20-Minute Residential Construction Deal Analysis
Analyze deals in the time it takes you to read this post
My craft is residential construction. I've told this tale many times before, but our process consists of purchasing land, building on it, and renting or selling it. Rinse, repeat.
It's a recurring set of actions, which means I deal with a recurring set of problems.
Among those are
Deciding where I will build
Finding the specific land I build on
Researching market sales and rents
Verifying zoning
Looking at flood zones and wetlands
Estimating my construction budget
Finding the best spot to eat after visiting the sites
You get the point.
Acristo Engine
In January of this year, I called my friend Jose; he is a programmer by nature and knew absolutely nothing about real estate development.
Me: "I need to build an app to help me budget my deals better."
Jose: "What do you mean by deals?"
Me: "Well, I build houses, and I need to estimate each individual cost and get an idea of how much the home will cost to build and how much money I can earn from it."
Jose: " You build houses?"
We began working daily and added a few more programmers to help with different components. Jose and I worked on the deal analyzer while the others worked on features that would seamlessly address the problems above.
One thing about Jose is that he doesn't shy away from any challenge, even if he's not an expert.
Me: "How do you think we can connect ChatGPT to this thing to get fast interpretations of building code information for these properties?"
Jose: "It's a black box; we just have to open it."
Black Box: a system or device whose internal workings are unknown or inaccessible.
Over the months, we've developed software to help real estate professionals speed up processes during the tedious task of due diligence.
Hello Acristo Engine.
This "engine" software that my team created is a cure-all for the tasks I outlined above and more. In fact, we were able to adjust its uses for many more situations and make it work for anyone within the U.S., whether you're in Florida or Wyoming.
This is where Wyoming is located, for those wondering.
The software is yet to be finished, and I'm not looking to sell anyone on this post. It's still cooking in the lab. Once it's ready, you will hear it here first.
We plan to roll it out to select users first and then give full access to all. There is a waitlist, which you can get on for early access at this link.
Back to the main point of the post
I want to show you how to analyze a new construction deal quickly. Use the Engine, and you can do so in the time it takes to read this post. However, many other tools can help you do the same (just not as fast).
Step-by-Step Walkthrough
Land Selection
The first thing you want to do is identify where you will build and ensure you can build on it.
The last thing you want is to buy a piece of land only to have the building department tell you no.
This is our process for quickly identifying suitable land:
1. Market Research and Location Selection
Identify the Market: Choose the market you want to build in.
Determine Lot Type and Location: Decide on the type of land and the location for construction. If you're building homes, you want a piece of land to build residential projects. Many tools are available to help you find this information, but when in doubt, just call the building department.
2. Analyzing Selected Lot
Once you find a few potential properties suitable for construction, you should perform additional checks to ensure there are no red flags.
Ensure Compliance: Confirm the lot meets the new residential property construction requirements.
Lot size: Make sure the lot is big enough for the type of project you want.
Parcel number: Preserve this number; you'll need it later.
Land Use/Zoning: This defines the specific standards for how land is to be developed. If you're building a home, make sure it's residential.
Evaluate Lot Characteristics
Flood Zones: Will add additional costs. Check with FEMA and the county to ensure your property is not in a flood zone.
Wetlands: Same as Flood Zones, wetlands can be a pain in the butt to deal with. Try to evade deals in wetland classified zones.
Check Out the Space: Use street view to look for utilities and get a feel for the area.
3. Sales/Rent Research
A crucial part of the analysis process is determining how much you can sell or rent your property in the current market. We would like to look at properties comparable to the ones we will build.
Determining Potential Sales Price
Define House Type: Decide on your house specifications. What will you build? (e.g., 1,200-1,400 sq ft, 3 bed, 2 bath).
Find Comparable Sales: Search for properties sold in the area with similar characteristics to estimate the selling price.
Square footage (within 10%)
Bedrooms
Bathrooms
Year built (within ±3 years)
Estimate Sales Price: Use the data from at least three comparable homes and get their average sales price to determine your estimated market value.
Determining Rental Price
Research Market Prices: Finding rent comps is the same process as finding sales; the only difference is that you will want to look at rent prices instead of sales. Additionally, HUD provides some rent suggestions for each county in the country that may help you get a better idea.
4. Analysis
Okay, you now have a target property that you want to build. The next step is to estimate and compare all project costs to your target sales or rent price.
Our process involves finding the puzzle pieces and putting them together. Below is all the information you need to gather before running your complete analysis
Land Costs
Market Value: The appraised value is based on comparable sales. This is the sales price from earlier. Go with your best guess.
Land Purchase Cost: The cost of the land.
Land Closing Costs: Legal, title, and city fees during purchase.
Construction Costs
Scope of Work (SOW): Define the scope as it will form the bulk of expenses. Lenders also like to see an organized SOW with all costs included.
Hard Costs: On-site costs like materials, labor, and equipment.
Soft Costs: Off-site costs like design, permits, and legal fees.
Financing (if applicable)
Loan Amount: Typically, a percentage of the appraised market value. Usually, no more than 70%
Loan Closing Costs: Fees for loan origination. This will vary from 3-5% of the total loan amount.
Monthly Mortgage Payments: Calculate the total monthly payments. It will vary from loan to loan.
Draws: Construction loans are provided in stages (draws), with fees for each draw.
Total Financing Costs: Loan closing costs, monthly mortgage payments, and draws added up.
Investor Considerations
Investor Returns: Calculate returns for debt investors (fixed return) or equity investors (based on deal performance).
5. Exit Strategy
An 'exit' refers to how you will get paid for the deal. With a new construction project, you can decide to keep the property as a rental or sell it.
There are costs associated with 'exiting'; this is when you calculate them.
Sales
Sales Closing Costs: Include fees like land closing costs and realtor commissions (typically 8% of the market value).
Holding Costs: Expenses such as utilities, landscaping, and other maintenance while the property is on sale.
Rent
Income: Estimate rental income based on market research.
Expenses: Include insurance, taxes, maintenance, and property management fees.
Refinance (if applicable)
New Loan:
New loan amount: Typically 60-80% of the market value.
Interest: Fluctuates depending on the market
Term: Typically 30 years
Monthly Payments: Calculate monthly mortgage payments plus expenses to get your total monthly payment for owning this property.
6. Interpreting the Numbers
The most important thing for us is determining our return on investment (ROI) for either scenario. To do this, you must have all the numbers from the past sections and arrange them to give you the ROIs.
Key Numbers to Know
Gap Funds: Total Project Cost - Construction Loan
If you paid all cash, then your gap funds are the whole deal amount
Your Gap Funds: Total gap funds minus investor funds.
Total Project Cost
Land cost + land closing costs + construction costs + financing costs + investor profits
Interpreting a Sale
Net Profit: Market value - (total project cost + sales closing costs + sales expenses)
Sales ROI: Net Profit / Gap funds
(aim for >25%)
Interpreting Rent
Money In the Deal: New Loan – Construction Loan – Investor Money – Investor Profits – Your money in the deal
Note: Yes, this number is probably negative. That means you need that money in the deal to own the property. If the number is positive, you have some leftover money in the deal; excellent job.
Rent ROI: Annual rent profit /Money in the deal
(aim for >12%)
Real Estate is a Puzzle
There you have it—a quick n' dirty analysis. We do hundreds of these a year. I liken this process to a puzzle where you rearrange several pieces to make them cohere. Is your ROI low? See what pieces can be scrambled to get your target ROI, such as lowering costs during construction or raising rents.
A mentor once told me that if you have to work too hard to make a deal work, it's probably worth skipping. Take that with a grain of pepper.
Cheers,
Adan