How much should I be investing in building a new rental home?

Question

I currently own a small lot in a small town in Western Washington State that I plan to build a small home on to rent. Based on local regulations and city codes, I'm limited to a 2 bed/1 bath/no garage home. I think I FINALLY found a few options that will fit on the lot (36' by 99', so very narrow).

The likely better-built option is more expensive and is really stretching what I can afford (and is also quite ugly). The cheaper (and cuter) option is likely not going to be constructed as well. I've been comparing builders by searching online for reviews but there's not much out there for the more expensive builder, but many poor reviews for the cheaper option.

I've never built a house before and it's been a doozy, esp when trying to figure out what to do first b/c there is so much chicken-or-the-egg scenarios. Just looking for some advice on what one should spend/invest etc, on a home that will be a rental property.

Gevonka Denson · Answer

Hi! It’s been a year since this thread and I was hoping to get an update. From our precious discussion, 2022 is when I want to prep/start the process of building. If you don’t mind sharing, I’d love to hear how things went/are going. Thanks much!

Gevonka Denson · Answer

I most certainly enjoy an over share and thank you. My goal is to get my reserves above a specific threshold. Currently doing some homework on those types of costs you mentioned and I need to increase my knowledge on this type of financing process. If you were blogging your journey, I would follow!

Tiffany Royal · Answer

Heh, your story is similar to mine. I bought a lot with a home that I just demo'd too and am now starting from scratch. Overall, this whole process feels like the question: Which Came First - The Chicken Or The Egg?

As for tips for the construction loan process - basically, have your budget ready, including bids for EVERYthing that you want the construction loan to cover. Or rather, even just what it will cost to build the home in general, regardless of what the loan covers or not, so you have an idea of how much it will cost and help with financing the project. Bank will want to know how much each bit is going to cost. Also be prepared to provide all sorts of financial documentation, including paystubs, W2s, bank statements, retirement statements, anything that shows your assets, all typical stuff like when purchasing a home. They'll want to do an appraisal of the property likely. They'll also want to know what kind of cash reserves you have in case there are overruns.

There are different kinds of bank options out there, such as closing on the construction loan and then closing on the mortgage (so closing twice) or finding a bank that has a 2 for 1 deal, where you pay closing costs upfront, and the construction auto-transfers to a mortgage (this is what I'm doing). Also, if you are not going to occupy the home, you need to tell the bank you'll need a Non-Owner Occupied Mortgage loan, b/c apparently, treating it like your own home and then turning around and making it a rental is ripe for mortgage fraud. (scary stuff, look it up). The interest rate is higher but, you're not committing a federal crime (LOL).

The nice thing about bank loans is that you're only expected to repay the interest accrued on what was spent per each 30-day billing cycle, so it makes it affordable during construction. I'm a little nervous about that though, and am currently trying to work with my banker to get an idea of how that works especially toward the end of the construction period and the bank is paying more and more to the builder. Again, just trying to budget for future costs.

The bank stuff hasn't been as much as a hassle as it has been figuring out what to build. I initially chose what I thought was going to be the most affordable and smallest house (I have a very small lot) and submitted everything to the city for the building permit and to the bank for a loan approval at the same time. Ideally, these both go through their processes at the same time, so when the building permit is issued, you can hand it right over to the bank and they can issue the loan.Turns out, the house I chose didn't meet the city's codes/design standards, sending me back to square one. All the research I did for choosing a home and bids for all the work to be done and submitted to both the bank and city is pretty much moot at this point.

My piece of advice: REALLY make sure whatever you're going to build will meet your local codes before you move forward on ANYthing. The local permitter will likely send your plans back to you for some fixes but hopefully it won't set you back too much and again, and time it so the building permit is issued just when your bank needs it.

This is probably WAY more than you wanted to know but, I'm an over-sharer. :)

Gevonka Denson · Answer

Thank you for the compliment. Good planning. My first step into real estate investing was a home I purchased in 2019. Needed some work. Long time tenant moved out so I’m renovating now. As stated, I am planning to build as well. My goal is to start in 2022. The land is cleared as there was another home on the lot that was demo’d. Do you have any tips on the construction loan process?

Tiffany Royal · Answer

Hi Gevonka, (what a great name!)

I've pretty much decided to go with the bigger/more expensive option. However, it turns out my construction loan won't pay for the entire project as I had originally hoped, so I'm going to build up cash savings the next six months to pay for all the non-loan covered costs out of pocket (Loan will cover excavation and house build; cash will cover appliances, exterior paint, driveway/walkway, permits, closing costs, temporary fence/toilet rental for contractors, etc). so I'm not terrifically in debt at the end of the project.

Gevonka Denson · Answer

Hi. Did you ever make a decision? I’m contemplating a similar situation. Would love to chat more if you have the time.

Tiffany Royal · Answer

The ugly option is 1,160 sq ft at $149K and the cute option is 843 sq ft at 94K. I'm debating between Coval and HiLine, basically. Familiar with them? On the Lot builders. Both homes are 2 bed 1 bath. Building in Bremerton.

Tiffany

Sherief Elbassuoni · Answer

@Tiffany Royal, a question, regardless of which one is cute or ugly, are the two options gonna get you the same square footage and the number of rooms/baths?

If the intent is being a rental, I will make the final heated areas and number of rooms/baths one of the leading factors to decide which route to go.

This is because area/no of rooms/no of baths will be reflected in the future rents.

Feel free to reach out if you got any comments or questions.

Best of luck!