Should I build 17-unit multi-family project?

[Aaron Nelson]

Hello! I've got a piece of vacant land under contract in Redding, CA which had approval to build 17 townhouse-style units, all 3/2.5 bath with attached garages, about 1350 SF each. The owner of the land recently passed away and I'm buying this 3 acre piece from the heirs for $150k. (Former owner had over $500k into the land and permits /engineeering/ architectural fees etc.)  This is an above-average class A location surrounded by newer developments (a fire station and a retirement home) as well as nice single family neighborhoods. It is very close proximity to several popular schools and colleges and there is huge rental demand and a scarcity of units available in this immediate area. There is also huge demand for furnished rentals for international students where I could further increase the rents, and from this unique location they could literally walk or ride bikes to the school campuses within the one-mile radius from here.

It looks like my all-in price to build including the land would be about $1.8 million ($105,000 per unit). The units should rent for $1200 each, bringing the annual gross rents to about $244,800. In our area there are literally no apartments like this available for sale. Neither have there been any sales of complexes this new and in this good of a location within the last 10 years. Researching back as far as the mid 1990's on my MLS I know that most units that sell are B and C locations that trade for around 8-12x the gross rents. The nicer buildings in nicer locations are definitely in the 11-13x gross rents-range. I recently represented a local doctor who purchased an 11-unit off-market apartment complex for $1.1 million. His was a similar type of location and building with all townhouse style units with garages built in the late 1980's. It was very clean and a good rental area, B+/A- area. It sold for 11.2 gross rents with a CAP rate of about 4.4%. He is ecstatic and would buy another building just like it if there were one available. Mine that I am considering building would be a better location and nicer units than that or anything I can find in the MLS that has sold. So even though there doesn't appear to be a ton of upside, with the worst-case scenario feeling like there must be worth at least 10% more than what the build-out costs would be it feels at least like it could be a project to consider.

My risk tolerance in pretty high and I've done quite a few rehab projects around here and have been actively involved in my market for over 10 years. I feel that the product I could deliver would be in high demand and there would be virtually no vacancies once this is completed. Worst-case scenario feels pretty palatable to me if it's worth at least what I have invested into it and the maintenance and management would be very minimal. I have other investors that have expressed interest in pooling money to do a project like this if I could find one worth pursuing in our area, so I also believe I could bring together the money to develop it and gain experience in developing properties, which is a primary goal of mine for the coming 5-10 years. So aside from just this project's fundamentals, my secondary goal is to gain experience with syndication, fundraising, and learning firsthand about the development process.

I am interested to hear from developers who have any insights into this and especially developers in markets similar to mine that don't have great cash flows but have high demand and potential for good appreciation. Is anyone building out projects like this currently or am I crazy to even consider this right now? 

[Joel Owens]

At 244,880 gross expected rents you would factor 40% costs ( vacancy, eviction, repairs, property management).

Now I know we use 50% on here and 60% if landlord paid utility but on a brand new complex in California I think buyers might go for it. The first about 5 years will not be much issues at all if built properly. I would keep a journal and pictures of the whole process to show a potential buyer the quality that was put in and no shortcuts were taken etc. It's one thing to tell them but " a picture is worth a thousand words " rings true.

So 244,880 X .60 = 146,928 NOI

146,928 NOI / 3,000,000 = 5 CAP resale

So all in 1,800,000 there appears to be a healthy spread on your project.

On all the plans and approvals you need to check if still valid and for how long as I have heard some areas it can take up to a year to get approval again if they have expired in CA.

You need to know soil samples and what construction method would be used for foundations etc. If soil requires extra reinforcing and it's harder to dig up expenses start climbing higher than anticipated. If it takes you longer to build market forces and exits might have changed since then. You need to look at permits applied for in your area to construct any multifamily units. If there are not any check occupancy at other places. If full with waiting lists and rents are growing above the 3% national average that bodes well. If there are a ton of permits already applied for then it's who gets to market first with a finished product and capitalizes. The last finisher gets to fall on their butt in a game of musical chairs.

So no permits ongoing and strong rents bodes well for you. You might want to build in a 100 basis points premium to sell at a 6 cap by the time you exit for worst case if markets change. Rents could also be stronger than 1,200 by the time you have completed lease up and build out. Time the project to finish not during the holidays where it's tough to land renters. During that time you have to give lower deposits and rent specials sometimes to get people in.

No legal advice