Build vs Buy, what is the right approach?

Question

Hi, all.  I am a newbie trying to get a handle on the financial trade-offs between buying a place to renovate vs building it yourself.  I have been looking at 5 unit apartment buildings.  An architect I spoke with recently told me that nobody is building 5 unit apartment buildings because the numbers don't make sense.  Not in Los Angeles. Might be different in Denver or Des Moines.

So I guess I am trying to get a handle on the profitability of development, especially small strip malls or smaller apartment buildings that are within my means. Is this a profitable line of business in Southern California?  Is it bleakest Mordor?  Something in between?

Cheers - Chris

Chris Penny · Answer

@Bill S., so I assume there is practically no single family home construction going on in your area because of the factors you mention.  And mulit-family needs economies of scale to pencil well. Basically it is supply and demand, no?  If the demand is high, rents are high and I can afford to construct. If rents are not high I need to find a property with the right price and potential to improve the rents.

Bill S. · Answer

@Chris Penny so there is a real easy way to figure this. Find a builder and see what the cost to build is. Around here, building costs are running about $200/sq ft. When you throw in soft costs like zoning approval, building plans and permits and land you get another $100/sqft. The leaves the cost to construct around $300/sqft. So far, that is well above the cost to buy existing and you can not sell for that. Bottom line is that here in my market it's still much cheaper to buy existing than build new. Your mileage may vary.

Chris Penny · Answer

My plan is the standard DeeperPockets BRRR approach.  I would own the property to produce income. But my goal for all my properties is  to get as much of my money out of the deal as possible, so that I have infinite returns, or close to it.

My thinking is...let's assume a 6 unit building.  Looking on Loopnet in LA for a 6 unit building shows a range of  $695,000 to $2,580,000.   The average seems to be around $1,200,000. So what would it cost me to build a 6 unit versus buy it?  I realize that the building would have to be on a certain sized lot with the proper zoning - assuming you could find such a lot.  If I build new I can get top dollar and have now maintenance for years to come. But will it be profitable to do so?

Jason Hsiao · Answer

Hi @Chris Penny, have you done any research on resale value in your area for apartments vs single family homes or PUD type of approach? Is your plan to sell off all of them individually and keep one for yourself or rent them out for cash flow? If not just go on Redfin/Zillow or Loopnet to try to find some recently sold properties to get an idea.

I suspect the architect is just saying a broad stroke statement without knowing all the details. They also do this to blow some newbies off bc they don't want to work with newbies or they don't have the expertise in the type of development you want to do. I wouldn't dismiss the idea just yet. That said, there is more affinity for single family homes than apartments in SoCal, maybe that's all what he meant.

Chris Penny · Answer

Thanks Russell. The approach I am taking is to work with commercial banks. I do all my real estate through a WY corporation and the banks I have spoken with have a minimum of 5 units before they will look at the deal.

What kind of financing did your family member get?  And how is a 4 unit more profitable than a 5?Cheers - Chris

Russell Brazil · Answer

One thing to consider is that in many places a 4 unit property is more valuable than a 5 unit property due to the larger pool of buyers and better financing terms a 4 unit can get. I have a family member actually who converted a couple of 5 unit properties into 4 units to unlock their maximum value.