When does it make sense to level a house and build new?

Land & New Construction
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When does it make sense to level a house and build new?

Donald Capwell
Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes

Howdy, all!  I searched for an answer to this, but didn't find it... Please just give me a link if there's already a discussion about this that I missed!  This question is for anyone that is currently doing this sort of deal, or regularly considers this and has done this sort of deal... 

BACKGROUND - 

I worked for a man that once helped build a homeless shelter some years back (10-ish).  During the process, he questioned whether someone could build a new home (3/2), and make it available to people that are in need for around $50K ("affordable" was his goal).  So, to settle the matter, he actually set out to do it.  He bought some land and then built 3 identical houses, side by side, fully stocked with all appliances, weed wackers, rakes, brooms and lawn mowers, "turn key" homes, and then sold them for $50K each.  Net profit per house was $150.00.  In the end, he was satisfied that his logic was sound - it could be done (this is "yesterdays" money, and not to imply it could be done in today's economy) - but he also realized that you certainly can't make a business case to do this!  

With this story in mind, what is the business case YOU use to pull the trigger on building a home verses walking away, with the assumption that a house is beyond rehab. (NOTE: I do NOT mean that you will make MORE money to build new versus rehab - assume a rehab is not an option, and you have to buy on the basis of discounted land value, area's desirability and comps, or you it's not a deal). I have a property that I'm evaluating, and the existing house needs to be torn down and a new house built. No, I will not be doing this work myself, but if it makes sense, I'd like to work with the investor that does this so I can learn. Houses going up in the area are upper mid-range to luxury finish. Without getting caught in the weeds, at what point and using which method to evaluate (ie: Net Profit, ROI, Cash on Cash return, etc) does it make sense for YOU to level a property and start over? Would you do it for $50K? Not less than $100K? 150K? More? What makes sense for you to pull the trigger, and what questions SHOULD I be asking that I'm not?

Next, as a sidebar to anyone that may be doing this in Norther Virginia, what is your cost to build per square foot for a upper-mid grade (new construction)? I've been quoted several rates locally, from as low as $95/sf and up to $135/sf for upper mid-range to luxury grade builds. Let's hear from you VA home builders!

Thanks for taking the time to answer.

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Judy Raymond
Fort Mc Coy, FL · Member since 2016 · 18 posts · 5 votes
10y

Be careful. You are buying a property with a building that you are going to have torn down than turn around and flip it to a builder for them to build or split the lot and build? If you tear the building down you are creating some issues that you may not have thought through. One is your lot right now has water, sewer, power etc. If you scrape you have now created new issues that you have to overcome with the building department and Public Works and the Utility provider. You are also potentially making it more difficult for someone to get financing on a vacant lot. If you plan to buy the property and hire a builder to come in and build it for you, you are losing all the profit. You may be splitting the profit but the builder is still going to be paid during construction of this project which bites into the profit. If you keep the existing building, possibly do the leg work to split the lot and market the empty to a builder/developer and the lot with the house to a rehabber or builder, you could probably make the same profit or more in half the time. New construction can eat a professional's lunch and rehab can destroy rock solid marriages. If you go into a project like this without much knowledge of construction or dealing with the govt entities involved you could be eaten alive.  That 50k profit quickly goes negative. I recommend the first thing you do is get a contract contingent on getting approval from the Building Department to be able to do what you think you want to do then go from there. The Building Dept, Planning Dept and Zoning Depts favorite 5 words are, "No you can't do that".  Good luck 

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  • Darlena Jones
    Strafford, MO · Member since 2015 · 181 posts · 61 votes
    10y

    When the cost to fix is more than the cost to scrape away/build new.

    2Reply
  • Donald Capwell
    OP
    Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes
    10y

    Thanks, @Darlena Jones, but rehabbing in this case is not the issue... it's not possible. The question, then, is what margin / profit / ROI do you need to realize before it becomes a deal for you? Obviously, nobody would do this for $150.00 - but what is YOUR required profit to build a house?

    Thanks

    0Reply
  • Chris MasonPro Member
    Moderator
    Lender · CA · Member since 2015 · 9k+ posts · 10k+ votes
    10y

    This might be unique to the wonky bay area, but it's not super uncommon (nor is it common per se) to see developers post things that amount to "if you remove this home from this plot of land, the home is free." Basically a bigger version of posting "pick this old but functional fridge up from my garage, and it's yours for free" on craigslist. 

    If the zoning, etc, works, you could technically use renovation financing to "renovate" the tear-down house by putting a better free one on top of it's (expanded, if necessary) foundation.

    Something to think of for both the tear-down portion of one project (cheap way to 'tear it down' is to give it away, if someone wants it), and for the 'renovation' portion of another project (find a free house for your foundation with garbage on top of it).

    0Reply
  • Mike D'ArrigoPro Member
    Turn key provider · San Jose, CA · Member since 2010 · 4k+ posts · 3k+ votes
    10y

    When building costs per sq ft are below market costs per sq ft.

    0Reply
  • Jeff Cox
    Hurst, TX · Member since 2015 · 34 posts · 6 votes
    10y

    I guess it depends where you are but i dont see it being an option unless you are getting the lot for real cheap, otherwise why not just get an empty lot. I dont see how a new construction is going to be cheaper than buying a house already in the area unless its just super inflated.  

    I know someone who did something like this where the house was already bulldozed and he just built on top of the foundation that was there and when it was all said in done his house was worth less than what he paid total to have it built(Granted i think he winged the whole proces). 

    I guess i could only see it being worth it if the area is soo hot and you get the land for cheap. I also think the main issue is that you have to wait roughly a year to "flip" it for money. So like it you were not able to do it all Cash then you would have to pay that mortgage and deduct it when you go to flip.

    Just my two cents ;)

    0Reply
  • Donald Capwell
    OP
    Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes
    10y

    Thanks, @Chris Mason.  I don't think I'm articulating my question well enough...  Let's try this...

    Does it make sense to tear down an existing home and build a new home if the NET PROFIT is $50K.  As someone doing this type of deal, is this something you do for $50K, or do you only do it when the net profit is greater than "X," when X=(fill in the blank). 

    I'm looking for someone that does these types of deals to sound off on the decision to pull the plug or not.  I understand that there is a lot to analyzing this, but in the end it comes down to "is it worth it" (like my former boss' example, above).  And, I understand that everyone has a different "worth it" meter, but I'm looking for a "normative average" for someone that does this.

    Thanks!

    0Reply
  • Mike D'ArrigoPro Member
    Turn key provider · San Jose, CA · Member since 2010 · 4k+ posts · 3k+ votes
    10y

    How much is your acquisition and construction costs. I think it really depends on what your total ROI is.

    0Reply
  • Darlena Jones
    Strafford, MO · Member since 2015 · 181 posts · 61 votes
    10y

    So, on new construction, the profit margin is highly dependent on the size/cost of the home.  If you're building a small house (like 1200 sq ft, 3/2/2), a builder might realize $5-$10k in profit but you can build a lot of them in a year.  

    If the home is larger (3000 sq ft, 4/3/3, high end finishes), then a builder can make $40k or more but you can't build as many of these in a year. 

    0Reply
  • Donald Capwell
    OP
    Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes
    10y

    @Darlena Jones, thank you!  That is very helpful information.  How long does it take your team to build a 3000 sf house?  (Asked to understand hold timeline). Also, as a builder, is it safe to say you have a line if credit with a bank?  What is you (average) cost of money (annualized)?

    0Reply
  • Darlena Jones
    Strafford, MO · Member since 2015 · 181 posts · 61 votes
    10y

    I hate when people tell me "it depends" but it was does depend.  Are you breaking ground in summer where you won't have any issues getting concrete in or working around spring rains?  Or are you breaking ground in the winter where you have to wait for a time where temps are above 32F

    In general, we build a ~3000 square foot 4/3/3 in 6-8 months once we break ground but it can take 2-3 months of preliminary work before we can even break ground.  We have to get plans drawn up (we do our own plans), funder lined up (we use a regional bank), get the appraisal done on the house plans, buy the lot/close on the loan (takes 3-4 weeks to close on a lot/loan), then get a concrete company ready before you can actually break ground.

    We pay around 5% interest on our construction loans.

    1Reply
  • Darlena Jones
    Strafford, MO · Member since 2015 · 181 posts · 61 votes
    10y

    and, we have multiple houses going at once.  I forgot to mention that.

    0Reply
  • Donald Capwell
    OP
    Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes
    10y

    @Darlena Jones  awesome.  Very helpful indeed.  Cheers...

    0Reply
  • Matthew Paul
    Severna Park, MD · Member since 2013 · 7k+ posts · 7k+ votes
    10y

    Location has a lot to do with it , schools , and demand . Northern Va  ,hot and expensive . If its a great neighborhood a teardown and new hous is a money maker if you buy right 

    0Reply
  • Donald Capwell
    OP
    Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes
    10y

    Thanks, @Matthew Paul, its rural, but close to 95 (and far enough from the insanity) to make this pretty attractive. That, and the high-end (ish) new housing developments popping up all around the site (and this one won't have HOA fees). My concern is in not being a builder, or knowing that end of the business, and whether or not this makes sense from a builder's perspective. I started the evaluation in this property to do a rehab, but there's just no hope in it, so I'll put some feelers out locally to see if a builder wants it...

    Cheers

    0Reply
  • Account Closed
    Investor · Princeton, TX · Member since 2014 · 1k+ posts · 1k+ votes
    10y

    I have actually seen a 3 year old $4,000,000 home be torn down to build a $7,000,000 home.

    You have to love new money.

    0Reply
  • Don Harris
    Realtor · Charlotte, NC · Member since 2014 · 935 posts · 467 votes
    10y

    @Donald Capwell if you own the land, JV with a builder , learn and split profits.Persevere .

    1Reply
  • Donald Capwell
    OP
    Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes
    10y

    thanks, @Don HarrisOffer is out on the property, so we'll see...  It's not the kind of money that @Account Closed is talking about (darn it), but it's a deal all the same (if they accept my toffee, of course).

    Cheers...

    0Reply
  • Donald Capwell
    OP
    Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes
    10y

    accept my TOFFEE????  Lol.  Darned autocorrect!  Now I need some candy...

    1Reply
  • James Leibiger
    Sussex, WI · Member since 2016 · 3 posts · 0 votes
    10y

    When the foundation, plumbing, wiring and most of the house requires work it's a no brainer to tear it down. Another thought would be to tear it down, removal cost would be about $20,000 (depending on size) and sell it as an improved lot. If the location is a desirable area you could easily sell it for land value as long as the total purchase price and disposal cost are less than the land value, you could make a great profit. Also find out if the basement is required to be filled in, if so that would be another cost. 

    0Reply
  • Donald Capwell
    OP
    Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes
    10y

    Thanks for the input, @James Leibiger.  No basement in this one, so that's easy, and the property is being sold for less than land value... 

    Cheers...

    0Reply
  • Mike F.
    Investor · Denver, CO · Member since 2015 · 570 posts · 521 votes
    10y

    Donald I think you should consider the dollar amount isn't as important as is the percentage. $50,000 is a nice big number but percentage wise if you built a 5 million dollar home to make 50K that is a horrible reward for your risk. If you  built a 80K home and made 50K that is a tremendous reward for you risk. 

    There is a LOT more at risk with a new build, 100% of the build, versus a rehab, maybe you're touching 10% of the house. A lot more management, bigger dollars and most of all a whole lot more time, just think for instance of just one facet -all the time dealt with the city building dept on a scrape etc... your reward for your risk and ROI should be big enough to justify all of your investment and especially your time which can be limited. Could you juggle 4 rehabs at once, could you juggle 4 scrapes at once? I think the rehabs would be much more manageable, so again, must have a large enough percentage of return on a scrape.

    If you're happy with a 10% return on 200K houses you are rehabbing with let's say 100 hours of hands on time management which would be $20K every maybe 3 months. Would you be happy with a 10% return on a 300K house you  scraped and spent 11 months on for a $30K return every 11 months?

    You have a lot more moving parts, lots more time, lots more to manage, lots more places to make a mistake doing a scrape. All of this goes down after you get great at them, but it will take you a much longer time to than with a rehab.

    Around here when somebody does a scrape they are usually looking at very big returns for big risks. Think scraping a $700K house and building a 2.5 million mini mansion in it's place and looking for a $300K-$400K profit.

    1Reply
  • Justin R.
    Developer · San Diego, CA · Member since 2015 · 1k+ posts · 1k+ votes
    10y
    Donald Capwell Another data point from someone currently doing a one-off build on an infill urban lot (I know, different variables than you). On a house that'll sell for $400k, I'm looking for a profit of at least 15%. The math would be different if land was plentiful and I could get more scale, but I'm just an investor trying to do the most with what I own. There's just a ton of risk in a one-off new build and I don't want to go for the ride as a non-professional builder with margins less than that.
    1Reply
  • Stephen Hundley
    Realtor · Lafayette, LA · Member since 2011 · 296 posts · 175 votes
    10y

    $20,000 minimum profit to build but more comfortable at $25,000

    1Reply
  • Donald Capwell
    OP
    Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes
    10y

    thank you, @Mike F. and @Justin R..  You both seem to confirm my suspicion, but I know everyone has a different threshold of what they'll endure for a dollar.  In this scenario, I'm estimating (very conservatively) a $50k-$60k net profit after an 8 month build, if the builder can do an upper mid grade build for $95/sf.  If he splits the lot, it becomes a no-brainier, but this is not my specialty, so something I'll flip to a builder.  By learning how to evaluate this type of deal, I'll spend less time on this in the future, and know when to walk away.  In any case, it's not a deal without a contract, which I hope to learn more about tomorrow...

    I appreciate the input!

    0Reply
  • Donald Capwell
    OP
    Rental Property Investor · Mesa, AZ · Member since 2015 · 149 posts · 52 votes
    10y

    thanks, @Stephen Hundley!

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