Should we build rentals on land we already own?

Question

We own 15 acres zoned R-5 in Snohomish County, WA. Our home/business is on about ~5 acres and the rest is cleared and flat with road access and electric already in. We were going to sell 5 acres to a neighbor to develop, but that fell through and now we're considering developing it ourselves. We're currently building a MIL (for my MIL) which caps us out on doors per parcel under R-5 zoning, but we can subdivide into up to 3 lots (5 acre parcels). Does it make sense as an investment to subdivide the 15 acres and build duplexes (or similar) as rentals to hold long-term? This isn't a strategy I've heard discussed before so I'm not sure how to analyze it. I figure I'd have about $50-70k in costs per parcel to subdivide, drill wells and install septic. I don't have experience managing a build like this so it feels like a big project to bite off early in my investing career but, I already pay a mortgage on the land, so why not try to cash-flow it?

Helen De la rosa · Answer

@Brian BundyI found this old post helpful, especially the Linwood- didn't know one can order pre-made home packages like a lego then have builder finish it. https://www.biggerpockets.com/topics/399943

Nik Moushon · Answer

This is exactly the problem that plagues everyone, especially developers. You just have to assess your risk tolerances and build in a worst case scenario to your numbers. If everything still works out then you should be good to go. The absolutely biggest thing, especially with first time builders, is getting your numbers absolutely correct and making sure you are accounting for everything. This is where first timer builders get hurt the most, unexpected costs and losses. With that said though I think you are on the right path for doing a build. Already having land, that is paid for, is a huge cost saver and will allow for project that normally would work to work because you dont have to have the cost of land acquisition. I'm actually doing something similar on the other side of the mountains from you. I am splitting my personal residence lot and building a duplex on it. Now the land is not paid for but I already have another rental that is helping me pay for my mortgage (as well as cover everything on that house) and once I have the duplex built or go to sell my residence I have calculated that with inflation alone I can cover the loss of value in the land. Thus I will have it "paid for" when I sell. I have also accounted for me not selling and keeping both and the numbers still work out because I basically have the land for free, even though on the mortgage they are tied together. Like you have found out the key for this type of project is the build cost, especially in todays market. Contractors are making up for what they lost in '08 and aren't afraid of showing it. Build prices are very HIGH, too high IMO, but thats the current market demand right now. My worst case scenario right now is that not only would I not be able to build but I would be forced to sell the lot. Even at a reduced price I would still be fine. I would just put that money towards my mortgages and refinance for lower monthly bills. I probably wouldn't be making money but I would be able to keep both my houses even if they were under water. That's assuming of course I don't lose my job too lol. But you have to draw the line somewhere in your risk assessment. If you take it to far you will just freak yourself out and start putting your money in your mattress lol.

Account Closed · Answer

@Brian Bundy if you're hell bent on investing locally I would find an alternative method than a traditional long term rental. Run a very honest pro-forma, and don't accept a 7% cash on cash return. You're better off investing in a REIT. I'm not sure what the big city investors do these days that are actually profitable besides flip stuff. Short term rentals? Room by room? Lease options? I know it's not the best time to buy anything, but I just go out of state. At least my stuff cash flows well and my money isn't sitting in my account.

Account Closed · Answer

@Brian Bundy I definitely wouldn't invest in building in this state of the market if your intention is to keep the property. Construction costs are high, prop values are high, cash flow in the western states is poor. That money may yield more invested elsewhere, held onto until the market offers better opportunities post correction, or... perhaps developing and flipping your land and property if you're open to it. A little risky, IMO, for an inexperienced builder. Many think we're coming to the end of this bull market, and that kind of project takes time. Last thing you want to do is sink a bunch of money into a project to wrap it up just in time for property values to start tumbling. I'm no developer, but I'm pretty sure construction costs soften substantially in a weaker economy as well.

Dante Pirouz · Answer

You have to run the numbers in order to know if this is worth pursuing. Try to calculate costs, get estimates from potential vendors/builders, look at possible future rental income (be conservative), and then calculate what the returns might be. Build costs are not yet at the point where building is a slam dunk. Existing housing stock + rehab costs are still cheaper in most places than building from scratch.

Brian Bundy · Answer

Account Closed Thank you both for your insight! Since I posted I have spoken with a couple of contractors and received some rough bids. Although the numbers appear to pencil out based on cost to build and local rental values, that is based on today's market. I tend to agree that we're overdue for a correction and I don't want to enter it with properties built at the top of the cycle. Especially considering I'm not an experienced builder and not well versed in controlling costs on this sort of project. The problem is I have been saying we're at risk of another market downturn since 2013 and I've been sitting on the sidelines the whole time watching my "dry-powder" drift away with the winds of inflation. I am looking for close-to-home investments for rental income...just now building my first list on listserve and planning to start attending court house auctions to observe/learn. Am I better to keep waiting for the market to turn or are there strategies that work for newbies entering the market at a bad time? I have about six months savings, an unused HELCO, great credit and income and ~5-10 acres I'd be willing to part with under the right circumstances.

Brian Bundy · Answer

Helen,This was super helpful! Thank you!