11/4/24, 9:40 AM 6 Things to Know About How Development Works

6 Things to Know About How

Development Works
Daniel Herriges · September 16, 2020

Depending on the circles you

travel in, the word "developer"
may elicit a strong reaction in you.
Maybe you hate and mistrust
them; maybe you see them as
enterprising risk-takers improving
your community; maybe you are
one. (If you are one, this article is
probably not for you.) Americans Photo by Aditya Chinchure on Unsplash

have strong opinions about real-

estate developers as professions go, to the point where academic research
has even found that one of the strongest predictors of how opposed
people will be to a new building in their neighborhood is whether they
think a developer is going to make a profit from it.

There is, however, a lot of misunderstanding about what developers do

and how their business model works. Here's a super-dumbed-down, 101
guide to six things you want to understand if you're going to have
informed conversations about development in your community. (This
article will focus on housing, but note that some of these apply more
broadly to retail, office buildings, or any sort of project.)

1. "Developer" is a broader category than you think.

Who builds new homes in your community?

Who built the oldest homes in your community?

https://www.strongtowns.org/journal/2020/9/15/6-things-to-know-about-development 1/11
11/4/24, 9:40 AM 6 Things to Know About How Development Works

Who built the home you live in?

The answer to all of these is: a developer. By definition, development is

just any activity that increases the market value of a piece of real estate by
building something on it. There's a certain irony when community
activists decry "developers" as profiteering interlopers whose motives
stand in opposition to the purer, gentler interests of existing
neighborhood residents—since those neighborhoods must have at some
point been the latest new development themselves. (Daniel Kay Hertz
memorably calls this the "immaculate conception theory of your
neighborhood's origins.")

But it is true that the category of developer used to look a lot different
than it does today. In "The Rise, Fall and Rebirth of the Triple Decker," the
New England Historical Society explores that region's iconic triplex
houses. All over Massachusetts and Rhode Island in particular, starting in
the late 19th century, triple-deckers were erected by many hundreds of
manufacturers, "mill owners, small builders and carpenters." The ante
required to be a developer of a single home on a single lot, or a small
cluster of homes, was simply not that great, and with vernacular
architecture and passed-down building techniques, it didn't have to be
your primary career.

The "developers" of the day—if they even used the term—were a far cry
from the industrial-scale homebuilders of today like Lennar or Del Webb.
The Suburban Experiment, with the rise of whole neighborhoods built to
a finished state, has changed the face of development and what we expect
a "developer" to be.

2. The cost of building sets the floor under the price of a

brand new home—and it's not cheap.

The most common misguided

refrain I hear in debates about
housing affordability is the
following:

https://www.strongtowns.org/journal/2020/9/15/6-things-to-know-about-development 2/11
11/4/24, 9:40 AM 6 Things to Know About How Development Works

The problem is that these

developers aren't building any
affordable homes, only luxury.
They need to build homes that
working-class people can afford.

Imagine if we asked the same

thing of Ford or Toyota. "You have
to sell a brand new Escape for
$5,000, because that's the most
many of our working-class
customers can afford." Of course,
Ford won't do that, because the
Escape costs more than that to
make.

We don't as often apply this logic to housing, I suspect, because many

people have very little sense of the actual cost of building a house. We
know there are cheaper houses in our communities, so we assume new
houses could be that cheap if the developer were willing to forgo a bit of
profit. In reality, the "used" house is much like a used car—it can be much
cheaper than the cost of creating it in the first place, because it's already
there and it is merely changing ownership. The theoretical floor on the
price of a “used” home is zero.

A new house, however, will never be cheaper than the cost of creating it.
Not without some sort of subsidy, since nobody's going to build at a loss.

3. Even nonprofit developers have a "floor" unless

subsidies are involved.

The exact same "floor" logic applies to nonprofit developers, like those
that build dedicated affordable housing. A nonprofit may not expect a
return on their investment at the end of the day, but they still have to be
in the black. If they spend more money than they bring back in, they won't
be able to keep building homes for very long.

https://www.strongtowns.org/journal/2020/9/15/6-things-to-know-about-development 3/11
11/4/24, 9:40 AM 6 Things to Know About How Development Works

These are 2017 estimates, courtesy of the Government Accountability

Office, of the median per-unit cost of building subsidized homes for low-
income residents in various markets across the U.S. This is the actual cost
to build, not the price to the eventual inhabitant.

Here is a 2019 exercise by the Terner Center at UC Berkeley in modeling

the construction cost—which, again, is the bare minimum sale price if no
subsidy is involved—of affordable housing in Northern California, for
many reasons one of the costliest places to build:

https://www.strongtowns.org/journal/2020/9/15/6-things-to-know-about-development 4/11
11/4/24, 9:40 AM 6 Things to Know About How Development Works

4. The rent on new apartments pays the cost of building

them.

Here's the development business

model in a nutshell. On the left are
the expenses associated with
building:

• Buy the land

• Pay for the architect, legal

fees, permitting fees,
marketing, etc. ("Soft Costs")

• Pay for the actual construction, landscaping, electrical, plumbing,

HVAC, etc. ("Hard Costs")

• Pay interest on your construction loan

On the right are the two main sources of financing for development:
equity (that is, cash the developer or any investor partners put forth) and
debt—that is, a loan.

https://www.strongtowns.org/journal/2020/9/15/6-things-to-know-about-development 5/11
11/4/24, 9:40 AM 6 Things to Know About How Development Works

If you're building rental homes, the way you pay off this loan is through
the rents you bring in after the building is occupied. There's nuance I'm
leaving out—often some fancy refinancing is involved, for example. But
the bottom line is that the rents on a new apartment building are how its
construction is paid for. And this sets a floor under them, much like
there's a floor under the sale price of new for-sale housing.

The rent coming in must cover the following things:

• The cost of operating the building

• Capital reserves for bigger maintenance needs, like an eventual roof

or HVAC repair

• Debt service, i.e. paying off the construction loan

• A debt coverage ratio, or a buffer in case of vacancy or higher-than-

anticipated expenses. The bank demands to see this ratio before they
authorize a construction loan, so they know the borrower won't be
likely to default.

So again, the problem with saying, "Nobody can afford the rents on these
swanky new apartments; they need to set the rent lower!" is that it doesn't
ask whether the developer can actually afford to set the rent much lower
than it is. Perhaps surprisingly, the answer—for brand new construction—
is often no.

Again, older, existing buildings—even just a little bit older—are an

entirely different ballgame. Because they already exist, the cost, like that
of a used car, depends only on what a buyer is willing to pay and what a
seller is willing to accept.

5. The price of land depends heavily on its development

potential.

Stop me if you've heard this one before:

Housing is expensive in cities because the land is so expensive. Dense

development is more affordable because it splits that land cost many ways.

This isn't completely false. But it's a simplification. Here's why:

https://www.strongtowns.org/journal/2020/9/15/6-things-to-know-about-development 6/11
11/4/24, 9:40 AM 6 Things to Know About How Development Works

Imagine you own a vacant lot, and you are approached by two developers.
One wants to build a single-family home like the one pictured on the left
below. The other wants to build an apartment building like the one
pictured on the right.

Which developer do you think can afford to pay you more for the lot?
Whose offer are you going to accept?

This thought experiment demonstrates that the price of land is affected

heavily by its development potential, because that affects what a buyer
can afford to bid. If you upzone land to allow more density, you've just
made it more potentially profitable. And the price will rise accordingly.
(But, it's important to say, usually less than proportionately. And so it's
still true that density tends to mean lower land costs per housing unit, just
not lower overall.)

6. Developers don't tend to make huge windfall profits.

Land owners do.

There's one more important corollary of the point about land costs
above.

Suppose Developer X and Developer Y both have their eye on the same
vacant lot. X has a project in mind that will deliver an 8% rate of return
(think: profit margin) if she can get the land for $100,000. Y is greedy and
wants a 20% rate of return—but to make this kind of profit on his project,
he needs to pay no more than $40,000 for the land.

https://www.strongtowns.org/journal/2020/9/15/6-things-to-know-about-development 7/11
11/4/24, 9:40 AM 6 Things to Know About How Development Works

Who is the land owner going to sell to? Clearly X, not Y.

In general, in a strong market, a patient seller of land (or a redevelopment

site, like a gas station that can be torn down) can hold out for the highest
bidder, and not accept a lowball offer. This means that the land owner can
bid up the price to just about as high as it will go while still leaving some
sort of construction viable.

To reiterate: it is very difficult in a competitive market for a developer to

reap a windfall profit, because another developer who's willing to settle for less
profit can just outbid them for the same plot of land.

Who actually pockets a huge profit in this transaction? The land owner
who sells to the developer.

This is important to understand when asking who benefits from high land
(and thus housing) prices in cities. It's a myth that it's predominantly the
"greedy developer" who does. The most reliable beneficiaries of high
prices are land owners: specifically, those who bought property cheap
years ago and have been sitting on it for a long time. (And this includes
homeowners who sell to other homeowners, not to a developer at all.
Homeowners are in fact, numerically, the biggest land speculators in cities
and often the primary beneficiaries of a growing economy that drives
rising land values.)

This article isn’t meant to paint developers as either virtuous or

villainous. The reality is, they’re business people, and if you want to
influence what they do, it helps to understand how their business model
works.

You May Also Like

https://www.strongtowns.org/journal/2020/9/15/6-things-to-know-about-development 8/11
11/4/24, 9:40 AM 6 Things to Know About How Development Works

These Cities Recently The 30-Year Mortgage No One Left Behind:

Passed Parking Reforms Was Bad. The 40-Year Nondrivers Are Facing
(and Yours Can Too) Mortgage Will Be Even the Housing Crisis Too
We’ve assembled a guide to three Worse. Greenfield development may be
towns and cities of varying sizes The Federal Reserve just cut appealing to people who are
that have recently revised their interest rates. Some people are fighting the housing crisis,
parking regulations. That way, celebrating the move as making especially on cheap rural land.
when you decide to pursue housing more attainable, but it's But if these developments are
parking reform in your own really just reinforcing the the only places with housing
community, you can use them as housing trap. Need proof? Look affordability, people who can't
examples of how parking reform no further than the 40-year drive — whether due to age,
strengthens cities. mortgage. disability, or finance — are out of
luck. That's not a real solution.
Oct 9, 2024 · Ben Abramson Sep 23, 2024 · Charles Marohn
Aug 16, 2024 · Anna Zivarts

Daniel Herriges
Daniel Herriges has been a regular contributor to Strong Towns since
2015 and is a founding member of the Strong Towns movement. He is the
co-author of Escaping the Housing Trap: The Strong Towns Response to the
Housing Crisis, with Charles Marohn. Daniel now works as the Policy
Director at the Parking Reform Network, an organization which seeks to
accelerate the reform of harmful parking policies by educating the public
about these policies and serving as a connecting hub for advocates and
policy makers. Daniel’s work reflects a lifelong fascination with cities and
how they work. When he’s not perusing maps (for work or pleasure), he
can be found exploring out-of-the-way neighborhoods on foot or bicycle.
Daniel has lived in Northern California and Southwest Florida, and he
now resides back in his hometown of St. Paul, Minnesota, along with his
wife and two children. Daniel has a Masters in Urban and Regional
Planning from the University of Minnesota.

https://www.strongtowns.org/journal/2020/9/15/6-things-to-know-about-development 9/11
11/4/24, 9:40 AM 6 Things to Know About How Development Works

Strong Towns Comment Policy

Be thoughtful, kind, and generous of spirit. Got it
Please read our Comment Policy before commenting.

14 Comments 
1 Login

Join the conversation....

LOG IN WITH OR SIGN UP WITH DISQUS ?

Name

 4 Share Best Newest Oldest

Joh Smith − ⚑
4 years ago

A few additional points that are of lesser importance than the ones raised above yet
nice to keep in mind.

When people complain about the added cost of all of the "luxury" extras put into new
b ld h ll h h f h l

PREVIOUS

For City Planners, Community Consensus Shouldn't Be

the Standard
NEXT

New York Isn’t Going Anywhere, and Neither Are Cities

https://www.strongtowns.org/journal/2020/9/15/6-things-to-know-about-development 10/11
11/4/24, 9:40 AM 6 Things to Know About How Development Works

Get Involved Resources About Site

Become a Member Books About Us Privacy Policy

Sign Up for Emails Action Lab Team || Advisory Comment Policy
Pitch a Story Blog Roll Board FAQ
RSS Feed Shop Employment Search
Press Contact Us

Strong Towns is a 501(c)3 non-profit organization. Our work is

performed under a Creative Commons Attribution-ShareAlike 3.0
Unported License. Please share with others to use for good.

https://www.strongtowns.org/journal/2020/9/15/6-things-to-know-about-development 11/11