Is this a Legitimate Land Deal - From a Yellow Letter?

Question

I sent a YL to a house built around the turn of the last century that was the orginal farmhouse that is now surrounded by duplexes, one of which has been townhoused.  The lot size is 32,000 feet and and extends from one street to another, with frontage on both streets.

I know nothing about "bringing property out of the ground" although I did townhouse a duplex some years ago, creating an increase in value of about 50%.

The cost of the lot with buidlings (to be removed) is 250k and the duplexes next door are 300K each, and the one that is townhoused has its asessed values increased to 400K, combined. Thus it would seem that there could be two lots of 16k sq. ft. with four townhomes of 200k, or 800K in total. The local market is strong and rents are even stronger.

I would be looking for an assignment fee to the eventual developers, and this could a great find from a yellow letter. I don't want to bring in potential builders until I "know what I have" or suspect I'll be taken advantage of as am not knowledge about this now. I dont know about construction costs, permitting, etc. It is zoned R-3, or thee units per lot so could conceiveably have three townhomes on each lot, or six in total at a total value of 1.2 million.

The owner is a burned-out landlord who is just finishing an asbestos abatement on the farmhouse and plans to turn it back into a rental, but is clearly tired of it and the property.  It was the original farmhouse for what once a 6000 acre farm: he said the title work on it is 34 pages long.

What might be my next step(s) in determining if this is a workable deal? It its current use its not a deal.

Will Barnard · Answer

Burt, first off, you need to find out exactly what the land can be used for and its highest and best use - you would have to pay for a HB use report. You then want a phase ! environmental report (also costs money). You then need to now what price per sq. ft. it will take to build what you intend to build. Finally, you need to know the exit value of the final product. From there, you can back out all your figures and calculate what you should pay for the dirt.

Lets start with some assumptions here. Lets say you can build two townhomes on each side for a total of 4 and each townhome would sell retail for $200,000. That means you will have $800k gross at the end. Lets also assume you can build these townhomes for $85 per sq. ft. and you make each of them 1200 square feet. Each townhome would cost you $102,000 leaving you $98k for gross spread to pay for holding costs, resale costs, debt service, dirt, and profit.
Expecting 8% to sell & 2% for holding costs, you have $78k left for dirt, debt service and profit.
Now lets assume you borrow 100% of the constructions costs ($102K which includes entitlements and permits) you borrow at 10%, and for 6 month term, your debt service would cost you $21k (rounded up).
Now you have $57k left over, per townhouse, to pay for dirt and profit. With $0 profit, you have $57k X 4 = $228k to pay for the dirt.

I am personally not going to build 4 townhomes spending 6 months and risking $say $500k+ without a profit of $100k+, so based on this example, the dirt would have to be purchased for under $125k.

Burt L. · Answer

Oh boy - not a road I really wanted to travel... At the risk of  Jon Holdman holding me down for a new pummeling on the 50% rule, does this really apply to new construction - when operating costs are lower?

Local investors are desperate for deals as this market has appreciated so much, and rents are strong and continually on the rise due to a virtually non-existant vacancy rate. Vacancies are often brought up in a humorous light at REI meetings now- they are just cause for another rent increase.

I can feel the bruising developing already.....I want to belive there is an additional route as a 500k value wouldnt cover the project costs. This may be the end of the path on this YL deal.

Burt L. · Answer

What a website! Where else can you go from direct marketing to doing calculations on land development- in a few moments? Its good to learn that the $100 per foot figure I was quoted isn't a hard number, and probably was just a quick response from the person quoting it - knowing that they can't go wrong at this rate.

I have to say that obtaining a H/B report to see if a deal is a deal, is daunting. If one had to do this for each SFR, it would be very hard for all the seminar promoters to gather people.

How would it be to look for ROI based on rental income instead of taking the profit right at the buildout and sale? Rents on either 4 or six units of three bedrooms should go at $1,400 each, or $5,600 or $8,400 monthly. Is there a cap rate formula to get to an acceptable return for such a proposed project? The cash on cash could be quite good in the current interest rate environment.

It doesn't seem that a large apartment building would be workable, as though the property does have duplexes at three of its four corners, at the fourth corner is a SFR. The apartments buildings down the street are all bordered by duplexes, before transitioning to SFR's.

As mentioned, the block is zoned 3-R, though no one else has gone to 3 units on a lot. Two duplexes to the east, and across that street - is the first apartment building of maybe twenty units.

Entering int a contract like this would be much different that the usual rehab project, and I don't know how to term it. I'm reluctant to have others come by the property address to help me assess the potential project, as I know what can happen if a property isn't already "under control". As I've seen at BP, having a trusted appraiser contact is very helpful.

I'm "out of my own league" on this, but am more than ready to try a different league anyway.

Will Barnard · Answer

Burt, the debt service figure was based on all units together, so in the example, no added room.
Key factor for you right now is the readability studies. Knowing the highest and best use will lead you down the right path. Perhaps it comes out that an 18 unt apartment building is the best use and therefore, you need to know if that is possible zoning wise.

$100 per sq. ft quoted without any upgrades sounds high. I can get that here in one of the most expensive  states to build. Secondly, when you build multi family and more than one at a time, you can get costs down due to economies of scale and quantity discounts.

Burt L. · Answer

I much appreciate the reply, Will Barnard. It seems somewhat similar to single family calculations where one starts with the ARV and works backwards to the max allowable offer.

I spoke with a general contractor, who said the cost per ft. starts at $100 per foot (no grantite, stainless, etc.). He didn't seem quite as informed about zoning, but said that if zoned R-3, that 3 units should be allowed per lot. Nothing else is larger than a duplex on the block, except for apartment buildings at the end of the street.

So it looks like there would have to be three units each and/or a higher value than the 200k per unit. Only one of the many duplexes is townhoused and they are each 1780 sq. ft. There aren't any other townhoused comps; the somewhat inaccurate Zillow shows them at 225K each, or $125 ft. The assessed values of $200K are stale as they are assessed each two years and there has been a substantial gain in value. since. That duplex was construcgted about about 17 years ago, though I dont know when the party wall agreement, etc. was done.

I am likely confused on an aspect of the "dirt" calculation provided, as it seems that the debt service of 21K for the project was applied to a single unit, so there may be a little more room for the dirt/profit calculation. I may be entirely missing something, as well, which is more likely.

It was suggested I get it under contract, with a longer than usual time to closing, in order to look further at the feasibility of it. I would need a stronger than usual contingency though. It seems I still have to find some more "exit value" and having two three-plexes likely doesn't provide the same 200K per unit as duplexes would. On a spread of $25 per foot ($125 exit value less $100 costruction cost per foot., it wouldn't seem to work. It would take 10,000 finished square feet to meet the sellers price of $250K, with no profit. It would seem the spread would have to be larger, or there wouldn't be any construction locally.

Recent single family sales show a value of $150 to $170 a foot for smaller houses, dropping to about $110 a foot as they get over 2000 sq. feet. Maybe smaller units would be better?

I'm certainly open to further suggestions on this analysis,  or whether I should just put "the head down, turn the jazz up, and get back to stuffing envelopes".  A land deal would definitely be a cool change of pace. When I townhoused a duplex before, I created the comps the other landlords told me they were quite pleased with. At least it has already been done here and the builder wouldn't be such a pioneer on this potential project, other than three units per lot.

I don't know if all this was only a very interesting exercise in feasibility. Is there anything else I might consider? The general contractor said this county is one of the easier ones to work with.

Jerry Puckett · Answer

Hold on Burt, let me call in the cavalry....there's a few guys around this site that know plenty about development:

Hey Bryan Hancock, Jon Klaus, any words of wisdom here?

Is this a Legitimate Land Deal - From a Yellow Letter?

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