Multifamily: To buy or to build...that is the question

Mike Hoherchak · 2019-04-30T08:38:45-07:00

What are your thoughts?I live in eastern PA and I'm learning that inventory of residential multi-family properties are very slim within my price point. The inventory that is available seems to be really old and run down and expected to have much deferred maintenance. With this in mind, I've been thinking what it would take to just find an acre or two and build my own MF. I recently learned I could do this with a local prefab company that can make a 3 unit. The average rent in my area is roughly $1396 with a +2% change year over year. So with a brand new build I think I could get $1200/m on the low end up to $1500 depending on location.The market I live in is doing well and more and more people are moving into the area due to cost of living and easy access to major metros within a 2 hour driving radius. The down-side is that the local municipalities and townships are a bit unfavorable to MF since they are trying to keep an "american dream" feel within the area (ownership of SFH are preferred). Needless to say, there might be a challenge with zoning if I'd like to build or turn a large SFH into a MF.Whether I buy or build my plan is to owner-occupy, paid for with a 0% down VA loan. I plan on moving out after 2 years and holding this property for cash flow for as long as it makes sense. This will be my first investment property and I'm leaning more towards building.Knowing all this, what are your thoughts on building a prefab MF vs buying one of the existing inventory? Pros? Cons? Any insight would be much appreciated!

Greg Dickerson

Developer · Charlottesville, VA · Member since 2018 · 4k+ posts · 4k+ votes

7y

@Mike Hoherchak I have family in Bethlehem so a little familiar with the Lehigh Valley area. For the most part you can almost always buy cheaper then you can build. Development cost or at all time high right now, zoning can be difficult and time-consuming. Construction is risky if you’ve never done it before. All that being said if you can find the right land at the right price you may be able to make it work. The biggest thing when looking at land is to check local city and county requirements, utilities, permitting cost, engineering costs, site work needs etc.

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Michael Wayne

Member since 2019 · 25 posts · 17 votes

7y

Hi Mike,

I think one of the biggest variables to consider as far as the investment thesis here are the cash flows in the near term. A new build, depending on the size, will take 12 to 24 months to complete and that's after all the headaches on the front end of that for designing, gaining approval, lining up a contractor, etc. Then you have to fill the place, which depending on number of units, can easily take 3-6 months or beyond. that's 18-30 months of minimal or no cash flow.

Not sure how you plan to fund, but there are much higher risks for both the debt and equity investors on a new build vs. a renovation project with an already occupied property. But as with any worthwhile risks, this inherently carries the bigger upside.

If your investors can tolerate this risk and you're able to finesse the zoning, I think building is the way to go, but both of these could easily up-end your deal which might leave rehab as your only option.

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Mike Hoherchak

OP

Bethlehem, PA · Member since 2015 · 27 posts · 8 votes

7y

@Greg Dickerson Thanks for your insight! I just started digging into all the nuances of what it might take for building a new project and I do understand it can cost a pretty penny. What I'm trying to figure out is if it's known that it's more expensive to build vs buy and existing property, why are people still building? There must be something I'm not seeing that makes it worth it.

@Michael Wayne My strategy for this would be as an owner-occupied financed with a 0% down VA loan, no other investors (ideally). High leveraged, I know, but if I'm planning on keeping it for the long term for cashflow, i don't see it as a huge concern as long as the numbers work on a conservative level. I would have the reserves to cover the holding costs. Sales and marketing are big strengths of mine, so I'd be able to market the property while it's still being built and fill it as soon as it would be complete. I don't see this as a problem for my area due to the demand. I will say I was looking into prefabricated MF's rather than traditional builds. Prefabs are homes build off-site in a warehouse and shipped to the location to be put together. Because the home is built in a different location they can also do all the foundation work at the same time cutting down the time almost in half compared to traditional builds.

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Greg Dickerson

Developer · Charlottesville, VA · Member since 2018 · 4k+ posts · 4k+ votes

7y

@Mike Hoherchak Developers build for numerous reasons. Returns can be better overall depending on location and market. It can be easier to buy but land and build than buy existing in a competitive market. Supply is down nationwide for new inventory. All things being equal new generally always rents first and rents for more. New always sells first and sells for more to higher end buyers and institutional investors. Several new builds are CO deals FOR apartment REITS. Lastly some of us are just developers we just like to build versus by existing. It’s in our DNA

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Jaysen Medhurst

Rental Property Investor · Greenwich, CT · Member since 2015 · 4k+ posts · 2k+ votes

7y

@Mike Hoherchak, I applaud your ambition. This question comes up a lot in the forums.

A ground-up MFR build is (generally) not a good idea for several reasons:

As a newbie, this is WAY too much to bite off. Unless you have a solid background as a GC or developer the process of ground-up construction is going kill you. The red tape, zoning, sub-contractors...it's A LOT and not for the uninitiated.
The numbers rarely make sense. Due to land and labor cost it costs more to build small MFR than it will be worth / can be supported by market rents. This is why you only really see SFH and large multi-families being built.

Let's say you want to build a MFR with 3, 2/1 1000 sq ft units. You'd expect to pay ~$150/sq ft for new construction (even pre-fab), plus the cost of the land, plus utility hook ups, plus holding costs.

Even if you get the land for a song ($20k) you're looking at $470k+ to build a property that will generate ~$4k/month rent. That's way below the 1% rule. On top of that you want to finance it 100%? The mortgage alone will be almost $2400/month. Just assuming the 50% rule, you're $400/month in the red.

The most expensive 3-unit I see in your area is listed for $430k and it's over 2X the size of the example above. So you're most likely building something that will cost more to build than will actually be worth, which the bank will never let you do.

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Scott P.

Rental Property Investor · Indiana...mostly · Member since 2019 · 468 posts · 245 votes

7y

I've done new rentals and "used" rentals and new and existing houses. There are a lot of advantages to new. Currently though in my area, the cost for new is much higher than existing or remodeled. (There was a time in my life when remodeling cost more than new.)

Owner occupancy gives you a financial advantage that pure investors don't have. For example, your interest rate should be lower and you don't have to bear the full cost of housing yourself somewhere else after the new rental is complete.

I recommend you talk to lenders though before deciding on a prefab. In my area, prefabs, even on permanent foundations, don't appraise for as much as traditionally built homes.

If you can make new construction happen you'll probably be better off in the long run but it will be a huge learning process, likely including a lot mistakes that cost you $, if you've never hired a builder and built before.

Best wishes!

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Multifamily: To buy or to build...that is the question

Multifamily: To buy or to build...that is the question

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