Townhouse development opportunity - good deal?

[Jill]

OK, I'll admit I'm venturing into uncharted territory for me. I've been talking with my next door neighbor for some time about going together to develop some kind of rentals. She's a high-end SFH building contractor. She has a little extra cash, we have a little extra cash. A friend of hers stumbled onto some land in a small town near here that is anxiously looking for a buyer. I think we can get it for less than $15K/acre. Our idea is to build "A" or "A-" townhouse-style apartments to rent out.

Facts to consider:
The market seems to be hungry for nicer properties. Her friend says that there is a waitlist for his townhomes, but he has no more cash to expand.
Growth in the area is slow and steady - about 2%/yr. But there are several small colleges in the area, two industrial parks and a couple of medical centers (one of them new)
Build cost, including land, would be less than $40/sq ft., for a 1000 sq ft apt,
so max of $40K/door. This translates roughly to $400/mo mtg (PITI) (w/ 20% down)
Rents are currently approx $1200/mo for comparable properties.

It appears to me, that even after management, maintenance, marketing, misc, that this is a no-brainer, mainly because we're "buying" at wholesale.

My only flashing red flag is the fact that over 30% of the townspeople are employed by one company. So I'll def be doing some serious assessment of that company. But even at 50% occupancy, it would still work.

What am I missing?

 

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[hatterasguy]

Your building costs are cheap in TX, up here they would be all of $60 a SF. We have to follow a ton of expensive fire and hurricane regulations though.

Sounds like a good deal if you can rent them all.

 

[Jill]

Cheap labor, for sure, although our builder (neighbor/friend) is going to have to reel-in her tendencies because she is accustomed to using the best-of-the best. But even at that, she can do $70/sq ft.

I just don't see much of a downside. We're targeting young professionals or young families who want a nice place with a SFH feel, with the yard and all, but can't yet manage a mortgage. $1200 should be do-able. But even if it's not, $1000/mo/unit still works.. and works well!!

 

[biophase]

I'm confused. First you mention high-end units and then you talk about 1000sf units for $40,000? I'm picturing row style townhomes with a 1 or 2 car garage on the bottom floor? Maybe my idea of high end or nicer units is different than yours? $40/sf does seem low. How many units are you talking about building?

 

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[Jill]

Probably 15 to start. After we get those filled, then 15 more, etc. The available land will hold around 100 units.

Well, I used the term "high-end" when reference the type of properties she typically builds. However, we're looking at probably "A-" props with tile instead of hand-scraped hardwood floors, solid paint rather than faux treatments, one elevation with shared walls, and simple roof lines, granite-LOOK laminate countertops as opposed to real granite, etc.

Remember, this is a dear friend who is not looking to profit on the build.
Does that make more sense?

 

[hatterasguy]

A high end condo in my neck of the woods starts at $1m.

"Low income" are $200k-$250k.

But the low end is where you want to be in this market.

 

[andviv]

Two concerns...

Schedule. Making sure they are completed on time and to specification (sorry, the PMP in me talking here)

Management. Who would manage the properties?

Also, the cost seems too low. Right now A- properties, ~10yrs old in the Dallas area are going for probably ~$80K per door, based on the few data I've seen. If building new product were that cheap then it means there is a big disconnect in the market in that area, and I'm not sure that is the case, given the boom the area is experiencing. Please take this with a big grain of salt as I haven't studied that much the Dallas area, so do some research about that, just to check.

 

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[Jill]

WOW!!! This is actually very exciting to me! I know this market pretty well, as a consumer. A decent house in a decent neighborhood will sell for $80/sq ft. A nice house in a nice neighborhood will sell for $100/sq ft. A Super-Luxury home in an Exclusive neighborhood will sell for $200/sq ft. Most people who visit our home think it's a "luxury show home". We could prolly sell it for $100/sq ft right now. Altho my friends from the bay area swear that it would go for $600-800/sq ft out there. Location, location, location as they say.

Yet, this builder friend of ours said she could easily build it for $70/sq ft, or less.

So maybe there is a disconnect between what I consider A- quality. Also, bear in mind that I'm not talking about Dallas proper for this opportunity. This is a little town about 30 miles from Dallas. e.g. a retail priced building lot will sell in suburbia for $40-80K (for 1/4 - 1/3 acre). We're looking at $12K/acre. That helps too!!

And Andviv, you're probably looking at retail prices/door. There aren't nearly as many fire sales in this part of the country as others right now. So retail prices aren't very discounted.

 

[SteveO]

1000 sq ft for 40K/unit brand new sounds attractive. Giving something a classification is fairly tough. An "A" property to me has amenities. Garages would definitely be a plus. Swimming pool, fitness center, wireless business center, are all items tht I associate with "A" buildings. I don't know what types of restrictions that the city will put on you but they usually have some requirements.

Since the property would be new, maintenance might be light for a few years. But, some repairs will need to be done. Don't forget about property management and landscaping. Insurance is a different animal on multi-family. Get some quotes. There will need to be an office for management once you get over a certain number of units. There will need to be a staff including leasing and maintenance as well.

While I am not sure of the costs for a property that is new, you can ballpark it between 3000 -5000 per unit, per year.

Construction loans are probably not going to be your best interest rate either. You might want to get some quotes here as well.

If the units can be built for that price though, it sounds like a sweet deal.

 

[Jill]

I'm only looking, SteveO, because you haven't found me any more opportunities!!!!

Thanks for the input. What were you referring to here:

While I am not sure of the costs for a property that is new, you can ballpark it between 3000 -5000 per unit, per year.

Are you areferring to maintenance, management, etc?

 

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[SteveO]

I'll tell you what....

I have been looking far and wide for a deal. Offers are constantly out. I am working with banks, agents etc... I only want to take down something that works.

The expenses that I gave are generalized and should cover everything from insurance to office supplies. I have not done any evaluations on newer properties for expenses though. The range is very broad but I would suspect that the expenses (not including debt service) would fit inside of that.

 

[SteveO]

Oh yeah. You should always be looking for opportunities!!! :smxG:

 

[Jill]

Oh yeah. You should always be looking for opportunities!!! :smxG:

Oh, I am. It's just so much easier to invest with you!!!

 

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[Edge]

My only flashing red flag is the fact that over 30% of the townspeople are employed by one company. So I'll def be doing some serious assessment of that company.

Is the company a publicly traded company? If so, this is the easiest risk to manage in your situation.

You could maintain an armageddon type option position on the company that would pay like a lottery ticket if something happined to the company. Cheap insurance.

 

[andviv]

Is the company a publicly traded company? If so, this is the easiest risk to manage in your situation.

You could maintain an armageddon type option position on the company that would pay like a lottery ticket if something happened to the company. Cheap insurance.

OK, Edge, as usual you bring new concepts for me... what is an Armageddon type option position?

 

[Jill]

That's brilliant, Edge, offsetting a real-estate risk with a securities option.

Yes, they are a Fortune 500 co. I may be asking you more about this. My only concern with this scenario, tho, is that oftentimes a company's stock will actually go UP when they layoff employees because the perception that the decreased salary expense will result in greater profits...

 

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[Edge]

OK, Edge, as usual you bring new concepts for me... what is an Armageddon type option position?

Armageddon, you know, like the company blows up, goes BK.

I was just pointing out the she could structure a positon of options (on the security of that company) that would pay out a lot of money if the company went bankrupt.

She identified the health of that company as a risk to her real estate holdings. I am just pointing out that that is an easy risk to hedge. You could think of it as cheap insurance, instead of insuring the real estate against fire or hurricane, you are insuring it against what you think the impact would be of the major employer going bankrupt.

 

[Edge]

That's brilliant, Edge, offsetting a real-estate risk with a securities option.

Yes, they are a Fortune 500 co. I may be asking you more about this. My only concern with this scenario, tho, is that oftentimes a company's stock will actually go UP when they layoff employees because the perception that the decreased salary expense will result in greater profits...

Yes, smaller restructuring type layoffs can increase stock price short term. Long term either the companies financials continues to improve and they start hiring again, or they layoff more again and investors identify the downward spiral.

I'd think it would be the downward spiral toward bankruptcy that you'd be concerned about. If the major employer does smaller layoffs that improve the overall health of the company long term, I don't think that would really impact the demand of your rentals. It's all about confidence in said company.

I think i've talked about it before also, but I think it makes a lot of sense to hedge exposure to large real estate holdings through derivatives of either local companies or commodity prices. How many areas can you think of where vacancy is dependent on the oil/gas exploration industry. Wouldn't it makes sense to hedge real estate holding in that area with short oil positions?

 

[andviv]

I get it.

I thought the armageddon-type was a well-defined structure and sounded new to me. Thanks for the clarification, and Rep++ for such a great suggestion.

 

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[Sid23]

Jill,

Is the $40/sf to build the "hard cost" or the "all-in" cost which includes land, soft costs (architects, engineers, landscape consultant, lighting consultant, interior design, legal, insurance, etc), environmental testing, plan review fees, municipal fees, school fees, fire/water/sewer fees, city permitting fees, etc.

In my area, it's well over $40/sf just for the land and the all-in price to build one apartment unit is about $250/sf and a condo/townhouse unit is well over $300/sf.

And your friend is willing to take the risk of building all of these townhomes for no profit? What type of GC fee are they taking? Why would they take on that much liability for no profit? I'm not sure of the laws in TX, but here the GC is liable for 10 years after construction and developers and GC's must carry insurance on every project for 10 years after its done.

I'm not sure how you only need to lease 50% of the units to make money (I've never seen that before), but if so, that's pretty good deal. We're usually looking at leasing 85-90% of units before turning a profit. On condos, we're usually selling 90% to break even and making the profit on the last 10% sold.

And Andviv asked a VERY important question, who is going to manage this development process? There is lot of many to be made, but MANY pitfalls in development as well...

-Sid23

 

[Jill]

These are all great questions. I'll try to answer them to the best of my knowledge.

Jill,

Is the $40/sf to build the "hard cost" or the "all-in" cost which includes land, soft costs (architects, engineers, landscape consultant, lighting consultant, interior design, legal, insurance, etc), environmental testing, plan review fees, municipal fees, school fees, fire/water/sewer fees, city permitting fees, etc.

In my area, it's well over $40/sf just for the land and the all-in price to build one apartment unit is about $250/sf and a condo/townhouse unit is well over $300/sf.

But don't you live in the Bay Area? The most expensive real estate market in the country? $40/sf for land is insane. The land is rolled into that cost because as I said in the original post, it looks like we can get it for under $15K/ac. Cosmetic stuff is a non-issue, really. If the big lighting, plumbing, landscaping folks want her business in the future, they'll provide free consultation. Not sure on architect, but will ask. WRT fees, are you talking about the ongoing propery taxes? Or just the build-phase?

And your friend is willing to take the risk of building all of these townhomes for no profit? What type of GC fee are they taking? Why would they take on that much liability for no profit? I'm not sure of the laws in TX, but here the GC is liable for 10 years after construction and developers and GC's must carry insurance on every project for 10 years after its done.

I didn't say she wouldn't profit. She just won't profit on the BUILD OUT. We would both be investors and share in ownership of the property.

I'm not sure how you only need to lease 50% of the units to make money (I've never seen that before), but if so, that's pretty good deal. We're usually looking at leasing 85-90% of units before turning a profit. On condos, we're usually selling 90% to break even and making the profit on the last 10% sold.

Right. But if my monthly mortgage ~ $400ish/unit and my rental income is $1200/unit . . .

And Andviv asked a VERY important question, who is going to manage this development process? There is lot of many to be made, but MANY pitfalls in development as well...

Another great question. We haven't ironed out the details yet. But she's a professional GC. She's been buggin' me for the past year to come shadow her so I can learn what she does, because I've expressed so much interest in it. So it will be management-by-committee for the most part, but we will defer to her professional expertise when the situation dictates.

OK, now I'm getting a little nervous about telling everyone how cheap it is to build here. You guys would HATE the weather!! REALLY, really hot summers. Big mosquitoes. Huge.

 

[Jill]

OK, I'm looking at this deal again. I got a little nervous when the economy started tanking SOooo badly and thot I'd better keep my own little bitty nest egg in cash. I've been out to see the land, and have a few more answers to y'all's great questions, in no particular order.

The architect is .50/sq ft. We would only pay this once, as each subsequent phase would likely have the same floor plans.

Environmental fees - GC has a guy she sends dirt samples to before breaking ground. Not costly. (Again, Sid, remember that Cali has BY FAR the most expensive and restrictive environmental laws of any state in the Union, as I recall.)

Other fees - I haven't looked at other fees yet, but from what I can see, both the fees and RE prop taxes seem to be in line with any other small town around here.

Management - Thru the build phase, we will manage-by-committee like I mentioned earlier. After it's built, then we will turn day-to-day management over to a professional management company. In fact, the friend of hers who built some of his own there first is interested in managing these for us, as well. Economies of scale should come into play a tad bit.

Financing - My GC typically uses an "angel" investor for hard money loans, then just pays her out of the profits. It's a sweet deal, because she can just call her and say, "I need $40,000 later this week to pay for the stone. It's in her acct the next day. BUT, she takes her juice from the sale. Since we're going to hold these for at least a little while, then I'm not sure how she'll do it. I, on the other hand, plan to just pay cash for the land. Then if I have trouble getting financing, I'll just pay as I go. If that means I have to sit on the land for 6 months before breaking ground, then so be it. Hopefully after Phase I is up and fully occupied, then it will be easier to get the financing.

Land - I was delightfully surprised by the location. It is not facing the service road of a major interstate, but is set off, behind the buildings that face the service road, if that makes sense. Across the street is a horse pasture. Behind and beside are what I would consider B- or C apartments. This is near a part of the Interstate that is recently built up with major box stores, Walmart, Home Depot, Best Buy, etc and lot of fast food. It is the freeway that goes thru the fasteset growing area of Dallas right now.

The purpose for my logging on today was to see if I could find of the spreadsheets that you MFH folks use for your analysis. If not, I'll build my own. But I figure you've already thot of everything, so might as well leverage that if you're in the mood to share! Hope to have it ready to review with some of you more seasoned investors at Beer And Pancakes next month! (I'll buy the pancakes!)

 

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[andviv]

very cool seeing you moving forward.

By any chance, do you know if the land used for horse pasture is for sale, and how much they want for it? Maybe you can scoop that one as well for a decent price, and then you can not only develop the community but also can come up with a service needed in the area that gives your community more value (a small mall, a self-storage unit, a carwash, I dunno).

 

[hatterasguy]

My only concern would be the managing in commitee part. I havn't done one of these before but my gut tells me that could possible cause problems. If all the partners don't agree on something, or if one person gets pissed off. I don't know, but I would be carefull at that part.

IMHO I would prefer silent partners who just want it done.

 

[Jill]

Thanks guys. Actually Andviv, I hadn't thot of that, because I thot it was kinda quaint to have the horses right by what would be the entrance. But I HAD thot of keeping me eyes on the older apartments that are adjacent, just in case they became available. Either raze them or re-model to match our elevations or such.

Hat ~ I would tend to agree with you. But the "committee" I'm referring to are myself, my husband and our next door neighbor who is VERY laid back and one of our best friends. Both of them trust my business sense. And both of us trust her building expertise.

I want to crunch the numbers, do a little more research about the area, and talk to the other guy there who has built smoething similar. But it LOOKS as tho a lot could go wrong, and STILL positive cash flow. I just need to prove it to myself, as much as is possible.

The comes the fun part - learning about construction loans to see if that's an option.

Are there any spreadsheets posted on here somewhere that you guys use for MF?

 

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