Rental Property Investor · Houston, TX · Member since 2019 · 30 posts · 13 votes
Hello BP nation. I wanted to hear your thoughts on building new. Originally I was looking to BRRRR in a gentrifying neighborhood. Most properties in The area I am looking at are in extremely bad shape and need to be torn down. It is very hard to find homes with good bones that would only need little updates and face lifts. Many of them need everything replaced.
Slowly people are buying these homes which are mostly in the 1200 square feet range and building larger townhouses and selling them. I don't have enough money to build a big town house but I could possibly afford to buy a piece of land and build a house with the same square footage (around 1200 sf) this means my house would be much smaller than all the new construction around but I am planning on renting it once it's built and refinanced.
I am curious to hear your thoughts on this strategy.
Developer · New Orleans, LA · Member since 2015 · 1k+ posts · 898 votes
7y
@Marzieh Rostami To illustrate and example, lets say you buy the land for $150k, and you build a 1200ft2 house for $132k (=1200ft2 @ $110/ft2), ignoring finance and soft costs, your total cost would be $282k. On a $/ft2 basis, your cost is $235/ft2. Thats pretty high for the south. In order for the bank to finance the project, you would need the value of existing house sales to be very near or above this valuation.
Now, lets look at the same lot ($150k) but lets build a 2,200ft2 house, using the same build cost (larger houses would be cheaper per ft2, but we will ignore that for this example). The build cost would be $242k (=2200ft2 @ 110/ft2), and your total cost, again ignoring finance and soft costs, would be $392k. On a $/ft2 basis, the cost would be $178/ft2, which is lower and more likely to be in line with the existing house valuations.
I also doubt that tearing down a 1200ft2 house to rebuild a 1200ft2 makes any financial sense. If we assume your new build costs are $110/ft2 (just a bit higher than my area), you should be able to do a full gut renovation for somewhere in the range of $50-70/ft2, depending on how much of the exterior needs to be replaced (siding, roofing, concrete flatwork, etc). If the house is as bad as you say, you should be able to purchase it for right around the land value.
Do you have any idea what a 1200ft2 house would rent for in your area. Using your numbers, it would need to rent for well over $2000/month to cashflow.
Additionally, given your numbers, I doubt that a single family new construction rental will work. I also would not be interested in investing so much money in an area that is a gentrification play, $150k for a lot is very high in my market, and we routinely have house values in the $150-$200/ft2 range. I have not been able to find a property in my market where the land value is over $100k that will work with a new construction duplex on it.
Developer · Charlottesville, VA · Member since 2018 · 4k+ posts · 4k+ votes
7y
This can be a good strategy however your margins are probably going to be thin due to the cost to build. You have to be careful that you do not end up in a negative cash flow situation.
You can almost always buy more income then you can build with single family homes.
Rental Property Investor · Houston, TX · Member since 2019 · 30 posts · 13 votes
7y
@Greg Dickerson
Thanks for your response. My contractor says he can build for $110/sf
If that is true then I think the numbers could end up working for me. I'm thinking of maybe building a duplex which I think would bring enough income to cover the expenses.
I just don't know if the price my contractor is giving me is realistic or it will end up costing much more. I will get more quotes and prices from other people if I actually decide to do this of course.
I was just wondering if there could be any other downsides to this strategy. Given that in the end it will be a lower quality, smaller duplex when compared to all the other new single family construction around. Thinking that I might want to sell 5-6 years down the road.
Developer · New Orleans, LA · Member since 2015 · 1k+ posts · 898 votes
7y
@Marzieh Rostami One big downside is that you will need a construction loan to do this, and most construction loans will required 20-25% of the total costs (land + soft cost + build costs) as a down payment/equity. That is hard to come by. Additionally, if the land is expensive, building small houses will make valuation a problem, as the land cost will be a larger chunk of the cost/valuation.
Developer · San Diego, CA · Member since 2012 · 133 posts · 114 votes
7y
@Marzieh Rostami I called it a BBRR. Buy, Build, Rent, Refinance.
It's similar in strategy but you may need several loans to make it work: acquisition, construction and permanent financing. Most lenders like to have a building permit before lending on construction. There are owner-occupied loans for building up to 4 units with FHA that may be worth looking into if that's the route you're going but they have a lot of hoops to jump through as well.
Rental Property Investor · Houston, TX · Member since 2019 · 30 posts · 13 votes
7y
@Mike Wood
Thanks for the information..when you say it will make valuation a problem do you mean that I might have trouble with the loan for when the bank is appraising the property?
I am gambling on a neighborhood that has just recently starting to gentrify. There are new construction one on each block maybe but it still hasn't altered all that much. What I mean is that there are lots of houses in extremely poor conditions so lot values are still relatively low. So a 5000 sf lot will cost around 150k. According to my contractor it will cost around 200k to build a small house. Would you say this would not be worth it.
Developer · New Orleans, LA · Member since 2015 · 1k+ posts · 898 votes
7y
@Marzieh Rostami To illustrate and example, lets say you buy the land for $150k, and you build a 1200ft2 house for $132k (=1200ft2 @ $110/ft2), ignoring finance and soft costs, your total cost would be $282k. On a $/ft2 basis, your cost is $235/ft2. Thats pretty high for the south. In order for the bank to finance the project, you would need the value of existing house sales to be very near or above this valuation.
Now, lets look at the same lot ($150k) but lets build a 2,200ft2 house, using the same build cost (larger houses would be cheaper per ft2, but we will ignore that for this example). The build cost would be $242k (=2200ft2 @ 110/ft2), and your total cost, again ignoring finance and soft costs, would be $392k. On a $/ft2 basis, the cost would be $178/ft2, which is lower and more likely to be in line with the existing house valuations.
I also doubt that tearing down a 1200ft2 house to rebuild a 1200ft2 makes any financial sense. If we assume your new build costs are $110/ft2 (just a bit higher than my area), you should be able to do a full gut renovation for somewhere in the range of $50-70/ft2, depending on how much of the exterior needs to be replaced (siding, roofing, concrete flatwork, etc). If the house is as bad as you say, you should be able to purchase it for right around the land value.
Do you have any idea what a 1200ft2 house would rent for in your area. Using your numbers, it would need to rent for well over $2000/month to cashflow.
Additionally, given your numbers, I doubt that a single family new construction rental will work. I also would not be interested in investing so much money in an area that is a gentrification play, $150k for a lot is very high in my market, and we routinely have house values in the $150-$200/ft2 range. I have not been able to find a property in my market where the land value is over $100k that will work with a new construction duplex on it.
Rental Property Investor · Houston, TX · Member since 2019 · 30 posts · 13 votes
7y
@Mike Wood
Thanks a lot for your detailed analysis. I hadn't looked at it this time way.
This was very helpful.
My contractor was telling me it doesn't cost that much more to build than to reno ste these homes which are I extremely bad shape. That's why I started to think about building new. But it seems like guy out are right. It doesn't make much of a financial sense. I will have to keep looking a property that needs less work.
Developer · New Orleans, LA · Member since 2015 · 1k+ posts · 898 votes
7y
@Marzieh Rostami I do not think your contractor is giving you great information. You would be saving all of the costs of framing and foundation ($18.50/ft2 on my recent 1790ft2 build), and most likely exterior siding ($6.35/ft2 on the same build) on a gut renovation. Other things should be cheaper as well when compared to new construction. I am able to do a gut renovation (to the studs) for around $50-60/ft2 here, my new builds cost $90-100/ft2.
While I personally prefer to build new over renovations, its not because the numbers say so, but other reasons (old layout doesnt work, existing foot print not be best use of land, etc). You might want to think about talking to other contractors.
With the above being said, new construction or gut renovation is an aggressive path if you have not done some renovation work before. New construction can be easier to budget for in the beginning, but there are still areas that can cause significant overages (allowance items), and renovations can have a budget that balloons if you or your contractor dont account for things.
Rental Property Investor · Houston, TX · Member since 2019 · 30 posts · 13 votes
7y
@Mike Wood
Thanks for the information. This was the contractor I used for renovations on my own house which wasn't major and he came in Lower than anyone else and did good work. But from what you're saying it seems he may not be giving me the best price this time around. I will definitely check with other contractors. Thanks.
Investor · Des Moines, IA · Member since 2013 · 137 posts · 49 votes
7y
What does your bank think? Your loan amounts will be inextricably linked to their appraisal. It sounds like you would have a hard time finding comps that would support your costs. Similar homes nearby would be dilapidated and the new construction would be in a different asset class (townhomes vs what you'd like to build-SFR?).
There are cases where a really good lender that knew that market could find a way to get you that loan. But IME, I like to use my network to help curb my enthusiasm LOL. If they have to work to get you funding, you're gambling.