New construction - Cost to build exceeds value?

Question

Hey BP Fam.. need some help! Spoke to a builder today who believes the cost to build our duplex is going to exceed the value in the area.

The neighboring lot is a 952 sf duplex (total sq ft- not per unit), appraised at $97,050 (land = $7K).

Long story short, he believes it’ll cost around mid $200K to build which would be more than the home is worth in the area (I somewhat disagree based on recent comps).

We’ve considered 1) holding on to it, 2) building anyway because the potential cash flow from these units will be attractive to investors (estimated $950 a unit), or 3) sell the lot and use that profit for a 20% down payment for a rental property. If you were in this situation with a hot lot to build a duplex on, what would you do?

Looking forward to hearing your thoughts!

Chris Seveney · Answer

@Briyana Hawkins

If you can sell the lot then I would sell it, I would not bank on getting funding if you decide to build

Mike Wood · Answer

@Briyana Hawkins  First off, I would not listen to the builder on that completed houses will be valued at (its also stupid so base valuation from one single data point).  If you want that information, talk to experienced local realtors.

With that being said, there are lots of areas that will NOT support new construction.  The costs to build new will simply exceed the value of the nearby housing, making the appraisal of such a project nearly impossible to justify the costs.

Unless your rolling in cash, you would need a construction loan for the build.  Every bank that I have every talked to about my construction loans will not fund the project if the total costs exceed the estimated finished appraised value.  To much risk on them if you default, then they got a construction project that is upside down.

If the area does not support new construction, then your land value will be very limited.  Maybe one of the neighbors want it, otherwise it just a tax liability.

Jason Wray · Answer

You have to factor in your overall expenses and do a cost analysis to answer your question.  You would have to factor in your down payment and closing costs.  That would allow you to calculate the cash flow versus the PITI.  At what point will you recoupe your DP and closing costs in order to start showing a cash flow profit.

200K at 20% down is $160K loan at 6.875% puts your P&I payment at $1051.09 (Not including taxes & Insurance) are there any HOA, Flood etc.

$40K down plus standard $6-8K in closing costs ($50K).  Ballpark taxes $2400 and HOI Insurance $1100 thats $3500 /12 =$291.67.

$1051.09+escrow of $291.67 PITI monthly of $1342.76 so ($950x2 units)$1900 - $1342.76 = $555.24 profit a month x12=$6,626.88 a year. It would take 7.5 years to recoupe your $50K before profits start.

The scary part is if you owe more than the other homes in the area it might be awhile or several years before you can refinance to get your intial capital back out.  The main goal is to be able to refinance in a short period of time to take out your initial capital and move to the next purchase.

Unless this could be used as an AIRBNB/VRBO where your STR exceeds the long term.

Mike Smith · Answer

@Briyana Hawkins I would do so comparable sales/listings research in your area to confirm your builders opinion.  If he is correct, it seems like insanity to build a new duplex for 200k if you can buy a used one for 100k.

I would highly recommend you sell your lot and buy a used home.  If you think the project cash flows at 200k aquisition cost, buy a used duplex for 100k and double your returns!!

New construction - Cost to build exceeds value?

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