Investing in multi-family residential construction?

Question

Hello, I'll try to keep it short. Essentially there is a property management company that finds investors to pay for the build of duplexes that are then sold for 30%-40% more than the cost to build. Appears to be a well oiled machine in terms of the construction and sale process-cookie cutter 1200 sq ft properties. A family member of mine decided to invest and just closed on the lot. He will be paying cash for the entire thing. If all goes well, I am considering investing. This side of real estate is entirely new to me and I want to learn as much as possible from those more experienced than I. For context, I do have a decent grasp on the real estate market and financing as I have been a mortgage loan officer for 4 years now. Alas I do not know everything lol. Some questions I have:

-What is the capital gains tax situation on something like this? Say I build, sell, and use those profits to build again. Is this where a 1031 comes into play?

-Thinking long term, is this something I could scale to make my primary source of income? The builds generally take between 4-6 months...is it realistic to think I can build and sell two in my first year?

-General guidance for other factors I need to consider???

TIA!

-What is the capital gains tax situation on something like this? Say I build, sell, and use those profits to build again. Is this where a 1031 comes into play?

-Thinking long term, is this something I could scale to make my primary source of income? The builds generally take between 4-6 months...is it realistic to think I can build and sell two in my first year?

-General guidance for other factors I need to consider???

TIA!

Stephen Dispensa · Answer

- First questions you need to ask: Are all the entitlements in place. This means, site plan has been signed off by the county, building plan is approved, site has water, electricity, and sewer/septic. If the answer to all of the above is "Yes" then yes building these properties is pretty straight forward. What I would do in your situation though, is get the addresses of some homes the builder has already built. Then go to the city or county building department web page and look up the construction permits for those properties. Check out the inspections they have done. Whether they used the city/county inspector or hired their own "private provider" inspector, the results of each inspection should be on there. Check to see how many they failed and what the issues were. This is always a good indicator of poor craftsmanship and project delays.

- Regarding @Basit Siddiqi's statement that if you are a developer the income would be treated as ordinary income, this is correct. However that will depend largely on the relationship between you and the company building these properties. If the project is co-owned in a limited partnership with them with them as the active partner as "developer" and you as a limited partner having no active role in the actual development process, this would be treated as capital gains income and you should absolutely use a 1031 Exchange to avoid these taxes. Speak with your accountant and your developer to figure this out.

- Of course you could make this your main source of income long term, however just remember this will get taxed as capital gains if you are a limited partner in these properties. Best long term strategy would probably to take an active role and receive some of the income as "ordinary" income or even payroll for yourself, and the rest as dividends to limit tax liability. Again, speak to your accountant.

Lastly, ask to speak to more clients of the developer. Ask them how they're handling these same questions you have and how satisfied they are with their projects.

Michael Smythe · Answer

Appears to be a well oiled machine?

So did Bernie Madoff's investment company...

What due diligence have you done on the company and its owners?

What protection will you have on your investment?

What's the Absorption Rate of housing in the area?

There are many more questions you should be asking!

Jeffrey Fleming · Answer

This is interesting, is there a requirement for how many builds to have in inventory to be considered a developer or is one sufficient for this tax incentive ?

Basit Siddiqi · Answer

if you buy, develop properties and then sell them.You are considered a 'developer' and the land / houses are inventory. therefore, the income would be ordinary and not capital gains.

Seo Hui Han · Answer

I've never done construction in Florida, but I have in Los Angeles and there is nothing cookie cutter about the process.  I'm curious if you are "purchasing" the lot, and the improvement is in your name, basically you are the owner?  I'm assuming the developer has already paid for all of the soft costs (architecture, permitting) before you, the investor comes along.  Are you and your money basically replacing the construction loan?  And what happens if there are change orders, such as an inspector comes and makes an 11th hour demand, there's an easement somewhere, or something like that?  Or does this kind of nonsense only happen in Los Angeles?   And who pays for builder's risk?

Michael Smythe · Answer

@Paige Corsello two helpful thoughts for you:

1) We don't know, what we don't know.

2) If you don't ask the right question, you won't get a useful answer.

Another poster answered your 1031 question, what purpose would repeating that answer serve?

Your other question about making this your primary source of income, is pretty much too generic to be useful. How can anyone predict your organizational skills, discipline, persistence, etc.?

BTW you did state, "Alas I do not know everything lol."

So, why are you being so negative about my attempt to address that?

Paige Corsello · Answer

You didn’t answer any

Investing in multi-family residential construction?

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