1.4 Acres in Charlestown is worth Negative $73M -- Why Housing is not being built right now.
The public information gathered from this Boston Globe article, can tell us a lot about the current housing crisis and why it takes drastic public participation to put a shovel in the ground as a step towards solving the supply crisis. For the time being, land for development purposes is effectively worthless, and its implied value is negative. I’ll show you why.
The article cites the total project costs about $176.2m to build 266 units. Assuming that includes the borrowing costs related to the cottonwood loan and the operating deficiency it will take to lease up to full occupancy, that means costs of solely construction (excluding land) these days are roughly $660k to build one unit of multifamily.
At $660,000 per unit in total construction costs, using the current market required return on private capital of ~6.5% for ground up multifamily housing, a project costing $660k would need to yield a net operating income of roughly $43,000 per unit annually to hit those return thresholds. Assuming that operating costs are about 40% of total revenues we can back into what the rent per unit should be annually through dividing $43k by 1 minus the expense ratio (1 - 0.4). That comes to about $71,500 in gross rent per unit per year, or about $6,000 per month. That might be achievable for a 3 bedroom unit in Charlestown, but that is certainly not as a blended average across all unit types.
Layer in the cities 20% affordability requirements along with ~20% premiums for union labor and the market rate units have to carry even more of the revenue burden to maintain the blended yield. The math spirals quickly, but for now, we can ignore both of those for the purposes of this exercise because the reason why nothing is getting built right now lies much deeper than affordable requirements and even union labor premiums.
Working backwards from what the market will actually bear, we can assume a rent of $3,500/month per unit across all unit types blended, that seems fair if not a little generous when we remember we are not factoring in affordable units. At $3500/unit monthly, gross revenue is $42,000 per unit annually, and at a 40% expense ratio, NOI is $25,000 per unit. At a 6.5% return on cost (about market for private equity), the total project budget can be no more than $385,000 per unit. It sounds like we did some math wrong if you remember the total construction cost of the bunker hill project was $660k per unit, but that is precisely where the crisis lies.
With the required project budget for market rate returns roughly $275,000 below actual construction costs of $660,000 we have an implied value below $0 attributable to the land. Multiply that $275k gap across 266 units and you get an implied land value of negative $73 million. More simply, the land is beyond worthless from a development perspective, it’s actually an active liability preventing shovels from hitting the ground. A developer would need to be paid $73 million to take the land and produce a feasible project at market rents.
That negative $73m number is the clearest possible summary of why housing isn't getting built across the city.
So how did building F in the bunker hill redevelopment solve this? The development team assembled a best case scenario capital stack, and they took land out of the equation. The Boston Housing Authority (a public entity) who owns the land, and has for almost a century, contributed the land at zero cost. What would usually be one of the largest line items in an urban development budget, was contributed free, and as the math above shows, that still wasn't enough to attract private capital.
Again based on the public information from the Globe, we know that the total cost of the project was $176.2m, and the loan from cottonwood was $122m (70% of the cost) we can subtract the loan from the total cost to get an equity requirement of $54.2m. Of that The city's new “Housing Accelerator Fund” injected $50 million of equity, 92.5% of total project equity. The city is contributing public funding as equity and is almost certainly accepting a return on cost of 5% or below, 150 - 200 basis points below what private capital would require. I assume with near certainty that there is a tax deal/abatement to push the expense ratio down by removing taxes from the operating budget, but even that is still below market returns.
Of the total capital stack, developers Leggat McCall and Corcoran contributed just $4.2 million combined, and they are likely being compensated via developer fee rather than meaningful residual equity.
Charlestown is one of the strongest rental submarkets in New England, and in the country, and it still required the public sector to absorb 92.5% of equity at below market returns just to get shovels in the ground. This is all because the land itself has a negative implied value of $73 million.
Not only do current owners of developable land all across the city have negative implied values, their cost basis is likely much higher than $0 and that means astronomical write downs of land values are necessary to achieve feasible project returns. If you look in Andrew Sq, you will see a lot of vacant land, permitted for development that will sit empty until market rents rise, or owners accept astronomical losses to get out of their liabilities. Owners with debt on land of this nature will likely be forced to accept updated values soon.
Disclaimer: Land rarely, if ever, privately trades for $0. Implied land value is somewhat of a theoretical concept that uniquely applies to land from a development perspective. in addition to that, the math here is overly simplified and Urban Developments require complex capital stacks with sophisticated investors who underwrite projects more deeply than a simple return on cost.