Tearing down & building townhouses

[Rob Meyer]

Hello everyone! Trying to understand the construction loan / rebuild process some more. 

Some quick info - 

- bought ~6,000 sq ft lot lot (has main house 3br 1bath, ~1200 sq feet, 1br 1 bath garage apartment currently rented) in February for $500k.
-Awesome location, and it’s one of the last old houses around, everywhere else has been converted to townhouses (sell for ~$400/500k each)

Our 5-year plan is to tear everything down and build 3/4 townhouses on our lot. If I were to do this, (and assuming simple numbers), Is it:

- pay an architect / engineer out of pocket to get a good plan for the property (maybe like ~$10k?)
- talk to a credit union about getting a construction loan for cost of rebuild (assuming $1,000,000 for simple numbers) + current mortgage (around $500k for simplicity)

- after building the properties, get it appraised by a bank (let’s say $2,000,000), which I do a cash out refinance which at 75% would be used to pay off the $1,500,000 million loan, i now have $500k equity in the house and a $2mm loan? 

Thank you so much!!! Just trying to understand the process / see if my math / understanding is wrong!!! 

[Nik Moushon]

@Rob Meyer

I don't know the exact numbers for your market so the numbers I throw out could vary (more than likely). 

First, you need to know EXACTLY what your build hard costs and soft costs are going to be. The "lets say is costs...." will only get you in a LOT of trouble. Spend the time to do the research and get the numbers as accurate as possible. This was easier pre-pandemic and more reliable. Unfortunately now a days you will need to have a large contingency number expecting prices to rise during your build. 

The logic that you described is a very condensed version of what happens...but you are missing several steps and your numbers are way off. You are mostly, severely, under estimating your soft costs and the not knowing the entire build processes. I dont have the time to do a complete list of everything right now but here are a few key points:

1 - You are doing townhouses. That means you are making 3-4 new parcels. So you have to go through a short plat processes. This will require a separate permitting and review processes. So more fees and time. You will have to stub all the utilities into the property before the building permit can be reviewed. Some jurisdictions will allow over lap her and some want. So double check. This will also require a civil engineer. Odds are this will be anywhere from $10-20k is my guess. Some banks will allow this to be a part of the construction loan and other want it done before. More double checking to do.

2 - You have not considered any permitting fees with your city. This could range from $2-5k or up to $10k+. All depends on what your city does. Its not just building permit review. It could be impact fees, parking fees etc. They could also require a SEPA (or Texas equivalent) or a traffic study. Best thing to do is schedule a pre-application meeting with them and ask all the questions. You will want to have at least some schematic designs for them to review. 

3 - Your arch/eng fee is very low. If you are assuming a $1m construction loan then your $10k fee is only a 1% of construction cost. Most arch fees will be in the 5-10% of construction cost range. So thats $50-100k cash you will need. Depending on the firm, structural will be included in their fee, but any site related professionals (civil, survey, etc) will not be and will be on you to do before they can start. 

4 - You said you bought the house for $500k. Is that cash or is there a loan on it? This will effect how much the bank will loan you because of the equity you have in the property currently. If you paid cash you should be ok. If you have it on a loan then you will have to put down a significant amount towards the construction loan to meet their LTV ratio. Dont forget the permit fee, time, and cost of demo and hauling all the material away. This could easily be $30k or more depending on the site and conditions. i.e. is there a septic tank to decomission and remove? Is the house old enough to require lead and asbestos removal before demo?

5 - Holding costs. On a million dollar loan the interest payment will get up to $5,000/month at the end. With all the unexpected delays that are common place in building now I would expect a build time of 18-24 months. Especially since you are new and have no solid relation with any builder. With delays you could be sitting for a couple months at a time with very little work being able to move forward on. So, at the end, say there are no toilets in stock anywhere, and are out 4 weeks for delivery. Since toilets are one of the last things that means you could have an extra month at nearly $5k in just interest payments. There are also utility and insurance costs. 

I did basically the same thing as you are doing, at least the process will be very similar. I did a write up on it here that you can read through. Gives a lot more of the details you are probably looking for.

https://www.biggerpockets.com/...