All Forum Posts by: John Blackman

Thank you @J Scott for starting the new construction diary.  It's been our inspiration to do one of our own now.  In this thread we are going to track the progress of our first Crowd Funded new construction project in Austin, TX

1122 Linden

So let's play a little catch-up since we've already done quite a bit of work getting to where we are.

DEAL ANAYLSYS

So the main thing we're looking for here is a 20%+ gross margin on the total cost of the project from a financial point of view.  Trees, flood plains, and other due diligence items can impact costs and the size we can build, but we'll get to those later.  Exits for new construction in the area show an exit price of $235/sqft.  The lot size is 181' by 51' = 9231 sqft.  The 40% Floor to Area Ratio regulation allows 3692 buildable interior square feet.  Since the frontage is greater than 50' and the lot size is greater than 7000 sqft, the City of Austin will allows us to build a duplex.  So we can do roughly two sides at 1800 sqft each.  $235 * 1800 = target exit price of $423,000 per side.

Our project cost is $110/sqft = $110 * 3600 = $396,000 for both sides, $198,000 per side.

7% in closing costs is $59,200 which includes both sides.

There were no demo costs on this lot so we don't have to add anything there.

This makes our max land cost to reach a 20% gross margin $260,000.  We were able to purchase the lot for less than that price, so it's good to go assuming we don't have any gotchas in the due diligence.

DUE DILLIGENCE

These are the items we check for in doing a new construction project.  They may differ in your area, so keep in mind this is specific to Austin.  Some may be the same, and there may be others in your market that we don't deal with.

1. Flood Zone

We check the City of Austin GIS database on line to see if there is a flood zone on the property.  There are two zones to worry about.  The 100 year and the 25 year.  If there is any 25 year flood zone on a property, we'll likely pass unless it is very small and only at the edge of a property and the house can be well above it.  A 25 year flood zone will trigger flood insurance for sure and is a big warning light.  The 100 year flood zone is ok in some areas.  Higher end buyers may not be willing to buy something in a 100 year flood plain, but lower end home buyers may be fine with it.  If any part of the house is in the 100 year flood zone, we always build the finished floor elevation to be 1 foot above that elevation, so even in a 100 year flood event, the house will stay dry.  In such a case we will use a pier and beam design, as they can be cheaper to build tall versus a slab.

1122 Linden is not in any flood zone, 25 or 100 year.

2. Lot Size

Here, we are looking for how much space we have to build and how big of a house we can build. The rules for Austin for SF-3 zoning (most common residential zone) are that you can build 40% of the lot area as enclosed space. So it's pretty easy to figure out how big of a house we will be allowed to build. If the lot is over 7000 sqft and has 50' or more of frontage we can build a duplex which increases the value of a lot substantially assuming that duplex condos sell in that market. In Austin we don't sell a duplex as a single transaction. We make a small HOA and sell them off individually to retail buyers. This doesn't work in every market, but it does in East and South Austin.

1122 Linden is 9200 sqft, a very large lot that gives us lots of options.

3. Trees

The City of Austin has a tree code that prevents building too close to some types of trees.  Our architect will do this feasibility study to determine if trees can be removed or built around.  Some trees can be removed, others if large enough will make a certain amount of space around them unbuildable.  There are rules for building a slab foundation vs a pier and beam foundation near a tree as well.  You can build pier and beam closer to a protected tree than a slab because the impact to the root zone is not as significant.  A tree in the wrong place can make some lots entirely unbuildable.  So this is an important step.

1122 Linden has some trees, but they are mostly on the borders of the lot.  Given the large size of the lot we can work around them.

4. Survey

It's always nice to get a survey but we rarely get one from the seller, much less one that is a full tree and topo survey.  The tree survey is required for the aforementioned reason.  The topo survey is important for determining the exact elevation lines if a flood zone is in play as well as determining the slope in the lot.  The City of Austin also has what it calls McMansion rules that prevent you from building above a certain height.  However if you have even a slightly sloped lot, where the top of that virtual tent is can mean the difference from being able to build one story or two.  So if you get this wrong, even though you have 40% FAR you might not be able to build two stories to achieve it.  This is where a good architect comes in to ensure that a design can fit inside that virtual tent.

This also creates another problem at the foundation.  To maximize your space you may be tempted to lower the elevation of your foundation.  On a super flat lot not in a flood zone, this is probably ok.  However if you have any slope to your lot there is going to be water drainage when it rains.  You must be very careful that you can still achieve 6 inches of exposed foundation  regardless of the slop of the lot to ensure proper drainage, otherwise you will end up with a leak and a wet house.  Ripping out carpet and hardwoods after the fact is a messy and expensive process.  So making sure your drainage plan is sufficient is paramount.  The topo survey will help you figure this out.

The 1122 Linden survey shows a very flat lot with all of the trees marked.  We may have to use some pier and beam near the trees, and slab elsewhere.

5. CC&Rs + Deed Restrictions + HOAs

Many of the lots we look at were platted in the 1930s, 40s, and 50s.  Some of the deed restrictions are actually on the plat!  So you have to look everywhere.  These restrictions may include items like only single family homes may be built in this neighborhood, or the servants quarters must be separate, or no people of color are allowed to live here (they are that old).  That type of restriction is obviously outdated and illegal.  The ones we care about are ones that restrict building size or type. 

If you don't pay attention to these, you can risk building your project and have someone complain half way through to the city.  This can lock your project up and potentially force you to tear it down.  If no one complains, and you get it done and sold, you got lucky.  I've seen some builders do this, but I would never risk the $400,000 to $650,000 required to build some of these projects on getting lucky.

For 1122 Linden, there were no restrictions on building type or size.

PRE STARTS

The key expenses you need to cover in addition to the land acquisition are as follows:

1. Architectural Design - We include this cost in our $110/sqft.  This is usually a fixed $/sqft for this service.

2. Engineering Design - We include this cost iin our $110/sqft as well.  This is also usually billed in $/sqft of design.  It is very important to use a good engineer with good insurance and a long track record.  Money spent on good engineering is better than money spent on a warranty in my opinion.  A good foundation and framing design will keep you from having a call back 9 years from now (Foundation warranties are usually 10 years) with a costly failure.  Don't skimp on foundation and framing.  Do it right, and use the engineer's insurance to offload your risk for a foundation failure.  Your reputation is on the line here too.

3. Soil analysis - This is required for the engineer to be able to build the right type of foundation.  East Austin has inconsistent soils, so this is particularly important where we build.

4. Permit fees - The City takes their cut

5. Utility hookup fees - If you are building a duplex where a single family house used to be, you are likely going to have to upgrade the water and waste water taps.  If it is single family, you may be able to simply re-use an old tap and save some money.

6. Builders Risk Insurance - This can usually be purchased in 24 hours if you have a good relationship with an insurance company, so I usually wait to buy this almost the day before construction starts or the day before we close a loan with a lender which will want to make sure they are an additionally insured on the policy.  I only buy insurance for my cost to build, not on the retail amount.

7. Demolition - If there is a pre-existing structure to demolish, you will need to pay for this as well.  Be sure to check with the title company and your lender that it is ok to demo any structure before a loan is issued.  The reason for this being that banks always want to be in first position on the property and a mechanics lien from a demo company would put them in second position if you don't pay the demo company.  Banks will usually be ok with this if you get a lien release along with the work and have a good relationship with them.  Before you demo, make sure to disconnect all of the utility lines!  A good demo company will do this for you, but as the owner, you may need to call the utility company to start the process.

1122 Linden has covered all of the above steps.  We have crowd funded the capital for the entire project so we do not have a bank for this project.  We have purchased the land, designed a building, had the foundation and framing engineering done, created a permit set, submitted it to the City of Austin and we expect our permit to be approved this week!

There is an old slab that needs to be removed which we plan on doing around the time we get our permit.

The rough schedule is as follows.  November and December are holiday months, so those are typically slow in the building business.

7/10 - Receive permit

8/15 - Complete Foundation

9/15 - Complete Framing

10/31 - Complete Mechanicals

12/15 - Complete Finish out

1/15 - Complete punch list, clean, photo, and list

@J Scott inspired me with his diary of a new construction project to do one of my own.  So not to be outdone, I'm actually going to do two.  This one will be for a project that we have recently completed.  I'll add new content every couple of days that represents a week's progress.  The other thread will follow the project we just crowdfunded on iFunding.com.

Just for some context, this is our 12th new construction project, so they are starting to look kind of familiar by now.

So with that let's get started on 1106 Berger. 

This is an East Austin lot about 6500 sqft.  That number is important because it is too small to build a duplex, so it has to be priced to build a single family home.  It has a large tree on it, but it's near the property line.  We later found out it is one of the largest trees in the county.

It's a corner lot too as you can see which means setbacks are going limit our buildable space.  It's also near a creek, so we'll need to check the flood plain.  It turns out that it is in the 100 year flood plain which is ok.  We can build the finished floor elevation 1 foot above said plain and according to the models it shouldn't get wet even in a 100 year flood event.

The Floor to Area ratio requirement is 40% (This is specific to Travis County, Texas) or less which would mean the maximum house size we could build is 6500 * 40% = 2600 sqft.  Sounds great right?  Well, we don't want to build too much house for the neighborhood or we would price ourselves out of the market, so we went for a simple 1500 sqft 3 bed 2 bath design.

The comps in the area at the time of purchase of the lot were about $180/sqft for new construction exits.  So our target exit would be $270,000.  We want to have at least a 20% margin after all costs are tallied and we budget $110/sqft to build for this area, although we are pretty good at coming in under this if the lot is not complicated.  This buys us room for surprises and if we beat our target we can give a little more back to the investors.

That means we are going to spend $165,000 on design, engineering, permitting, utilities, sidewalks, bushes, grass, fences and house construction, $19,000 on transaction costs (7% of sales price), and some amount on land.  We want at least 20% of our out of pocket costs (land + construction) in profit.  This is critical because it means we can stomach a 20% dip in home prices and still sell the project without losing money.  You can speculate on future prices, but that is what gets you killed during a market down turn.

This leaves a max land purchase price of roughly $45,000 which we were able to achieve.  The light is green, let's go buy it!

The story behind this lot is kind of neat.  The neighbor owns it and just used it for a place for his kids to play as they grew up.  They have since left the house and now he doesn't use the lot, so there was only a small tool shed on the lot to demo which didn't cost very much.

From a technical perspective, you can sign a profit sharing agreement or form an LLC with an operating agreement that contains the profit splits.

It's going to be hard to get a seller off title too, but if you don't then they can hold your sales price hostage.

I do not like keeping the seller in the deal at all.  Even if you write out all of the control so that you run the show, it can be very problematic.  Sellers are likely to be emotionally invested in their property and will want to 'manage' the project.  Unless you are very certain that the seller will stay out of your way, I think you're asking for a headache.

I did this once, and I will never do it again.  The deal that I kept the seller in is my benchmark bad deal.  Whenever I think something is going wrong in a deal, I just think about the deal where I kept the seller in it, and the problem de'jour melts away by comparison.

It ended up making money, but was such a stressful drawn out drama of arm twisting and posturing that I think I started going gray before that deal finally closed.  So I certainly have some trauma around this scenario which is biased for sure.

Whatever you do, make sure the seller has 'ZERO' control over the project; they just get a negotiated return when you sell it.

Also keep in mind that not all deals have a PPM. In fact I would guess that most small ones don't. If it is friends and family money you still want to have an agreement. This is usually an LLC with an operating agreement, but can sometimes just be a joint venture.

The PPM is mainly for taking solicited funds and deals that warrant the expense that goes along with them.  You can likely reuse your PPM for future deals as well.

@Stephen D. 

There was a convenient turning point in my career at Microsoft.  I had just finished a big project with them and there was some down time around the holidays where I was able to spend more time on the Real Estate business.  Within a few months I was easily spending about half of my time on developing the business and half on keeping my responsibilities afloat at Microsoft.  However at that point I was no longer growing in my career, I was just keeping up.

Then came the next project at Microsoft which would have sent me to China for three months to help start a new factory for one of our device partners.  That would have unplugged me from the Real Estate business for three months.  I think it would have hurt the business in a big way.  I also have two kids aged 1 and 3 which I did not want to be away from for 3 months.  That is 25% of my little guy's life!

Fortunately the timing worked out that we had 4 projects that were exiting at that time which yielded for me about half of my annual salary.  So I figured this was the time to put up or shut up.  I would have 6 months to close another 4 sales which would cover me for the rest of the year.  Seeing as how we have 14 that should finish by the end of the year, there was really no reason not to quit and go full time to help bring those other projects in on time and budget.  My time was officially better spent on Real Estate in terms of yield per hour of work than it was at Microsoft.

@Jason K. 

If you are both signing for the debt, then it seems fair to at least split the leveraged returns 50/50.  However, each deal is different and there are no hard fast rules about how to split returns.  There is an idiom that if both parties are unhappy with the splits then it's a fair deal.  However, ideally everyone would feel they are being compensated fairly once you sign the joint venture agreement or formation docs.  Please formalize your agreements as well.  It may sound hard to believe, but you will forget spit details and writing them down keeps everyone honest.

I also try to take a long term view and sprinkle in some extra for the other side at the end of the deal.  You have to be sure to keep this information a secret until the end of the deal, otherwise they will come to expect it and it doesn't have the desired effect.  This does two things.  One, the other side doesn't expect it, so they are pleasantly surprised.  Two, they will feel indebted to you and want to do another deal. 

Getting the next deal is always more important than maximizing your current one. 

Now only do this if the project went well and you have a good working relationship after 16-18 months of overcoming obstacles.  I've had to fire GCs and partners too, in which case I just try to exit the deal as smoothly as possible.

Expectation management is everything.  Always keep a little in reserve to surprise your GCs, vendors, and partners.  Use the extra to solidify the good relationships and reward work well done.  It feels good to give.  Your partners will be delighted, and you'll have more deals coming to you instead of having to hunt for them.  I promise.

First off everything is negotiable. 

That being said I would structure it based on when and who the value is provided by.  The key points in my opinion are:

1) Finding the deal - This is worth a nice fee.  Pay more if it gets paid on the back side of the deal.

2) Managing the construction of the project - This is your typical GC role.  This is usually a fixed fee or cost plus.  In an investment deal I like fixed fees assuming you are building a spec home.  If it is a custom, then cost plus is more the norm.  Here this fee would be less if paid out during the project, and possibly more if paid at the end.  I have worked deals with my GCs that if they are willing to go without a fee during the project, I will treat it as equity at the end of the deal.  This creates alignment with the capital role and the GC.  It also lowers the overall capital required to get the project done.

3) Raising the capital - This is worth a nice fee too.  Traditionally a percentage of the raise is paid to the person who raises the cash.  *Please be sure to adhere to all securities laws when raising money.*  Investors need to have their expectations managed and kept informed so they don't show up and try to take over your project.

Keep in mind that when raising the money you are going to have to pay your investors.  I'd recommend keeping the deal the same for all investors and keep it simple.  The more complex you make your payback model, the harder it is for people to understand, the harder it is for them to say yes.  Complexity also tends to make people think you're hiding something.

With the above set, you can dial the equity knob to reach a target return for your investors and split the rest between you and your partner however you see fit.

In our deals, we charge no fees.  We only take returns based on project performance so alignment is guaranteed although that is not typical for all investments.

When setting up your proforma, always always ALWAYS under promise and over deliver.  Set investor expectations as low as you possibly can to where they will still do the deal.  Surprises happen.  New expenses show up you couldn't predict.  If everything goes according to plan you should pay your investors back more than you promised.

Good luck,

If you can find the right coach, yes.  Make sure they have a track record and the relationship is mutually beneficial.

Well now that you've called me out, I've really got to throw down.