2. APPROVAL
Name: Jonathan Silcock
Degree: Master of Business Administration
Title of Project: Bringing Green Home: A feasibility study on sustainable
building practices in the residential building industry.
Supervisory Committee:
___________________________________________
Name
Jeremy Hall
Senior Supervisor
Associate Professor of Strategy
Segal Graduate School of Business
___________________________________________
Name
Neil R. Abramson
Second Reader
Associate Professor of International Strategy
Segal Graduate School of Business
Date Approved: ___________________________________________
ii
3. ABSTRACT
This paper is a feasibility study on sustainable building practices in the residential
real estate development industry. Sustainable, or “green,” building practices is an
emerging market sector within the building industry. The residential market has been
slower to implement green innovations than the non-residential market. This paper uses a
variety of academic theories and concepts to assess the new home industry with a focus
on innovation within the construction sector. The paper concludes that the residential
building industry structure and current business model do not align with the principles
and requirements for a successful implementation of widespread green building.
Keywords: Innovation, construction industry, residential real estate, green building,
sustainable building
iii
4. EXECUTIVE SUMMARY
This paper is an academic overview of the residential building industry with a
specific focus on the feasibility of sustainable, or “green” building practices. The paper
draws on concepts and theories related to economics, innovation and entrepreneurship
with a specific focus on construction industry research. These sources are employed in
conjunction with industry analysis to assess recommendations for the integration of green
building practices into the residential real estate industry. The paper assesses the North
America industry and uses examples from the British Columbia residential market. Due
to the variety and individual requirements of residential building types and styles, the
discussions and analysis focus on the feasibility of the outcome and not on the details. As
such, this paper does not attempt to examine the technical details of specific “green”
technologies or standards.
The intent of green building practices is to reduce this level of consumption and
waste through the creation of structures that are environmentally responsible and
resource-efficient throughout a building's life cycle. The development, construction and
long term operation of buildings and homes are a leading source of waste, electricity
consumption, extraction of natural resources and greenhouse gas emissions. The green
building movement seeks to change the impact of the built environment on the natural
environment. Green building practices have gained traction in the non-residential
building sector, but have had limited success in the residential sector.
iv
5. The feasibility of implementing green building practices is doubtful for the
residential industry under normal market conditions. The home builders and home buyers
do not have sufficient economic, social or political incentives to commit to a green
project and government and design professionals do not have sufficient power to
engender change. In addition, the green building movement has some liabilities of image
and definition that also act as barriers to widespread acceptance.
Green building practices are poorly defined by advocates and poorly understood
by the target market. There are too many organizations that offer rating systems for a
building concept that is difficult for the builder and homeowner to grasp. Buyers and
builders may be suffering from ‘green fatigue’ as green and sustainable buzzwords are
currently ubiquitous throughout the business, retail and marketing world. Consolidation
may occur in the green building rating organizations and this could result in a green
building definition that is easier to understand and obtain certification. The current
certification requirements are onerous, time consuming and thus expensive for the home
builder.
The speculative nature of development, the historical liabilities of the construction
industry and a lack of current consumer demand are some of the impediments that make
any green project implementation difficult. Existing data is limited and residential case
studies are largely anecdotal due to the newness of the green building sector.
Furthermore, this limited evidence does not make a convincing business model for a
profitable residential development. The benefits of a green home have not been proven to
provide enough value to the builder or the homeowner to overcome a perception of
higher costs. Green building practices has gained traction in the non-residential building
v
6. industry as that business model is less speculative and the developer is more likely to be
involved over the long term with an ability to recover the initial costs.
The construction industry is perhaps the least likely participant in green building
practices. The industry has an ingrained aversion to innovation; in fact, a recent study for
the National Research Council of Canada suggested that innovation in new home
building results in lower profitabity for firms (Seaden, Guolla, Doutriaux and Nash,
2001). This is likely the result of the dominant design-bid-build business model where the
“lowest bidder” wins the contract. This business model also creates the liability of
separation (Reichstein, Salter and Gann, 2005) that limits interaction between the
building life cycle participants of design, production and use. In addition, the
construction of a building of any type is a complex and time consuming process and the
work is completed by a diverse range of small companies. Gann (2001) argues that the
small size and resources of most firms limits the absorptive capacity to learn and make
technological advances. These construction industry characteristics are in conflict with
the green building practice which relies on technology innovation, interaction between
life-cycle participants and an ability to learn new concepts. These conflicts limit the
ability of a residential real estate developer to implement a successful and profitable
implementation of a green building project for new homes.
Today, a certified green residential project is not feasible in economic terms. The
new technologies and processes are too radical for the industry and this level of risk is
unappealing to buildings and homeowners alike. However, there is hope for future
financial viability of green building as changing consumer demands and government
involvement may shift the economics. Increasing awareness of environmental concerns,
vi
7. rising energy costs and health related concerns are issues that are addressed by green
building principles. An entrepreneurial firm can position itself for future success by
integrating green building principles into current business practices.
vii
8. DEDICATION
This paper is dedicated to my wife, Jen, and my new-born daughter, Elsie
Katelynn. Thank you for your ongoing love and support of my academic ventures.
viii
9. ACKNOWLEDGEMENTS
I would like to thank Jeremy Hall, Ph. D. for his guidance and encouragement on
this paper. The end result of the learning process is not adequately summarized within the
limitations of this paper. This is an emerging industry sector and the learning continues.
I also express my gratitude to Team Summit – Jeff, Johan and Nina. Thanks for
pulling me through the program. My thanks also go to thank John Morley for being a
supporting and understanding boss over the past two years.
Finally, I need to thank my family and friends for the patience and support. Life
would have been a lot tougher without my support network.
ix
10. TABLE OF CONTENTS
Approval ............................................................................................................................ ii
Abstract............................................................................................................................. iii
Executive Summary......................................................................................................... iv
Dedication....................................................................................................................... viii
Acknowledgements .......................................................................................................... ix
Table of Contents...............................................................................................................x
List of Figures.................................................................................................................. xii
List of Tables .................................................................................................................. xiii
Glossary .......................................................................................................................... xiv
1: INTRODUCTION .......................................................................................................15
1.1 Purpose ..........................................................................................................15
1.1.1 A Changing Environment..........................................................................16
1.1.2 Format of the paper....................................................................................18
1.2 Background....................................................................................................19
1.2.1 Residential real estate: evolution of an industry........................................19
1.2.2 Real Estate products ..................................................................................19
1.2.1 Developers and homebuilders – The supply side ......................................21
1.2.2 Homebuyers – The demand side................................................................22
1.2.3 Current Strategy for Home Building Industry...........................................22
1.2.4 The Building Life Cycle............................................................................24
1.3 What is Green Building? ...............................................................................27
1.3.1 Climate Change: The Inconvenient Truth .................................................30
1.3.2 Commodities in a global market................................................................32
1.3.3 Quality of life.............................................................................................33
1.3.4 Sustainability: A matter of definition ........................................................33
1.4 The Building Industry: A reluctant innovator ...............................................35
1.5 Recent developments.....................................................................................37
2: INDUSTRY ANALYSIS.............................................................................................39
2.1 Overview – Residential Building Industry....................................................39
2.2 British Columbia Building Industry..............................................................40
2.2.1 Industry size and growth............................................................................40
2.3 Value Chain Analysis – New Home Building Industry ................................42
2.3.1 The Developer: Minimal costs and maximum returns ..............................43
2.3.2 The Design Team.......................................................................................47
x
11. 2.3.3 Government Agencies: Protecting the public interest ...............................49
2.3.4 Financiers: Risk and return........................................................................50
2.3.5 The Construction Contractor .....................................................................52
2.3.6 The Real Estate World: Marketing and Sales............................................57
2.3.7 The Purchaser ............................................................................................58
2.3.8 Value Chain Summary...............................................................................59
2.3.9 Value Chain and the Liabilities of Construction .......................................60
2.4 Five Forces Analysis of the new home building industry.............................62
2.4.1 Force 1: Threat of substitutes ....................................................................64
2.4.2 Force 2: Threat of new entrants.................................................................66
2.4.3 Force 3: Bargaining power of buyer..........................................................68
2.4.4 Force 4: Bargaining power of suppliers.....................................................70
2.4.5 Force 5: Industry rivalry............................................................................71
2.4.6 Industry Attractiveness – potential for profit.............................................72
2.5 Key Success Factors (KSF)...........................................................................73
2.6 Summary of Competitive Advantages...........................................................75
2.7 Opportunities and Threats .............................................................................76
2.7.1 Opportunities for the building industry .....................................................76
2.7.2 Threats for the building industry ...............................................................77
2.8 Strategic Options for the residential developer .............................................78
3: FEASABILITY ANALYSIS FOR GREEN BUILDING PRACTICES.................80
3.1 Overview of Green Building Practices - Shades of Green............................80
3.1.1 Residential Green Building .......................................................................81
3.1.2 Standards and Technology.........................................................................83
3.1.3 First Costs..................................................................................................85
3.1.4 Cognitive Legitimacy ................................................................................87
3.1.5 Socio-Political Legitimacy ........................................................................88
3.2 Green Building Practices – Drivers of Change .............................................89
3.2.1 Developer – Supply Side ...........................................................................90
3.2.2 The Design Professional – Supply Side ....................................................92
3.2.3 Construction Contractors – Supply Side....................................................94
3.2.4 The Home Buyer – Demand Side..............................................................96
3.2.5 Government and Society – Demand Side..................................................97
3.3 Supply and Demand Summary....................................................................100
3.4 Pathways and Barriers .................................................................................101
3.4.1 Barriers to Implementation......................................................................101
3.4.2 Pathways to Sustainable Building Practices............................................102
4: CONCLUSION AND STRATEGY RECOMMENDATIONS..............................105
4.1 Feasibility of Green Building in Residential Building................................105
4.2 Profit Potential for a Green Building Company..........................................108
4.3 Strategies to capture future demand ............................................................108
4.4 Tilting at Windmills ....................................................................................110
Reference List.................................................................................................................112
Works Cited..............................................................................................................112
Works Consulted ......................................................................................................116
xi
12. LIST OF FIGURES
Figure 1 - Residential Home Building Activity Chart.......................................................40
Figure 2 - Net Migration to BC 2003 to 2009 (Source: CMHC).......................................41
Figure 3 - BC new home building industry – units and dollar volume (Source:
CMHC)..............................................................................................................42
Figure 4 – Residential Starts in BC by type, 2003 to 2009 (Source: CMHC)...................42
Figure 5 – Modified Design-Bid-Build Cycle ...................................................................45
Figure 6 – Construction contract flow chart ......................................................................55
Figure 7 - Porter Five Forces for New Home building industry........................................64
Figure 8 – BC Residential sales in annual volume and average price (Source:
CMHC)..............................................................................................................66
xii
13. LIST OF TABLES
Table 1 – Residential building by product type (Source: CMHC) ....................................20
Table 2 – Value chain activities and estimated costs.........................................................43
Table 3 – Barriers to Innovation in Building Value Chain................................................61
Table 4 – Threat of substitutes...........................................................................................65
Table 5 – Threat of New Entrants to New Home Industry................................................68
Table 6 – Bargaining power of buyer ................................................................................69
Table 7 – Bargaining power of suppliers...........................................................................71
Table 8 – Industry Rivalry.................................................................................................72
Table 9 – Key Success Factors (Source: Grant, 2008, p. 90) ............................................74
Table 10 – Sample of LEED checklist items (Source: USGBC, 2008).............................84
Table 11 – BDC 2007 survey results.................................................................................86
Table 12 – Green Goals Framework - Developer..............................................................91
Table 13 – Green Goals Framework - Design Professional ..............................................94
Table 14 – Green Goals Framework - Contractors............................................................95
Table 15 – Green Goals Framework - Homebuyer............................................................97
Table 16 – Green Goal Framework – Government and Society........................................99
xiii
14. GLOSSARY
CAGBC Canadian Green Building Council
CHMC Canadian Housing and Mortgage Corporation
LEED The Leadership in Energy and Environmental Design (LEED)
USGBC U.S. Green Building Council
xiv
15. 1: INTRODUCTION
1.1 Purpose
This paper is an academic overview of the residential building industry with a
specific focus on the feasibility of sustainable, or “green” building practices. The paper
draws on concepts and theories related to economics, innovation and entrepreneurship
with a specific focus on construction industry research. These sources are employed in
conjunction with industry analysis to assess alternatives for the integration of green
building practices into the residential real estate industry. The paper assesses the North
America industry and uses examples from the British Columbia residential market.
Due to the variety and individual requirements of residential building types and
styles, the discussions and analysis focus on the feasibility of the outcome and not on the
details. As such, this paper does not attempt to examine the technical details of specific
“green” technologies or standards. The technology details are important to the process
and available elsewhere in numerous case studies of the green building industry. Instead,
the paper treats green building as an opportunity to trigger what Schumpeter called
“irresistible and irreversible innovation” (Schumpeter, 1934) in an industry that suffers
from a dearth of innovation.
15
16. 1.1.1 A Changing Environment
The built environment, or a building, occupies a central place in human life and
activity. The Canadian climate is not always hospitable and it is estimated that Canadians
spend close to 90% of their time indoors (Lucuik, 2005). Buildings provide utility to
society as homes, schools and place of business, but these same buildings also have
externalities that are becoming more visible in the natural environment. The
development, construction and long-term operation of a building have a detrimental
impact on the natural environment. According to United Nations estimates, building
construction and operation accounts for 33% of global energy consumption, 65% of
electricity use, 50% of extracted natural resources while producing 35% of world
greenhouse gases (GHG), 20% of water effluents and 25% of solid waste in landfills
(Lighthouse, 2008).
The intent of green building practices is to reduce this level of consumption and
waste through the creation of structures that are environmentally responsible and
resource-efficient throughout a building's life cycle (USGBC, 2008; EPA, 2008). A green
building promotes a holistic approach to the creation of a building and focuses on an
integrated design, construction and operation concept. This integration does not need to
involve radical technologies and gizmos like geo-thermal heat systems, “green” roofs or
homes made of recycled materials; it can be a simple and subtle design change that
incorporates the impact and function of long-term operation into the base building
specifications. The term “green” building may conjure up images of radical hippy living,
but the term simply refers to an integrated approach to good and thoughtful home design.
16
17. Over the past few decades, homebuilding practices in North America have not
placed a high priority on environmental responsibility and material efficiency as there
was minimal consumer demand for a green home (BDC, 2003, Kannan, 2008). Today,
there is growing evidence that suggests both home builders and home purchasers want to
make environmental responsibility a higher priority when building or buying a new
home. (BDC, 2007, RCLCO, 2008)
In part, this shift in priorities can be attributed to the emergence of climate change
and sustainable business practices as some of the leading business, social and political
issues of the first decade of the twenty-first century (Rees, 1992, Elkington, 1994,
Marshall and Toeffel, 2005, Stern, 2007, IPCC, 2007). Numerous studies on existing
green building have shown that a green building can reduce material waste, increase
energy efficiency and produce a healthier indoor environment (Lucuik, 2005, BDC, 2006;
Lighthouse, 2008). Green building practices have the potential to reduce the “ecological
footprint”1
(Rees, 1992) of a home, but only if the practices are accepted and
implemented by both producer (the homebuilder) and consumer (the home purchaser)
alike.
In theory, a home constructed using green building practices would consume
fewer building materials, produce less waste and use less energy to construct and operate.
However, these theoretical benefits of a green building remain largely unproven. There is
limited empirical data as green building is only at the introduction phase of its life cycle
(Rogers, 1962). The acceptance of the nascent green building concepts would not only be
a paradigm shift for both home builders and home buyers, but it would also be a leap of
1
UBC professor Rees and his doctoral student are credited with developed the “ecological footprint” to
describe the needs of a human versus the carrying capacity
17
18. faith based on theory and technology that is in its infancy. In addition, there is no single
accepted definition or standard for green building, so both the home builder and the home
buyer are faced with confusing and competing claims, products and organizations.
It should be an easy decision to build or buy a new green home based on the
promise of lower operating costs, a feeling of environmental responsibility and a
healthier home. However, the acceptance of green building in residential building has a
multitude of barriers to overcome. The barriers relate to the structure of the building
industry, the number of participants, the legitimacy of green technology and the liabilities
associated with the construction process. These issues are examined in relation to
academic studies related to innovation and entrepreneurship with a specific focus on the
construction industry. These concepts include cognitive and socio-political legitimacy
(Aldrich and Fiol, 1994), liability of newness (Stinchcombe, 1998) and various liabilities
and uncertainties associated with the construction industry (Reichstein, Salter and Gann,
2005). This research is used in conjunction with Porter’s Value Chain and Five Forces
analysis to assess the feasibility of implementing green building practices in the
residential building industry.
1.1.2 Format of the paper
In the remainder of the introduction, I will touch on numerous topics to set the
context for the green building movement and describe the residential building industry.
Chapter 2 will provide an industry analysis using Porter’s Five Forces framework and
Value Chain analysis. Chapter 3 will analyse the green building sector to identify barriers
and pathways to implementation. Chapter 4 will provide recommendations and some
strategic pathways to overcome the previously identified barriers.
18
19. 1.2 Background
1.2.1 Residential real estate: evolution of an industry
The residential real estate industry fulfils a basic human necessity – the need for
shelter. Over the millennia, the need for basic shelter evolved into a desire for homes,
offices, factories, airports, shopping malls and other buildings to support all manner of
human activity. In the modern global economy, the building industry creates employment
opportunities throughout a complex value chain that stretches around the world.
According to 2006 estimates, the global construction industry yields an annual
output of $4.6 trillion US, contributing to 8-10% of the Global Gross Domestic Product
(GDP) with a workforce of 120 million people (USGBC, 2008). In 2007 in Canada
alone, the construction industry accounts for 6.7% of total employment with 1.13 million
jobs and 6% of GDP at $72 billion CDN (StatsCan, 2008). Canadian residential
construction accounted for $23 billion CDN of the 2007 figure or about 33% of all
construction activity. By comparison, the 2006 figures for the US show the construction
industry as 14.2% of the $10 trillion US GDP. This includes all commercial, residential,
industrial and infrastructure construction. Commercial and residential
construction accounted for 9% of the GDP for total of over $900 billion US (US
Department of Energy, 2006).
1.2.2 Real Estate products
Within the North American building industry there are four main building types
identified by use and separated into two categories: residential and non-residential
(industrial, commercial, and institutional). A residential building is any building used as a
residence or dwelling. Industrial buildings include food-processing factories,
19
20. manufacturing plants and shipyards. Commercial buildings include office towers,
warehouses and shopping centres. Institutional properties include government buildings
such as schools, hospitals, government offices and prisons. There are currently 13.3
million residential homes and over 500,000 commercial and institutional buildings in
Canada (Natural Resources Canada, 2006). It is worth noting that developers and
operators of non-residential buildings have adopted green building practices more quickly
than their residential counterparts have.
In Canada, the residential real estate market has four product types: single family
home, semi-detached, townhouse and apartment (CMHC, 2008b).
Table 1 – Residential building by product type (Source: CMHC)
Residential
Type
Description Construction
Material
2007
Number of
Starts2
in
BC
Single – Detached Building containing
only one dwelling
unit
Concrete foundation,
wood frame, 1 to 2
levels
14,474 (37%)
Semi – Detached One of two
dwellings located
side-by-side in a
building,
Concrete foundation,
wood frame, 1 to 2
levels
2,111 (5%)
Row or
Townhouse
One family dwelling
unit in a row of
three or more
attached dwellings
Concrete foundation,
wood frame, 1 to 3
levels
4,175 (11%)
Apartment All dwellings other
than those described
above. Includes
condominium and
high-rises
Wood frame up to 4
levels.
Concrete and steel for
>4 levels.
18,435 (47%)
Total Starts in 2007 39,195 (100%)
2
A building “start” is defined as the start of work on a building usually when the concrete foundations are
poured. (CHMC, 2008) This signifies a credible commitment to the construction of the building.
20
21. Each building type has distinctive characteristics that require a different building process.
Generally, homes, townhouses and low-rise buildings use a wood frame structure with
mid- and high-rise condominiums and apartments use a concrete and steel structure.
Developers and homebuilders create these properties and buildings.
1.2.1 Developers and homebuilders – The supply side
In basic terms, a residential developer transforms an existing piece of property
into a new real estate product in the form of a single family, townhouse or apartment
style building. This new home is sold to a homebuyer. A homebuilder is the firm that
oversees the construction of the new home product for the developer. Developers and
builders in the residential sector have a dramatic range in size and scale. Some companies
are sole proprietors building one home at a time; other companies have hundreds of
employees building hundreds of homes and condominiums a year. Regardless of size, the
developer and builders operate in a competitive industry with low margins (Seaden,
Guolla, Doutriaux and Nash, 2001, Reichstein, Gann and Salter, 2005). As a result, the
real or perceived costs for green building innovation may be the single biggest obstacle
for green building acceptance on the producer side. According to a Reed Business
industry survey in 2007, 78 per cent of industry respondents believe that a green building
adds significantly to “first costs” than conventional buildings. This response differed
significantly from the 56 percent in 2006 and 44 percent in 2003. This is coupled with the
60 percent of respondents who answered that the “market is not willing to pay a
premium” for green building. (BDC, 2007) In a cost sensitive and competitive industry,
these beliefs present a significant obstacle to the adoption of green building.
21
22. 1.2.2 Homebuyers – The demand side
According to real estate industry literature, a new homebuyer has three initial
criteria: location, size and price (Lewis, 2008; Marak, 2008). Only after these criteria
have been satisfied will a buyer consider other features such as countertops, bathroom
fixtures and green building features. However, recent surveys indicate that green building
features are becoming more important to purchasers. A 2007 survey by Royal LePage, a
real estate brokerage, indicated that 75 per cent of homebuyers want their next home to
be a green home and 63 per cent were willing to pay a premium for the benefit (Royal
LePage, 2007). Another recent survey by Robert Charles Lesser & Co (RCLCO), a real
estate research firm, identified that approximately one-third of US homebuyers could be
swayed towards purchasing a green home (Kannan, 2007).
A homebuyer is sensitive to price and relative value of real estate. A homebuyer
also has a choice in real estate products: the new home product offered by a developer, or
previously owned home, also known as a resale home. A resale home is typically
available in a greater volume and offers a wider selection of products at a lower price
point than a new home. However, a resale home is, by definition, an older and used
product that may require renovations and lacks modern features that the new home
product can offer. In addition, a yet to be built new home has the opportunity to use green
technology during construction whereas the existing resale home cannot. The homebuyer
is presented with a price-performance decision with the purchase of a new home.
1.2.3 Current Strategy for Home Building Industry
The current generic strategy in residential real estate development is to buy
inexpensive land in the best location possible and then build homes as inexpensively as
22
23. possible by using easy to replicate building designs and practices. The industry business
model is based on the design-bid-build process that originated in the nineteenth century
and is still the dominant model for real estate development in the western world (Seaden
et al., 2001). This model is explained in greater detail in Chapter 2, but works on the
“lowest bidder’ principle. As a result, developers and builders are constantly looking for
cost advantages to ensure a profitable venture. As in most “lowest bidder” industries, a
low cost operation is a competitive advantage in the building industry.
It is important to note that a developer does not receive any revenue until a
homeowner has completed the legal conveyance of the property at the time of
occupancy.3
There are some exceptions, but generally the developer is paid when the
home owner moves in. As a result, every dollar spent up to closing is a direct cost
incurred and carried by the developer. A significant amount of capital is required to fund
a project whether it is a single family home or a high rise apartment building. The
developer will use a mix of equity and leveraged debt from financial institutions or other
investors for funding. Real estate development is a high risk endeavour: expenses are
high, sales are uncertain, cash flow does not occur until the property is completed.
All these factors combine to produce an industry that works on speed of
construction at the lowest cost possible in order to get a homeowner into their home as
soon as possible. Once the homeowner takes possession, the developer is no longer
involved in the project aside from some warranty obligations: this is known as a “turn-
key” development. This term refers to the moment when a homeowner turns the key in
the lock of their new home. From that moment forward, the homeowner is responsible for
3
Occupancy refers to the issuance of an occupancy permit by the local building authority. A home does not
need to be occupied by a resident or tenant in order to have occupancy.
23
24. operation and maintenance of the new home. The industry business model that is
predicated on location, speed of delivery, low cost and “turn-key” delivery seems like a
poor fit for the integrated green building approach. The building life cycle reveals some
additional challenges for the building industry.
1.2.4 The Building Life Cycle
A simplified building life cycle is site selection, building design, construction,
operation, maintenance, renovation and the eventual demolition and removal of the
structure. This life cycle is a building-specific modification of the life cycle assessment
framework of design, production, use and dispose/recycle drawn from Matos and Hall
(2007). Depending on material and location, this life cycle could span decades to
centuries. A well-built wood frame home can survive for centuries with proper
maintenance and, as many people in Vancouver know, a poorly built and “leaky condo”
can need a complete renovation, and sometimes even demolition, within a decade.4
The
residential building life cycle has several notable economic and organizational features
that differentiate a residential from a non-residential building.
First, building costs are front end loaded and occur at start of the development.
These “first costs” relate to property acquisition, design and construction. These
significant costs are borne solely by the property developer until time of sale. Rarely will
the initial developer be the final home owner. This is different than a non-residential
building where the developer is often the long-term building owner and operator.
4
There were dozens of failures in the building envelope construction of residential buildings in Vancouver
between 1990 and 2005. These failures resulted in water ingress and damage to the structures through
rotting and corrosion. These buildings were dubbed “leaky condos” by the media and residents and
required significant, costly and ongoing repairs to correct.
24
25. Second, a residential property does not produce revenue for its owner as its
primary function. Its primary function is to serve as a dwelling. Moreover, the home
owner will incur continual operating and maintenance costs for the lifetime of the
building without an offsetting revenue stream. This is different from a non-residential
building whose primary function is the production of a revenue stream through rental or
industry. As a result, the developer of a non-residential property often remains the owner
and operator of the building to generate cash-flow and recover the initial investment
costs.
Third, the participants in the life cycle are separated from each other and do not
remain involved from start to finish. For example, the building designer will likely never
be in contact with the building operator or occupant. Likewise, the construction team will
not be involved in the maintenance. In their research on the construction industry,
Reichstein et al. (2005) refer to this disconnect between design, production and use as the
liability of separation. The separation limits integration, knowledge sharing and feedback
between participants and reduces the opportunity for improvement based on input from
all participants. Furthermore, the nature of the supply chain and construction practices
also creates the liability of assembly. Due to in-situ building assembly, this liability
discounts the involvement of off-site suppliers of materials and services such as
designers, architects and engineers. As a result, their contribution to product and process
development activity is often overlooked. Home construction and use of the building is
also tied to a specific piece of property. Reichstein et al, refer to this characteristic as the
liability of immobility and it limits the use of off-site automated factory technologies and
25
26. also exposes the building and workers to weather and climate conditions during
construction.
The life cycle relationships highlight a few issues inherent in residential building
industry. “First costs” are initially funded by the developer and not the eventual home
owner. Maintenance and operating costs are paid by the home owner and the property is
not intended to produce revenue. The liability of separation restricts the interaction and
knowledge sharing between participants in the building life cycle. The liability of
assembly and liability of immobility limit the use of off-site production facilities and
expose the production process to the local elements. These issues combine to create a
series of isolated functions within a residential building life cycle. As a result, both cost
and function are assessed in isolation from the other participants.
These “liabilities” limit the ability of a developer to respond to customer demand
just as it limits the ability of a home owner to request changes to the home product. This
creates a limited feedback mechanism within the building supply chain from design to
operation. Innovation and change are also stifled as the developer is unwilling to bear the
costs without knowing if the product will find a willing buyer. This factor is also termed
the liability of uncertain demand (Reichstein et al., 2005).
This is a brief overview of the residential building industry and the industry will
be examined in more depth in Chapter 2. The green building sector has found some
traction in the non-residential sector, but has had limited success in residential building
due in part to the liabilities that have been discussed.
26
27. 1.3 What is Green Building?
The mainstream green building movement in North America is less than a decade
old. As a result, there is a cacophony of competing definitions, standards and
organizations as the sector emerges. The absence of a standard definition creates
confusion for both the homebuilder and the home purchaser. The US Environmental
Protection Agency (EPA) website provides a comprehensive definition of green building:
Green building is the practice of creating structures and using processes
that are environmentally responsible and resource-efficient throughout a
building's life-cycle. This practice expands and complements the classical
building design concerns of economy, utility, durability, and comfort.
Green building is also known as a sustainable or high performance
building. (EPA, 2008)
The EPA definition contains several important aspects about green building.
First, the philosophy of green building is applied throughout the building life-
cycle and embodies a holistic approach to the life-cycle that connects design to
construction and construction to operation. Green building is not an add-on feature to a
conventional building: green building practices are an integrated and long term approach
that involves changes throughout the life of a building that involves designers, builders,
contractors and purchasers.
Second, the “green” in green building is a misnomer and a distraction from the
intent of the building practice. The word “green” refers to the environmentalist roots of
this building philosophy and not necessarily the physical attributes of the building. A
green building does not need elaborate and expensive features such as a green roof, geo-
thermal heating and recycled water system– most changes are simple and subtle such as
operable windows to provide natural ventilation and larger roof overhangs to block solar
27
28. gains. A green building uses conventional building techniques and materials with an
integrated design approach for the long term functionality of the building and comfort of
the occupants. In fact, the French-Canadian wording of green building is perhaps a more
apt description as the French “bâtiments durables” translates to “durable buildings.”
Third, green building practice is also mindful of the importance of economics, and
by extension profitability, throughout the lifecycle by creating a functional building that
will perform at a high level over a long period of time.
These considerations can be translated into the three goals of effective green
building practices as provided by the US Green Building Council (USGBC):
1. Reduce the costs for construction, operation and maintenance through increased
resource and energy efficiency,
2. Reduce the impacts on human health and improve human comfort through
building location, non-toxic building materials, improved indoor air quality and
lighting,
3. Reduce the impact on the environment through conservation of resources,
energy and water at every stage of the building life cycle. (USGBC, 2008;
CAGBC, 2006)
As outlined early, buildings consume a significant amount of resources while creating
greenhouse gas emissions and waste. In the US, residential and commercial building
account for 72% of electricity consumption, 39% of energy use, 38% of all carbon
dioxide (CO2) emissions, 40% of raw materials use, 30% of waste output (136 million
tons annually), and 14% of potable water consumption (USGBC, 2008). A reduction in
any or all of these areas through improvements in efficiency or conservation could have
significant economic and environmental impacts – the positive kind.
28
29. During the past decade, numerous green building organizations have emerged
with different agendas, standards and terms. In addition, multiple local, regional and
national organizations certify green projects including LEED (Leadership in Energy and
Environmental Design), Green Globes, Built Green, Net Zero, Eco-Density and a host of
other independent or self-labelled “green” terms. The number of voices and lack of
coordination add to market confusion and reduce the legitimacy of a green building.
The green building sector could help establish a triple bottom line (TBL)
accounting framework for the building industry. First coined by John Elkington in 1994,
TBL expands on traditional financial performance by including social and environmental
performance in company accounting (Elkington, 1998). Looking towards the future, the
building industry needs a triple bottom line approach to combat the triple threat of
climate change, dwindling commodities and concerns about health and wellness.
This leads to the first proposition in this paper:
1. Climate change and environmental activism is one pathway that will promote
acceptance of green building principles for homebuilder and home purchasers..
2. The cost savings associated with energy conservation and resource efficiency by
homebuilders and homeowners will be accelerated by rising energy and
commodity prices.
3. The health and wellness benefits from a cleaner and toxic free home
environment have the potential to become the key marketing tool for the green
building concept.
The following sections contain additional information on these three concepts.
29
30. 1.3.1 Climate Change: The Inconvenient Truth
Over the past several decades, the environmentalist movement has grown out of
people’s concern for the earth’s resources and the impact on the human population. Over
the past five years, the ideals of this former fringe group have moved to forefront of
public awareness. Suddenly, the environment, and more specifically global warming
caused by human activity, became a leading social, political and economic concern.
Three notable reports are worth highlighting for their contribution to the ongoing debate
on climate change.
In 2006, former US vice-president Al Gore turned his power point presentation on
global warming into an Academy Award winning movie. An Inconvenient Truth told the
direct and dire story about the consequences of global warming and the public responded
at the box office; the movie became the fourth highest grossing documentary of all time
(IMDB, 2006). Arguably, Al Gore used Hollywood to break through a psychological
barrier to reach the mainstream population about the crisis of global warming.
In October 2006, following on the heels of the Hollywood treatment of climate
change, Nicholas Stern, the former Chief Economist at the World Bank, released the
Stern Review on the Economics of Climate Change (2006). Stern’s report focused on the
economics implications of climate change and the report contained numerous conclusion
including “serious, irreversible impacts from climate change associated with business-as-
usual (BAU) paths for emissions,” (p. iii) and that climate changes threatens the basic
elements of life, water, food, health, for people around the world. Stern concluded with
an estimate that it would cost 1% of global GDP to stabilize CO2 in the atmosphere
30
31. levels by 2050 to counteract global warming.5
If no action occurs, Stern estimates the
cost to the global economy is a loss of 11% to 20% of per capita consumption by 2050.
In February 2007, the UN and the Intergovernmental Panel on Climate Change
(IPCC) released its fourth assessment in a series on climate change.6
The report
contained numerous findings and made two claims based on scientific data and models.
First, “warming of the climate system is unequivocal.” (IPCC, 2007, p. 5) Second,
anthropogenic, or human activity, is “the primary source of the increased atmospheric
concentration of carbon dioxide since the pre-industrial period results from fossil fuel
use, with land use change providing another significant but smaller contribution” (IPCC,
2007, p.2) In summary, the earth is heating up and human activity is a major cause.
The findings of the IPCC and Stern reports were generally accepted by scientific
and government bodies alike, although skeptics still exist. Stern’s report (2006) also
contains four recommendations for counteractive measures:
• Reducing demand for emissions-intensive goods and services
• Increased efficiency, which can save both money and emissions
• Action on non-energy emissions, such as avoiding deforestation
• Switching to lower-carbon technologies for power, heat and transport
Green building practices address all four areas of action suggested by the Stern report. In
addition, Stern’s figures show that buildings and power production accounted for 8% and
24% respectively of global greenhouse gas (GHG) emissions in 2000. In order to make a
5
In June 2008, Stern revised his estimate to cost 2% of global GDP due to the faster than expected
accumulation of CO2 since 2006.
6
Incidentally, Al Gore and the IPCC shared the Nobel Peace Prize in 2007 “for their efforts to build up and
disseminate greater knowledge about man-made climate change, and to lay the foundations for the
measures that are needed to counteract such change." (Nobel, 2008)6
31
32. difference on the environment front, GHG associated with buildings and power
generation need to be cut dramatically.
1.3.2 Commodities in a global market
Rising raw material prices and increased energy costs can act as another catalyst
for the acceptance of green building practices. Based on existing green buildings and case
studies, a well-designed green building requires fewer resources to build and less energy
to operate (BDC, 2007). The increased efficiency of a green building translates into less
money and can insulate against future spikes in energy costs. In July 2008, the future
contract for a barrel of US light sweet crude oil peaked at $147 US a barrel (BBC, 2008);
a year earlier in July 2007 the same barrel cost $77 US and in September 2000, the price
was at $16 US. The long-term price for the cost of oil, gas, electricity and other
commodities such as lumber, cement and copper will continue to trend upward as world
demand increases with population growth and the supply of these non-renewable
resources decline.
In addition to its use as fuel, oil is a direct or indirect component of every material
used in the building industry. Some building materials such as roof shingles, asphalt
paving and plastic piping contain oil products in the material. All other goods are
fabricated, shipped, driven or otherwise handled by a piece of equipment that runs on an
oil-based product such as gasoline or diesel fuel.
Green building practices aim to use building resources more efficiently through
better material selection, innovative building practices and recycling. Moreover, a green
building uses high performance heating and cooling systems that aim to reduce the
32
33. energy requirements for building operation. A common and simple change that fits the
“green” criteria is the switch from the fluorescent light bulb to the compact fluorescent
light bulb. The desire of the homebuilder to reduce building costs by using fewer
materials and the desire for a homeowner to save money on utility bills are two economic
reasons to support a residential green building.
1.3.3 Quality of life
There are multiple health related crises emerging across North America and
around the globe. Preliminary studies show that green building can minimize and
mitigate some of the risks by improved the indoor building conditions at work and at
home (Lucuik, 2005). Natural air circulations system, natural lighting and non-toxic
paints, mutagen free carpets and upholsteries are some of the examples of simple
improvements that can improve the quality and comfort of an indoor space. Studies have
shown that a higher quality of indoor space can lead to improved productivity in the
workplace (CAGBC, 2006) by more research is needed to prove the long-term
relationship.
Environmental responsibility, cost savings and health benefits are three pathways
for homeowners and homebuilders to create both supply and demand for a green building
product. In turn, these three pathways could produce a more sustainable business model
for residential building, but sustainability carries some problems as well.
1.3.4 Sustainability: A matter of definition
Similar to the term “green”, the term “sustainability” has become a ubiquitous and
almost meaningless buzzword. Many companies across many industries apply the generic
33
34. terms “green” or “sustainable” to their products, when neither the company nor the
consumer may understand the term (Marshall and Toeffel, 2005). The same confusion is
present for the green building industry as competing standards and definitions result in a
variety of claims. When an industry cannot agree on its purpose, then it is unrealistic to
expect consumers and producers to understand the value of green building. This matter of
ambiguous and poorly defined terms and concepts is an impediment to industry and
consumer acceptance.
The term “green building” presents a paradox; although a green building may be
more environmentally friendly than the traditional home, the only truly green building is
the one that is never built. Likewise, “sustainable development” is not applicable to the
building industry as a building is incapable of self-repair or regeneration. However, in
this paper, the terms “green building” and “sustainable development” are used in the
spirit of the 1987 Brundtland Commission on Environment and Development definition
of sustainable development as “development that meets the needs of the present without
compromising the ability of future generations to meet their own needs” (World
Commission on Environment and Development, 1987).
However, this definition is also an elusive concept as “sustainability” in the terms
of real estate development incorporates value-driven issues of personal preference and
not necessarily issues of human survival. Accordingly, in our North American consumer
society “green” and “sustainable” become synonyms for “good” or “quality” whereas for
others, the word “sustainable” equates with basic human survival and health (Marshall
and Toeffel, 2005). This may seem to be a matter of semantics, but a consumer is
confused and also sceptical when an American oil company describes itself as sustainable
34
35. in the same manner that a non-governmental organization (NGO) describes a clean
drinking water project in sub-Saharan Africa as sustainable. In this context, it is not
surprising that consumers, producers and industry are confused and sceptical to accept
the plethora of definitions and products. This scepticism has resulted in the term
“greenwash” which refers to products that have dubious and unsubstantiated claims of
sustainability.
It will take some time before consolidation occurs for the accrediting bodies and
government agencies before the public understands the green building concept. Until
then, confusion and competing claims will only damage the legitimacy of not only the
“green building” movement, but also all things “green.”
1.4 The Building Industry: A reluctant innovator
Building practices have not changed significantly in centuries. In fact, some
construction research suggests that the industry structure has not evolved from nineteenth
century practices and institutions (Bowley, 1966; Seaden, et al., 2001). Incremental
changes in technology have altered the appearance of a modern building, but the basic
material and construction process have changed minimally as architects, contractors and
trades people have the same roles they had a century ago. Bowley (1966) suggests that a
lingering Victorian era societal hierarchy exists within the construction industry that
stifles innovation and change that she refers to as “the system.” A professionally trained
architect or engineer is at the top of the hierarchy with the trades people and labourers at
the bottom. “The system” shares similarities with the liability of separation (Reichstein et
al., 2005) as it creates barriers to innovation, and diminishes incentives to pursue change.
These observations have merit and are backed by recent empirical studies on innovation
35
36. from Canada and the UK that suggest that the construction industry lags behind over
industries in innovations due to a number of industry liabilities. (Seaden et al., 2001,
Reichstein et al., 2005) Seaden el al. (2001) finds the construction industry is
characterized by “low levels of expenditures on activities associated with innovation,
such as research and development” (p. 631). The classic definition of an innovation
comes from Schumpeter (1934) and pertains to the commercialization of a new idea or
invention, which in the case of the building industry can be new products, processes, or
industrial organization. Green building is an example of an innovation that incorporates
all those ideas, but needs to make the transition from idea to commercial viability.
Green building practices have the potential to change the building industry
through the integration of design and construction process, but a change to the building
industry is a formidable challenge. The industry participants are reluctant to invest time
and money into a new and unproven area such as green building. These issues are
explored in greater detail in Chapters 2 and 3. A change in the building industry attitudes
towards environmental responsibility may provide an opportunity for the industry to
engage in innovation that can lead to what Baumol (1990) refers to as “productive
entrepreneurship,” or a change through innovation that creates a net social benefit for
society. Traditionally, the building industry has engaged in “unproductive
entrepreneurship,” or rent-seeking behaviour. When externalities including contributions
to climate change and environmental degradation are included, then the industry may
even be considered a “destructive entrepreneur” (Baumol, 1990). Recent events in the
global housing market may confirm that residential developers may be considered
“destructive.”
36
37. 1.5 Recent developments
Since the start of research for this paper in 2007, the North American housing
market and subsequently the global credit markets have collapsed on a scale not seen
since the Great Depression of the 1930s. The US new home real estate market is the
epicentre of this collapse. Fuelled by easy credit, low interest rates and exotic mortgages,
the US housing market experienced double-digit growth in sales and volumes in every
year since 2003. Homebuilders responded with the construction of nearly 2 million new
homes a year in 2005 and 2006. Similar properties booms took place in Canada, the UK
and Europe. This housing boom came crashing to a halt in 2007 when concerns over US
sub-prime mortgage risks surfaced.
However, the world population continues to grow. The UN predicts world
population to grow from 6.6 billion people in 2005 to 9.2 billion people in 2050 (UN,
2006). Although the forecast are subject to revision, US new housing starts are still
forecast at nearly a 1 million new homes a year for the next 5 years (USHBA, 2007).
Locally, the Vancouver forecast is a net migration of over 35,000 people over the next 3
years (CMHC, 2008f). People need homes and eventually the current inventory of homes
for sale will be used. Demand will outstrip supply and the building industry will recover.
The timing of this recovery is unknown. In the meantime, the development industry has
time to assess its current business model. Arguably, some aspects of the current model
are responsible for the current financial crisis and rapid decline of new home starts. On
the flipside, the consumer also has an opportunity to assess their needs in a housing
product. Size, features, location and affordability are all concerns.
37
38. This is a snapshot the current and dynamic state of the global economy and the
building industry. Chapter 2 presents an industry analysis that assumes static and
predictable conditions or “business as usual.” The building industry that emerges from
the current crisis may look different.
38
39. 2: INDUSTRY ANALYSIS
This chapter contains an industry overview of the residential building industry in
British Columbia. The main sections of this chapter are an industry analysis using
Porter’s Value Chain and Five Force models. These analytic tools identify the key
success factors for the home building industry.
2.1 Overview – Residential Building Industry
The residential building industry involves a series of complex relationships
among government, financial institutions, property owners, construction contractors,
design professionals, real estate agents and homeowners. Each of the aforementioned
groups has its own supply chain that includes numerous other suppliers, services and
manufacturing industries. The inputs from this collection of industry and services
combine to create the output of a new home. As previously discussed, there are several
types of new home products including the single family home, townhouses and apartment
units. Although the final home product may appear different, the industry process of
development and construction follows a similar path.
39
40. Figure 1 - Residential Home Building Activity Chart
Developer
Financial
Institution and
Investors
Design Team
Construction
Contractor and
Trades
New Home
Sales
Home Owner
Government
Bank
Marketing
2.2 British Columbia Building Industry
2.2.1 Industry size and growth
New home construction in BC occurred at record levels over the past five years, but
building starts are forecast to decline over the next few years. The BC trends follow
similar trends across Canada and the US; however, the financial uncertainty precipitated
by the “sub-prime mortgage” collapse has rendered short-term forecasts obsolete. Long-
term growth is predicted to recover, but the timing is uncertain. As shown in Figure 4
housing starts of all types peaked in 2007 and are forecast to decline over the next few
40
41. years (CMHC, 2008b). Despite the market uncertainty, BC’s economy is forecast to
grow moderately over the next several years and outpace the national average. Population
is also forecast to grow with a net migration of over 50,000 people a year as shown in
Figure 2.
Figure 2 - Net Migration to BC 2003 to 2009 (Source: CMHC)
2003 2004 2005 2006 2007 2008(F) 2009(F)
Net migration to BC 35,850 39,721 48,444 48,276 52,999 56,200 56,900
Net migration
to Vancouver 23,661 26,216 31,973 31,862 34,979 37,092 37,554
Economic and population growth should result in a continued long-term demand
for housing. According to a recent report by the Canadian Mortgage and Housing
Corporation (CMHC), there were 41,301 units under construction in BC at the end of
June 2008, up 14.1 per cent over 2007 levels (CMHC, 2008a). CHMC (2008e) also
reported a shift towards denser housing forms such as apartments due to high land and
building costs.
CMHC volume and sales figures since 2003 provide an estimate of the residential
new home industry size in BC. Increased home starts in combination with a rise in
property prices have doubled the value of new home activity over the past five years from
estimated revenue of $10 billion in 2003 to over $20 billion in 2008 (See Figure 3).
The industry generates significant economic activity for BC. The following
section contains a value chain analysis that highlights the extent of this activity.
41
42. Figure 3 - BC new home building industry – units and dollar volume (Source: CMHC)7
Year 2004 2005 2006 2007 2008(F) 2009(F) 2010(F)
Volume of Starts 26,174 32,925 34,667 36,443 39,195 35,800 31,500
Average New Home Price 385,000$ 410,000$ 435,000$ 510,000$ 550,000$ 598,000$ 598,000$
Total Dollar Volume (Billions) 10.08$ 13.50$ 15.08$ 18.59$ 21.56$ 21.41$ 18.84$
Figure 4 – Residential Starts in BC by type, 2003 to 2009 (Source: CMHC)
Residential Dwelling Starts in BC
Percentage by type
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
45,000
Units
Appt
Row
Semi Det
Single Det
Appt 9,272 12,420 14,698 14,295 18,435 18,200 15,600
Row 3,297 4,387 4,459 4,476 4,175 3,850 3,000
Semi Det 1,353 2,062 1,791 2,239 2,111 1,950 1,400
Single Det 12,252 14,056 13,719 15,433 14,474 11,800 11,500
2003 2004 2005 2006 2007 2008 (F) 2009 (F)
2.3 Value Chain Analysis – New Home Building Industry
There are numerous participants in the new home building industry. This section
will highlight six primary stakeholders: the developer, the design team, government, real
estate agents, the construction contractor and the purchaser.
Porter (1984) suggests that a dominant part of strategic management is “how a
firm can actually create and sustain a competitive advantage in its industry” (as cited in
Grant, 2008, p. 78). He also suggests that competitive advantage grows out of value a
7
Methodology - Housing starts from the previous year are used as a proxy for sales. CMHC uses MLS to
track house sales and many new homebuilders do not use licensed real estate agents or MLS.
42
43. firm is able to create for its buyers in excess of the firm’s cost of creating it. Following on
these comments, the objective of a development company is to create a real estate
product where the value of the product exceeds the cost of the inputs required to create it.
2.3.1 The Developer: Minimal costs and maximum returns
A residential developer creates a speculative real estate product. A developer
takes a piece of land and creates one or more buildings that are sold to purchasers. The
real estate sale to a customer generates the eventual revenue, but economic profit is
created by adding value to the original piece of property through a series a transformative
activities. These value-adding activities can include an advantageous property
acquisition, re-zoning of the property, infrastructure improvements and constructing
vertical structures such as new homes and apartments. Due to speculative nature of
development and the uncertainty of future demand (Reichstein et al., 2005), market
research and intelligence is a value adding feature. The production of the right product in
the right location is critical to the success of a development. Development companies and
their projects vary dramatically in size, scope and market. The developer of a single
family home in Fort St. John goes through a similar series of steps to a high-rise
apartment builder in Downtown Vancouver. The following is a list in Table 2 of the
traditional sequence of activities that developers will coordinate.
Table 2 – Value chain activities and estimated costs
Description % Estimated Cost
Step 1: Market research <1%
Step 2: Property selection <1%
Step 3: Economic analysis <1%
43
44. Step 4: Property acquisition 10% to 20%
Step 5: Project design 6%
Step 6: Permits, approvals and entitlements 1%
Step 7: Financing 8%
Step 8: Construction 55% and up
Step 9: Sales and Marketing 6%
2.3.1.1 Development Organizations
In the residential industry, there are two segments of developers: the traditional
developer and the integrated developer. A traditional developer will outsource most
activities to outside firms. An integrated developer will keep most activities within the
company. These two organizational structures result in different companies with different
competitive advantages and strategies, but the main difference is the approach to the
construction and building activities. The construction component of a development
project has the largest proportion of total costs, contains the most complex systems and
subsequently carries the most risk.
Both organization types follow the industry business model known as design-bid-
build. This system originated in the nineteenth century and is still the dominant model for
real estate development in the western world (Seaden et al., 2001). The business model
works on the “lowest bidder” principle to transfer risk and liability across the various
participants in the building value chain. The design-bid-build model uses a competitive
bidding process to determine the “winner” of the respective contract. The winner is then
required to complete the contracted scope of work for the money stipulated in the
contract. The developer conducts this process for the design team, the construction
contractor, real estate agents and eventually the homebuyer. Figure 5 illustrates the
design-bid-build process with the associated participants.
44
45. Figure 5 – Modified Design-Bid-Build Cycle
CONCEPT
BID ON
DESIGN
DESIGN
BID ON
BUILD
BUILD
BID ON
HOME
NEW HOME
DEVELOPER
DESIGN PROFESSIONAL
CONSTRUCTION CONTRACTOR
HOME OWNER
The traditional and integrated developer each takes a slightly different approach
to the design-bid-build process. A traditional developer uses the market to mitigate the
risk and financial exposure of the real estate project. However, the developer incurs
transaction costs associated with each market interaction as search costs and negotiations
with suppliers have a transaction cost (Coase, 1937). In addition, the supplier takes a
portion of the risk away from the developer. As a result, the traditional developer usually
trades profit margin for risk mitigation within the value chain. An example of a
traditional developer is Vancouver-based Westbank Projects. For their Woodward’s
Redevelopment Project, Westbank conducted Steps 1 to 4 in-house, but hired Henriquez
Partners as the architect, Intertech Construction as the general contractor and Rennie
Marketing Systems for the marketing and sales (Westbank, 2008). The terms vary for
each of the suppliers, but the contracts have a series of incentives, bonuses and penalties
that will motivate each firm to work towards the successful and timely completion of
their scope of work. According to Dewald, Hall, Chrisman and Kellermanns (2007), this
“quasi-integration” is a form of governance where Westbank, as the dominant firm, can
retain “a degree of managerial control” over its suppliers “without the associated costs
45
46. and rigidities of ownership” (p. 281). Westbank spreads the risk and shares the reward
with numerous suppliers through market contracts; however, Westbank also cedes
potential profit margin to its suppliers and incurs transaction costs.
An integrated developer will keep as many of the activities within the company as
possible as well as the associated control, risk and potential profit margins. An example
of an integrated Vancouver based developer is Solterra Developments. Solterra’s strategy
is an attempt to maintain a greater amount of control, but also an attempt to avoid market
related transaction costs. Building on the work of Coase (1937), Grant (2008) suggests
that, “If the transaction costs associated with organizing across markets are greater than
the administrative costs of organizing within firms, we can expect the coordination of
productive activity to be internalized” (p. 342). This theory can help explain Solterra’s
internal design department, internal construction management division and internal sales
team. Furthermore, within the construction division, there is a drywall company, a pre-
manufactured wall plant, a window plant, a plumbing company and several other
construction related trades. Solterra’s vertical integration allows the developer to retain a
larger amount of control over the supply chain. In Solterra’s case, it has integrated
backward into the design, construction and sales activities. This integration is also a
source of competitive advantage as the company can develop specialized activities and
expertise within the company. A notable exception to Solterra’s vertical integration of the
design team occurs with the architect. This is a matter of reputation and another source of
differentiation discussed in the Design Team section.
46
47. 2.3.2 The Design Team
The design team is a collection of architects, engineers and consultants from
various disciplines that are required in the planning, design and construction of a safe and
functional building. The essential consultants are a collection of university trained and
professionally licensed consultants that include the architect, surveyors and the
professional engineers.8
Not only does this group need to follow the laws of physics, but
the architect and engineers must follow the local, national and international building
codes and guidelines. The design professional group is legally required to design, inspect
and certify that their building project meets the minimum required standards for the
health and safety for human occupancy. A failure to meet these standards can be costly to
rectify and sometimes deadly in the rare event of a building failure due to design errors.
To mitigate this risk and liability, each group has its own governing institution for
ongoing training and certification. In order to practice in good standing, each architect
and engineer is required to carry a significant amount of professional liability insurance.
The developer requires this group to open a building and pays a hefty transaction cost to
transfer a large amount of liability onto the shoulders of the architect and engineers.
The developer retains other consultants to enhance the aesthetic properties of the
building and property such as interior designers, landscape architects, acoustic and
lighting consultants to name a few. These consultants are not required to hold a
professional designation or provide a certificate of work. While paint, furniture and
landscaping may add to the look of the building, the structural integrity is more important
to the health and safety of the occupants. Thankfully, structural integrity of a building is
8
A professional engineer carries the designation of ‘P.Eng’ in one of various disciplines including
geotechnical, civil, structural, mechanical and electrical
47
48. not a selling feature; it is an implicit requirement that a new home will stay standing.
However, attractive colour palettes and a carefully manicured landscape feature are
selling features that most purchasers of a new home expect and appreciate; the framing
and plumbing of a building are rarely a concern for a home purchaser (until something
goes wrong).
The developer assembles a design team of professional and other consultants
through a bid process based on a basic building concept. Each design team member will
have a variety of roles throughout the design and construction of the building. First, they
receive input on the functional requirements and budget constraints from the developer.
Second, the design team takes the developer’s requirements and creates a series of plans
and specifications that meet the local code and zoning requirements specific to the
property location. These plans become the blueprints for the building. Third, the design
team will interact and oversee the construction of the building by providing answers and
direction to the construction team during the tender period and the construction phase of
the building. Finally, the design team, most notably the architect and engineers, conducts
inspections and certification for the building for both the developer and the building
authorities prior to occupancy by the public. This is a simplistic overview of a lengthy,
costly, complicated and iterative process that is difficult to value.
There is a large degree of consolidation within the design professional industry
and this can be attributed to the strong price competition and lack of bargaining power
with developers for projects. Developers will solicit proposals and award fixed price
contracts from the various design companies. Although the majority of firms compete on
price, a few architects and interior designers are able of extracting superior rents due to
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49. reputation. Arthur Erickson is an example of a Vancouver-based architect who can
command a design fee that is significantly higher than the industry standard based on
reputation. Another example is the local interior design firm of Alda Pereira Design. Ms.
Pereira was featured on the Oprah Winfrey Show and was able to use that visibility to
raise both her reputation and fees. A celebrity architect or interior designer can also
provide a competitive advantage for a developer as a way to differentiate the real estate
product.
2.3.3 Government Agencies: Protecting the public interest
There are multiple levels of municipal, provincial, national and even international
agencies that have a myriad of rules, regulations and approvals for various aspects of a
property development. For a project in the City of Vancouver, multiple levels of
government regulations must be satisfied and various permits and approvals obtained at a
series of sequential gates that can take months to years. At the design stage, the architect
must follow the City of Vancouver building guidelines, the British Columbia Building
Code (BCBC) and the National Building Code of Canada. At the development permit
stage, a project must obtain neighborhood approval through a series of public hearings,
City approval of the form and character of the building and City planning confirmation
that the development fits into the Official Community Plan (OCP). If the project is
located near parks or water, then the provincial and federal government can be involved
from the BC Ministry of the Environment and the Federal Department of Fisheries and
Oceans. During the construction process, the City building inspectors need to inspect and
approve a series of sequential steps, WorkSafeBC (formerly the Workers Compensation
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50. Board) enforces regulation for worker health and safety and a variety of national and
international standard associations conduct assessments of the quality of work.
Government agencies also receive revenue from building permits, property
transfer taxes and other building industry related fees. In addition, developers are often
required to provide infrastructure upgrades to city and municipal services around the new
building site. These additional requirements are often listed as “Voluntary Gifting
Agreements” (VGA) and form part of the development permit requirement, although
there is rarely anything “voluntary” about the requirements. The VGA work can include a
range of services that generally include upgrades to local sanitary, water and sewer
connections, but may include park, green space and other off-site improvements. To
paraphrase Adam Smith (1776), rarely does a developer commit a community act out of
benevolence; the developer builds parks and rehabilitates fish habitat out of self interest
to satisfy government requirements.
2.3.4 Financiers: Risk and return
Financing a real estate development is a major component of the value chain. A
developer needs a large amount of capital and financial institutions and investors are the
best source of capital. A typical financing scenario involves the developer using the land
and some equity as collateral and a lending institute provides the financing for the
construction portion of the project. Construction costs account for the largest portion of
the development budget, often over 80 per cent of the total budget.9
The construction
loan proceeds are released on a progress completion basis. The developer will submit a
progress draw to the bank, the bank will verify the progress through a Quantity Surveyor
9
Figures based on author’s industry experience and cannot be specified due to confidentiality issues.
50
51. and then the funds will be released to the developer. The developer in turn will pay
suppliers and contractors on a similar progress completion basis. The progress draw
occurs once a month and usually takes 30 days to process, but may take 60 days; this
means that a contractor may wait for over two months before receiving payment for
completed work.
Securing construction financing may also depend on sales and this involves the
pre-selling or “pre-sale” of residential units. The level of pre-sales provides a measure of
security to the financial institutions that the project will be successful. Pre-sale thresholds
vary, but some Vancouver-based banks require 60 to 70 per cent of units sold through
pre-sales.10
Projects that fall short of this threshold will continue to spend sales and
marketing dollars until this level is achieved. Overwhelming success during the pre-sale
stage can be a mixed blessing for several reasons. The Woodward’s project is an example
of a pre-sale success. All available units were sold on the first day of pre-sales in 2006 for
a building that will not be ready for occupancy until 2010.
A sellout presents two problems. First, a rapid sell-out indicates that the units
were potentially under-priced and the developer could have extracted more revenue from
the demand curve. Second, the developer has now fixed the future revenue of a project
that may take years to complete. This is a real problem in an inflationary economy as
rising construction costs can quickly erode the fixed sales revenue and force the
developer into a negative financial position before construction has even started. This
situation has recently put forced some Lower Mainland developers to cancel pre-sale
contract or even declare bankruptcy (Penner, 2007, CBC News, 2007). Experienced
10
Figures based on author’s industry experience and cannot be specified due to confidentiality issues.
51
52. developers will secure a fixed price construction contract prior to the pre-sale event. This
allows the pre-sale price to reflect the actual project costs. After securing financing and
achieving pre-sale success, the developer must now manage the construction portion of
the project.
2.3.5 The Construction Contractor
The construction of the building is the largest cost component, involves an
enormous amount of people and carries the most risk. The integrated developer will use
the in-house construction team and the traditional developer will use the services of a
general contractor. A general contractor (GC) is a construction management company
that will coordinate the sequencing of material and labour required to construct a building
according to the design. Regardless of the route, the developer needs two essential items:
an accurate construction cost budget and reliable construction schedule.
2.3.5.1 The Bid process: winners and losers
An accurate and secure construction contract is one of the most important steps in
the development process as it allows the developer to set the sales price of the new home
product. The award of a construction contract is an elaborate undertaking that is ruthless
in competition and Byzantine in complexity. There are numerous forms for a contract
such as a fixed price, stipulated sum, contract management, cost-plus and these types of
contracts can be awarded through a competitive bid process or through negotiation. A
common scenario for the traditional developer involves a competitive bid process that
results in the award of a fixed price contract to a general contractor. The process starts
when the developer solicits interest from a series of general contractors.
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53. Each interested GC receives the plans and specification for the building and
works to compile a bid price by a specified deadline or “closing.” Just as the developer
will solicit numerous bids, the GC will also solicit numerous quotes from the different
subcontractors within the construction industry. For example, the GC will ask four or five
electrical contractors to provide a price for the electrical component of the building.
These subcontractors may also be providing prices to other GCs. This process occurs
with dozens of subcontractors on each building as each subcontractor operates in a
narrow specialty known as sub-divisions of work. In most cases, a subcontractor employs
licensed and certified trades people such as plumbers, electricians, gas fitters and
carpenters for that field of expertise. In addition to the various subcontractors and trades,
the GC must also make allowances for supervisory and administrative staff as well as a
contingency factor for unforeseen events.
On bid closing date, the GC decides on the best combination of subcontractor
prices and then compiles all the individual quotations into one price. This price represents
the dollar amount that the GC is willing to accept in order to complete the construction of
the building. The closing day is a frantic and stressful day as secrecy and signals between
the trades and the GCs continue up until the deadline. The developer will then award the
construction contract based on numerous factors including sub-trades, schedule,
reputation and, of course, price. Although, the developer will likely choose the lowest
bidder there is no obligation to do so.
Subcontractors and even the general contractors tend to be small companies with
only few employees and limited professional staff. For instance, a drywall company may
consist of a few workers and the owner who operates out of a truck. In this scenario there
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54. is no office, no accountant and low barriers to entry or exit. One estimate suggests that
over 99% of construction contractors employ fewer than five technical staff (Gann,
2000). The lowest bidder process awards a fixed price contract to a small company with
little to no barriers to exit. The developer’s attempt to transfer risk often results in a larger
liability through a contract with a small contractor with limited resources.
There is a large transfer of risk in this process and an associated large transaction
cost. The GC has committed to build a building for a fixed amount of money with little
recourse for changing conditions and cost overruns. As a result, the GC and all of the
related trades include a contingency factor on top of their profit margin. This helps
protect the GC, but also increases the cost. The developer incurs this increased price as a
transaction cost in return for the transfer of the largest cost and risk to the GC. Once the
GC is awarded the contract by the developer, the GC will then award the smaller
component contracts to the individual subcontractors. The developer has a single contract
with the GC and the GC then has dozens of contracts with the subcontractors (Figure 6).
A similar process occurs with the integrated developer, but with some obvious
differences. There is no bid process with a third-party GC, but there is the same need to
obtain pricing and contracts from the various trades. Even a highly integrated developer
does not possess all the construction capabilities within the company and requires outside
contractors. This process is just as important for the integrated developer as the
construction costs need to be established and fixed prior to the real estate sales process.
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56. 2.3.5.2 Construction: The Build
The construction of a building is a juggling act of schedules and budgets. The
construction of all buildings follows a predictable sequence that starts from the
foundations, and works upwards and outwards. Subcontractors and trades build on the
work of previous trades. If one trade arrives too early, then trades are working in
competition, if a trade arrives late, then subsequent trades will be delayed. For example,
the roofer can only work once the framer is complete and the framer follows the
foundation crew. All tasks needs to start as soon as possible in order to meet a project
deadline.
Another proposition for this paper: a successful (on-time and on-budget)
construction project is directly related to the completeness of the contract bid documents.
A contractor is asked to assign a fixed price to a three dimensional building that is based
on a series of two dimensional blueprints and an encyclopedia of specifications from the
architect, structural engineer, mechanical engineer, electrical engineer, civil engineer,
interior designer and a host of other consultants. It is important to realize that every
separate discipline issues a separate set of drawings and specifications; the architect
produces one set of drawings and specifications, the electrical engineer produces one set
of drawings and specification and so on for every engineer and consultant.11
In theory, the plans are coordinated and complete; however, in reality, time and
budget constraints result in incomplete and poorly coordinated drawings and
specifications. The contractor is expected to interpret and translate and incorporate these
11
Technology and software advances in the production, coordination and distribution of plans will make
the bid process more transparent and save a lot of paper. Ideally, a three dimensional or virtual
representation of a building is required to visualize the final product.
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57. incomplete plans into an accurate price. If the contractor misses an item and does not
seek clarification before the contract is signed, then the ‘winner’ of the bid process can
quickly turn into the financial ‘loser.’ The developer and consultants will attempt to make
the contractor cover any omissions in the contract. In the reverse situation, if a required
element is not specified on the drawings, then the contractor will seek a change order to
the original contract for this extra work. Disputes, delays and claims for extra work
based on discrepancies in the drawings are commonplace on a construction project. The
author suggests that the time and money to produce complete drawings prior to the bid
process may have the best return on investment for the entire building process. An on-
time construction project also helps the sales team.
2.3.6 The Real Estate World: Marketing and Sales
Real estate marketing for a new home project can be simple or elaborate with the
corresponding cost. Marketing requires a cost-benefit analysis by the developer as the
return on investment is often hard to quantify. Some developers use advertising and
promotion for the product and some developers rely on the on-site “presentation centre.”
A typical presentation centre is a small building constructed on the project site in advance
of the pre-sale process. The building often contains a model suite that represents the
future product for potential purchasers to examine. The model unit provides an effective
medium for the purchasers to experience and visualize the room sizes, kitchen cabinet
colors, carpet styles and bathroom fixtures. The presentation centre also serves as the
sales centre and is staffed by a sales agent.
Sales agents are the distribution channel for the developer to the home purchaser.
An important point to note about the sales team for a new home project: the sales staff
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58. does not need to be a licensed real estate agent; they merely need to be employed by the
development company. A traditional developer will outsource and use a licensed real
estate broker whereas an integrated developer will use in-house staff. Both types of sale
staff work on commission, but a licensed broker will command a higher fee based on
better training and a better sales network. For example, a licensed realtor can use the
Multiple Listing Service (MLS) to list new home properties and the developer sales staff
cannot. Both situations require the sales staff to interact with and inform the potential
purchasers with the ultimate goal of a home sale.
2.3.7 The Purchaser
The development and building process culminate when a consumer purchases a
new home. The new home purchaser occupies numerous markets segments of product
types, demographics and price points. Buying a new home is the largest purchase that
most people will make in their lives and it is not a decision that is taken lightly by the
consumer. Real estate agents segment their clients into two main categories: location
driven and budget driven (Lewis, 2008, Marak 2008). Location dictates many of the
decision criteria for the consumer; commute time to work, proximity to a good school,
access to public transit and neighbourhood safety are all important criteria for a
homebuyer. For many homebuyers, a preferred neighbourhood is selected and then the
buyer adjusts expectations on price point and home features. That is, the homebuyer
places location as first priority and will sacrifice home size and features in order to make
the location work within their budget.
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59. 2.3.8 Value Chain Summary
The building industry has a complex value chain that is complicated by the
individual nature of each building. There are several key points that emerge from the
analysis:
• The building process involves the coordination and collaboration of dozens, if not
hundreds of firms, suppliers and agencies.
• The Design-Bid-Build industry structure has not changed for decades. This
structure is designed to transfer risk along the value chain from the owner all the
way to the sub-trades and suppliers.
• The risk transfer and lowest bidder system have transaction costs and create
adversarial conditions, as participant battle over scopes of responsibilities.
• The construction and design industries compete on a price structure that is based
on previous experience from similar projects.
• Pre-sale finance conditions allows the developer little room to adjust to rising
construction costs
• Most contractors are small firms with limited resources.
In summary, the above key points discourage innovation as the building industry
is valued on the cost of time; that is, each participant and contractor competes on a price
structure based on previous schedules. An innovation to process or technology at any
point in the value chain will affect all the linkages and result in cost uncertainty and
added schedule risk. For example, a common LEED standard requires all ventilation
ducts to remain sealed until the ventilation system is operational. This keeps the dust and
contaminants from the construction process out of the air circulation of the building. How
would a contractor price this method the first time? The innovation may increase material
costs and may take more time to install. The innovation may in fact require less time and
59
60. fewer materials, but the cost of the innovation is unknown until after the first
implementation. In addition, innovation requires a learning period. Most firms in the
building industry are small and have limited resources to spend on learning a new process
when the old process will also work.
The inherent uncertainty of innovation compromises the ability of a participant to
win a lowest bidder contract while mitigating the risk of the new product. There are
alternative contract methods for estimating and paying for the cost of an innovation, but it
will not be a fixed-price low bid. In the building world, the easiest approach will be to
avoid the innovation if possible rather than risk a new unknown variable.
The pre-sale condition of financing also places constraints on any innovative
methods such as green building technology. Sales revenue is fixed before the production
of the new home and revenue must exceed future costs to return a profit to the developer.
Any innovation that could jeopardize future costs will not be embraced by the speculative
real estate developer or the cost and schedule sensitive contractor.
2.3.9 Value Chain and the Liabilities of Construction
The Value Chain analysis revealed areas within the development process that act
as barriers to innovation and entrepreneurship. Primarily, the construction industry
operates from past experience and is unable to assign a price to forward looking change.
Innovation would change the price structure and this would make a competitive bid
process more complex. The industry is also separated into conflicting production
segments by the design-bid-build structure. The project relationships are often adversarial
and innovation has limited opportunity to develop as shown in Table 3.
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61. Table 3 – Barriers to Innovation in Building Value Chain
Construction Liability List
Reichstein et al. (2005)
Barriers to Innovation in Value Chain
Liability of Separation Separation of participants in building life cycle;
restricts interaction between design, production and
use
Liability of Uncertain
Demand
Future sales are unknown and unpredictable; the same
applies to future contracts for construction and design
team
Liability of Assembly Assembly occurs on site, but suppliers are located off-
site; suppliers do not interact with final product to
learn, but supply chain is a leading source on
innovation
Liability of Projects Team of low bidders in assembled for a single project
and then disbanded; relationship and learning do not
continue
Liability of Immobility Production takes place in-situ and limits the ability to
use manufacturing and factory style technologies
Liability of Smallness
(Stinchcombe, 1965)
Companies have scarce resources that are allocated to
the immediate job; no resources for training or R&D
This barrier analysis assumes that innovation adds value to the building industry
value-chain, and that the current model needs improvement. Arguably, the participants in
the building industry do not want innovation as any change will alter the delicate balance
of pricing and cost structure within the vast array of contractors and subcontractors. In
fact, Seaden et al., (2001) found that the more profitable residential trades tend to be less
innovative than their less profitable industry counterparts. The opposite was found in
non-residential trades and contractors where innovation was positively related with
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