Tear Downs

3 Replies

Looking to possibly purchase a lot or purchase a lot with a home for teardown...When this is done, basically the purchase of the property/teardown is a sucken cost?  is that correct?

Also was a typical financing for this sort of thing? How much do you have to bring to the table in terms of % of cost?

Not sure what you mean by a "sunken cost."  The cost to purchase and tear-down the existing house would be considered Cost of Goods Sold (COGS) from an accounting standpoint, as would any other costs associated with the new construction.

As for financing, it depends on how you finance.  If you go with a construction loan from a portfolio lender, they'll typically be looking for you to bring about 35% of the total cost of the project (purchase plus construction).  You'll also have to have permits in-hand before they'll finance the construction portion of the loan.

Originally posted by @J Scott:

Not sure what you mean by a "sunken cost."  The cost to purchase and tear-down the existing house would be considered Cost of Goods Sold (COGS) from an accounting standpoint, as would any other costs associated with the new construction.

As for financing, it depends on how you finance.  If you go with a construction loan from a portfolio lender, they'll typically be looking for you to bring about 35% of the total cost of the project (purchase plus construction).  You'll also have to have permits in-hand before they'll finance the construction portion of the loan.

 Okay, makes sense.  I thought it was sunk, because if a lot+teardown is 100K, then your New Construction is $300K, the total cost of project is $400K, and once you purchase and tear down that likelihood of recovering your initial investment is extremely low

But either way the number is 35% to the table plus permits.  Thats good to know.  Thanks!

Originally posted by @Christian Hutchinson :

Okay, makes sense.  I thought it was sunk, because if a lot+teardown is 100K, then your New Construction is $300K, the total cost of project is $400K, and once you purchase and tear down that likelihood of recovering your initial investment is extremely low

The question is too general.  In some cases, if you tear down a house, the cost is sunk as the value of the house + land was greater than the value of the land alone or the land with additional development.  In other cases, the value of the land with new development is going to be worth more than the value of the land and the previous structure on it, including the cost of building the structure.

This analysis should be undertaking BEFORE the land/structure is purchased.  And if you deem tearing down a structure to be a sunk cost before you purchase, it would seem obvious that you shouldn't purchase with the intent of tearing down.

Now, if you purchase with the intent of tearing down and then economic conditions changes such that tearing down proves to be an unprofitable decision, then it's quite possible that the tear down was a sunk cost.  This should be a rare occurrence for a smart investor.

In your example above, if recovering your initial investment would be impossible at the total project cost of $400K, then yes, the tear down was a sunk cost.  But, that will generally be known before you purchase the property, in which case, the purchase (with intent to tear down) wouldn't be recommended.