The Dangers of Too Much Regulation in Real Estate Investing

Over the past 15 years I have worked on dozens of projects that required dealing with various municipalities in order to get permits and inspections. To be honest, it is getting frustratingly harder and harder every year. Increased regulations, fees and control mean delays and unexpected cost increases. Here are some of the problems I have seen.

When I first started to do land development, condo conversions and larger renovations you used to be able to have pre-application meetings with the municipality, the community and the local Councillor. Each department (i.e. parks, transit, sanitation etc) would meet and review your proposal. They would tell you what they did / didn’t like. You would adjust it and by the time you actually submitted the development permit application you were relatively secure in knowing your proposal had no major objections from the city.

The pre-application meetings still exist, except now, with the last few projects I have done, the municipality has come back months later with requests for more (costly) reports. Often there is no real reason why these reports are needed nor why they couldn’t have been asked for back at the beginning o the process. This costs both sides time and money.

Each project has a “go / no go” moment where you fully commit or not. In years past, you would have a fairly clear idea of city costs and timing before you hit that point. These days you do the pre-application process, make the decision to commit and then, months later, the city keeps asking for more information.

These delays cost the developer in a variety of ways:

  • There will be carrying costs with your building (insurance, mortgage payments, taxes and utilities). The longer the delays in waiting for permits the higher these costs run. How do you properly budget for that in the initial analysis stage of the project?
  • Delays in the municipality processing the permit application (which, for even mid-sized projects, can now be a year or two) can expose the developer to a change in the economy. Budgets based on the market reality at the start of a project can be vastly different two years later when you finally get your permits. This can mean greatly increased construction costs or reduced resale values of the finished product. The trouble is, you already committed long before.
  • Delays in processing can also mean the loss of your contractors as they move on to other jobs because you are not ready for them.
  • These extra requests / reports from the city can lead to real costs. For example, a request for a storm water report on one of my recent projects led to me having to install a huge, water storage tank with a catch basin underground. The costs of the report, city fees, tanks, installation, pipes, digging up and redoing the parking lot etc. ended up adding $100,000 to the project. Not only is that a big number in itself but it only came to light after the “go / no go” point. That greatly affected the profitability of the project. Add to that six extra months of carrying costs and increased costs for other after-the-fact city requests like landscaping and parking and that project went upside down quickly.

Before, most of the work with the municipality was up front. Now it tends to be linear. We complete one step, then new reports get asked for, once that is done even more is required and so on.

I have also noticed that the administrative level in a lot of cities has been broken up into little fiefdoms with each department not working or communicating well with other departments. For example, in the villa project I did I had to have 13 different inspections and approvals (i.e. one for parks, one for overland drainage, one for sidewalks / boulevards etc.). This definitely could have been done much more efficiently with greater departmental cooperation.

In days past your engineering team and the city used to work together to find the best solution for all. Now, municipalities tend to see the developer and the engineering team as the enemy. Common sense solutions aren’t as easily found as before.

Costs to the developer have greatly increased, as well, as the municipalities attempt to pass more and more costs down the chain. When I was growing up the municipality would do the infrastructure work (i.e. put in public roads, sewers etc) and then put a levy on the land which the eventual developer(s) would pay. Now, almost all infrastructure work is the responsibility of the developer.

While the city no longer does a lot of that work it still forces you to have the job done by an authorized contractor. Knowing that they have a captive customer, the city-approved contractor charges a lot more to do the work than if the developer could hire any contractor they wanted. As long as the quality is the same, why should a small list of anointed contractors be allowed to control this work, at a much higher fee?

This increases the developer’s costs which get passed on to the end buyer in higher property sales. At the same time the city can brag about keeping taxes lower. The municipality also typically asks for a lot more from the developer than they used to do back when they did it themselves.

Since I first started doing this work until today, the fee structure has started to change as well. Before, your permit application fee would include a certain number of inspections. The number of inspections allowed before you have to start paying for inspections is now substantially lower and, in certain cases, you now have to pay inspection fees in addition to the application fee.

A few of you might be thinking, “Good. It is about time those greedy developers had to pay.” The problem is that most developers aren’t huge corporations. Most are just small mom and pop sized companies. There also isn’t, typically, a lot of profit on these projects so any increase in fees has to be passed on to the end consumer. This is one of the reasons why property resale values have increased so much in the past few years.  Sometimes, however, the economy may not allow the developer / builder to pass on these costs. The end product still has to be priced competitively with other similar buildings in the area.

As a developer / builder / investor try to make sure that you get all of the required reports / costs that the municipality will need before you get to the “go / no go” point. In the pre-application meeting specifically ask each department what things they might ask for. Try to make your budget as firm as possible before you commit.

If you work for a municipality please remember that you are dealing with people’s lives here. I fully understand the need for regulation to protect the public, but the pendulum has swung too far in the other direction. Continued requests and delays will eventually lead to people saying, “It is just too much hassle” and stop doing new projects. That will lead to fewer jobs, fewer new projects and a less vibrant city.

Investment money always goes to the place which promises the highest return for the least amount of risk. Adding regulatory hurdles, costs and time delays increase risk and reduce returns which will make that money seek out other, more easier to deal with, municipalities. The goal should be to make it as easy as possible for real estate investors while still maintaining quality and safety.

Read more about this topic in Cash Management in Real Estate Investing.

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