Does this strategy make sense?

Question

My partner and I looked at a property on a fairly major street in Woodland Hills, CA over the weekend.  It's a small house in really bad shape that we see as a tear down.  It's on a 7700 square foot that we believe is zoned R2.

So, our thought was... We demo it and build a new duplex there.  They're asking $480K, but we're assuming we could get it for around $430K.  A 2400 square foot duplex (1200 square feet per unit) at roughly $150 per sq ft to build = $360K  So, roughly $790K all in.

We estimate we can rent these brand new units for about $2500/month, grossing $5000/month.

We're not sure what the property will appraise for when done, but if we refi once it's done (BRRR) and pull $700K out, it looks like the mortgage payment + taxes & insurance would be about $4000/mo.  So, we'd net $1000/month.

I know these are rather vague numbers, but does it make sense at all??

Justin R. · Answer

@Trevor Baker I've been converting SFR properties into small MFRs for the past 7 years a little south of you in SD.  The strategy has been very good to me, and I'm a fan.

Separate your construction costs into soft, horizontal and vertical components - soft for city fees, professional services , and holding/financing costs ... horizontal for any site prep, public improvements, and underground work ... vertical for foundation and everything on top of it.  The vertical part can run around $150/sqft if you have strong relationships.

To give you some other data points, I have three projects going at the moment.  One is 3 units.  The other two are 4 units - I can't make the numbers work for just two units unless I'm able to keep the existing unit and add on or construct on the lot.  Problem is those properties are prime flipping candidates too and if they're in a price range that makes sense for B&H, they generally make *more* sense to flip.  In short, it's really really hard to justify Buy-Develop-Hold at this point in the market cycle because buyers are willing to pay so much - it generally makes more sense to Buy-Develop-Sell instead.

Kristina Heimstaedt · Answer

@Trevor Baker I would definitely double check your build costs. Most developers I know are building closer to $400/square foot.

Rent: You're going to get $2500/month off of 1200 square feet? Don't get me wrong, I'm not familiar with that market so maybe it's doable. I can definitely get those numbers on the coast here, but it would definitely be a push to get that in a non-coastal city.

Cash out financing: I would talk to a lender about how easy it is to do a cash out refinance. It's my experience that those still aren't that easy.

All of this being said, I agree with @Gordon French that if your end is $1000/month off of your $90k investment with an appraisal total of $790,000, that doesn't seem terribly great. Based on the kind of math I do, I would calculate that at a 1.11% ROI. Don't get me wrong, it gets you in the game, but this would be a lot of money tied up until you refinance and even so, it's not a very good ROI.

Be patient and keep evaluating deals. It's the way to get to the punch first when you can recognize the deal before others.

Gordon French · Answer

Im new here so forgive me if I am missing something. So, your going to spend $800,000 in the sort term and pull $700,000 back leaving $100,000 tied up with a return of $1000 a month? This is another reason I would never live in that state.

Im clearing $500 a month with a $70,000 loan and 0 out of pocket.  With $80,000 I could cash flow $1400 a month.

That sound like a terrible investment but as I said I am very new here. First day on this site.

Aaron K. · Answer

Have you accounted for the holding costs for the time that you will not be collecting rent while pulling permits and obtaining all other requirements to build the duplex, and during construction.  I think you might also want to talk to a couple of contractors to get a firmer number on construction costs.  Also in a quick look on Redfin I believe that I found the property you are considering (I don't want to reveal the address on here) and it is listed as a hot home likely to sell soon, so I think it may be unlikely you will get that steep of a discount.

Jo-Ann Lapin · Answer

I would for sure check your number 350 to 400 per sq foot on more realistic

Michael Guzik · Answer

@Trevor Baker I don't know much about your area but I do know those prices are insane man.

I really like your creativity but I think it could be used in a much better situation that makes better sense financially. People in my area would think you are smoking crack for wanting to put that much into a property to even cashflow 3k a month. There are way too many what ifs and assumptions in that scenario. Maybe those are typical numbers in Cali but here in Texas that is just absurd. The only way I could see that specific situation being a win is if you get it at a steep discount, finish the tear down and rebuild it swiftly and as cheaply as possible, and the property appreciates like crazy. This seems like an appreciation play and I'm not a big fan of that. I believe cash flow is king and in this situation it just doesn't work out IMO. I'm sure in a 1-2 hour drive from your area you can find a similar situation that will work out much better numerically and that would be my advice. Good luck!

Does this strategy make sense?

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