Example spec home deal analysis

[Jimmy Nguyen]

Hello spec home builders,

I was wondering if you could review my breakdown of a potential deal I was looking at.  It involves purchasing a piece of land to build a spec house.  Let me know if I'm missing something in my analysis or if I made an error in my math.  I'm particularly wanting to know if I'm missing some additional expense that would cut into my profits.  I understand the comparable data that I listed is a little old and the cost/sqft construction estimates are not as accurate as a thorough breakdown, but I needed something to start with.  

Here goes:

Example deal: We find a .35 acre lot in Virginia in a good neighborhood with good schools. The lot is selling on MLS (retail) at $234,900. If we purchase at this price we would include $7,047 (3% buyer closing costs), which gives us a purchase total of $241,947. We would buy the land cash and take out a construction loan @ 6.5% interest.

Comparables of homes sold in the area (based on Zillow data):

1. Sold 5/29/15 for $790,000 - Built 1988, 4br/3ba - 3,180 sqft on 1.12 acres with 552 sqft garage and partial basement
2. Sold 9/9/15 for $625,000 - Built 1977, 5br/3.5ba - 3,130 sqft on .3 acres with 440 sqft garage and 350 sqft basement
3. Sold 5/09/16 for $600,000 - Built 1981, 4br/2.5ba - 2,397 sqft on .32 acres with 462 sqft garage and partial basement
4. Sold 6/18/15 for $515,000 - Built 1982, 3br/3ba - 2,116 sqft on .17 acres with 399 sqft garage

If we are to build a new 4br/3.5ba home at 2800 sqft with average-sized garage and partial basement for a maximum cost of $110/sqft that would equal $308,000. The cost of construction ($308,000) + 6.5% interest on construction loan ($20,020) + land price ($241,947) = $569,967. If we can sell the home for $650,000 - 48750 (7.5% for real estate commission + closing costs) we would get $601,250.

The profit from the sale of the home would be ($601,250 - $569,967) = $31,283
Percent profit on sale price = 4.8%
Cash on cash ROI if paying only for land ($31,283/$241,947) = 12.9%
$Profit/sqft = $11.17/sqft

The numbers do not look overly attractive. If we are to be successful and reach our minimum goal of 15% profit on sale price, we will have to do one or more of the following:

1. Buy the land for $65,000-$70,000 discount
2. Bring down the cost of construction to $85-$90/sqft, which would be challenging if we are doing a high quality, energy-efficient construction
3. Sell the home at the high end of the comparables at around $725,000, which seems doable in the right market environment since it is a new construction and will be a high quality, energy-efficient home

Of course, the profit does not take into account my salary as a general contractor for the job, which is factored into the $308,000 figure.  That would be around $15,000 - $20,000.  

I realize now that direct marketing for land or working with wholesalers to find affordable lots would help increase the chances of making greater profits on spec homes.  

Any suggestions or thoughts?

Thanks in advance.  

[Suzanne Griffiths]

Hi Jimmy Nguyen I see just a couple minor things.

-initial closing costs, make sure you are including title company fees, title insurance, pro-rated property taxes, etc.
-holding costs, make sure you are including utilities. You'll have porta potties, temporary power and water initially and the actual utilities once you connect services through the end of the project.
-seasonal challenges. If you start now, when is your completion date, will it run you into winter or into a busy season for contractors? Are there potential delays due to snow etc.
-cost per square foot, I would figure conservatively closer to $125 per square. This will vary based on your area but will also provide you a contingency.
-comps. Try and find comps within 6 mos, same bedroom bathroom profile (you don't want to compare a 3 bedroom to a 5 bedroom), +/- 10% on square footage and only new construction. Watch the distance from your current location. Try using Redfin instead of Zillow. You can use the filters to find more like matches.
-last make sure you are conservative on your days on market and the holding costs after the construction is complete.

When we are running our numbers we won't do a project if it doesn't have a 20% ROI, we don't look much at the dollars as that can push you to make an emotional decision that could cost you

Good luck!