Build/develop to rent?

Question

As I scan commercial and residential property, I regularly find these portfolios for sale. A couple have got my wheels turning, so I thought I'd poll the professional audience. One in particular is a 20+ single story, slab style home development. All homes are on the same street. All of them have stamped concrete floors that look like wide plank hardwood. They are all brick or vinyl siding, so I am sure they are all low maintenance, both inside and out. 100% occupied with a waiting list is the part that really stuck out to me.

So my question: have any of you ever built strictly with the intent on renting the properties upon completion? This seems like a solid strategy to me, but I would love to hear from you guys. Here are some of the pros and cons that I see:

Pros:

• Property management costs would be lower over the life of ownership due to proximity of homes in portfolio, low maintenance flooring, siding, etc.
• You could build them with more robust systems(HVAC, plumbing, etc) knowing they would always house renters
• Your portfolio would be concentrated as opposed to spread all over a geographical area
• Your exit strategy would be super attractive if you were to sell as a package
• Quicker than purchasing and potentially rehabbing an older property, and accumulating them one by one
• You could sell a percentage of them to recoup a portion of your investment, and rent the rest, which should put you with solid equity from the gate

Cons:

• Entry costs and length of time from start to first months rental income for construction
• Funding the construction, or finding the right lender to fund such a property/development
• Knowing the correct price point of the finished product, or what the community is lacking
• Local zoning or possibly being prohibited to build SFH to rent
• Higher construction costs vs. multifamily(apartments or townhomes)

I know there are many other strategies out there, but as one wanting to accumulate a nice rental portfolio, this seems to be a solid approach. I am curious as to what you guys and gals have to say about it.

Scott Choppin · Answer

@Kris Reeves

You question is a good one, sorry we all haven't been quicker to respond (HT to Audrey for jumping in with some good help).

The link to my real estate development thread is here: https://www.biggerpockets.com/forums/44/topics/427...

I do have some thinking around this idea. I can't answer each of your questions, but if after further review and research on your part you need help, I would be happy to engage offline via phone.

Reactions to the ideas of building a for rent SFH project or portfolio:

1. Ask yourself this questions, are there already existing homes that can be bought and rehabbed for lower or equal cost and rented to a similar rent to a newly built SFH?

If this is "yes", then you need to consider the time, expense, and risk/complexity that is inherent in a development project. Versus much less of that than buying an older home, rehab, rent. You allude to some of the risk items in your post, interest carry as an example. You will have interest carry on either rehab or new const, but the complexity of involving the local government in your business plan can/does insert a whole new level of review and approvals (read: risk). These approvals can take more time (zoning, design review, subdivision platting, plan check of buildings under more stringent building codes), most all of which you'll skip on a rehab.

I'm not saying rehab is simple or easy, just that in comparison development is more risky, complex, and costly in terms of time and energy.

One way of offsetting this development risk is to partner with a development company or hire a consultant who has the expertise and team to move through the development process more expediently.

2. If you do get over the question of rehab versus development and you pick development, there a some items to consider on an SFH new construction rental portfolio.

A. Your operating expenses will likely be higher, due to more maintenance issues related to a house versus an apartment building, more water heaters to break, more exterior items to maintain - fences, site work, drainage, etc. In my personal experience, I was involved in a deal in the Midwest where the company I worked for underwrote an SFH tax credit project, and the opex were much higher per unit. I have not done an SFH rental portfolio build myself.

B. Your maintenance costs will be higher in the long run, due to your maintenance team having to move from house to house to complete repairs, move tools, move trucks and personnel.

C. You may pay higher property taxes on a per unit basis as you are now taxed on a larger land area per unit, versus a MF project with more units on smaller land areas. Depends on the mill rate and special districts, but should be taken into consideration.

D. You likely would not "upgrade" the HVAC beyond normal specs and you'll get no rent uptick having a better quality unit. Oh you may want a mid to mid upper brand, versus super cheap, that is a good choice. But I interpreted you statement to be something like "industrial grade" which you don't need.

E. You land cost per unit on land purchase may be higher than a MF site, again efficiency of number of units on a given piece of land. To a point, more units equals more efficiency of land cost per unit and higher returns.

I think that covers it for the moment, but let me know what questions you have after review. Also, do you have a specific site identified?

Thanks

Scott

Scott Choppin · Answer

@Kris Reeves @Mateusz Prawdzik

Just wanted to add some clarification.

1. I am a huge proponent of development (I am a developer after all)

2. What I was after for Kris was for him to be rigorous and thorough in the initial analysis of rehab versus new construction.

I must respectfully disagree with Mateusz, to say that "the risk/reward isn't there" on SFR rental, this may or may not be true. I just want Kris to do the math, which it sounds like he is in process (partly why he's on BP asking the question).

3. The time to look at the development model is when existing product becomes expensive enough to warrant building something new.

The way I think about this is as two sides of the same formula:

• buy below replacement cost

or

• buy/develop above replacement cost (I call this the "development model).

In a recessionary environment, when values are down, you can buy units below replacement costs. For example you can buy existing at $80k per door, where replacement cost (think: build cost) is $100k per door. In that model you are benefited by buying existing at a discount. You would not build new, to sell at a loss, so no development takes place.

In an inflationary environment, or up market, you are the in the "above replacement cost" or development model, where you can build for $100k, and sell for $120k. In this case, your development profit is $20k per unit. If you hold it long term at the end of the development process, you are really "buying" at the $100k build cost (I think, Kris, this is where you may be).

In this case, you can build and sell for a profit, which is where most markets are now (not all, but most all major urban centers). In this environment, you may have to pay $120k per unit to buy existing, or may find it slightly cheaper, but the units need rehab, and you end up close to $120k anyways. Plus you have to compete with all the other buyers in the market, whereas looking at the development model eliminates lots of (not all) competition from less sophisticated buyers.

Now before everyone flames me, I am generalizing, you might find distressed assets that have nothing to do with market conditions. Also, there's lots of friction in the development process, and my example is simple by design (this is why I recommend working in joint venture with a seasoned developer or development consultant). Once you get the concept, you can then add the other complexities that come with development and see if the "above replacement" model works for you. Some folks just don't do development, and I accept that. It's not for the faint of heart, at all.

So, back to the question at hand for Kris. It sounds like existing is very competitive/expensive, which invokes the development model. Then he needs to decide if he has the networks of help to dive into development, then appropriately and rigorously underwrite the SFR rental model, and see if the investment returns exceed the "buy existing" model. At that point, after making a rigorous and ground assessment of the two models, if the returns for development exceed purchase of existing, you pick that one. Then build your networks of help to execute.

Scott

Audrey Ezeh · Answer

You are very welcome! (just noticed I didn't actually include the link to Scott's thread but I am glad he picked up on it). Wouldn't it be amazing if you and Cameron link up? Man I hope that works out for you!!

Like other's have said, I am shying away from SFR builds. I am making all my plans towards MFR. With the existing properties I buy, I am particularly attracted to duplexes, 4plexes etc on a large lot than I can eventually build on. As a matter of fact, I will be closing on 2 such duplexes in 2 weeks. So even if you are not ready to build, you can source great deals with the right lot size, zoning etc for what you want to do.

Like you, I want to hold these things and pass them on to my kids so the newer the better but it all has to make $$ sense!

Best of luck to you and keep us posted :)

Chris Youssi · Answer

I LOVE new duplex's/ 4 family rentals for many reasons . In fact we just broke ground on 3/12 duplex's and are getting quotes for an out of state project for the improvements so we can begin building late summer/ early fall on 184 units ( all 4 families ) 84 we will be selling and renting the other 100. Here are a few strategies that have helped us along the way:

1.) We are developers and as such act also as our own GC's

2.) We obtain zoning / all permitting  / develop the sites  / design our own buildings and have complete control.

3.) We build everything to the 9's and 10's easier to rent  /  higher rents / easier for exit strategies when selling.

4.) New = less maintenance not more - shiny pennies are always attractive  - the latest in designs fits and finishes

5.) Volume allows us to obtain favorable pricing - we are in the $75-95/ sf range which includes fireplaces  granite / volume ceilings 2 car attached garages etc...

Best wishes moving forward

Audrey Ezeh · Answer

No Kris, it is not a bad thing at all. As a matter of fact, it is my long term goal...just have to get a few things in place. Here are a few links that might help you as you mull things over.

1: This is a podcast with a gentleman that does exactly that..he builds to rent and as long as he is hitting the 1% rule, he is happy.  https://www.biggerpockets.com/renewsblog/2016/03/3...

2: Search this real estate development thread...there are many posts on the subject.

3: Follow this thread by @Scott Choppin you are welcome :)

Steve Olson · Answer

@Kris Reeves

Awesome questions and I'm sorry I'm a little late here.  I have extensive experience in this.  There's some great feedback on the forum here.  I think you have a lot of the pros and cons.  But I'll add a few pros: year one bonus depreciation on new construction.  Awesome tax break if you're a real estate professional.  And the volume play is correct.  If you can get in with the right subs and be a consistent source of business for them, you'll deliver product lower than what the local market can.

The biggest con is property management.  That has to really be dialed in.  And depending on how you interface with your investors, I may be able to give some pointers specific to your situation.  We've built over 4000 doors in 3 states and have a lot of investors, so we've become pretty good at those conversations.  Not because we're smart...but when you keep banging your head against a brick wall you eventually figure out a better way :)

Caren E. · Answer

What a good reply. I am no where near that level of sophistication but thought I would add one thing from my limited experience, but an issue I hear over and over in the podcasts.

It is difficult to make sure your builder is going to be all they say: on time, with milestones and ordering plans to meet them. In a large development this will be crucial. It will not just be the numbers, but the execution.

Mateusz Prawdzik · Answer

@Kris Reeves For SFR development to rent out, unless you know the town and the town is literally begging you to build a community on the land, and you have plenty of land... The risk/reward isn't there. Stick to big unit commercials like 50+ Units if you want to develop and rent.

A. You don't need as much land

B. Depending on the area, the rent is basically the same once you incorporate all the expenses

C. Less property management cost

D. Price per unit is way more in your favor

The list can keep going, but IMO ask yourself the same questions @Scott Choppin said, and 99% of the time, the risk/reward isn't there, especially if this is your first time around the block in developing. But I mean hey, the best way to learn is to do.

Kris Reeves · Answer

@Audrey Ezeh Thank you so much for chiming in! I had listened to that podcast episode when it came out over a year ago, but honestly had forgotten all about it! I went back and re-listened to it yesterday. Cameron is actually about 5 hours away from me! I am going to reach out to him and hopefully gain from his experience. So thanks for that, and for directing me to Scott's thread!

@Scott Choppin I really appreciate your detailed response to my post. These are all great considerations, and you have given me exactly what I was looking for in my request. I will be leaning on my local contacts and friends who are in development as I dive further into researching this. I may take you up on a conversation in the near future, and I appreciate the offer.

To answer your first question, there are existing homes in my region that I can rehab and put into my portfolio. The competition is high, therefore there are fewer and fewer to choose from, and the prices are being driven up. So there are two things have driven me to consider the build-to-rent approach: what I just mentioned about supply, and the portfolios for sale that I began this thread with. I am 39 years old, and the thought of having brand new rentals sounds attractive when I consider holding my portfolio forever. This will be our business, and we will treat it like one. So when I build them, I will know them inside and out from the first night of rental.

Again, thank you both for chiming in!

Kris Reeves · Answer

This may be a good thing that nobody responded, or maybe a bad one!

Build/develop to rent?

Most Popular Reply