The answer to what a builder will pay for a lot or a teardown is not as black and white as it may seem. There are many factors involved, including issues that add to construction time, typical construction costs and addition soft costs.
Let's say, for example, your property is in a municipality that takes six to eight months for city approval to demolish. That is far different from a city willing to move forward with no conditions in two months. Builders typically use hard money or investor-pooled funds that cost them anywhere from 6 percent to 9 percent interest annually. Downtime is extremely costly and eats significantly into profit.
Now let's examine the influence of neighborhood associations or neighborhood committees. They may call for architectural conformance or compliance, or a coastal commission review. This can cause delays up to a year or more. Neighborhoods can vote to limit construction size, impose moratoriums and add criteria for remodeling, causing the need to modify building size and so-called envelope specifications, and ultimately causing a diminished selling price and profit.
The calculations are pretty simple. A developer's profit is the spread between the price it costs to build per foot (including land, interest, architecture, permits, incidentals, real estate commission, other closing costs, etc.) and the selling price per foot, based on the size of the newly built home. If a proposed new property projected to profit $700 per foot is suddenly diminished in size by 600 feet because of a neighborhood-imposed restriction or zoning change, that could result in profit loss of over $400,000. If not factored in from the beginning, this could cause a builder to lose everything.
Typically, calculations for a desired profit are figured on an annual basis. For simplicity, it is easy to think a project will take one year from start to finish. But what happens if delays occur, say, because of rain, yet another possibility? If the project takes 18 months before funds are returned, there are an additional six months from which the expected return must be calculated.
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If a typical return is 20% annually and the project goes six months over, the annual return is diminished to 13.333%, which is unacceptable to most investors. Not only do delays cost money; there can also be lot and soil conditions that require the construction of footings, retaining walls, extra steel, extra concrete, extra weatherproofing, deeper trenching, additional retrofitting and supports, all of which add to material cost, labor cost and time.
The easiest projects to build are flat lots with no risk of city or coastal intervention. Cookie-cutter floor plans with no expansive, open spans between studs ensure less steel. Avoiding hillsides and sloping lots will lessen the concern for retaining walls and extra engineering.
After all of this is behind us, it is pretty simple to assess value looking at sales of similar comparable lots. Views will add value, as will homes in good public school districts, on special cul-de-sac streets or in trendy locations where residents can walk to coffee.
One big thing to remember that is often forgotten: The lot size is a huge consideration because it will limit the size of the home that can be built. The bigger the new house, the more feet to figure the spread for profit. If the builder builds for $800 a foot and sells for $1,000 a foot, he is making $200 for every foot. You can now understand why developers want to build every foot possible.
For more information, please call Ron Wynn at 310-963-9944, or email him at Ron@RonWynn.com.
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