Howdy, all! I searched for an answer to this, but didn't find it... Please just give me a link if there's already a discussion about this that I missed! This question is for anyone that is currently doing this sort of deal, or regularly considers this and has done this sort of deal... BACKGROUND - I worked for a man that once helped build a homeless shelter some years back (10-ish). During the process, he questioned whether someone could build a new home (3/2), and make it available to people that are in need for around $50K ("affordable" was his goal). So, to settle the matter, he actually set out to do it. He bought some land and then built 3 identical houses, side by side, fully stocked with all appliances, weed wackers, rakes, brooms and lawn mowers, "turn key" homes, and then sold them for $50K each. Net profit per house was $150.00. In the end, he was satisfied that his logic was sound - it could be done (this is "yesterdays" money, and not to imply it could be done in today's economy) - but he also realized that you certainly can't make a business case to do this! With this story in mind, what is the business case YOU use to pull the trigger on building a home verses walking away, with the assumption that a house is beyond rehab. (NOTE: I do NOT mean that you will make MORE money to build new versus rehab - assume a rehab is not an option, and you have to buy on the basis of discounted land value, area's desirability and comps, or you it's not a deal). I have a property that I'm evaluating, and the existing house needs to be torn down and a new house built. No, I will not be doing this work myself, but if it makes sense, I'd like to work with the investor that does this so I can learn. Houses going up in the area are upper mid-range to luxury finish. Without getting caught in the weeds, at what point and using which method to evaluate (ie: Net Profit, ROI, Cash on Cash return, etc) does it make sense for YOU to level a property and start over? Would you do it for $50K? Not less than $100K? 150K? More? What makes sense for you to pull the trigger, and what questions SHOULD I be asking that I'm not? Next, as a sidebar to anyone that may be doing this in Norther Virginia, what is your cost to build per square foot for a upper-mid grade (new construction)? I've been quoted several rates locally, from as low as $95/sf and up to $135/sf for upper mid-range to luxury grade builds. Let's hear from you VA home builders! Thanks for taking the time to answer.

When the cost to fix is more than the cost to scrape away/build new.

When does it make sense to level a house and build new?

Fort Mc Coy, FL · Member since 2016 · 18 posts · 5 votes

10y

Be careful. You are buying a property with a building that you are going to have torn down than turn around and flip it to a builder for them to build or split the lot and build? If you tear the building down you are creating some issues that you may not have thought through. One is your lot right now has water, sewer, power etc. If you scrape you have now created new issues that you have to overcome with the building department and Public Works and the Utility provider. You are also potentially making it more difficult for someone to get financing on a vacant lot. If you plan to buy the property and hire a builder to come in and build it for you, you are losing all the profit. You may be splitting the profit but the builder is still going to be paid during construction of this project which bites into the profit. If you keep the existing building, possibly do the leg work to split the lot and market the empty to a builder/developer and the lot with the house to a rehabber or builder, you could probably make the same profit or more in half the time. New construction can eat a professional's lunch and rehab can destroy rock solid marriages. If you go into a project like this without much knowledge of construction or dealing with the govt entities involved you could be eaten alive. That 50k profit quickly goes negative. I recommend the first thing you do is get a contract contingent on getting approval from the Building Department to be able to do what you think you want to do then go from there. The Building Dept, Planning Dept and Zoning Depts favorite 5 words are, "No you can't do that". Good luck

3 Reply

Mike Wood

Developer · New Orleans, LA · Member since 2015 · 1k+ posts · 898 votes

10y

@Donald Capwell I am a build and hold investor. I buy vacant land in my area and build duplex rental units, so my perspective is different from yours, so take it for what is worth. I use a GC/Builder on my projects.

For my, I want my total costs (land, construction, holding costs, finance cost) to be no more than 85% of the final appraised value, with a goal of 25%. This allows me to turn my construction loan into permanent financing with almost no cash tied up in the property (assuming 75% LTV permanent financing). I dont plan on selling, so I do not include the 6% sales commission in these numbers. If I did, I would reduce the percentages by that amount.

As for your questions about when to demo, I look for houses that I can get at land value, which would typically be very small house that need extensive renovations (these would be in areas where land is limited and valued at $75k-$100k, to put it in prospective). This issue I have is new houses are valued at more $/ft2 than renovated existing houses, so that make the decision to bulldoze easier.

When I look at renovation projects, that percentage needs to be no more than 70% of final appraised value. I want more equity on these type of project to account for sales commission (if I choose to sell) and the headaches of older rental properties.

You also need to understand that the larger the house, generally lower the cost per sq foot. 1 yr ago I built a 3/1.5 duplex, 2450ft2, and the construction costs were $68/ft2, I am currently building a 2/1 duplex, 1780ft2, and the construction costs are $90/ft2 (there are some features on this build that added cost, but most was due to less sq footage).

1 Reply

Manolo D.

Contractor · Los Angeles, CA · Member since 2015 · 4k+ posts · 1k+ votes

10y

@Donald Capwell Im on the CA market, and most numbers won't work here. I have a rule of total costs out the door would be 80%, if I spend 80%, then that means I make 20%. However, I am waiting for a large builder like Jay H of Oregon to pitch in his numbers. LOL. Anything that comes out 20% would work for me, specially because our numbers here are in the mid 6 figures most of the time, meaning 20% is high 5 or low 6 figures still.

1 Reply

Bill Gulley

Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes

10y

Funny, I just sold rural land with a tear down, closed last month.

I've been the non-profit route and for profit route to acquired property to demolish as well.

I was chairman of a city rehabilitation committee that investigated blighted areas and properties for redevelopment, some aspects we looked at:

Pretty well mentioned above that when the cost of rehab exceeds the market value a scrapping is probably in order.

There can be more to it as well.

Land is scarce, that's why it's valuable. It serves a social, economic and community need, as partly mentioned, so, what's the highest and best use?

What is the social impact of a demo? Are the improvements of historical value and add to the quality of life for a community? This can translate into a higher market value, while intrinsic values are difficult to establish by comparable properties some common sense in the market is at play. Or, are we talking about a blighted property that restricts values of neighboring properties? Never forget the value of good will of your business in your community.

What market cycle is the subject property in, a declining area or a busting market for rehabbed or new construction, how will the subject appreciate and what's the effect on the neighborhood?

Tearing down a million dollar home to build a four million dollar home can make economic sense, it the area supports that market value.

In residential properties, land should not exceed 20% of the market value, excess land begins to decline in value. Commercial land could be 50% or more of the market value and be economically viable. A car lot can easily fall into it's land values exceeding the costs of improvements.

Pretty simple usually, the cost to buy, demo and remove debris cannot exceed the market value of the land.

Then consider alternative uses of the land, are we restricted to a home or can we put an office or retail operation in there? Can we change the use and thereby the value?

Is it really a total tear down? In most jurisdictions there are different requirements for new construction vs. a rehab. You might tear out a building leaving one wall and qualify as a rehab, still having a new building functionally. I've seen rehabs with just the framing remaining, that can save thousands of dollars. Tear out and debris removal can be less than a new foundation and framing the same area. No, you can't call it a new home, but showing the original wall and improvements may not make any difference at all. I know one home very well that was 1.2M and had a gut rehab with extensive landscaping that is now offered at 12M, the footprint was not changed. Knowing the owner, it probably has at least 5M in profit and yes, I'd think it's overpriced too. But that isn't going to be financed with Fannie Mae, LOL.

Don't forget asbestos and lead paint issues with a tear down, $$$$$!

Also, don't forget the option of moving a house that has good bones, you might get a free house and spend 20K to move it and be ahead on another lot.

Always look at the bigger picture! :)

2 Reply

Donald Capwell

OP

Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes

10y

Originally posted by @Judy Raymond:

Be careful. You are buying a property with a building that you are going to have torn down than turn around and flip it to a builder for them to build or split the lot and build? If you tear the building down you are creating some issues that you may not have thought through. One is your lot right now has water, sewer, power etc. If you scrape you have now created new issues that you have to overcome with the building department and Public Works and the Utility provider. You are also potentially making it more difficult for someone to get financing on a vacant lot..

I recommend the first thing you do is get a contract contingent on getting approval from the Building Department to be able to do what you think you want to do then go from there. The Building Dept, Planning Dept and Zoning Depts favorite 5 words are, "No you can't do that". Good luck

Thank you, Judy... I very much appreciate this insight. I didn't consider scraping the property for the builder, but your comment helps to consider the "why" not to do it in the future!

Also, great suggestion in the contingency. I spoke with Zoning yesterday, and his land is zoned A-1, but the project manager in the department said its "unlikely" that they'd I'll allow for re-zoning to residential to allow for the splitting of the lot. This said, there is new construction going up "a city block" (in the country) from this land, and it is a community builder with lists this size and smaller. I'm not a fan of contingencies, but definitely see value in getti g hem when I'm walking down unfamiliar territory like this. Thanks for the heads up!

0 Reply

Donald Capwell

OP

Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes

10y

@Mike Wood, thank you for your input and numbers. Very helpful to know what you do. I don't immediately aspire to build homes, but perhaps down the road a bit... For now, knowing what to look for helps me analyze a potential deal for someone that can actually profit from it, so this has been a great...

Thanks!

0 Reply

Donald Capwell

OP

Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes

10y

@Manolo D., I appreciate the insight! 20% is a good number, but to @Mike Wood's point, 20% on a larger property is greater than 20% of a smaller one, when effort is factored in. As so many suggested, there are a lot of moving parts to scraping, which is why I value all of the input!

Thank you!

0 Reply

Donald Capwell

OP

Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes

10y

Originally posted by @Bill Gulley:

Funny, I just sold rural land with a tear down, closed last month.

In residential properties, land should not exceed 20% of the market value, excess land begins to decline in value.

Pretty simple usually, the cost to buy, demo and remove debris cannot exceed the market value of the land.

Always look at the bigger picture! :)

Thanks, Bill...

1. How was your recent rural land zoned? Was it aggricultural, or residential? Have you had to get involved with re-zoning? (I realize every area is different, but what were some lessons learned?)

2. I wasn't aware of this number, but will use it in my calculations going forwar. Thank you

3. So this works conjunction with #2... the more valuable the home that will be built, the higher allowable value for the land (scrape and removal being a set cost, assuming lead/asbestos/other environmentals are accounted for). For someone that finds something like this off the radar and wants to flip it to a buyer to profit from, you'd have to know what the buyer would build.

So, I know my next steps are to speak with some local buyers, even if my offer is rejected. It will help me evaluate these in the future. This type of deal has been off my radar until now, so I live and learn.

Truly, everyone, thank you for all of the great info!

0 Reply

Manolo D.

Contractor · Los Angeles, CA · Member since 2015 · 4k+ posts · 1k+ votes

10y

Donald Capwell Me and Mike Wood have different standards, his strategy for new builds is buy and hold, to my understanding, he can live without profit per project as long as it can qualify for financing and get his money back, but in exchange, he gets monthly cash flow, which is a great strategy, simply rinse and repeat, then you'll have a bunch in 5-10 years to replace monthly income. he does have limits 85% on new construction and 70% on rehabs. Mostly we do not have anything in CA below 70% on rehab, even if you are lucky enough, you get 70% if the rehab is substantial. Nor you can find any land that is worth less than 25%, mostly are priced at 30-35%, while in other areas, some have 0 value on land, and some even have negative value. Land is tricky also. Hence my strategy to have 80% across the board. that should give me about 10% profit, plus profit on construction.

1 Reply

Donald Capwell

OP

Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes

10y

Originally posted by @Manolo D.:

Donald Capwell Me and Mike Wood have different standards, his strategy for new builds is buy and hold, to my understanding, he can live without profit per project as long as it can qualify for financing and get his money back, but in exchange, he gets monthly cash flow, which is a great strategy, simply rinse and repeat, then you'll have a bunch in 5-10 years to replace monthly income. he does have limits 85% on new construction and 70% on rehabs. Mostly we do not have anything in CA below 70% on rehab, even if you are lucky enough, you get 70% if the rehab is substantial. Nor you can find any land that is worth less than 25%, mostly are priced at 30-35%, while in other areas, some have 0 value on land, and some even have negative value. Land is tricky also. Hence my strategy to have 80% across the board. that should give me about 10% profit, plus profit on construction.

Great stuff... Thanks. Knowing that there are so many strategies to this makes it challenging, but fun. Knowing what to look for from multiple angles (big picture, as @Bill Gulley stated) helps present a creative, if not blended solution that makes a property turn I to a deal! ;)

0 Reply

Donald Capwell

OP

Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes

10y

duplicate post.... Sorry!! ;)

0 Reply

Jay HinrichsBusiness Member

Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes

10y

@Donald Capwell profit aside.

Rehab loans = Easy dime a dozen most anyone can get one. ( unless your just starting have no credit and no money)

New construction loans = very difficult and most folks cannot get one. ( Even if you have great credit and money banks want to see Experience and lots of it normally)

depending on sales price at exit net profits tend to be 10 to 15% of gross.

Although like one other posted about simple cheap mid west starter homes and making 10k a door on those.. I would not personally do that. too much work and risk for that return.

Profits on new builds vary to the region your working in and depends on who or what your competition is.

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1 Reply

Bill Gulley

Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes

10y

Originally posted by @Donald Capwell:

Originally posted by @Bill Gulley:

Funny, I just sold rural land with a tear down, closed last month.

In residential properties, land should not exceed 20% of the market value, excess land begins to decline in value.

Pretty simple usually, the cost to buy, demo and remove debris cannot exceed the market value of the land.

Always look at the bigger picture! :)

Thanks, Bill...

1. How was your recent rural land zoned? Was it aggricultural, or residential? Have you had to get involved with re-zoning? (I realize every area is different, but what were some lessons learned?)

2. I wasn't aware of this number, but will use it in my calculations going forwar. Thank you

3. So this works conjunction with #2... the more valuable the home that will be built, the higher allowable value for the land (scrape and removal being a set cost, assuming lead/asbestos/other environmentals are accounted for). For someone that finds something like this off the radar and wants to flip it to a buyer to profit from, you'd have to know what the buyer would build.

So, I know my next steps are to speak with some local buyers, even if my offer is rejected. It will help me evaluate these in the future. This type of deal has been off my radar until now, so I live and learn.

Truly, everyone, thank you for all of the great info!

The property I had was ag, with residential use which is common.

Residential appraisals begin disallowing more than 20% in land value to arrive at a market value, secondary market isn't in the ag business or commercial arena. A 1M home should have a lot value of around 200K or less.

Economies of scale are at play here, a standard contractor fee of 15-20% of a sale price, if it's a $100K home maybe 20K, if it's a 400K home you're at 80K. If I charge 10% over cost on fixtures to go get them, I mark up a $40 faucet $4.00, if it's a $500 faucet, I'm taking $50.00. The larger the price tag the more room you have available to profit at market value, with a 1200 sq ft econo home, I'm pretty well stuck with basic costs, no frills and low margins......so I knock out 50 of them a year or, I might build 5 3,600 sq ft homes at a much higher per sq ft cost.

Not really, you need to know what could be built, what is most profitable, don't forget time on the market trying to build a white elephant.

Some investors might not be able to spell economics, but they understand the basics, or should. :)

1 Reply

Donald Capwell

OP

Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes

10y

Thank you, both, @Jay Hinrichs and @Bill Gulley. And my goal is certainly NOT to build a white elephant, which is why this thread has been so helpful. I am not in the new construction business, and normally am uber-conservative with my numbers, so having an understanding of what a deal looks like to a builder helps me a lot... And I will add that much more of a conservative slant to the eval. I won't feel a sense of loss, either, if the builder trips over himself to do the deal because my evaluation was too conservative. good for him/her, and an opportunity for me to learn even more directly from them...

Cheers!

0 Reply

Mike Wood

Developer · New Orleans, LA · Member since 2015 · 1k+ posts · 898 votes

10y

To add to what @Manolo D. said, land can be tricky. I don't think there is a good % of cost that works everywhere. I know that it varies dramatically by neighborhood around me. My current project under construction right now, land is 7% of the total cost, the one before that was 15.5%, but I am working out the details for my next project where land is going to be 24% of the total cost. Also, around me there are tons of area where vacant land has little to no value.

I can definitely find areas where land is at or over 30% of total cost. I don't think of land costs as a percentage of costs, but more I look a the value of the land verses what that land can sustain building wise. If the area can support high $/ft2, then I can afford to pay more for land. Generally the more expensive the land, the more valuable housing is. California is a perfect example of this.

I would not pay more for a property with a tear down house than the land value minus all removal/remediation costs. Since I will make my equity during the build, i generally dont anticipate getting too much equity on the cleared and ready to build lot.

I have looked briefly at building SFH for sale. When I looked into it, I wanted to clear 20% after all costs (including sales and closing cost). These were for sub $200k house. For larger houses (which I dont have the stomach for that level of risk yet), I would reduce that %.

Also something to consider, around me new houses sell for 10-20% higher $/ft2 than older houses. Not sure if that is similar in other city's.

1 Reply

Jay HinrichsBusiness Member

Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes

10y

@Mike Wood on the west coast you can throw % of project allocated to the land right out the window.. its inverse in many areas.

For instance I paid 750k for a lot in Palo Alto 6 sq ft tear down in Barron Park and spent 400k building the home.

I looked at a nice lot yesterday in Oregon 500k and would spend about 600k building the home sales price 1.5 to 1.7

I am looking to just be an investor in Austin.. were builder developer has lots tied up for 300k and will sell for 1.2 to 1.5 build cost in Texas are lower than west coast as we know so 5k sq ft fab home can be built for 600k or so.

really depends on the market... one size does not fit all.

And in much of the mid west unless its a re gentrify area like or an assemblage play land is basically worthless as existing homes sell for half of what it would cost to rebuild .

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2 Reply

Manolo D.

Contractor · Los Angeles, CA · Member since 2015 · 4k+ posts · 1k+ votes

10y

Donald Capwell Speaking of evals, whenever I do a project, I treat each and every piece different, I only care about the output, I don't care if the land has no value or high value, what I am concerned about is if when I list all my expenses out plus contingency, I will still make maybe 10-15%, then I will be happy to undertake it, on smaller value, like repair project for a client I tend to do in the low to mid 20s, only because it is so dynamic and something might pop up in the middle.

0 Reply

Rita Blinchik

Pasadena, CA · Member since 2015 · 3 posts · 1 vote

10y

Did someone mention time needed to obtain permits? I just build a house in a relatively upscale area, and permits alone took about 12 months to obtain.

1 Reply

Donald Capwell

OP

Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes

10y

Yikes, @Rita Blinchik, that's insane! Is that normal out your way???

0 Reply

Rita Blinchik

Pasadena, CA · Member since 2015 · 3 posts · 1 vote

10y

unfortunately, pretty standard. We live in California. The problem here is too many existing constructions. :)

0 Reply

Charles Terrizzi

Jacksonville, FL · Member since 2015 · 60 posts · 15 votes

10y

I have wanted to build my own rentals just because I think I can make a nicer, long term excellent product. I agree with many, the work is just what seems to be a discouragement. I have built a house ground up and it was difficult. It was about $50k too (ten years ago).

Sure would be nice to build a multi family, since around here they are incredibly expensive.

0 Reply

Zana Blue

Investor · Saint Augustine, FL · Member since 2015 · 227 posts · 61 votes

10y

Know this does not apply everywhere however if you are in a historic district you may not be able to level the house...

0 Reply

Donald Capwell

OP

Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes

10y

Thanks, @Zana Blue.

0 Reply

Roy N.Pro Member

Rental Property Investor · Fredericton, New Brunswick · Member since 2013 · 7k+ posts · 4k+ votes

10y

Originally posted by @Charles Terrizzi:

I have wanted to build my own rentals just because I think I can make a nicer, long term excellent product. I agree with many, the work is just what seems to be a discouragement. I have built a house ground up and it was difficult. It was about $50k too (ten years ago).

Sure would be nice to build a multi family, since around here they are incredibly expensive.

Charles:

The OP's conundrum certainly is not restricted to houses.

I walked a multi this week (50-unit) and came away thinking what it really needs is a bulldozer ... the location is fine, the view is good to very good, but the buildings are old, tired and were poorly built (read: corners cut everywhere) ... a shining example of functional obsolescence!

While I would not drop any money into rehabbing those buildings, the cost to acquire, knock them down and build new just cannot be justified.

1 Reply

Trent Currie

Investor / Chief Acquisitions Officer · Billings, MT · Member since 2011 · 91 posts · 24 votes

10y

@Donald Capwell

Hey Donald- Here is my most recent experience close to your scenario above. I won't go into extreme detail.

The deal was in my local market. Currently the market is very stable house prices are appreciating well. We have a local vacancy rate of 3.4%. The low vacancy rate coupled with the lack of available laborers has created a shortage of rentals and single family homes. Homes are moving quickly and even distressed buyers are being able to move properties through the MLS in what would have been a short sell scenario a few years ago. This market has made it difficult to find those value added deals on existing homes where we could go in rehab, rent and hold or flip.

With the lack of deals and shortage of inventory we were left with a few options. Most deals available had so much competition that it drove the asset price up way past our acquisition criteria. Pretty much any of your standard vetting processes such as the 50% or 2% rules would make a property fail. Most of the local investors are accepting sub par returns in order to keep making deals go it appears.

We knew our opportunity was only in new development for property that might reach our criteria. From spec homes we had our costs for per square foot already known for a variety of finishes. If you don't know your cost per square foot call up some of the local custom builders and just ask what they are able to do it for. They will give you some ball park numbers of what they can build a house for.

Unfortunately with the rising tides the raw land and land with services rose too. On lots that were previously 42.5k for a ready to develop lot we were seeing prices in the 62k range. It was time to get resourceful.

We set out into a older neighborhood to find something not on the market. Shortly after that there was a small lot in an older neighborhood that came up. Another developer had torn down the main house (rough cost of 5K) and left up some of the other structures. They wanted to get the property moved since they had other projects that were prioritizing. We were able to pick up the property for about 50% of what we would have for a lot in other areas of town.

The lot was cleaned up with the other structures torn down. It took about a week or two to get the site prepped. Construction is moving along swiftly and the project will meet all of our acquisition criteria, ROI expectations, and standards for units.

Negatives of the process:

It does take more time (site prep and unknown factors. Could you do more deals by passing on this one?)
There could be serious complications (You don't know what is below that dirt. For instance imagine if the site has some environmental contaminants below grade. Now you have a huge problem.)
Every jurisdiction has its own regulations. In Houston we were restricted on tearing down a home due to its age.)
It can take a significant amount of time doing a new construction process (spec sheets, meeting with contractors, etc.. It all depends on how you have it set up)

Positives:

Personally I like the control factor. I know exactly what I am building. All the systems are designed to last for years.
Customization to meet criteria
Additional strategy in a crowded market (Flips are hard to come by right now)
New construction is desirable by renters
Lower Maintenance (It should be mostly care free after getting the initial bugs sorted out)

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When does it make sense to level a house and build new?

When does it make sense to level a house and build new?

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