Stupid question on development?

Question

Ok this probably going to sound stupid but for development(or builder).

Ok say I buy a piece of land(half and acre) and build a house how do i make money on that? So a new house will cost a lot more money cause your paying for today'sconstruction cost. What will stop the person from going down the street and paying half of much on a older house (1950's construction cost). I guess the only way will be like Donald Trumps way, buy land and build 20+ condos on it.

Thanks, Mike

Don Konipol · Answer

I think you are a little confused.  An old house is worth significantly less than a new house because the old house has depreciated - it's useful life has been used and it remaining life is somewhat less than a new house.  In order to bring an older home up to closer standards of a new home, a large amount of money would have to be spend on replacing and upgrading.

Most houses are built for a 50 year life, with a moderate amount spent each year for repair.  Lets say a house is 25 years old, and has been kept in good repair but not upgraded.  It should be worth about half what a similar new construction house is worth.  This comparison is for the building only; all other thing being equal we would add back the land value which should be the same for each (land does not wear out so it doesn't depreciate.

What often confuses people about older homes is that they appear to increase in value.  This is because very often the land they sit on is close to downtown or in other desirable locations and the value of the land increases so much it disquises the depreciation of the structure.  Inflation would also disquise the structural loss of value, however our analysis of old vs new should stand up under any scenario.

Bill Gulley · Answer

Don, have you ever considered teaching? Good description! Now, as to the condo comment, if you have land the first thing to do is to identify the highest and best use for the property.
          
          Every square foot of land in the country is zoned for a particular use....even where there is said to be "no zoning" it is set aside, by ommission to other restrictions, for a particular use.
          
           While the intended or planned purpose for that land is stated by local authority, from an economic stand point, it may or may not be at its highest and best use.
          
          Land is valued based first on this perception of intended use. Farm land might sell for $1,500 an acre in an area, but residential property be be $15,000 an acre. So, the first trick to  making money with the land is to identify its highest and best use and if that best use has not been identifed and is not zoned appropriately, the easiest way to make money is to have the highest and best use permitted, change the zoning or obtain an exception to the zoning so that the property can be utilized at the highest level. 
          
          Donald Trump has probably mastered this. You can't really make big bucks competing with all the other investors trying to buy properties that carry higher prices. Finding cheaper properties and transforming them into higher use or more economically viable properties is where making money from the land begins.
          
          Your property is probably not zoned for multi family dwellings if it's right down the street from single family structures, but it could be. If it can be permitted, you land will be more valuable with a multi-family structure there than it probably would be with a single house.
          
          But, changing the right to use the property may not be available to you, the local authorities may not allow it, for many reasons (might be because you didn't pay the right politician, LOL)
          
          So, now you must conform to an established use requirement. Now you have to decide what the best use will be under those rules. Let's say it's a single family detached structure, a house. Now what the best house to put there that yields the highest return......and the analysis goes on.
          
          My point here is that if you own land, you might have acquired the land under certain assumptions that effected its price to you. If you can change those assumptions or rules to a higher and better use, you can profit from that alone, without driving a nail. Later, Bill  .   PS. Sorry its so long!

Mike Kruser · Answer

I use to think of it as buy a used business vs starting a new one, used business you can buy everything 50Â¢ on the dollar and new business well..you have to buy it new. But now i see how things work, i was comparing apples and pears there (from the business point)

Bill Gulley · Answer

Ralph,  appraisers call external factors mentioned as "external obsolesence" (location) and inside factors "functional obsolesence" (poor floor plans, small closets)..

Ralph S. · Answer

Good post by Don.

Aging homes suffer from two types of obsolescence/depreciation.  Functional and Economic.
Functional obsolescence is what Don describes, to a point.  Besides care and maintenance, upgrades and remaining useful lives, there is the functionality of the structure itself.  Design and use change over time.  Going back, bedrooms baths and closets get smaller, laundry rooms move back to garages or basements, eat in kitchens go away, garages become detached or donâ€™t exist, etc.  Go back far enough and you even get what Iâ€™ve got in my 1890 built rental, a bathroom off the kitchen.
Economic is outside the house itself â€“ itâ€™s Location, Location, Location.  Things that happen after the home was built.  Don also gives an example of this.  It would impact all the homes in the neighborhood.  Local employers coming or going, freeway noise, airports, zoning changes, all sorts of stuff come into play here.
Both really need to be considered.

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