost rate required for a developer to take on a project. Neighborhoods that are perceived as riskier places to invest will command a higher rate than neighborhoods perceived to be safer. In our interviews, we heard that the rate ranges from approximately 5%-7%.
But risk is in the eye of the beholder, and we could not reasonably assign different rates to the neighborhoods in our model without making value judgments about those locations and about investors’ appetite for risk. Instead we chose to assume a constant 5% yield-on-cost for all neighborhoods. In other words, the annual NOI after all operating expenses have been paid is 5% of the total development costs.
Operating expenses include the maintenance, staffing costs, utilities (including water and sewer charges), insurance, and management fees. They do not include taxes.
Our model allows the player to choose between two levels of building service: standard and full. Standard service includes the minimum staffing required to operate, and no special amenities. Full service includes a doorman and simple amenities like a gym and a common terrace, which increases the operating expenses.
In our interviews the operating expenses for a standard level of service ranged from $7.20-$8.23 per gross square foot, with a median of $7.36. The range for the full level of service was $8.00-$10.00, with a median of $9.00. Our model uses the medians of $7.36 and $9.00 per gross square foot for standard and full service, respectively. Many new buildings today offer more costly amenities, such as swimming pools and screening rooms, which naturally increase the operating expenses in those buildings above what we considered in our model.
The player can also choose to pay the building staff prevailing wages, which also increases operating expenses. The additional cost of prevailing wages increased operating expenses by a range of 15%-34%, with a median of 24% which is the figure used in the model.
Adding the operating expenses to the net operating income produces the income after vacancy.
Every building needs to factor in the income lost to vacancy. Vacancy includes the period at lease-up before apartments are rented, as well as periods of lost income during tenant turnover. Vacancy also includes income lost due to unpaid rent.
Interviewees reported a vacancy factor of 4%-5% of building income, with a median of 4.5%. Adding this vacancy factor to the income after vacancy results in the income before vacancy.
REAL ESTATE TAXES
In New York City real estate taxes for multifamily buildings are calculated through a formula that derives the building’s market value from the building’s income. Many new buildings in New York City today receive a real estate tax abatement, but these abatements phase out over time so developers must estimate what the real estate taxes on the building would be absent the abatement.
The estimates for real estate taxes ranged from 22.5%-30% of a building’s gross potential rent, and our model assumes the median of 28%. The gross potential rent is the total rent that would be collected if all units were rented, and we arrive at it by adding the real estate taxes to the income before vacancy.
NET SQUARE FOOTAGE ADJUSTMENT
Every square foot of the building incurs a cost to build and to operate, but not every square foot produces rental income. For example, hallways, stairwells, mechanical rooms and common areas cannot be rented, so their costs needs to be imputed to the apartments.
A buildings efficiency rate is the amount of square footage in the building that can be rented out relative to the total square footage of the building. Our sources stated that efficiency rates ranged from 67%-82%, with a median of 80%. This means that 80% of the building’s square footage produces rental income.
We divided the gross potential rent by 80% in order to arrive at the annual rent that needs to be charged per net square foot.
We assumed an 800sf apartment, which is the size of an average 2 bedroom apartment.
The land subsidy assumes that the land is transferred to the developer at no cost, or that government subsidizes the full cost of the land. The cost of the land is effectively $0.
The construction subsidy reduces the hard costs by 50%.
REAL ESTATE TAX ABATEMENT
The real estate tax abatement assumes that $0 are owed in real estate taxes in the first year of operations. The game is built on a first-year scenario only, so no assumption is made about the real estate tax liability in future years.
The cross-subsidy amount is calculated by increasing the rent 10% in some units (the subsidizing units), and distributing the total from this increase equally among the remaining units (the subsidized units). The increase is calculated on the necessary rent to cover costs given all the user’s choices, including subsidies.