custom home- land at historical cost versus fair market value

[Account Closed]

I am evaluating a prospective build of a custom home.

My wife and I purchased a tear-down for a rather deep discount to the market value. It was an REO and both the bank and listing agent understated the GLA by around 200 square feet. At prices of $200/sq. foot in my area for these small homes (new construction nears $300/sq. foot) I can't help but wonder how $40,000 of value appeared out of thin air ($200/foot X 200 feet). In addition to the extra square footage, it was purchased for a discount of about $10,000. In total we have a home that we could net $50,000tomorrow if we sold (excluding transaction costs).

Construction Costs (150/sq. foot): 3,000 sq. foot home- $450,000

Land costs: Historical- $300,000; Fair Value- $350,000

Total cost- ?????

Tearing the house down effectively eliminates my new found $50k in equity. Even though it’s only on paper, doesn’t tearing the house down represent an opportunity cost of not selling and finding another lot (in the amount of $50,000)?

How should I be thinking about my land costs given the scenario?

[Lynn Currie]

Hi @Account Closed ,

If you decide to develop, think of your land cost as an actual expense. Ignore FMV.

Your math would be as follows:

   $300,000 - Land (this is what you paid, right?)
+ $450,000 - Construction Cost
--------------------
  $750,000 

The answer to your second question is where you, as a developer, make a decision. Yes, the $50k is lost opportunity cost. 

What is the potential sales price of the home that you just built for $750,000? Is it $1,000,000? $800,000? If it's $800,000, developing doesn't make sense. If it's $1M then you might want to think about it. 

For example, it would take 5 $50k lots to make the $250k that you can make in the $1M sales price scenario. Is that doable? Is the time frame the same? Are you more comfortable with that strategy? 

There's no right answer, just the one that you feel is right for you and your market.

Hope that helps,

Lynn