Thinking like a Builder: Part 1
If you understand how residential builders make their buying decisions, you will be likelier to achieve success in buying and flipping land. Some builders search for property strictly by geographic area. Others search for parcels that would enable them to reach particular buyer submarkets, such as housing type, price range, lifestyle and age group. Either way, builders begin by casting the net into their areas or markets of choice and sifting through potential acquisition candidates. They often have to pick through dozens of properties before they find one they think they can develop profitably and frequently spend varying amounts of time, effort and money collecting information before they even know if the parcel will work. Their due diligence focuses on obtaining answers to five fundamental but critical questions.
What can I build
How many can I build
What can I sell them for
How long will it take to sell them
What are the costs
These questions collectively define economic feasibility and influence every decision builders make, from their initial contact with the property, during contract negotiation with the seller, subdivision approval, the day of closing and beyond.
The value of development property is relative not only to the value of the end product, but also hard and soft costs, that is, site improvements costs and the expenses that will have to be incurred during the approval process. Residential builders and developers do their income and expense projections for properties on a per lot and not a per acre basis because profitability is a function of how the property can be used and not the number of acres in it. Accordingly, for all practical purposes, the parcel's overall size is a meaningless number in the builder's determination of property value.
I will keep my comments about the article for the time I finish reading your Part 2 but for now, I do have some questions and they are as follow:
1) How do you know what should you pay for a lot or per lot on which you can build $500,000 house?
Basically, if the city allows you to build 4 houses on an acre and you have a 10 acres lot in an aria where the houses are selling for $500,000 each, you can build 40 houses. Now, the cost of labor and the permits and other holding time cost, etc. would take a toll but you should still know how much should you have the lot costing you in proportion with other costs and profit/s in order to be safe. Is there some kind of formula developed, which tells you how much should you pay for the land, how much should be your labor, material, permits and the profit after all in percentage?
2) Would you say that I have a safe deal on the table if I am going to pay $200k for a 0.3 acres flat lot with ocean view on which I can build a SFR 4/3 and sell it for about a 1 mill and maybe even more?
To lot had once a house siting on with no traditional foundation (flat about 2" tick concrete poured on the ground flat like we do driveways) but the same house got knocked down as being unsafe after being damaged in earthquake a decade ago. Based on my survey of the swimming pool aria, which was not removed, the damage wasn't severe. Th cracks are barely 1/4in to an inch wide and long as much as the lent of the structure or less.
Alex
Alex, a 10AC property is not going to yield 40 quarter-acre lots. You have to deduct at least 25% to take into account land area lost to development (new streets, etc.) as well as physical features (slopes, irregular shape, etc.). This means out of 10AC, and deducting only 25%, you would have 326,700 SF of land area available for subdivision development.
In my experience, builders take the projected sale value of new home on its lot x 25% minus the cost of installing site improvements (streets, curbing, sidewalks--not sticks and bricks cost) to estimate land value.
If you apply the above to the deal you are considering, you should be able to tell if it makes economic sense.
Nancy,
My only cost will be to clean the ground and build the home. Under the most expensive estimate that calls for $120 per sft, I would still be more then OK/ The reason I asked the question is to cover the chance that I missed something.
My number 2 question pertains to a single lot on which ones was a house so the street, power and water are there. In fact, even a gate
Alex
Hmm, that sound like the land owner would have to pay me to take the land(?):
$1,000,000 (Finish product) x 0.25 = $250,000
$250,000 - $500,000 (sticks and bricks) = - $250,000
I know I got something wrong but if I am not, I am planing to send about 100 offers a day to do ask owners to pay me to get their land. Just kidding. Which part I didn't understand correct?
If the new home on its lot would sell realistically for $1mil, the builder's total cost for the land plus site improvements would have to be no more than $250K. When I said site improvement costs, I think I specifically said that that was for street, curbing, etc. and NOT for the cost of actually building the house--not for the "sticks and bricks" cost.
I think you said that the price for the lot was $200K. Using the rule of thumb, then, your site improvement costs shouldn't exceed $50K
OK, now is clear. I had a chance to review a lot couple of years ago on a very steep slope. The seller wanted low price but when you consider that I had to build the access road and bring the power, sewer and water, I p*****. In conclusion, the 25% formula can serve as a nice reference when it comes for evaluating lot value because you know right away if you would be starting on a right foot.
Last question, if the owner agrees to carry until the package (improvements + lot) are sold while subordinating the land to the bank who'll finance the construction, should you allow 25% to become 30% or more or as a rule of tomb this would be consider either risky or the final profit would not be there as much as it should?
Alex, I don't understand your question. Do you mean that if the seller takes back paper and subordinates to your construction lender that you should pay more for the lot? If that's your question, the short answer is it depends on the circumstances. I can't generalize.
Nancy
This is what I was thinking. Seller wants high price for the lot, which turns to be about 30%-35% of the price for the finished product. Because he wants to much for the lot, which buy the way in the city that is very slow to approve the plans + coastal commission, etc. I was thinking about structuring deal as follow.
Agree on the $350,000 purchase price. Give lets say $1,000 earnest money to open en escrow subject to plans being approved at what time I would add in lets say 5% -10% of the purchase price while he'll continue to wait until the improved property sells.
Technically speaking, he would like to hold first trust position. However, this will efect my ability to get the construction loan because the bank would want the 1st position also. Because of that, I was thinking that somehow he can subordinate the land to a bank. Is that more clear?
Alex, if the lot price is $350K and new home on lot would be worth $1mil, I don't know any builders who would be jumping to do the deal. You had said the lot was $200K. At $200K for the lot, the deal may make sense. At $350K, I don't think so.
Nancy
Nancy, the 200k deal was a separate deal. The 350K I p***** on 6 mo ago but still thinking how I can make it work because I know the seller. Thanks!
Alex, you can always wait 10 years until the market catches up with his greed! Good luck.
Nancy
Of course. I would have to buy it cheaper OR let it seat. After all, no wonder why is still not sold.
As far as the other lot, the realtor is relisting it for the third time so it has to be motivated. In situation like that, what do you consider to be more prudent: Going for the low(er) cash purchase price or for the good options? Tying up the cash or tying up the property with little less profit but also less risk.
It's the old price v. terms. Only you can decide how much you should discount the price to compensate you for taking on more risk. Only you will know just how risky it would be for you to buy the land non-contingent, given the circumstances, the property, etc.
From what has been said, I think you are applying some lovely rules which are applicable on one side of the country and you are now trying to apply them to the absolute unique, one of a kind, area of Southern California at a time when many strange and wonderous things are occuring.
Given my limited knowledge of that particular spot. Once having spent over a year in many appearances before the Costal Commission and even going so far as to make a scale model of the house and installing string lines on the model showing the sun exposure, roof exposure and the views from other hillsides I mean it was a lifes work, and the payoff was that the planners and committes of that area were bent on preventing any construction that did not include their sacred cows, designated contractors and architects. I mean Gothic man.
The proper approach to building in that area is by single client, single design only. You go on the high road. This is the area that wants to embeded diamonds in bannisters. Have sliding spot collectors in garages so that vintage cars can releave themselves and the collectors can be slid out and cleaned. This is the area in which my client wanted a squash court installed in the house. No he does not play squash. Its an entirely different trip. You must know the people the commissions and the items that motivate. No it is not money. Its all sorts of perks and invites. It is an in game approaching it from this viewpoint is the only proper way and still there is a risk. So hesitate, listen not to those who would apply other rules to a very specialized area, besides, some very interesting soil and fault patterns have been newly discovered in that area and there is the possibility that a dwelling just might change Zip Codes some dark and stormy night. I mean when a man keeps a rubber boat and a set of oars by his bedside and he is half a mile inland. I hesitate.
Cautious Lucius
Lucius, alas I fear that you missed something I said in the very beginning of the very lengthy threads between Alex and me: three little words -- "in my experience."
I have no doubt that "where a man keeps a rubber boat and a set of oars by his bedside and he is half a mile inland", life tends to be lived differently with different site constraints. (I would add, however, that CA is not the only place in this country where governmental bodies seek to impose unreasonable, bizarre or surrealistic requirements on developers.)
The sticks and bricks cost of a diamond studded custom house with 24 ct faucets will be costly wherever it is built. In CA, such a house will command more than $1mil with corresponding land values. All is relative.
The Alex-Nancy correspondence was limited to discussion of 2 lots--one for $200K and one for $350K--where Alex believed the end product would sell for $1mil. He didn't indicate that the $1mil house would be diamond studded.
Nancy, I love Lucius and consider him to be my friend but he easily gets mad, although he denies that. One thing thou, (in scientist opinion) it is true that with age we all begin to be like kids again and that's our Dear Mr_L thee warrior, the rebel, the challenger, the contractor, broker, writer, poem and I respectfully must cut my list short because if I continue, we might run out of HTML code. When I ask him for advise he wouldn't tell me more then 15 words unless they are spoken in front of a readership group of at list 111, but when I ask the same question.... ah, vanity.
So your comments are well appreciated and the rule of tomb and 25% make a lot of sense in any aria. The house I am going to build would be well blended spanish stile wit few amenities to stand up against the competition. One the Lucius have described now goes for 5, 7, 11 and even 15 mill US dollars and we are not interested in those at list not in this post. And on top of that, I Believe in What the Bank Believe and follow th same appraiser religion. So, if the bank or savings and loans for that effect believes that house built on thee lot in question will worth in fact OVER 1.3 mill conservatively, I believe in that religiously because the equity line of credit with 6 zeroes is what I love the most in this business. It just feel right!
I love exotic architecture but this one will not be exotic and I do appreciate the comment about the coastal commission but if TCI allows for the pictures to be posted, you would be surprised how many normally-nice and even some older B- crop houses are still siting there in the same hills. And yes the lot is DEAD FLAT and if we think about life boats half a mile inlend, we may too start thinking about putting up the syndicate that would start building a beach resort in Colorado, because you know, you never know. Before we declare ourselves hopelessly cautious, I will take a compromise and consider gladly a post modernistic ISO container masterpiece, that Mr. Foster will on his discretion design for his friend, incognito. God knows he'll do the tremendous job making me safe in hills above the water!
Anticipating Alex.
Alex, thanks for providing your clarification and perspective.
Nancy
Yes, yes, I am over whelmed. Carry on, stay conservative in your arch. and I am sure you will do well. Be prepared for some rather interesting times in Permits, but I have faith in Alex. He can talk the muzzle off a mad dog.Thats spelled Madd Doug. I think he is still on the board.
The Coastal Commission: It proves the proverb. "A government bureau is the nearest thing to eternal life we'll ever see on this Earth." Originaly conceived as a temporary agency.
Alex, see if you can long term lease a really crummy lot in that area 99 years would be nice. Delay lease payment til completion of construction. 60 days. We will of course pay all taxes. (I intend upon completion to petition to reduce the value of the lot.) I will build a container house of about 3,000 sq. ft. We will design it so it looks like a newly arrived space ship probably crewed by Borgs. I have a buyer who is a Treky with money. We will sell it to him. He complete with his improbable non conforming clothing will move in and oh my god. We will probably generate three lines of indignant persons with signs. lst line, those that love red tile roofs. 2nd line those that delight in adobe bricks. 3rd line, who else the local resident Termites. After all it is a full steel termite proof house. Dental work is still not available to elderly Termites.
You Alex and Nancy will of course identify yourselves as the Developers, I shall remain unidentified. Bullet proof vests will be issued with the deeds. But, and here is the real payoff.
You will display on site full drawings of your next project which will of course be, red tiled roof' psuedo spanish look a likes.
The publicity will be unbelievable. You will become famous, yes even write "How Too"
books. Be elected to the Coastal Commission and in years to follow on to Washington, perhaps Secretary of Housing.
Lucius
Hey Nancy, I told you. That's my friend Lucius. the No. 1 of the - [T. E. A. M.] -
Together Everyone Achieves More! Cooperation not the competition!
The Deal Shop!
Revision:
Hey Nancy, I told you. That's my friend Lucius. He learned most of his goodies form Marcus Orelius then the real cream of the crop thinking got aquired when he joined Borgs. The conteiner houses, they've been used universum wide for 7 light years ...Lucius is their ambasador in US and the houses are for the first setlers .. kind of like a pilgrims form space type of thing. Now that's universal democracy combined in - [T. E. A. M.] -
Together Everyone Achieves More! Cooperation not the competition!
The Deal Shop!
Revision:
Hey Nancy, I told you. That's my friend Lucius. He learned most of his goodies form Marcus Orelius then the real cream of the crop thinking got aquired when he joined Borgs. The conteiner houses, they've been used universum wide for 7 light years ...Lucius is their ambasador in US and the houses are for the first setlers .. kind of like a pilgrims form space type of thing. Now that's universal democracy combined in - [T. E. A. M.] -
Together Everyone Achieves More! Cooperation not the competition!
The Deal Shop!
Revision:
Hey Nancy, I told you. That's my friend Lucius. He learned most of his goodies form Marcus Orelius then the real cream of the crop thinking got aquired when he joined Borgs. The conteiner houses, they've been used universum wide for 7 light years ...Lucius is their ambasador in US and the houses are for the first setlers .. kind of like a pilgrims form space type of thing. Now that's universal democracy combined in - [T. E. A. M.] -
Together Everyone Achieves More! Cooperation not the competition!
The Deal Shop!