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Villager II Feasibility Analysis Excel Spreadsheet

Funtional Program

Sample Survey Questions

Design Economics 2000-
Measuring Costs and Benefits in Real Estate Investing
Using IRR (the Internal Rate of Return), an Example

Granny Flat Assignment- the "Villager"

"I cannot give you the formula for success, but I can give you the formula for failure, which is:
Try to please everybody."

Herbert Bayward Swope

INTRODUCTION

There can be no doubt that a continuing and developing crisis in providing affordable housing is proving to be an intractable problem in cities in North America. Mono-cultured suburbs with vast rows of expensive single purpose, single family housing is shutting out not only the poor but young people and ordinary workers, even middle class folks. Towns were once thought of as places where people from different economic classes could mix together; a blend of housing types and styles combined with proximity to stores, offices, markets, entertainment and, perhaps, industry produced places that were walk-about types of villages, towns and cities. A lack of affordable and nearby housing stock will be a brake on the economic development of city-states. Silicon Valley is experiencing just such a phenomenon now.

Neo-urbanist design requires a wholesale change in approach to zoning. Perhaps James Howard Kuntsler (Home From Nowhere and Geography of Nowhere) is right: "Burn all the zoning codes" or maybe we should substitute "Performance Zoning", where form is specified instead of function; minimum densities instead of maximum densities or build-to lines instead of front yard, side yard and rear yard setbacks or standard transition lines, to name a few examples. Performance zones (open zoning) would allow single family homes to be just that or converted to duplexes or triplexes or rooming houses or used partly for commercial uses such as law offices, hairdresser salon or corner store. Granny flats could be added to the rear yard and used as an apartment or, in fact, for commercial purposes instead. Apartments could be added above the garage or in the attic, all without a zoning change and pitched battles with the neighbors.

As renowned Dutch architect, Rem Koolhaas put it: "Architectural Specificity/Programmatic Indeterminancy"

We will examine one possible (partial) solution to the affordable housing crisis- a redsign and updating of the 'granny flat'. This challenge is based, in part, on the lecturer's experience in the 1960s when he lived at 1011 and 1/2 Seabright Avenue, Sanata Cruz, California. 1011 and 1/2 was a slab-on-grade granny flat built in the rear yard of the Big House (address 1011 Seabright, of course). The elderly owner of the Big House rented out the granny flat to students to help her with her on-going living costs. On-street parking or parking in the driveway was sufficient in the relatively benign climate of Northern California. Surrounded by gardens with elaborate flowering shrubbery, it was a pleasant, cheap and convenient location, close enough to the University of California at Santa Cruz for a couple of students to share. A return visit to the area, some thirty years later, finds the little home still occupied, this time by a lovely, young couple with a baby. Interestingly, their last name was identical to the lecturer but no relation!

In Northern California and especially in Santa Cruz, granny flats constructed in the rear yard proved a popular and enduring part of the housing stock. Initially, perhaps, built for granny, they survive to this day providing affordable housing for students, teenagers, nurses, teachers, gardeners, labourers, nannies, young marrieds, short order cooks, store clerks, bus drivers, waiters, secretaries, office workers, ...

Building materials, slab-on-grade construction and other factors may make granny flats less expensive in the California climate but there still may be lessons for northern shelf cities like Ottawa. The student is free to experiment with either in this assignment.

One case study is fully documented here. The students, however, are expected to design their own solution and perform an in-depth quantity survey (cost analysis), fully documented and referenced. The student is also expected to do a cost/benefit analysis; this is part of the way in which architects can justify their designs on something other than costs and budget. An over-reliance or over-emphasis on costs means that architects are constantly being asked to cut their projects. Cost/benefit analysis will give architects the tool they need to justify an increase in cost based on the additional value that the design modification provides.

Keeping the elderly in their existing communities longer, making better use of established infrastructure, increasing block security, helping folks to pay their mortgages on the Big House and addressing the density deficit in North American cities, granny flats should be encouraged. Many cities with their tin pot dictators have banned granny flats outright through their use of the municipal by-laws. Others, more devious and using political cover, create onerous rules such as impossible rear yard and side yard setbacks, huge levies in the form of Development Charges that make the construction so expensive as to be prohibitive, rules that the occupants have to be related to the family in the Big House (discrimination) or that they have to over a certain age (reverse ageism) or that the units can only be temporary while granny is alive (wasteful and dumb).

Municipal politicians act in this manner because they are concerned with the reaction of existing homeowners (who vote in disproportionate numbers) who turn into raging nimby'ites, motivated by greed and fear, when confronted by densification and change. As long as social order is maintained, homeowners have nothing to fear from granny flats and densification. Prima facie, because rents have increased through densification, property values should go up not down as folks add basement units, lofts, duplexes and triplexes, granny flats, apartments above the garage and so forth. It is never said, but perhaps another factor in the minds of existing homeowners, is the thought that granny flats and other forms of densification will bring in an immigrant population or change the racial mix or bring in lower economic classes or an underclass of undesirables.

'Warehousing' elders in managed care facilities can often be a dehumanizing experience; moreover, it is a costly one too. In Ontario, such retirement homes cost between $2,000 and $5,000 per month. They may include some level of care and a meal plan for one or two meals per day. The 'suites', which are typically glorified hotel rooms, do not compare to the Villager design shown here in either area or livablity or convenience or joie de vivre.

RULES FOR THE DESIGN PROGRAM

1. Perfect the design of a 'granny' flat subject to the following constraints:
a) maximum finished square footage shall be no more than 660 square feet at grade;
b) maximum overall square footage shall be less than 1,000 square feet including finished are in the basement (if any) and loft area (if any).
2. You may design the unit for Northern California or for Ottawa.
3. If you choose Ottawa you must include a full basement with minimum finished ceiling height of 8 feet.
4. Minimum ceiling height on the ground floor is 8 feet; you may choose a cathedral ceiling or a 9 foot ceiling if you prefer. (If you use a 9 foot ceiling height or a cathedral ceiling, there may be additional costs which you must show in your cost analysis. But you also will get higher revenues in the form of a decrease in your expected vacancy rate- it decreases from 5% to 2.5%).
5. For an Ottawa location, you must include a single car garage attached to the home.
6. For Northern California, you may assume parking on the street or on the driveway.
7. If your design has a basement, the finished space in the basement (if any) must be 5 feet from finished grade to the underside of the joists to be considered 'livable' space. Finished space must have windows with the exception of the basement w/c (if any).
8. Your design must include: kitchen, MBR (12 foot by 12 foot minimum), deck, porch (minimum depth of 6 feet), LR, DR and w/c, garage (if Ottawa is your chosen locale). Options include second bedroom, second w/c (or rough-in), FR, cathedral ceiling or 9 foot ceiling, loft, walk-in-closet.
9. You may wish to add (at a small marginal cost) a few design elements that make your design more elder-friendly; over-size windows for better light, over size doors and walkways and hallways for walkers and wheelchairs, pull bars (plywood reinforced) for the toilets and tubs, no-step entry from walkway and garage (if any).

Student Solutions

"Chippers". Howard Baek, Caroline Kim, Patrick Wai, Tommy Ong. Carleton University, School of Architecture, Fifth Year. December, 2000.

More Student Work

QUANTITY SURVEY

1. The students may use any reliable, properly referenced source for cost analysis.
2. Some suggested sources include:
a) R. S. Means (home construction and renovation)
b) Hanscomb's Yardsticks for Costing
c) Home Depot Pro Book (recommended by a student)
3. You may wish to attend the Canada Mortgage and Housing Corporation (CMHC) library on Montreal Road to peruse these and other sources or you may fuind adequate resources through a web search. The library is open from 8:30 am to 4:30 pm.
4. You must use a recent source that provides up-to-date costs and which is regionalized (i.e., costs are different in Northern California and Ontario).
5. Specify whether you are using Canadian or US dollars.
6. Show your list of materials and labour costs for each assembly and sub-assembly.
7. Estimates of soft costs and land costs are provided below.

BENEFITS

1. One Bedroom granny flat in Ottawa with garage rents for $950 Cdn. monthly.
2. Two Bedroom granny flat in Ottawa with garage rents for $1,350 Cdn. monthly.
3. One Bedroom granny flat in Norther California rents for $1,150 US monthly.

SOFT AND OTHER COSTS

1. Assume lot cost of $30,000 Cdn. in Ottawa with an additional amount of $3,500 for the well or $50,000 US in Northern California (assume piped services available there).
2. Assume soft costs including legal, building permit, development charges, finance costs etc. are 50% of hard costs.
3. In Canada, add 7% GST to all soft and hard costs.

OPERATING COSTS

1. Assume property taxes of $1,500 Cdn. per annum in Ottawa and $3,000 US in Northern California.
2. Assume insurance costs of $700 Cdn in Ottawa and $1,500 US in Northern California.
3. Assume that all other costs (eg., utilities) are paid by the tenant.
4. The vacancy rate is 5% if you use an 8 foot ceiling height on the main floor or 2.5% if you have a cathedral ceiling or 9 foot ceiling on the ground floor.

EQUITY AND DEBT FINANCING AND OTHER ASSUMPTIONS AND CHALLENGES

1. Let us assume that your equity is the cost of the lot and well in Ottawa and lot cost in Northern California. Equity is that part of the financing that comes from your own resources; it is generally not leveraged or pledged for loan or debt purposes.
2. We will assume that the balance of your capital costs are funded by a conventional bank mortgage with a coupon rate (interest rate) of 7% with a 20 year amortization period (the time over which the entire principal amount of the mortgage is retired); use a CRF (Capital Recovery Factor) of $77.53 payment per month of principal and interest on each $10,000 of mortgage funding.
3. Your project financing now has two components- equity and debt, the latter by way of a bank provided first mortgage. If you had a deficiency in your capital structure if, for example, the bank will only lend you 75% of the capital costs or appraised value and if your equity contribution is just say 15%, you have a financing 'gap' of 10% of your costs. This gap can be made up by a) raising more equity, b) putting in place more debt (eg., a second mortgage) or c) creating a debenture product that has characteristics of both debt and equity.
4. Note that many appraisers, with an abundance of caution, will provide the bank with an appraised value that is less than cost. In that case, even with a 75% debt ceiling imposed by your bank, you will then find that you are only able to debt finance less than 75% of the project's costs. Since you will find that rates of return on equity are highly sensitive to gearing ratios (i.e., the higher the leverage (debt as a percentage of porject cost), the higher the rate of return on equity), you will want to have the maximum amount of low cost debt on your projects.
5. Having said this, you will also have to recoginze that with debt comes risk- in the event that your projects do not do well (for example, you can not meet your periodic obligations from project cashflow) you must make up the deficiency from your own resources. Failing that, your project will go into default and may be sold under power of sale provisions.
6. Power of sale means that the lender has the right to step into your shoes and sell the property. As a general rule, properties sold under power of sale do not attract the highest possible price. Proceeds are applied first to any unpaid property taxes, then the commission owed to the realtor for selling the property, then the principal amount of the debt, then interest, then other allowed costs and then finally to the equity holder position. Usually, there isn't much left over for this, so this means that risks (on your equity) are very real. In economic downturns, many real estate investors who are highly geared get wiped out, so be careful.
7. Real estate investors want to "over mortgage" their projects for the purpose of generating additional funds for investing in still other projects. Banks don't like this, However, you can obtain the same result by putting into the capital structure of every project a 'management' fee payable to your company for creating and managing each project. This is not the same as the construction management fee or a payment to a GC (General Contractor) for construction. If you are financing 75% of a project through debt, you will then generate 75% of this management fee in cash for your company or business; it is a way to keep the lights on and body and soul together, so-to-speak. Put this way and being moderate as well as being up-front about it, banks generally will accept such fees as being appropriate and acceptable.

SAMPLE BUDGET- Ontrario

(for demonstration purposes only- the student must produce their own based on a researched and referenced quantity survey.)

Capital Costs:

Site- lot $30,000, well $3,500, septic $5,000

Site Servicing- culvert $800, gravel driveway $1,000, grubbing $500

Hard costs- main level ($85 per s.f., 620 s.f.) $52,700, basement finishing ($30 per s.f., 360 s.f.) $10,800, garage ($30 per s.f., 200 s.f.) $6,000 {total hard cost $69,500}

Soft Costs- construction management $2,000, arch. fees $600, engineer $500, legal $500, interim finance cost $400 interest and $700 commitment fee, DC (development charge) $3,500, building permit $700 {total soft cost $8,900}

Contingencies- $2,500

GST- $8,300 (approximately 7%)

$38,500 site (29.6%)
$ 2,300 site servicing (1.8%)
$69,500 hard costs (53.5%)
$ 8,900 soft costs (6.8%)
$ 8,300 GST (6.4%)
$ 2,500 contingencies (1.9%)
$130,000 total all-in cost (100%)

Cost/Benefit (Cashflow and IRR (Internal Rate of Return)) Analysis:

(Note: you may wish to use a speadsheet program such as Microsoft Excel. See, for example, the Kanata Co-op and Kanata Co-op Charts.)

Cash Out (Capital):

Week 0- purchase lot with well $33,500
Week 1- building permit, committment fee, engineer fee, arch. fee, legal fee, site servicing, DC $8,800
Week 2- 15% of hard costs $10,425
Week 3- 25% of hard costs $17,375
Week 4- 40% of hard costs $27,800, construction management $2,000
Week 5- 10% of hard costs $6,950, septic field $5,000, interim finance interest $400, contingencies $2,500
Week 11- release of 10% holdback $6,950
Week 13- payment of GST $8,300

Cash In (Operating):

Week 4- first and last months' rent $2,700
Week 10- second month's rent $1,350
Months 3 to 11- $1,350 monthly at start of each month
Month 12- nil rent
Month 13- $1,350, etc.

Cash Out (Operating):

Mortgage

$33,500 Equity
$96,500 Mortgage (7%, 20 year amortization)
$748.16 P + I monthly payment

Other

$1,500 annually property taxes
$700 annaully insurance
nil repairs and maintenance

Internal Rate of Return

Find the Internal Rate of Return (IRR) for the project. The IRR is the interest rate or discount rate that is applied to all cash inflows (Y) such that they are exactly equal to all cash outflows (C). You can determine the IRR by solving the following equation:

SUMMA (t = 1, n) {Y(t)/(1 + IRR)**t} - SUMMA (t = 0, n) {C(t)/(1 + IRR**t} = 0,

where t = time period and n = total time period.

Assume you hold the property for ten years and sell it for exactly your original cost.

- $33, 500 Cashflow out (equity) at time 0 (land and well purchase)
$5,022 Net Cashflow in Year 1 (Total rent $16,200 less mortgage $8,978, insurance $700, property taxes $1,500)
$5,022 Net Cashflow in Years 2 to 9
$71,045 Net Cashflow in Year 10 (Net rent plus sale of property for $130,000 less principal still owing on the mortgage of $63,977 which must be repaid to the mortgage company on the sale of the property after ten years. Note that you are assuming that your free cashflow from years one to ten, amounting to $50,220 ($5,022 per year) is not reinvested in the project to, for example pay down the mortgage. Your free cashflow is assumed to be used for consumption purposes; i.e., it is money 'in your jeans'.)

Solving the above equation gives an Internal Rate of Return (on equity) = 18.9% p.a.

This is the Internal Rate of Return on the project's equity; that is, for an investment up front of $33,500 of the principal's own funds, he or she can expect a return of 18.9% per annum which is a rate that is considerably above the kinds of returns that one could expect from investing in, say, treasury bills or in a bank savings account. Of course, the equity is true risk money in the sense that if the economy turns down and the unit is vacant, the owner could lose all or part of his or her funds.

The project's internal rate of return can be calculated by assuming that all financing is equity (i.e., there is no bank debt (mortgage)). So we can calculate the project IRR as follows:

- $130,000 Cashflow out (equity) at time 0 (land and well purchase- all provided through equity)
$14,000 Net Cashflow in Year 1 (Total rent $16,200 less mortgage which is nil now since all financing is equity in this case, insurance $700, property taxes $1,500)
$14,000 Net Cashflow in Years 2 to 9
$144,000 Net Cashflow in Year 10 (Net rent plus sale of property for $130,000 less principal still owing on the mortgage which is nil because all financing was in the form of equity).

Solving this cashflow profile for the IRR yields a project Internal Rate of Return of 10.8% p.a.

Essentially, we have three segments that make up this project- the equity component which has an IRR of 18.9% p.a., the bank debt piece which has a rate of 7% (i.e., the rate on the mortgage financing) and the overall project which has an IRR of 10.8%. You can think of the project's IRR as a kind of 'weighted' average of the IRRs of the component pieces (the equity and the bank debt, in this case). Projects can have many segments of financing such as bank debt, sub-debt, debenture holders and equity; there can be components and ranking within each category. Generally speaking, the higher the ranking of the financing, the lower the rate of return will be, but they will also have greater security. In the matter of a default, highest ranking debt gets repaid first. So as an equity holder of securities, one would expect to have a higher rate of return since they are shouldering a higher risk profile.

A project rate of return of 10.8% may seem low compared with some alternative investments. One might expect that investment in dot coms will have higher yields, albeit with a higher risk profile. Adding a granny flat to an existing residence to accomodate an elder provides other benefits in addition to the financial ones we are trying to quantify here. An elderly relative still living in the same neighborhood providing an increase in block safety and child care and mentoring as well would seem to provide significant benefits to the family and the community too. A project return of 10.8% may also appear attractive to persons who might otherwise be putting their money into savings accounts or treasury bills which yield in the range of four to six percent at this time.

The risks associated with construction such as cost overuns, fire, warranty problems or higher than expected vacancies and lower rents seem controllable when compared with, say, investment in dot coms where software assets can rapidly and explosively depreciate or where your greatest assets (your software 'kahns' and management) go home every night. Investment in high risk, high reward enterprise is probably something that appeals more to people in a younger demographic. Investment in granny flats with a lower risk profile and lower potential return is something that will appeal to risk averse persons of all age groups. It may be that the higher expected returns of investment in, say, dot coms, is offset by the higher probability of failure so that the actual returns of both types of investments might be quite comparable.

SENSITIVITY ANALYSIS

Test 1

Include a vacancy rate of 5%. Net revenues decline to $4,212 per annum.

Solving the IRR equation gives an Internal Rate of Return (on equity) = 16.9% p.a.

Test 2

Include a vacancy rate of 5% and a reduced rent of $1,200 per month. Net revenues decline to $2,412 per annum.

Solving the IRR equation gives an Internal Rate of Return (on equity) = 12.6% p.a.

Other Tests

The student may wish to test the design with further modifications to the design program such as: a) Assume the well, septic and lot are 'free' because the flat is in the backyard of an existing home and you expect to hook up to existing services. In this case you may assume that your equity is equal to 25% of the (now reduced) capital costs and the balance is provided by a mortgage. b) Try a) again without finishing the basement; this will further reduce your capital costs although your rent will decrease to $900 per month too. c) Assume you build the flat in your backyard for an aging parent or your teenage son or daughter. Determine what your 'opportunity' cost is based on the assumption that you finance 100% of the capital costs of a one bedroom flat and that you simply want to know what your additional monthly payments will be. d) Try your hand with different building materials, design and benefits for a flat in Northern California.

It is clear from the sensitivity tests done above that the benefits produced by this project (at least as measured in dollar terms) is very sensitive to a decrease in revenues. Students will also find that the results are quite sensitive to an increase in capital costs and any change in leverage. That is, if more of the project is financed through equity and less through (relatively) low cost money (eg., a bank mortgage) then the internal rate of return drops rather precipitously.

In the case where you are constructing the granny flat for your own account (i.e., where you have the benefit of using your own back yard so that your land costs are nil and your servicing costs close to zero) and where you intend to have your family live (i.e., your elders, teenagers or other relatives, say), you can still measure the benefits of the project using the concept of imputed rents. These are market rents that you would have received if the unit or, indeed, the main residence for that matter, was rented to a third party. Imputed rents are very real even if you can't touch and feel them and, best of all, they are tax free. This is one of the great (hidden) advantages of home ownership. Once your mortgage is paid off and you own your own home free and clear, the benefits of imputed rents are maximized (less so in the case of the USA, which alone among G7 nations, allows mortgage interest tax deductibility.)

OUTPUTS

1. Plan views.
2. Elevations.
3. Isometric (optional).
4. Model (optional).
5. List of parts, suppliers, sub trades and all 'hard' costs together with catlogue numbers and references including deck, porch and paved driveway.
6. Capital Budget showing hard costs and soft costs. Remember when you are doing a quantity survey to include labour as well as materials. You may also need to include allowances for certain items where you do not have all the data such as kitchen cabinets or lighting fixtures. You may also add the cost of a construction superviser for the duration of the project and a margin for overheads and profit. It is not unusual to add 10% for overheads and another 10% on top of that for profit (i.e., 21% of the capital budget). Profit is not a dirty word. Profit allows a firm to grow and develop; invest in employee training; buy newer equipment and invest in the latest construction techniques too. Always check 'both ends against the middle'. Capital budgeting is like drilling the Chunnel- you start on the English side and on the French side and hope that both tunnels meet in the middle! So, a) do a detailed cost breakdown using a credible source of data. b) Provide reasonable allowances for design elements where there are still a lot of design unknowns. c) Add in a contingency fund of not more than 10% and hopefully around 5%. The contingency fund is used for coping with unforseen problems and for ensuring the quality of construction too. You should spend all of it. d) Put in place an incentive for all parties to share in cost savings and in time-to-complete too, using some equitable formula. e) Do a reality check- use some notional cost per square foot times the gross floor plate to make sure that the total capital budget is neither hideously over the top nor unrealistically low. If it is, check your assumptions!
7. Operating Budget showing all revenues and expenses.
8. Cost/benefit analysis using an internal rate of return calculation.
9. CPM schedule showing construction of the home in not more than 35 days. There are five ways to look at the CPM schedule. 1) Students can take the total cost of materials and supply and install from a source such as RS Means or Hanscomb's Yardsticks, subtract the cost of materials and then divide by the unit cost of labour to arrive at the number of person-hours for the task. Dividing this by the number of persons working on the task will yield the length of time for that task in project work-days. 2) Students may wish to contact sub trades realizing that they tend to estimate low. 3) Students may call a GC (they usually tend to provide estimates that are on the high side). 4) Students can use their own judgement based on their experience. 5) Some combination of the above can be used to arrive at realistic estimates of task times. Scheduling is also often done using a 'both ends against the middle' type of approach- if you know when a project must be completed by and you know when it will start, you obviously have two important constraints in place. This is not all that unusual; if you are building a home for a client, the start date is when you sign a contract for design and the end date is dictated by when the client needs to move in or when their tenants need to move in. Then you can work forwards from the start date and work backwards from the end date. Put your schedule up on a web site or on a board where you can see it and digest it. Remember CPM is designed to assist you in project scheduling but nothing has yet replaced human judgement and experience. In summary then, you will need to: a) estimate task times, b) put together a preliminary schedule based on what tasks logically precede and follow others, c) run the CPM, d) test your assumptions- see what tasks might be done in parallel and then do a sensitivity test (run the CPM again). CPM software can be a big help here especially if you are working on a complex project with lots of variables and you have to run dozens of scenarios!
10. Functional Program and On Line Survey- on a spreadsheet summarize your functional program including all aspects of your design (linear feet of wall, room areas and uses, etc.) based on a (non scientific) web survey of potential stakeholders (investors and residents).

SAMPLE FLOOR PLAN- (Based on a 'granny flat' at 1011 and 1/2 Seabright Avenue, Santa Cruz, California)

Design Economics

DRAMATIS PERSONAE