Why Building/Developing is Better Than Flipping These Days

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Why Building/Developing is Better Than Flipping These Days

Juan Diaz
Flipper/Rehabber · Emeryville, CA · Member since 2015 · 158 posts · 124 votes

Just thought I’d share some of my experiences with you all in the San Francisco market. The big, HUGE take-away that I’m getting from my experience over the last year and a half is that there is absolutely no money in flipping around here. Zip, zero, zilch. The market is so competitive that practically all the inventory is going at prices where we’d likely lose money. Now, before you say to yourself: “This doesn’t matter to me, I don’t operate near San Francisco!”, I have strong reasons to think that if you’re ever facing a similar market, that it will be very, very useful.

This was not something that I discovered solely because I was doing a deep dig on market inefficiencies, it’s something that happened because of the crazy situation we’re in here in the Bay Area. I’ve been a full-time flipper since about 2009-2010, so I missed the bubble when it happened. That meant that when the prices were rising like crazy in west Oakland, I was doing everything that I could to try and find ways to make money.

I was looking at tiny houses in west Oakland on a decent-sized lot, and wondering if there was room to expand. I crunched the numbers, and at the time 350-360 per square foot was about the top of the market. I did some quick math for new construction, and realized that I could build a brand new addition for about $200/square foot. Boom! Easy money.

Since that revelation what I’ve done is looked for small houses, on lots with room to build. If I can add on at $200/square foot in areas where the price per square foot is much more than that, it’s money in the bank. This has been incredibly helpful in helping me buy properties—the numbers don’t pencil for anyone else, but they do for me because I’m adding on.

With this success adding on, I’ve started developing, and have had some pretty fantastic results. The cost per square foot is a bit higher now with brand new development, usually around $250/square foot, but if you’re building 2000 square feet from scratch at a sale price of $400,000, you’ve got a potentially great deal.

The other part of this equation that I’ve left out so far is this: land prices haven’t caught up with the crazy housing prices. Commercial lots, yes. Large lots for housing developments, yes. But these smaller lots that can only host one to four houses/townhouses/units are much less in demand. I bought a lot in North Oakland for under $150K, and I’ll sell for $900K, with rehab costs of around $350K. That’s an insane return! It’ll take six or seven months, sure, but that’s a pretty great investment. It’s pretty crazy to me that these lot prices haven’t caught up with everything else yet.

I know that there are some downsides to the approach, including the time it takes to develop and the steep learning curve for those who don’t have a lot of experience with construction. But if you’ve got the gumption to take it, it’s a great opportunity in a super-hot market.

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Jan H.
Investor · Saint Johns, FL · Member since 2015 · 141 posts · 100 votes
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@Juan Diaz, great insight, thank you for your ideas.

One thing is not clear though: You are saying that  if you're building 2000 sqf at $250/sqf, you have a great deal at the sale price of $400k? Would it not cost $500k just to build it? Am I missing something?

Question for you developers: does the $250/sqf figure include all plans, permitting, infrastructure-related cost (water, sewer, utilities etc.), building? Or is this figure just a construction cost?

I know a few smaller developers who buy old homes on the peninsula, demo them and build a new custom home. They make a killing on them, but could never figure out how to raise $1.5M-$2M to play in that game. Emphasis on 'couldn't ' as now I am figuring it out...;)

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  • Karen MargraveBusiness Member
    Moderator
    Realtor, General Contractor, and Developer · Redding, CA · Member since 2009 · 7k+ posts · 4k+ votes
    11y

    @Juan Diaz

     We are spec builders and have been developing real estate for over 30 years. In certain markets new construction makes sense, the trick is knowing if you're in one of those markets. It sounds as though you are. 

    However; not everyone has the skills, or capabilities of developing a project from the ground up. There's a lot more that goes into getting a project designed and approved than many realize. In addition, actually managing a construction job requires its own skill sets. 

    For those with all the pieces to the puzzle, new construction can be a great route. We enjoy it. 

    4Reply
  • Jan H.
    Investor · Saint Johns, FL · Member since 2015 · 141 posts · 100 votes
    11y

    @Juan Diaz, great insight, thank you for your ideas.

    One thing is not clear though: You are saying that  if you're building 2000 sqf at $250/sqf, you have a great deal at the sale price of $400k? Would it not cost $500k just to build it? Am I missing something?

    Question for you developers: does the $250/sqf figure include all plans, permitting, infrastructure-related cost (water, sewer, utilities etc.), building? Or is this figure just a construction cost?

    I know a few smaller developers who buy old homes on the peninsula, demo them and build a new custom home. They make a killing on them, but could never figure out how to raise $1.5M-$2M to play in that game. Emphasis on 'couldn't ' as now I am figuring it out...;)

    5Reply
  • Eli F.
    Real Estate Lender · Orlando, FL · Member since 2015 · 155 posts · 12 votes
    11y

    @Juan Diaz shhh you are supposed to keep this a secret -to be honest with you I was looking at building permits today to do the same thing.

    1Reply
  • Kevin Wood
    Investor · Houston, TX · Member since 2013 · 471 posts · 267 votes
    11y
    Originally posted by @Juan Diaz:

    Just thought I’d share some of my experiences with you all in the San Francisco market. The big, HUGE take-away that I’m getting from my experience over the last year and a half is that there is absolutely no money in flipping around here. Zip, zero, zilch. The market is so competitive that practically all the inventory is going at prices where we’d likely lose money. Now, before you say to yourself: “This doesn’t matter to me, I don’t operate near San Francisco!”, I have strong reasons to think that if you’re ever facing a similar market, that it will be very, very useful.

    This was not something that I discovered solely because I was doing a deep dig on market inefficiencies, it’s something that happened because of the crazy situation we’re in here in the Bay Area. I’ve been a full-time flipper since about 2009-2010, so I missed the bubble when it happened. That meant that when the prices were rising like crazy in west Oakland, I was doing everything that I could to try and find ways to make money.

    I was looking at tiny houses in west Oakland on a decent-sized lot, and wondering if there was room to expand. I crunched the numbers, and at the time 350-360 per square foot was about the top of the market. I did some quick math for new construction, and realized that I could build a brand new addition for about $200/square foot. Boom! Easy money.

    Since that revelation what I’ve done is looked for small houses, on lots with room to build. If I can add on at $200/square foot in areas where the price per square foot is much more than that, it’s money in the bank. This has been incredibly helpful in helping me buy properties—the numbers don’t pencil for anyone else, but they do for me because I’m adding on.

    With this success adding on, I’ve started developing, and have had some pretty fantastic results. The cost per square foot is a bit higher now with brand new development, usually around $250/square foot, but if you’re building 2000 square feet from scratch at a sale price of $400,000, you’ve got a potentially great deal.

    The other part of this equation that I’ve left out so far is this: land prices haven’t caught up with the crazy housing prices. Commercial lots, yes. Large lots for housing developments, yes. But these smaller lots that can only host one to four houses/townhouses/units are much less in demand. I bought a lot in North Oakland for under $150K, and I’ll sell for $900K, with rehab costs of around $350K. That’s an insane return! It’ll take six or seven months, sure, but that’s a pretty great investment. It’s pretty crazy to me that these lot prices haven’t caught up with everything else yet.

    I know that there are some downsides to the approach, including the time it takes to develop and the steep learning curve for those who don’t have a lot of experience with construction. But if you’ve got the gumption to take it, it’s a great opportunity in a super-hot market.

     Great post and glad to see someone making money in this crazy market. I went back and invested at home in Houston. Couldn't afford the deals here despite working in tech. It's a great lesson that I'll keep in mind if I ever have the capital or my market moves that way. I think Austin in the next 5 years may see a similar uptick.

    0Reply
  • Skylar Dejesus
    Johnson City, TN · Member since 2014 · 140 posts · 133 votes
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    Very informative post I enjoyed!

    0Reply
  • Jon Klaus
    Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
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     Juan, do you have a building permit yet for your N Oakland lot?   I think you may find that in high regulatory markets it can take a lot longer than 6 to 7 months to get to exit.  

     Also, in markets where infill development has allowed large profit margins, competition will be coming in very strong.     Markets tend to be inefficient for only short periods.  But that doesn't mean you shouldn't jump all over them when you find them.   

    1Reply
  • Juan Diaz
    OP
    Flipper/Rehabber · Emeryville, CA · Member since 2015 · 158 posts · 124 votes
    11y
    Originally posted by @Jan H.:

    @Juan Diaz, great insight, thank you for your ideas.

    One thing is not clear though: You are saying that  if you're building 2000 sqf at $250/sqf, you have a great deal at the sale price of $400k? Would it not cost $500k just to build it? Am I missing something?

    Question for you developers: does the $250/sqf figure include all plans, permitting, infrastructure-related cost (water, sewer, utilities etc.), building? Or is this figure just a construction cost?

    I know a few smaller developers who buy old homes on the peninsula, demo them and build a new custom home. They make a killing on them, but could never figure out how to raise $1.5M-$2M to play in that game. Emphasis on 'couldn't ' as now I am figuring it out...;)

     Sorry, $400/sq ft for sales price. That's fairly standard for fully-fixed-up houses in west Oakland.

    That $250/sq ft includes everything. The number shades a bit higher if you're building on a slope, building in a place with excessive permitting, etc.

    0Reply
  • Juan Diaz
    OP
    Flipper/Rehabber · Emeryville, CA · Member since 2015 · 158 posts · 124 votes
    11y
    Originally posted by @Jon Klaus:

     Juan, do you have a building permit yet for your N Oakland lot?   I think you may find that in high regulatory markets it can take a lot longer than 6 to 7 months to get to exit.  

     Also, in markets where infill development has allowed large profit margins, competition will be coming in very strong.     Markets tend to be inefficient for only short periods.  But that doesn't mean you shouldn't jump all over them when you find them.   

    One of the reasons this deal is so good is because it's in Oakland...they have a pretty good building department, probably the most efficient one in the Bay Area. To clarify, the flip itself probably won't sell in that 6-7 month timeframe, but from purchase to open house it should be within that time, and then perhaps another 30-60 days to close. That said, if we went full steam ahead, we could probably build an SFR from scratch in about three months. One month for permits, three months for construction (but likely four to five), and then sold within another two months.

    Comparing the building department in Oakland to Berkeley: We acquired a lot in Berkeley, and that one is going to take a nightmare-ishly long time to get through the building department, but the profit is fat enough to be worth it.

    1Reply
  • Joseph M.
    Flipper/Rehabber · Los Angeles, CA · Member since 2009 · 1k+ posts · 732 votes
    11y
    Juan Diaz , interesting post . With prices per square foot so high in the SF Bay Area and other areas development does seem like a good strategy . In Los Angeles I have been hearing a lot about "small lot subdivisions " . Developers will buy a lot and then build many houses on that one piece of land . I don't see these being a great deal for the buyer since they seem to go for about 750k ( for a 3bedroom house ) This is a relatively new ordinance and now you are hearing about a lot of rent control tenants getting evicted from units in order to make way for these new developments . Some are upset about these developments, but there is a real lack of housing which is the main reason the city allowed for these developments in the first place . I could see why not as many people would be interested in development because it is more complicated versus the typical rehab project , but it seems like the rewards can be significantly greater. Just curious , are you mostly building single family homes or condos/townhomes ? What is the lending situation like these days for construction versus rehab/fix and flip projects ?
    0Reply
  • Anthony Caleca
    New York City, NY · Member since 2015 · 52 posts · 6 votes
    11y

    love your post, I'm also in the development field as well, more towards new development but love seeing others have success in the field. Congrats man keep crushing it!

    0Reply
  • Manolo D.
    Contractor · Los Angeles, CA · Member since 2015 · 4k+ posts · 1k+ votes
    11y

    I still need a JV or money partner to jump in these kinds of deals, the learning curve could put you out of business, it is easy to lose 30k on a build, and if you don't finish, a lot more. there are more pitfalls than light at the end of the tunnel. For someone considering, think of the worst case scenario not only the rewards, this is not for the weak heart, it needs deep skills, before jumping in, try to do a couple of gut-out rehabs first so you will get a feel the 30% of what you are getting into. Not your typical GC with 2 guys with them who purchases materials from home depot can do this.

    Greater risks for greater rewards. I could build, I couldn't find someone to back up the finance, running the numbers, and selling of it, I have a different problem. LOL.

    0Reply
  • Juan Diaz
    OP
    Flipper/Rehabber · Emeryville, CA · Member since 2015 · 158 posts · 124 votes
    11y
    Originally posted by @Joseph M.:
    I could see why not as many people would be interested in development because it is more complicated versus the typical rehab project , but it seems like the rewards can be significantly greater.

    Just curious , are you mostly building single family homes or condos/townhomes ?

    What is the lending situation like these days for construction versus rehab/fix and flip projects ?

     Right now I've got five development projects going on. One lot with two SFRs to be built on, one lot with a 2000+ sq ft house, one sloped lot w/ 3500 sq ft house, one lot with four townhouses, and one lot with a single 1500-2000 sq ft house. It completely depends on the available space--we basically build to the capacity of the lot, because we make money on every little square foot we can build (although limited by the neighborhood for max square footage/unit).

    Lending for us is mostly identically from flipping to developing. My partner usually provides the money for all the construction. I will say though that bigger lenders tend to be more likely to lend on development than flips. We've got a banker that's willing to lend to 0% LTV and 100% of construction costs, IF the development prospect is good enough. There's less unknowns with new development than flipping, which the more conservative lenders appreciate.

    @Manolo

    I'm in agreement--that's most likely why the space is as profitable as it is. I did a lot of building from the studs up before I got into additions, and from there into new construction. If you gradually work your way up through the construction ladder, it's probably the best way to approach beginning development.

    0Reply
  • Joseph M.
    Flipper/Rehabber · Los Angeles, CA · Member since 2009 · 1k+ posts · 732 votes
    11y

    Juan, thanks for your response. Sounds like you are pretty busy with five projects going on, that's great! 

    Interesting about the lending aspect. That does make sense that lenders would feel more comfortable with new construction, since you are dealing with less unknowns. 

    0Reply
  • Michael Rodriguez
    Randolph, NJ · Member since 2015 · 2 posts · 1 vote
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    Hey everyone. I am new to BP and I am enjoying it so far. This thread is really interesting and since I'm new to the investing world with no experience I definitely want to learn more from everyone on BP. I like the idea of developing, but how can I get into that kind of business? Who should I work for or can I as a sole investor network with contractors/builders to make deals?
    1Reply
  • Mandy Jay
    Investor · Los Altos, CA · Member since 2015 · 7 posts · 0 votes
    11y

    Great post! Thanks for sharing.

    Assuming you hire licensed architects and general contractors to build the homes, and hire licensed realtors to sell the homes, do you need any sort of license or other credentials for yourself in order to do the development business?

    If your lot is in a fault zone, do you need to have any inspection on whether there is an active fault beneath the lot? Or would you avoid lots in fault zones altogether?

    How would the affordable housing requirement of the state impact profits? Or would you avoid areas where such a requirement is applicable?

    Have you considered larger development projects, e.g., 20 town houses on an acre of land? Would the answers to the above questions be different for the larger projects?

    0Reply
  • Steve Porter
    Investor · Akron, OH · Member since 2013 · 24 posts · 4 votes
    11y

    This is the approach I've taken in Ohio. I still flip if I can find a good deal, but I've built a few spec houses this year, and I'm starting three more this week to finish out the year... Actually a lot easier than flipping and easier to predict returns and easier starting from the ground up. I pray and hope the market stays stable, but we roll with the punches! Great Post!! 

    0Reply
  • Karen MargraveBusiness Member
    Moderator
    Realtor, General Contractor, and Developer · Redding, CA · Member since 2009 · 7k+ posts · 4k+ votes
    11y

    @Mandy Jay  You don't need any special licenses to be a developer. However; every project is unique, and that's why it's important to have a good foundation under you when you're getting into development, and have an understanding of the entire process, etc.

    For property in a fault zone, as long as it's a buildable lot, you would need experienced geotechnical and structural engineers, as well as all the other trades.  

    Here's a link to the first in a four part series I did on development. It's just a broad overview, and I'm sure there's better posts on BP if you do a search. So you want to be a developer?

     
    1Reply
  • Mandy Jay
    Investor · Los Altos, CA · Member since 2015 · 7 posts · 0 votes
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    @Karen Margrave: Thanks for your reply. I've read your first blog and look forward to the rest.

    0Reply
  • Ryland Taniguchi
    San Francisco, CA · Member since 2015 · 786 posts · 717 votes
    11y

    Development can be great if you know what you are doing. Definitely opportunities with higher and best use sometimes than the flips. I missed out on a flip that was zoned low-rise multifamily (LR1) that I would have built 3 row houses on and sold for $2.2 million total. Was a way higher and better use than the person who outbid me for the flip.

    But I would never say you can't find flips in an area. Is there not a single person flipping in your area? The areas that I work in Seattle like Queen Anne, Magnolia, Fremont, Wallingford, Ballard and Greenlake are considered impossible find flips by many market. Yet we find something every month. Just have to 10x the amount of effort to find the deals.

    3Reply
  • Juan Diaz
    OP
    Flipper/Rehabber · Emeryville, CA · Member since 2015 · 158 posts · 124 votes
    11y
    Originally posted by @Mandy Jay:

    @Karen Margrave: Thanks for your reply. I've read your first blog and look forward to the rest.

     I agree with Karen's feedback. In regards to building larger projects, we want to make sure that we are more certain of the processes involved in developing before we increase our scale. Building from scratch has a lot of pieces, and right now our biggest development is a four-townhome parcel in San Leandro. After we're able to successfully develop these parcels, we may look at larger opportunities, but because of the size and risk, we want to make sure we've got our processes down before we scale up.

    The other hurdle you'll run into is that financing will be very hesitant to lend you money on a big development unless you've already proven your bona findes. It's a natural progression to go from flipping to building an SFR to building a 2-4 unit project to building larger projects. I don't know that we would have been able to secure financing for anything with 10+ units before completing our 2-4 unit projects, but then again, we haven't tried

    0Reply
  • Joe Fairless
    Investor · Cincinnati, OH · Member since 2013 · 2k+ posts · 1k+ votes
    11y

    @Juan Diazreally cool that you were able to switch from flipping to development. The transition makes sense but I suspect it's not an easy one as @karen 

    @Karen Margravepointed out 

    1Reply
  • Mandy Jay
    Investor · Los Altos, CA · Member since 2015 · 7 posts · 0 votes
    11y

    @Juan Diaz: Have you thought of this ramp-up process: Buy a larger land (e.g., an acre). Get the plans for the maximum number of units approved (e.g., 20 units). Build and sell the units in smaller batches, e.g., 2 units, then 4 units, then 6, then 8. I assume the profit margin for a larger development is higher when the project is eventually completed.

    0Reply
  • Chris Field
    Investor · Milford, CT · Member since 2015 · 200 posts · 69 votes
    11y

    I have always built, I dislike remodeling its a lot of work and quite frankly a PITA.

    In my area its the same inventory wise, the amateur flippers are back and bidding stuff up to the point where their is no margin left on it. I can compete on some stuff simply because I'm more sophisticated and can see and do things with a piece they cannot. But that's not typical. 

    Frankly it drives me nuts, these guys are annoying and only poke their heads out when the market is good.

    0Reply
  • Chris Field
    Investor · Milford, CT · Member since 2015 · 200 posts · 69 votes
    11y
    Originally posted by @Mandy Jay:

    @Juan Diaz: Have you thought of this ramp-up process: Buy a larger land (e.g., an acre). Get the plans for the maximum number of units approved (e.g., 20 units). Build and sell the units in smaller batches, e.g., 2 units, then 4 units, then 6, then 8. I assume the profit margin for a larger development is higher when the project is eventually completed.

    I just finished a 9 unit townhouse site and my next project is a 15. The larger sites are no different than the smaller ones just larger numbers. Banks typically want to see a track record before you go to bat on the larger stuff, which is a pretty big hurdle to jump for anyone new.

    My bread and butter are spec houses in the $350k range. Than I stepped up to a $1.7m site, the next one is $2.8m, and after that who knows but I'm certainly not done.

    If you go very large 50-200 units than you would start to do phased construction, but for the smaller ones like mine I just do it all at once.

    The larger sites can become quite complex in terms of regulatory approvals, and political in some cases. Also quite frankly the highest barrier to entry is the cost. You actually do need deep pockets to do the larger sites.

    You also need a lot of knowledge about the construction process which goes back to the bank's wanting experience. You can make a mistake on a simple spec house and it costs you $10k or $20k. Not the end of the world you learn. BUT you make a mistake on a 15 unit site and it can easily cost you $100k or more. So you need a lot of experience in the field because mistakes can literally make or break you.

    YMMV

    0Reply
  • Brian Whelan
    Real Estate Broker · NYC Metro Area · Member since 2015 · 58 posts · 28 votes
    11y

    great post Juan and thanks for sharing. Givien the high price points in NY I often wonder is the design and build from the ground up a better route here too!

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