It’s in the numbers: New construction homes in MA (Part 2)
In my first post on flipping houses, I wrote about how investors would get into new construction projects after realizing that they are missing out on opportunities.
Why most don’t just plunge straight in to a new construction project after their first couple of flips is a combination of psychological hold back and lack of contacts.
Within my network, the average number of years before an investor gets into new construction projects is approximately 4.
The lack of contacts bit can be overcome if you’ve got a good network of experienced investors/friends that could share their contacts. The key is to get a solid builder who could do the job at $110 - $150 per sqf. More on that number later.
The psychological hold back is tougher barrier to overcome; one that is closely tied to financial security.
“I will never take on a large project if it doesn’t excite me. The final product at the end of the process has got to excite me.”
“If not, it’s just sleepless nights.”
- Sid Gehlot, investing since 2009
Here’s why.
In a light flip where you’re dealing with updating floors, windows, a kitchen remodel and paint, things are within your direct control. You could pay a GC to get that done easily. If your GC abandons you, you know you’ll survive. You’d go to Home Depot to pick out the materials and somehow pull it all together. Get your friends and family to paint.
In a more complicated flip where say, a new septic is required, you’d know the approximate timeline that you would get that system up and running. If you’re swapping out a failed 4-bedroom system for another 4-bedroom system, you’re just waiting for the weather to permit that. No frozen ground, no big deal!
In new construction projects, you’re often dealing with unknown factors. Unknown factors affect the duration of your project and prolong holding costs. Without strong and cheap financing - and guts to withstand uncertainties - missteps and delays could erode profit margins and even throw an investor into the negative.
New construction projects come in 4 forms; here I rank them from most to least risky. Of course, the reality of risk is circumstantial, but for the sake of compartmentalizing:
Developing raw land.
Removing an existing property in its entirety - foundation and all - and developing a new property on a different location within the same land.
Adding new properties on land with existing residents.
Tear downs.
I will be talking about points 1 and 4 on the basis of building in accordance to by-right permitted zoning bylaws.
Building by-right
So few words, so much weight.
The ability to build within by-right permitted bylaws is every investor’s hope because it eliminates time delays from seeking variances. Variances are like seeking special permission to go out of the box.
Why should towns give an investor special treatment knowing that it would fatten their profit margin? The justification has to be unshakable.
Every plot of land falls within a zoning district that is determined by the town. Each zone has its set of rules for the purpose of which the land can be used (i.e. residential, commercial, institutional etc), and to what dimensions and setbacks the buildings have to conform (e.g. 100ft frontage, 40ft front setback, 20ft side setback, 30ft yard setback, 45ft height restriction etc).
Here are screenshots of Boxborough’s zoning bylaw. You could click on either image to open the actual document.
Boxborough’s Use Regulations. Screenshot from Boxborough Zoning Bylaw, amended through September 2018.
Boxborough’s Dimensional Regulations. Screenshot from Boxborough Zoning Bylaw, amended through September 2018.
If your lot falls within the AR district, you could only build a single-family house by-right. As compared to being in the R1 district, the latter gets an additional option of building a multi-family house (with additional requirements stated by footnote 1).
Building within these permitted bylaws will get your building permit approved with high certainty. Note that I wrote “high certainty” instead of “guarantee”. There is no guarantee in real estate.
Developing raw land
Raw land is looking at a plot of land that looks like a wilderness camp site.
It’s the riskiest form of new construction development because aside from knowing how much square footage of land there is, you don’t know what the quality of the land is, and at times, you may not know entirely what is on it. I don’t mean trees.
Quality of land pertains to its ability to support a new property.
If, like me, you’re in a suburban area without sewer connections, you’d need a septic system for your sewage needs. For this, you’d need the soil to work in your favor - its composition must allow drainage. Aka, it would need to pass the perc test.
The geography of the land matters too. Where your property is on a slope in regards to where the septic system needs to be placed has gravitational considerations that further impact the design of the system.
Second form of basic life support is a well, for water. You’d need to dig for one. How do you know that you could just drill right into the soil into a depth that you need?
You don’t.
You may hit a ledge (bedrock) and go no further unless you employ explosives to break up the rock layer.
Finally, there’s consideration for what’s on the land. In the embedded YouTube video above I’d say that that piece of land is fairly predictable- you could at least see that you’d need to clear trees and even out the land. Things get tricker if you have a dense forest with rocky outcrops and uneven surfaces. Not only would you have to clear more trees, haul or blast rocks, you’d have less visibility as to what is the composition of the land.
Less visibility equals higher risk.
Risk is further increased when there are wetlands in the vicinity, because these are not stagnant and could shift to end up on your land.
Wetlands in MA are protected by law. “If you want to work in a wetland resource area or within 100 feet of a wetland (an area called the buffer zone), [you’d have to] contact [the Town’s] conservation commission before you start work.” - extracted from Guide Protecting Wetlands in Massachusetts.
I’m presently working with a developer on a development where the design has had to deviate from the original plans because wetlands had crept into the lot and occupied a part of it. Can’t touch that part of the lot now.
And the final consideration…
What if there’re protected species of plants or animals living there?
Take a look at this piece of land at 107 Tokatawan Spring Lane (in blue border) in Boxborough:
Its got the works: a potential vernal pool, rare species, rare wildlife and wetlands (lighter green with blue stripes).
It belongs to the town for good reason. I know the town is not going to sell it, but what if it belongs to a private party who wants to?
A developer once saw this listing and asked for my assessment.
I’m not sure if the lot conforms to the Town’s zoning dimensional regulations; I’m pretty sure I checked that out because I left my measurements of 82ft and 157ft on the plot. Regardless, to me, it was redundant to explain its conformity.
The 100ft wetland buffer itself would limit development. Plus the fact that whatever new building that is constructed would need to be set back 34ft from the front of the lot… development was basically a non-consideration for me.
Tear down new construction
Of all the new construction analyses that I do, this is the most common. While it is a fact that new construction happens in all towns, they occur must frequently in towns that have a median listing price of $1,000,000.
Just refer to Trulia’s price heat map for that list.
Knowing whether a new construction deal is possible boils down to knowing the new construction numbers in each town.
In Concord (not West Concord), I know that if a new construction is 4 bedrooms, 4.5 bathrooms and 4,500sqf, it’s going to be at or around $1,600,000. That’s my primitive number for determining if it’s even worth my time to dig a little deeper into a more precise market value.
In Lexington, that number has a wider range, depending on lot size and frontage (which affects curb appeal). But I’ll be looking at a 5 bedrooms, 5 bathrooms, 5,000sqf property at around $2,000,000.
Cost for a new construction home
After enduring this long post, the good news is that new construction numbers are the easiest to run.
Remember in the earlier part of this post I said the key is to get a solid builder who could build at $110 - $150 per sqf? In these towns, you’d be looking at the upper end of that range, at $150/sqf. Multiply the desired footage by this figure to get the construction cost of having a new property.
That’s it.
You don’t have to go into the details; just regard that as cost from putting in a new foundation to ending up with a final product.
The cost of construction for building a 5,000sqf home in Lexington is 5,000 X $150 = 750,000. This is hard cost.
What should be the purchase price?
Estimated sale price = $2,000,000
Construction cost = $750,000
Demolition cost (assuming there is an existing building on the land) = $10,000
Realtor Commission at 5% = $100,000
Holding costs on a 9 month purchase to sale project is summation of below = $78,045
Financing at 7% from a bank on whatever the investor is borrowing. Say that’s for construction costs only: 7% X $750,000 divided by 9/12 = $39,375
Utilities: $400 (as an example) X 8 (I’ll deduct a month for the time when the house is just in frames and without utilities) = $3,200
Insurance: $400 (as an example) X 9 = $3,600
Property taxes: $25,000 X 9/12 = $18,750
Tax stamps (MA taxes sellers at the sale of property, at the price of $4.56 per $1,000): $2,000,000 divided by $1,000 X $4.56 = $9,120
Closing costs = $4,000
Expected profit of 10% (investors aim for 12%, but it realistically goes down when the property value is higher) = $200,000
Purchase price = 1 - 2 - 3 - 4 - 5 - 6
Purchase price? $861,955?
Deduct another $100,000 for contingency. You need it for time delays when you’re carrying such a large loan.
Are there homes going at around $750,000 in Lexington? Sure there are. You’ll just have to pounce on them when they appear. And prepare to overbid.
12 Bates Road came on the market on 1/24/19. It went Under Agreement 14 days later and sold on 3/5/19 for $750,000. This property is in a cul-de-sac, which is the fundamental blueprint for a luxury neighborhood. Definitely a great DEAL!
Is the risk of new construction worth it?
I’ve come to realize that to investors, new construction projects are but another form of real estate investing. Just another deal that requires due diligence and comes with a weighted assessment of risk versus reward.
At the end of the day, risk should always be an educated assessment. Financial projections should based on facts and not what you or your agent think the market is going to be - that’s gambling.
“Do your due diligence objectively. Then stick to your number.”
“You’ll make it out with some money.”
If you are a buyer looking for a new house in an excellent neighborhood, you should most definitely consider building it!
What?! You’re saying that investors take at least 4 years before they get into new construction projects and you’re asking ME to take the leap immediately?!
Yes.
If you were the one who purchased the $750,000 home at 12 Bates Road in Lexington, that’d be you gaining an instant home equity of at least $300,000. That’s the sum of $200,000 in profit, plus $100,000 in agent’s commission since you won’t be selling. At least that amount, because your financing costs will be much lower with construction loans and refinancing.
Wouldn’t you like to buy a new house at a $300,000 discount?
Think about it.
And talk to me if you’d like me to find that deal for you!
Stay tuned for Part 3
Phew. What a long post! I know, it’s a complicated process even though I said the numbers are the easiest to calculate.
It took me many hours of poring through bylaws to qualify new construction deals on single-family homes and this post does not even put a dent on the entire world of new construction. How do you factor in costs for developing raw land for a 20 unit subdivision? Or a 100 unit mid-rise apartment building?
Uh… I’m not there yet. I could probably share something on point 3 above (adding new properties on land with existing residents) in a year though!
Part 3 on the buy-and-hold strategy will be easier to digest, I promise.