New construction for rental, good or bad idea?

Question

Hi everyone,

I’m trying to invest in real estate and I’m not sure if the plan is a good idea, and I need your help.

I want to invest in new constructions SFH and put them for rent. I’m a new General Contractor and built 2 houses so far. The scenario will look like this:

Land: $25,000

Build a 1,200-1,300sqft house : $115,000(3bed2bath)

Total :$140,000

Rent in the area I want to build $1,400

PM : 10%

How would I analyze I deal like that considering building 5 SFH’s with all cash?

I’m inexperienced about how the yearly appreciation works on real estate so I can’t get to the right numbers when analyzing a deal like that.

If any of you had such situation to deal with please tell me your experience or opinion.

Thank you in advance for your time.

Nicolae

Mike Wood · Answer

@Nicolae Iovu  Assuming your talking about NOLA, I think your rental rate is high, given your budget for land ($25k lots are not a great area in NOLA). Also, the area would have to have sales comps that can support the new construction costs (in your example, sales comps would have to be $108-115/ft2 or higher).

If you pick the right area, you should be able to build in equity, especially if you GC the build yourself.  As for normal appreciation, I would suggest ignoring that for any analysis for long term rental.

If you pay cash for the property, you will have more cash flow, but your cash on cash return will be lower than if you had a mortgage.  Try the BP calculators to compare the two methods.

In NOLA, I would expect for your expenses to be at least 35% with new construction if your using a PM.

Mike Wood · Answer

@Nicolae Iovu All of my units are in Orleans Parish, in the city of New Orleans.  Currently we only have 2/1 and 2/1.5 units, ranging from 850-1050ft2, with rents ranging from $950-$1350 ($1.11-1.28/ft2 per month).   The biggest difference in price is the area the units are located.

I would say that while your new construction unit will be much more appealing than an existing house, that does not mean it will rent for significantly more money than existing units (assuming the same features, bed/bath, finishes).

Most of my units (except 3) were ground up new construction built specifically for long term rentals.  If the valuation works, then it can be a good way to add units.

Nicolae Iovu · Answer

@Jay Hinrichs I know it’s kinda disturbing knowing how fast the value of a new construction can go down. But yet with the market of today  if I buy a house to rehab it in that area it would actually cost me more than to build a new construction. It’s like a trap and that’s why I’m having a hard time getting the numbers to make sense.

Thank you for writing.

Nicolae

Nicolae Iovu · Answer

@Mike Wood I will definitely double check with the zoning in St Bernard since once I was told that they have not changed anything and it’s ok to build for rentals. But with them you never know how fast laws can change.

Also about the rent rates I got comps for regular 1,200 sqft house in that area no less than $1,200-$1,300/month.

In what area you have your units in Nee Orleans and what rates do you get?

Thank you

Nicolae

Jay Hinrichs · Answer

that amazes me that new construction would go down in value like a car.  I guess that's true when you can buy an already built property in the same block for less than construction costs.. so new construction reverts to the mean.   foreign concept for us west coast folks. :)

Mike Wood · Answer

@Nicolae Iovu  In the past, St. Bernard parish has not been very landlord friendly, something that you should check into (I recall some areas like Chalmette where the city council tried or did pass zoning that prohibited rentals).

I would really do some digging on the rental rates.  I think your high based on what I see with my units in New Orleans.

If you finance the builds, you will need a minimum of 20% equity in the finished property, but it sounds like you are thinking about building with cash, so that may not matter.

Another thing to consider is the fact that new construction will go down in value initially, as the premium of new wears off.  So you will likely not see alot of appreciation in the value in the near term from the post construction valuation.

Nicolae Iovu · Answer

@Mike Wood Thank you for writing.

The lots I’m looking at are in Arabi/Chalmette and it’s around good schools, that’s why I’m looking in that area. New constructions comps go for $130-$140/sq max in that area.

I’ll do more research to make sure the market is still in that range.

Thank you for your time.

Nicolae

Nicolae Iovu · Answer

@Marty Friedemann I thought about that but I guess I’m too scared since I’m new in this. I know I can build houses on low cost and at no fee for me but How would I put a deal like that on the paper for example for an investor to go in with me?

Thank you so much for your time!

Nicolae

Marty Friedemann · Answer

Hi Nicolae,

Leverage would typically be a bank loan or perhaps some other form of debt or equity. The idea would be that if you use less of your own money, you can do more deals at the same time, and grow your business faster. However, more leverage means more risk. It is certainly something to look into.

Nicolae Iovu · Answer

@Marty Friedemann Thank you so much for writing and you have a great point about being conservative with the deal to make sense today. I will definitely stay with this approach to make sure I won’t get burned.

Also about leverage, you mean if I’ll work with a bank maybe ?

Thank you again 🙏🏻

Nicolae

New construction for rental, good or bad idea?

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