Is it Better to Build New or Renovate Existing Homes as an Investor?

by | BiggerPockets.com

Is it better to build new investment properties or to buy and renovate existing homes?

This year, we’ve seen a number of real estate investors posing the question of whether it is now better to simply build their own rental homes versus buying and rehabbing those already out there. What factors should investors really be paying attention to in this equation? Which is the best move for you?

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The Buy or Build Dilemma

Many are asking if it is now just more profitable to build because properties in their areas are so expensive. They may have a point.

While it may be perfectly acceptable and normal to buy negative cash flow properties in other countries, there is no need for it in the United States — at least, not yet. However, many investors are finding that the numbers on available rental homes just don’t work. In some cases, this is because the investor hasn’t changed their demands as the market has changed. For others, it is because prices and demand have risen so much that properties can’t cash flow when using financing. Just wait until interest rates go up!

Related: An Investor Analyzes: What’s Better, Local or Out-of-State Real Estate Investing?

It is true that in some markets, some real estate agents and home sellers are pricing their properties to a point where it does appear cheaper to build. You can literally construct a brand new home for less than one that may be 10 or 20 years old. In the very long run, that may result in better cash flow. However, that isn’t the end of the math. So what else do investors need to consider?

turnkey-stigmas

The Problem With New Construction as an Investment

There are three challenges to the new construction strategy.

1. Build Time

In many markets, it can easily take 12 months to build a home. That’s if everything goes right and if the construction is well-timed around seasonal weather. When it comes to new condo buildings or more complicated structures, that construction time can be two years or more. There is no cash flow coming in during this period. None. That means no positive returns. That means all of the holding costs need to be covered by the investor, too.

2. Risk

Building can be highly risky. There are many additional risks and potential issues that can arise when building from the ground up compared to renovating an existing property. That liability can be extended out a year or two after completion if you end up selling that property to someone else. Let’s not forget that you’re speculating on what the rent could be. Anything can happen in a market during the time you’re building.

3. Lack of Leverage

New construction typically requires larger down payments. That means coming up with a lot of upfront cash. Cash for the land. Cash for the building materials and labor. Cash for the plans, permits, and holding costs. Now compare that with spreading your capital amongst three or four existing rentals with cash flow. There will be a substantial difference in wealth building potential and yields.

house-flipping

Rehabbing Existing Rental Properties

I love new properties. There are a lot of beautiful ones. I like historic homes, too — but I understand why some buyers like shiny new homes and condos. However, in the time it takes an investor to build a new home or duplex, another investor could have acquired a portfolio of 10 properties — properties that are already cash flowing and are delivering returns every month. The leveraged path means earning appreciation and building up equity in multiple properties at once, all while providing the safety of diversification. Think about it. If you plan to hold for 10 years but spend two building and finding a tenant, you’ve already lost 20 percent of your returns and cash flow compared to an existing property.

Related: 3 Reasons to Always Buy Distressed Property (& How to Find One)

At some point, building new housing may be necessary, but there are still so many vacant homes. Last summer, the data showed that the ratio of empty homes to homeless people was 6 to 1. Some vast mansions that lie empty could house multiple families. But we’re still building new. That’s something to think about.

The bottom line is that new homes are nice. In some cases, they are needed. Property prices are high in some places. But investors don’t have to build when they can find deals that make sense in other areas. The less speculation you engage in, the better. For me, that means buying based on actual current rents and cash flow, not a roll of the dice — though perhaps I am just fortunate to be focused on the Midwest, where there are more great deals on existing homes.

What will you do? Have you had to face this challenge?

Let me know your thoughts with a comment!

About Author

Sterling White

With just under a decade of experience in the real estate industry, Sterling currently manages over $10MM in capital, which is deployed across a $26MM real estate portfolio made up of multifamily apartments and single-family homes. Through the company he co-founded, Holdfolio, he owns just under 400 units. Sterling was featured on the BiggerPockets Podcast and has been contributing content to BiggerPockets since 2014, with over 200 posts on topics ranging from single-family investing and apartment investing to wholesaling and scaling a business.

11 Comments

  1. Julie Marquez

    Good article. But something you didn’t mention is the quality of the home. I like new build because I like updated systems, and I like mold-free, bug-free, damage-free, rot-free, stress-free. Sometimes you never know what you are going to get with an old home, and even if you fix an issue, is the root of the problem still there? And somethings on an old house you can never change. But I guess you could change 4″ walls to 6″ walls, right? With a new home you know exactly what you are getting and exactly what maintenance issues happen during the life of the property.

  2. Chris Field

    12 months to build a home? For a custom build sure but something for a rental? I can build a raised ranch or simple colonial in 90 days. Back in the 80’s my uncle did a few in under 60 days.

    2 years to rent ready would be for something big like those needle skyscrapers in NY.

  3. Tim Dye

    This is an interesting question and you bring up some food for thought. There are certainly advantages and disadvantages of each. But one variable to consider is that with existing (older) homes, one advantage is that motivated sellers often provide a discount not available with new homes / new builds. This is often enough of a discount that it offsets the issues that an older home has. I was in new construction for 10 years, and it definitely brings its own set of issues and obstacles as well!

  4. Sandra bean

    Your article was very informative for a newbie like me. Presently I am in the process of relocating from the Bay Area in California to Cincinnati Ohio. Planning to purchase anywhere from 2-4 properties in a 12 month period. The goal is to create positive cash flow in good neighborhoods. University /med school areas appeal to me. I like historical neighborhoods also. All I need are key people who invest in those areas to make connection. I have done my research on the history and the demographics of Cincinnati. If anyone out there can shed more light I am all ears.

    ncinnati

  5. Alejandro Perez

    Hi Sterling. Sterling I have to decide soon If I go ahead and construct an 11 unit multifamily building in Miami or sell it (lot and approved plans and permits by the city). By selling it I will recover the money I invested and maybe $50,000 profit only (after spending 2-3 years with the money invested {not invested in other things}. The area is very hot and rising in rents here in Miami. I really want to build it, and have a general contractor that has done some buildings there with success. The only doubt is if to start this endeavour or selling it to get $500,000 back and start investing it for down payments on loans for aquiring alreeady constructed multifamilys. With the new construction (which only takes 10 months to complete), the area is always 100% occupied for similar buildings (most of them old, just a few renovated recently), and rents can be increased. It will have a healthy NOI to hold some years, and then selling it. How is the analysis of a future investor after 5 years if the buiding is only 5 years old. Will investors be very interested in buying if the sales price I ask for gives 7% cap (based on NOI)? THat means selling at 7% cap, which will only increase with increase of rents (which will be obtained every year as are is in high demand, low supply, near to donwtown), it will not increase by doing renovations obviously because the building iwill be only 5 years old. Any input you can give me I will deeply appreciate.

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