Should i start a construction for 12plex unit at current market?

Question

Hey everyone,i have land and plans for a 12plex in South-West FL.

Considering if I should proceed with construction at this market or should i just sale the land.

On one hand, contruction costs are high, insrance&intretst&property taxes are high and increasing and vacanicies are relatively high... on the other, once complete, it's defentiley an asset i'd be glad to own for many years.

Under my current assumptions, once stabilized:

Expected Cap rate of 7.5%

Expected COC of 6%

Jonathan Cappon · Answer

Thanks for the input Luis! One point I'd question is whether a lower CoC than cap rate necessarily means negative leverage, since CoC also accounts for principal repayments, which build equity. But indeed the overall debt service (calculated at 7%) drags me down.

I agree that stress-testing the construction costs, lease-up period, and permanent financing is critical and taking this in considration in my underwriting.

I'm also looking into the market value of the land with the plans in place to compare selling now versus the potential upside of developing and holding long-term.

Regarding sale after stablizaion (which i dont intend to do), do you think assuming sale at 6.5% Cap rate from NOI is correct/resonable assumption?

Luis Ochoa · Answer

Fair point on CoC. Principal paydown drags it down, and the equity build only shows up when you refi or sell.

Yahoo Finance recently ran an article on where long-term rates may go over the next five years, and many of my builder clients expect rates to fall once their two-year projects finish, which would bring in more buyers and push prices up.

Article I'm referring to: Mortgage rate predictions for the next five years: How high will they rise?

Matthew Morrow · Answer

@Jonathan Cappon the replies above caught the big one. If cash-on-cash comes in under the cap rate, the debt is costing more than the property earns. Before deciding, I'd run it a few ways: today's construction and takeout rates, a longer lease-up than you're planning, and construction costs with a real contingency. Then compare that to what the land sells for today and what you could do with that cash. Sometimes selling the dirt to a builder is the better risk-adjusted move. Let us know what you decide.

Luis Ochoa · Answer

@Jonathan Cappon , one number jumps out: your cash-on-cash (6%) is below your cap rate (7.5%). That means your permanent loan costs more than the building yields, so the debt is dragging your return down. Before you decide build vs. sell, re-run it with the takeout loan you can actually get today and see where the two numbers land. Then get a broker's opinion on the land with plans attached, because approved plans are often worth real money to a builder, and compare that check to your projected profit after a 10% cost overrun and a slower lease-up.

Chris Seveney · Answer

What are the details of the 12plex? Could you do a build-to-rent townhome-type product that you could also split up and sell individual units later on?

It is always very difficult and challenging to time the market. One thing I will say is, if construction costs do come down, then I would definitely consider it more. If the construction costs are still high, I would possibly wait till they come down. In Southwest Florida, I am already seeing GCs and other contractors struggling a bit.

Lastly, do you have all the permitting completed? That would be the first thing I would do: make sure the project is shovel-ready, so when you are ready to go, you can start.

Mohamed Youssef · Answer

Jonathan, I’d first clarify whether the 7.5% is based on your total development cost, including the land. I’d also run the numbers using what you could sell the land for today. That helps you compare building with selling.

The other piece is how much cash you’ll need between breaking ground and stabilization. I’d test a construction delay, slower lease-up, and lower rents to see how much additional cash those scenarios require.

Wanting to own it long term makes sense. The question is whether the projected return leaves enough room for the construction and lease-up risk.

Does your 6% cash-on-cash assume permanent financing already quoted by a lender, or an estimated refinance after completion?

Jonathan Cappon · Answer

Thanks, Mohamed.

Indeed, the 7.5% is based on total development cost, including the land, financing costs, project management, and a 5% construction contingency. Technically, it’s a yield on cost.

Your point about using the land’s current market value is relevant - that’s the opportunity cost of building rather than selling today.

My model assumes two years of construction, followed by a lease-up year with 50% average occupancy, which produces roughly $39k of negative cash flow before stabilization. I still need to test the combined impact of delays, cost overruns, and lower rents, and calculate the additional cash required.

The roughly 6% CoC assumes permanent financing at 7%, amortized over 30 years. Whether I can secure those terms is a key item to verify.

Ultimately, that’s the question I’m trying to answer: does the return leave enough margin to justify the development risk versus selling the land now?

Should i start a construction for 12plex unit at current market?

Should i start a construction for 12plex unit at current market?

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