Unit Mixes for New Rentals, Part IIII

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In the first post in this series I examined historical unit mix data to see what types of purpose-built rentals have been built in twenty of Ontario’s largest cities. The data shows that since 2000 developers building new rentals have generally shifted to more 2 bed than 1 bed units while significantly reducing the number of studio and 3 bed units. In the second post in this series I discussed whether or not historical unit mix trends can be used as a guide for new rental developments, and compared the advantages and disadvantages of different unit types. In the third in this series I illustrated the general points made in the second post by suggesting actual unit mixes and unit sizes. In this post, the fourth in this series, I describe general approaches developers can use to choose the best unit mix for their rental projects.

How should developers choose the unit mix for a proposed rental project? The simplest answer is to copy what other developers have been doing. This can be approached in two ways.

The first method is to determine the unit mixes of individual purpose-built rental buildings, typically new and recently constructed buildings, and use them as guides. This method has the advantage of focusing on a small number of rental buildings, which means buildings which have been particularly successful can be picked out from less successful buildings. The biggest disadvantage of this method is that a small sample size means that historical trends are more or less ignored.

The second method is to study historical unit mix data for the entire purpose-built rental market, much like I did in the first post in this series, and use historical trends as a guide. This method has the advantage of including the entire rental supply, not just a handful of buildings, thereby increasing sample size and improving statistical reliability and the ability to identify long-term historical trends. The disadvantage of this method is that the unit mix of particularly successfully projects are not separated from less successful projects, and short-term trends may be masked due to the large sample size and/or long time frame.

Which method makes the most sense? Copying rental buildings which have been successfully absorbed into the market (at market-leading rents, presumably) is useful since it’s hard to argue with success, while on the other hand tracking broad-based, long-term historical trends based on the largest possible sample size is useful since it means you’re using statistically reliable data. One method focuses on what’s working in the market right now, while the other method takes into consideration long-term trends and market-wide comparisons. Combining the two methods makes the most sense.

Neither method, however, considers the developer’s construction costs, which can vary quite a lot by unit type. With that shortcoming in mind, let’s add a third method.

The third method is to determine the per-unit (“per-door”) construction cost and optimize the proposed unit mix by working backwards from rents. In other words, figure out what rents are achievable in a given market for each unit type, then compare with construction costs. Unit types which could theoretically achieve higher rents than they cost to construct should be included in the proposed unit mix, while unit types which would cost more to construct than the rents they could achieve should be excluded. Similarly, unit types which could theoretically achieve the largest gap between achievable rents and construction costs should be most plentiful in the unit mix since these will be the most ‘profitable’ units, while unit types which are likely to be the least ‘profitable’ should be least plentiful in the unit mix. The disadvantage of this method is that it’s very inward looking because it does not incorporate historical trends nor buildings currently being constructed in the market: by ignoring these two methods, each developer would likely generate wildly different unit mixes for each proposed building, since each developer is going to input their own unique construction costs. In other words, by focusing on construction costs and ignoring competition and historical trends, developers could easily design some weird unit mixes that may not be appropriate for the local rental market and its renters.

Obviously, combining of all three methods I’ve described above would be the smartest approach for developers choosing the unit mix for proposed rental properties. It means collecting a lot of data and juggling a lot of variables, but it’s worth the extra work and effort since it’s important to get the unit mix right so that renters want to rent units in your building and it can keep up with the competition, both existing and future.