Are You Prepared to Take Advantage of the Slowing Housing Market?
As America faces a housing inventory shortage, many investors are wondering, are we ever going to get back to normalcy? There unfortunately is no short answer. In fact, experts have been trying to figure this out since the financial crisis in 2008. America is still recovering from this crash as fewer homes were built within that decade than in any decade since the 1960s. So the problem is not only today’s market, it’s the recovering market we have been dealing with for nearly 15 years.
Supply fell to a record low of 910,000 units in December of 2021, down 18% from the previous month and 14.2% from a year ago, according to the National Association of Realtors (NAR). And because of this, demand has risen, resulting in skyrocketing home prices that continue to climb. But instead of getting alarmed, it’s best to start thinking outside the box. Instead of looking for already built homes, which is not an easy route in today’s market, try to look for plots of land that you could do a ground-up construction on. When there is no inventory, make it yourself. A ground-up construction project could be your ticket to getting that investment property you’ve been seeking.
Investing in ground-up construction comes with great rewards, however there are some risks you should consider. Here are some tips to help you get started, before you break ground.
Tip #1: Make Sure Your Developer is Experienced in Ground-Up Construction Projects
It’s important to hire a developer that really understands what a ground-up construction entails from beginning to end. Be sure to interview your developer on all aspects of the job.
It’s best to hire someone who has had a lot of years of experience doing exactly what you need for your project. Make a habit of doing proper due diligence by asking questions:
- How many ground-up projects have they done in the past?
- How many of those have they done in the past 3 years?
- Have they worked in this state before (eg. do they know the unique regulations/building requirements that may be in place)?
- Are they connected to reliable sub-trades?
The last thing you want is to be faced with something your developer is not sure about, so it’s best to be mindful of how experienced your developer really is.
Tip #2: Thoroughly Assess the Memorandum your Developer Generates
When your developer is writing up the memorandum (OM) for your project, be sure to read it thoroughly to make sure they haven’t left out important parts of the underwriting process. Some factors include vacancy rate, project timeline, expense ratio and rent projections.
Tip #3: Evaluate the Entitlement and Environmental Risks
Before you start your ground-up construction project, make sure your developer understands the entitlement and environmental risks of the project. When talking about the entitlement risk your developer or project consultant needs to understand the risk of entitlement because every region in every city has different rules and processes you must follow.
For example, let’s take a look at Los Angeles.
According to an analysis done by Berkeley Law, Los Angeles allows for development of five or more units up to a 49-unit threshold. However, if you were to build a residential development of five or more units, you must undergo discretionary review. This particular rule is unique to the city of Los Angeles, and does not necessarily apply to neighboring municipalities.
When it comes to evaluating the environmental risk it is extremely important to consider if the land you plan on building on was used for industrial purposes. If this is the case, make sure you ask your developer about it and do a Phase 1 study.
The truth is with every project whether you’re doing a fix and flip or ground-up construction there are risks to consider. However, in today’s real estate market, spending your time, effort and money on a ground-up construction may become a better investment and is one way you can take advantage of record low housing supply.