What are the pros and cons
The following article was provided by RCN Capital
In recent years, a pressing question has come to the forefront of investors’ minds in the real estate investment property finance industry. Should I invest in existing real estate or turn to the appealing option of ground up construction?
According to an article on Forbes.com, “On a new development, there is a much faster “recapture period” (the length of time it takes to regain your initial investment). Once the construction is completed and the building is leased up, the developer can get a new loan in order to capture all its equity.”
This is certainly a positive aspect of ground up construction but there is so much more to consider between the two options. The pros and cons must be considered before any investment, but here are a few of the most important ones for investors trying to decide what to do for their next project: existing real estate or ground up construction.
New ground up construction – pros & cons
There are plenty of pros when it comes to investing in a new ground up construction build. The investor/builder may have their own vision for a property they’ve always wanted to build and a ground up construction loan can allow them to fulfill that. Ground up construction allows a builder much more freedom with the clean slate of a new property rather than rehabbing a property that is already in place and just needs a few repairs. This room for creativity is appealing to investors because the house can turn out exactly how they want it to. They may have to conform locally to properties in the area, so their new property doesn’t stick out and impact the resale but picking every aspect of the house they are about to build is still exciting.
Speaking of houses to conform with, there is also an advantage to ground up construction that investors can take advantage of in relation to the nearby properties. With a neighborhood already in place, the investor has numerous examples to base the After Construction Value off, so a valuation of the property is much less stressful and much more accurate. This relates to that recapture period that was previously mentioned. Having an investment property close in value to the rest of the neighborhood helps an investor recoup their money that much quicker to collect a profit or move on to their next investment.
An often-overlooked strategy in the ground up construction process is what the investor will do with the property after its built. So much time and energy go into the build process, and rightly so, but as an investor, you now have a brand-new beautiful property to take advantage of. The “build-to-rent” strategy allows for more control from the investor, and they can set their rents at whatever price they see fit. They need to keep in mind that they’ll need to secure a tenant for the property to cash flow, but on a brand-new property there is a high ceiling for what the investor can charge. These brand-new builds can be the most attractive when it comes to finding a renter.
The last pro we’ll discuss in accordance with new ground up construction strategy is the fact that the builder would get more time in relation to investing in existing real estate that needs rehab. Usually, lenders will start their ground up construction loan programs at 18–24-month periods. This allows the builder up to 2 years to complete a ground up construction build which should be more than enough time for someone to create their dream investment property. Also, lenders such as RCN Capital, offer extension options to ensure the investor has all the time they need. This way, they don’t feel rushed, and the property comes out exactly how they planned it.
Not everything will work in favor of the investor when it comes to ground up construction. There are a few cons to consider when choosing a new build. It shouldn’t deter investors from the appeal of ground up construction, but they should be prepared for these potential roadblocks and game plan accordingly.
First, the planning process for ground-up construction is much more intense. There is a lot to do ahead of time before a hammer and nail can be picked up to start the build. Investors will need architectural plans, entitlements, and permits in place prior to the build. There is a good amount of red tape to get a new construction build approved in a town, so just be prepared to roll up your sleeves and get your ducks in a row before the build starts.
Although investors have more time to build, there is more room for error in a build process. With existing real estate, a lot less can go wrong because sometimes only a few aspects of a property need to be rehabbed as opposed to everything needing to be built. Storms or natural disasters can wipe out progress, so getting a home to the “weather tight” checkpoint is a big step for investors. Navigating the build process is important. A common practice used by builders is to plan for the unexpected, meaning that they increase their budget and give themselves more time on the back end in case something does come up. On an 18-month term, plan to have the house built in 14-months in case something was to push back progress. That 4-month buffer could be the difference between completing the build on time or not, so planning for it just in case is crucial.
The last aspect that could be a con is the fact that labor and material costs fluctuate. To complete a build, labor and materials are the two most important aspects. Depending on market conditions and inflation, these costs could be higher than an investor wants to pay for them but might not have a choice if they want to complete the build on schedule.
Existing real estate – pros & cons
When deciding between new ground up construction and investing in existing real estate, there is one glaring pro in favor of the existing real estate. The hard work is done, and the house is already built. The stress level of any project reduces immensely when the property is already in place. This allows an investor to either rent out the property in its current condition and seeing cash flow quickly or be able to make a few minor adjustments and repairs to give the property a face lift and increase the rent after they are completed. The road to seeing a profit is much shorter for investors when they choose existing properties.
Another pro for investors when investing in existing real estate is experience can be gained at a much quicker rate. Experience plays a huge part in rates and leverages for investors, so if they can complete four fix and flips in the same amount of time it takes them to finish one ground up construction build, that gained experience could be much more appealing.
Besides experience, approval from lenders is easier when dealing with existing properties. For a lot of lenders, experience is imperative if they are going to lend on a ground up construction build. However, for long-term rentals or fix and flips, new investors will regularly get approved if they choose to invest in existing real estate.
Investors must also consider the fix and hold model as a serious pro rather than confining themselves to a fix and flip. When investing in existing real estate, there are so many possibilities and routes to financial gain. The fix and hold model is growing in popularity. With the fix and hold, renovations can be funded by a lender, the work can get done on time and then the investor can increase the rent they charge on the property. This jump in rent can be significant and can transform a property that wasn’t hard to acquire into a cash cow for investors. With a new construction build, an investor is locked into the rent they charge initially for a while and there is not much room to enhance the property and charge more in rent.
Like any real estate investment strategy, there can be cons when investing in existing real estate as well. It is worth noting that these cons are not deal breakers, but worth considering when you are devising a strategy as an investor.
The first con is a lack of freedom when compared to a new ground up construction build. There is a lot less room for creativity in an existing real estate property. The house has been built, for the most part the design and model of the house has been decided. An investor can change that, but sometimes it is not worth that hard work and intensive labor when new countertops and windows can be a much quicker route to profit. So not only is there less room for creativity, but it is also stifled to make money as quickly as possible.
An additional con when it comes to investing in existing real estate is the time frame in which an investor must make repairs and stay on schedule and on budget. These 12-month terms should usually be enough time, but the extra months that ground up construction builders are afforded works in their favor. It is important for investors to always stay on schedule. Not being able to complete the necessary rehab on a 12-month term hinders their profit and puts a damper on their growing portfolio. The goal must always be to complete the work on time, pay off the loan, and look for potential buyers or renters to work towards making a profit. Just be aware of that shorter time frame for existing real estate and avoid it becoming an issue.
For the last con of existing real estate, we can find some common ground with the ground up construction. Much like ground up construction, making repairs to existing real estate relies heavily on labor and materials. The current market will always dictate those prices, so an investor could be stuck paying what the current rates are. Market research is crucial, and if the labor and material costs will sink the potential profit of a fix and flip, transition their strategy to invest in existing real estate that is in rent ready condition can be a solid move to avoid this potential con.
There are always going to be pros and cons when it comes to real estate investing no matter what strategy you are looking to employ. The key for the best investors is being aware of these pros and cons and game-planning accordingly. Being able to pivot between strategies to survive in the business when the environment gets a little tougher is vital for successful investors. New ground up construction as well as investing in existing real estate are both proven avenues to success. It all comes down to the investor. How much work they are willing to put in and how prepared they are for potential issues should determine which strategy they want to use. Have any more questions about real estate investment strategies or loan options? RCN Capital is always here to answer as we’re just a call away!