Is this a good deal?

Question

I am currently working on the entitlement of two side by side parcels in the Malibu/ Topanga area in Los angeles county. The process should be completed and properties should be ready to build within a year.

I'll have either the option to sell the developped lots to a builder/developper or go ahead with the construction.

here are both scenarios:

Options 1

selling the developped lots (2 -2.5 years)

Initial investment 500k + developement cost 300k = 800k total costs (in cash; no lending on undevelopped land)

Resale value 1400k-1500k

profit 600-700k

Annualized return (cash on cash) 36%

Options 2

building and selling the homes (3.5 - 4 years total)

Hard costs + lending costs = 2500k

+ land 800k = 3300k total cost

resale value 5000k

profit 1700k

Annualized return (cash on cash) 50%

These are very rough numbers and do not include taxes commissions etc, but as you can tell building seems the most attractive option;

However, building caries significant risks; many things could go wrong. The construction could take much longer to complete, costs could increase, the market could experience a downturn by the time construction complete, wild fire are also a threat in this area..

High end Malibu homes also take a while to sell and i could be stuck with a huge liability for months; this local markey is not really liquid

Retrospectively am not really satisfied by either scenario; even though i'm glad i did it as i learnt a lot.

I think a multifamily development in a gentrifying area would have yiedled much better.

Multifamily properties appreciated above 10% in some part of los angeles this year, whereas the mountain areas where the lots are haven't really gone up

Given that 800k in equity could buy me a 3200k rental, i calculated that i could have yielded above 40% in cummulated gains and rental incomes each year, cash on cash, without doing anything but buying a low risk 8% real cap rate property

Multifamily construction would have yielded way more

What is your opinion on this investment?

Nick G. · Answer

Account Closed

First, I would also not be making any decision off of rough numbers, I think you should be dialing in the possible costs of each scenario as accurately as possible.

Unless you have experience in building, I'd go for the first option. Far less risk for a good reward in potentially half the time. Plus, you could always continue on with option 2 if circumstances change.

Just my opinion, good luck either way!

Account Closed · Answer

Thank you all for the feedbacks

Planning is indeed risky business, but if you do your due diligence right before buying and have a bullet proof architect your risks are not that great.

In my opinion developping land in this area is an architect business; someone who has tons of experience dealing with the local bureaucracy and can save on costs doing most the job himself.

The increased risk of construction essentialy lies in the amount of money at play; 2.5 millions is serious money for most of us.

I have experience in construction and my experience tells me to be careful.

Contractors can bail on you or screw up their job, you can have unexpected expenses, material prices can go up, and all this while you pay a high interest construction loan

Basically you can waste a lot of time, quickly lose a good chunk of your profit or even los emoney if you are not careful.

Planning is that regard is much more predictable; Consultants are paid standard fees, permits are the same, application processing time is pretty much the same, etc

I think entitlement and construction of urban project such as appartment building is faster and carries less risk in case of RE downturn. Moreover there is a real lack of supply of appartment in Los angeles

You can always rent appartments in the city; you cannot necessarily sell or rent houses in the malibu mountain if the market is down

Oren K. · Answer

Cedric,

You appear to be on the right track in the sense that there is a value stack in taking land through the planning process, servicing process, construction process and onto stabilization. At each stage, there are costs and you are adding value but are taking the 'risk' of significant time (months or years).

My brother and I have done a couple of similar small plays and in our analysis, the largest share of the value stack is the getting through the planning process as it has the most 'risk'. There are several unknowns that you can not control (politics, neighbors objections, etc). Servicing and construction are well understood in terms of cost and time so while you make  profit on them, the margin is generally not as large as the margin on getting through the planning process.

So far, for us, the risk / reward ratio has favored selling after the planning process vs. going on.

Depending on how well you already know the various stages, you could keep going or as we are considering, after the planning stage, bring in a partner. You sell the property into the partnership at the higher value and share in the ongoing costs and profit. You get to learn from a more knowledgeable person and still share in the upside.

Good luck,

Oren

Is this a good deal?

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