On the Economics of Good Design
“Good design is good business.” - Thomas Watson Jr., former CEO of IBM.
This phrase is attributed to a speech that Thomas Watson Jr. gave at the University of Pennsylvania in 1973. It was the distillation of a mantra that Watson had used to transform IBM from a stodgy stalwart of office life to “the paradigm of the modern corporation,” as design historian Steve Heller puts it. The words are oft-repeated to the point that the slogan has become a trope in corporate circles, and their peddling by an architect can appear admittedly self-serving. Stick with me, though, as they are worth repeating and exploring, especially in the context of developing middle density housing. Here, good design is too often seen as a luxury, a capricious endeavor that might add value but is not strictly necessary for the success of a residential development project.
To play devil’s advocate, this might be true enough in cities like Los Angeles where the housing shortage is so acute. Because of the lack of supply, you are likely to get just about any dwelling (legal or otherwise) rented. By at least adhering to code you can build something that is good enough to be habitable and good enough to be rented. But who gets out of bed each day and strives for just good enough? And does good enough maximize your leasing value? And when real estate cycles turn, how well will just good enough maintain consistent value? As an architect, I of course believe in the benefits of good design for its own sake: it can elevate a space and everyday experiences. It is a real differentiator in a market awash with big gray stucco boxes, and it can measurably improve one’s quality of life. As a realist, though, I also understand that developments are significant financial endeavors that need to be profitable and it is difficult to justify any additional costs. Thankfully, good design can help with that as well. There are several compelling reasons why good design makes good financial sense for residential development.
Before getting into the monetary metrics, however, it is worth briefly defining what I mean by good design as I want to separate this term now from any idea of aesthetics. There are a number of ways to define design, but I choose to look at it as a deliberate and attentive process. Saul Bass posited that “design is thinking made visual,” Steve Jobs famously said “design is how it works,” and Louis Sullivan proclaimed that “form ever follows function.” Somewhere at the intersection of these three maxims–with a bit of poetry mixed in–lies the essence of good design. Viewing it in this manner separates the design of the building from the “look” of the end product. In other words, you may choose to decorate a building differently than I would, but that should have little bearing on whether that project is well designed. I am not advocating for any one “style” over another when I advocate for good design, nor am I of the position that you need to use expensive materials and finishes. I am advocating for thoughtful resolution of program elements that anticipate user needs, efficient allocation of resources, and a striving to improve the everyday quality of life of the end user.
One of the main ways in which such good design can benefit a residential development financially is through increased property values. When a development is well-designed, with attractive, functional, and livable spaces, it is more likely to be seen as a desirable place to live. This can lead to higher prices for units in the development, as buyers are willing to pay more for a home that they perceive as being of higher quality. Design here becomes a differentiator, and the increase in property values can translate into higher profits for the developer.
For rental units, this difference can be more pronounced through the capitalization of additional income. In the rental market, properties that are well-designed and well-maintained are often able to command higher rental rates than those that are poorly designed or poorly maintained. This is because tenants are willing to pay more to live in a property that they perceive as being of higher quality. Well designed units also work better with a tenant’s lifestyle, which can tend to reduce tenant churn. If a tenant likes where they live, they are less likely to want to move. Good design can increase rental income and keep it more consistent. This additional income can be transformed into significant additional value based on local cap rates.
Importantly, good design benefits a development financially through increased efficiency as well. When a development is well-designed, it is more likely to be functional and livable, which can make it more attractive to buyers and renters. Thoughtful design can also increase living space by reducing inefficiencies in layout. Increased living space means increased rentable space, which benefits the project’s financial performance.
These are just a few manners in which good design can have a healthy impact on a project’s profitability. The reasons are great in principle, but let’s try to quantify them with some basic back-of-the-envelope (BOE) analysis. I’ll take the example of efficiency and throw in a bit of math and development jargon (sorry).
On a recent project, for example, we were able to layout the stairs in a novel manner that gave about 100 sf in usable living space back to each dwelling unit. Assuming $4 psf rents, that’s an extra $400 a month for each unit, or an extra $4,800 in net operating income (NOI) per unit. If we capitalize that at a 5% cap rate that means that a small tweak in layout translates to an added value to the project of $96,000 per unit in the first year! On even just a five-unit project that small move creates almost a half million dollars in additional value for the project.
Let’s take a similar example and look at an increase in rent. Say a certain design move is expected to increase rent by 10%. Assuming the average rent in Los Angeles of about $2,800 a month, that change could mean an extra $280 a month or $3,360 in NOI annually. At a 5% cap rate, that translates to an increased valuation of $67,200 per unit. Following similar logic we can provide a dollar value on investing more on things that would save costs in the long run (more energy-efficient windows or better insulation, for example). Determining how much you are willing to spend initially for that added end-value would then be a matter of individual hurdle rates. With these simple BOE calculations in mind, however, it becomes clear that good design has real quantifiable benefits to a project’s financial success.
So what can all this cost? It varies, of course, but the great thing about it is that it can be relatively inexpensive. On average, the architecture design of a project falls somewhere between 7% and 12% of construction costs. That means that even a generous increase in design spending of say 30% would mean an increase of less than 2.1% to 3.6% to the project overall. If that investment can increase the end project value by even just 10%, then that can already represent a significant multiple on investment in the long run.
In the end, it is worth taking the design discussion out of only the aesthetics arena, both for architects and for developers. There are so many intangibles when assessing design that its impact can be hard to appraise. Many organizations have even bought into the idea that “good design is good business,” but they don’t necessarily understand why. Using some simple BOE real estate math, we can start to quantify the saying. These are very simplified examples, of course, but the logic is sound. Good design is not just a luxury in the world of housing development, but rather a crucial factor that can have a significant impact on a development's financial success. Especially in the missing middle, it can act as a significant product differentiator. By investing in good design, developers can increase property values, rental rates, demand, and efficiency, all of which can contribute to higher profits while creating a better overall project along the way.