buying land for multifamily development?

Question

We have a lot of posts on BRRRR properties but not a whole lot on buying land to build multi families . The purpose of this post is to discuss, share experiences, ideas to explore on the subject further hoping we can have a greater understanding of it. I think the reason for this is the barrier of entry is higher? we will need a team of people with experience to execute it? In major metropolitan cities like San Diego, most Class C properties are expensive and most doesn't even cash flow. I have spent the last 3-4 months analyzing deals the broker sent me and what I can find on the market. The number just doesn't make sense. I did found 2 properties that were 5 units and had a lot of upside but they were in escrow. we are focusing on acquiring 2-4 units at the moment but also playing with the idea of buying land with development opportunity and build 4-5 units. I will be going in with a friend that can execute the planning and construction. I think one of the top goal for the mayor is to solve the housing crisis in our city and build affordable housing. I think San Diego is trying to remove parking limits for new developments. (I know they are talking about it but not sure where we are at). I think I'll just list out the pros and cons and we can have an open forum for people to add comments to each area.

Pros:

1. higher the risk higher reward, whether it is building it for rental income or building it for sale, the reward is greater on the ROI than BRRRR and flips

2. It is exciting, the extensive legworks and preparation turning an idea into reality. Creative and sky is the limit. from is flat piece of dirt and turn it into nice housing that people will enjoy living there is rewarding and a sense of great accomplishment.

3. skill building, it require many areas of expertise from start to finish. the amount of knowledge and skills one will learn is a lot more than just flips or buy and hold. from the understanding of zoning, city planning, drafting up plan with architect and engineer, approvals, documentations and financing. the list goes on and on. maybe this is as much as a cons than a pros depends on how one sees it.

4. development low income housing, we have a housing crisis, and developer are not focusing on people with low income, they have their eyes on where the money is. dealing with state programs can be lengthy but worth the effort in my opinion if the outcome is to build something that is profitable at the same time giving family a better home/environment so their kids can thrive. I truly believe that improving a neighborhood can have a great impact on kids future. I was one of those kids are easily affected in a bad area but with the right enviorment that my parents work so hard to put me through and I became successful. At least comparing to my peers.

5. self growth, not just skills but just like any successful business, there will be undoubtedly difficult going down this path, but the willingness to push through when things are hard, when things goes wrong, and dealing with each problem with absolute determination to solve it. we talk about a lot that its so important to get our first deal for people that observing on the side line vs actually committing on doing their first deal. same idea here, you can work for a developer for years and wait for the right moment to start your own or you can just build a team around you and just do it. d

Cons:

1. Very lengthy,  managing everything at each phase so it can move into the next phase. they say less than 50% of a project’s duration is the visible construction period on site. the essence of development typically involves pre-purchase, concept stage, purchase, town planning, working drawing and documentation, pre-construction, construction.

2. The risk, lots of things can go wrong even with good experience developers let alone someone doing it for the first time. financing coming at the right time as needed? building issues, under budget, housing market goes down, list goes on.

3. location, location, location, isn't that what we hard all the time, so finding a piece of land with development opportunity in the right location would require a lot of legworks and understanding of that particular market.

4. most high demand areas doesn't have a lot of land sitting there, maybe need to buy it with a piece of property on it and do demolition.

I hope some of you find this as an interesting topic and would love to hear your input!

Jaysen Medhurst · Answer

@Jian Guan, the reality is that small multi-family ground-up construction just doesn't make sense in the vast majority of markets. This is due to the cost of land as well as rising construction costs due to a pervasive labor shortage. This is why you only see SFH, which command the highest market price, and large apartment complexes, which have economies of scale, being built. In a market like San Diego where there is high demand and high land prices, this is especially true.

The crisis of affordable housing is real. It is a result of decades of various factors coming together. The short-term problem is that large-scale, affordable housing doesn't make sense financially. With all the work required to build up from the ground, a developer needs to squeeze out the most profit they can. That means building A-class buildings that will command the highest rents. If affordable housing were a viable business model, you'd see them being built. Without substantial government subsidies, tax breaks, etc. the numbers just don't work.

There's a saying among RE investors who deal with large apartment complexes: "If you want a C-class property, build an A and wait 30 years."

Robert Campbell · Answer

I presently own small (4-plex) MF properties.  At one time, due to so few opportunites, I considered building.  I didn't take long to realize I would get killed financially.

If it was financially viable, everyone would be doing it.  It's nice to think about the greater good but at the end of the day - the project still has to float.

As an aside, it's a widely held belief that one of the biggest risks a business person faces is depending on a favorable outcome from a  government entity's decision.

Nick Marrs · Answer

@Jian Guan I’m a Structural Engineer from Los Angeles and have designed and built many multi-families throughout Southern California. The best way to increase the return on investment for new multi-family developments is from the affordable housing density bonuses and incentives, especially in San Diego which has some of the best incentives and decreased parking requirements. You can get up to 50% more units, and if you are located in a high transit zone parking can be even less than 1 parking space per unit. PM if you would like to discuss any properties in more detail, I would be happy to help you.

Jay Chang · Answer

I am part of ULI, and a lot of experienced real estate developers I met that have been through 2-3 market cycles are cautioning the risks of development. Here are couple reasons:

• We are heading toward the peak of a market cycle. Although the current home mortgages are much more conservative compared to those made prior to 2008, unicorn companies and personal debt are highly leveraged. If these bubbles burst, then they can cause a financial meltdown and heavily impact the housing market.
• As you mentioned, development is a lengthy process and uses short term construction loans. If a meltdown does occur, then there is a good chance that your bank will stop funding your project midway. A renovation project or BRRRR, on the other hand, will be able to survive the downturn with its existing cash flow.

Although a ground-up development typically offers higher IRR, you must consider the higher risk that accompanies it. One thing to mitigate risk is to have very wealthy investor(s) backing your deal. If the debt goes south, then you can still continue funding the project with 100% equity to avoid liquidation.

I hope this helps!!

Colin L. · Answer

@Jian Guan  City Council did in fact vote 8-1 to eliminate parking minimums when located in a transit priority area.  There will be a second vote sometime soon.  Of course there is plenty of push back and some votes may flip but I think it will still pass.

https://timesofsandiego.com/politics/2019/03/04/san-diego-city-council-votes-to-repeal-minimum-parking-requirements-for-new-housing/

Here is map of the transit priority overlay:

http://sandiego.maps.arcgis.com/apps/webappviewer/index.html?id=fee2c61136d7469b9d633301899df706

Funding projects that are 100% affordable is very difficult. IMO the better alternative is to build a project that is market rate and includes 10-20% affordable which will allow you to use the State Density Bonus to increase your density by up to 35% (50% in City of San Diego) so for instance a property that allows 10 units can be increased to 15 units .  The base zoning must allow at least 5 units to do this.  You also get other incentives like reduced parking, and deviations from zoning such as increased FAR, building height, etc.

One more thing to consider when looking for sites is to look for properties in the new Opportunity Zone, which has a lot of great tax advantages.  There are a lot of OZ's in San Diego.

Chris K. · Answer

@Jian Guan

I think you will need to first narrow down the scope of new construction. Building a few 5 units is a very different project than building a mid/high-rise building. It's also different from building a bunch of smaller 5 units in a development. Having a narrower focus will allow for a more meaningful conversation.

With that in mind:

• I think it's hard to say that ROI on a new construction project is automatically higher than just purchasing an existing property or flipping.

• My experience with new construction --- as a lawyer, investor, and business owner --- mostly come from larger projects. For larger projects, you are forced to rely mostly on specialists to get the job done (e.g. proper GCs, architects, lawyers, consultants, etc.). It's arguably more hands-offish then an average flip once all the pieces are in place since everyone involved in the project should be at least competent at what they do. The question then becomes whether you can afford such a team for the project. To state the obvious, not all markets/project can support such a team. For example, you probably cannot afford that kind of team if you are just building smaller properties.

• Consider the NYC metropolitan area. There's an incredible amount of new construction happening at the moment. For example, if there is anything resembling a vacant land on the NJ side, someone is going to put a decent sized building there. Part of this has to do with the fact that the average rent in this area increased by $1k or so in the past ten years. That kind of natural appreciation makes it an attractive market to build new projects. You don't see these kinds of projects in the tertiary market that I live in.

• Politics and local laws can have a drastic impact on new construction projects. Not to stereotype the area, but my guess is that San Diego is probably a bit heavy handed when it comes to those matters. From a developer's perspective, they generally like to work in areas where they can count on support from the local government.

• Low-income housing is such a complicated topic. We work on a lot of those projects out here in the Northeast. In fact, we have customers that primarily focus on such projects and they make money from it. I don't know anything about the San Diego market, but there could be 100 different reasons why these projects don't appear in your area. It's a topic on its own.

To answer your underlying question, I think most people struggle to jump into new construction projects because the scope of the project they want to work on is not large enough to support a proper team. To overcome this problem, the folks would either: (1) need to raise more money and aim for a bigger project; or (2) cut corners somewhere (e.g. using a smaller GC then the project requires, using less skilled architects, etc.).

Disclaimer: While I’m an attorney licensed to practice in PA, I’m not your attorney. What I wrote above does not create an attorney/client relationship between us. I wrote the above for informational purposes. Do not rely on it for legal advice. Always consult with your attorney before you rely on the above information.

buying land for multifamily development?

Most Popular Reply