Build and Hold. Pros and Cons of building new SFR rentals

2 Replies

In areas where the rental market is strong and purchasing rate is low, it makes sense to investigate the buy and hold market, right?

Under contract right now, I have two 1-acre land parcels with a house on price $85,000. One house is a bulldoze, and the other requires $20,000 to be in tip top shape. ARV is anywhere from $100-$110k conservatively (for a 30+ yr old home). Zoning in the area is 20,000 sf minimum lot size, SFR, and is located in two succinct downtown overlay zones (like a vin diagram). As the city grows, these lots have the potential to become more valuable as they are authorized for mixed use (work and living) as well as light commercial. When this property came available, the idea was to split both lots in half creating four total lots. This will leave is with a fixer upper SFR, two raw land lots and one with sewer, water and power connections in the ground (which is a considerable advantage). My partner and I agreed that it would be a wise investment to subdivide the lots and sell the land parcels for $25k each. This would give us back $75k ( nearly our initial investment ) and for the cost of subdivision + rehab, we would have a rental property capable of bringing in $800 per month, conservatively. Pros to this scenario, are that I invest $40k, and within a year return with $37.5K (minus sales commissions, but $25k per lot is a low baseline) and half the interest in a more-or-less free and clear cashflow property. My partner will pay for and facilitate the subdivision, the rehab, and manage the property with cash and his own sweat. In exchange for his contributions, we will split the cashflow 60/40 or some agreed upon division proportionate to the expense, to be determined.

This, I believe, could be a solid plan.  Back up plan is, if need be, to sell the Fixer house at market value and divide the interest, yielding $50k each in positive returns, minus costs to sell the investment house.

The idea came to mind, however, when I learned about the concurrent zoning overlays that their may be some reasonable credibility in appreciation.  So now describing the original plan, I would like to pose the alternate plan and take your input. 

Fast forward, we now have one SFR, and three vacant lots in an area that could reasonably bring $1000 per month rent (given new or like new construction). We own the land, and we have utilities at one of the home sites. What if, instead of selling the lots, we hold them in order to build three additional rental units, given that we could build the homes for $100k or less each, hard and soft costs? Discussion points:

- What type of lending would be the appropriate choice for the construction?

- How do lenders valuate or view build and hold loans?

- Could you refinance after the build is complete to ensure cash flow?

- Could/should I take out a mortgage on the land prior to building?

- What are the expert pit falls to this strategy?

- What would lenders say to manufactured homes, versus spec built?

- If my partner is securing all the lending, how should the profit be divided?

- What is the exit strategy? The exit strategy, exit strategy?

- Has anyone been in a similar situation?  Was it successful, why or why not?

@Matt Huneycutt  

What are you trying to accomplish?? If executed properly I think either scenario might work. I dont know the area where these properties are but if the demand is there for rentals then that should work to build and hold or sell them. 

I would be wary of counting on the direction of future zoning. If an overlay already allows a higher density then great but counting on it coming and basing valuations on that could be costly. Been there and done that and have the bruises to prove it.

Manufactured homes depreciate and do so quickly, they are disposable housing to most banks. As far as loans for building spec......even with great experieince banks are a bit shy about them. There are smaller community banks that offer construction loans for specs but after construction you will need to convert.

As far as mortgaging the dirt, I would use cash if you can becasue if not you will have to refinance or kill the debt to split the lots.  There are numerous possible pitfalls- make sure you understand the zoning for the property inside and out. The property you say requires a lot size of 22,000 square feet is there a street frontage requirement? Be sure there are no easements that would affect your ability to build as well.

Your split with your partner should hinge on what you each bring to the table.

My exit strategy is always very simple a little money and low or no risk is better than a lot of risk and a lot of money. If you are unsure about the project and you can turn it and make a quick $20-30k splitting the lots and selling them and sell the house as well. I would take it an move to the next deal.  From what is sounds like the funding strategy 3 specs could be an issue. I would have all my ducks in a row from funding to build cost, rent rates etc before I woud proceed.

Thanks Ken,

The initial concept was to extract the value of the land via liquidation, and maintain the existing house as a consolation prize.  We began thinking though, that perhaps the lots could be worth keeping. But after some reflection, I believe you are right...that our best move is to stick with the plan and sell the lots. We can pool the cash from the sale for a more logical buy and hold opportunity with existing homes in the Charlotte area. 

The financing piece for this type of deal is the real unknown. Could you tell me, what ballpark terms could I expect for construction loans, and what type of loans would/could I convert to after the build is complete?