Land Pre-construction produces > 100%
returns
Unlike many people, I have a very broad definition of
pre-construction which can be summarized as follows:
Pre-construction is the pursuit of real estate
projects that offer the opportunity to ride rapidly
increasing prices over time without the need to put
tenants in place to defray costs. Since no tenants are
involved, this opens the possibility to making
investments in locales that are far removed from where
you live.
If you adopt this point of view, then a whole world of
“alternative” pre-construction investments opens up to
you. Today, we are going to look at one specific type
of investment: investing in developing land projects
where baby boomers might want to retire or own a second
home.
Before we get into the specifics, let’s talk about what
all investors want:
·
Low risk
·
Good investment returns; and
·
Minimal use of their capital;
Quite frankly, these 3 reasons are what got me into
preconstruction real estate investing in the first
place. Now let’s see how these might be achieved on a
purchase of investment land that we believe to be VERY
desirable to baby boomers.
Suppose we are considering the purchase of a piece of
property for speculation of future returns. If, like
me, you believe in the impact of the baby boomers, then
you will do 3 things to control your risk:
1.
Carefully select a land project where you are
solidly convinced that baby boomers will want to possess
it at any costs;
2.
Make sure that you believe that baby boomers will
be AWARE of this project in the future do to somebody’s
marketing; and
3.
Manage your finances and investment portfolio so
that if you are wrong and you do take a loss, it is not
catastrophic to you.
For the time being, let’s assume that you have met these
conditions on a pre-construction project and now you are
ready to analyze your returns and your use of capital.
Now we have to resort to hard analysis. Let’s look at
the following ASSUMPTIONS:
1.
The pre-construction land project is assumed to
increase at least 25%/Yr in price;
2.
We plan on holding the land for 2 yrs and then
resell.
3.
$200,000 purchase price with $5,000 in closing
costs.
4.
Annual taxes/association fees of 1%.
Let’s take a look at three cases in a pre-construction
spreadsheet format to how things might turn out under
this scenario.
Case 1: 10% down payment, interest only,
all payments made by BUYER.
Case 2: 10% down payment, interest only,
all payments made by SELLER.
Case 3: 5% down payment, interest only, all
payments made by SELLER.
Cases 2 and 3 require a bit of explanation. There are
some early stage pre-construction land projects
available where the developer will take a percentage of
your purchase price and escrow an amount that will make
your payments for a period of time---- typically 2
years. This means that during your 2 year hold, you
would only pay taxes and association fees. To enter
this in the spreadsheet, we just show a 0% rate during
the holding period.
If you scroll down, you can review the performance of
each case. It may surprise you that even under Case 1,
where you paid in a total of $48,600 out of pocket, you
still see a return on investment of 127%! That equates
to 51% annual return on investment. Compare that to
what your friendly banker is giving you in your CD.
For many investors, pre-construction or not, they would
prefer not to have to put in that much money so let’s
look at Case 2 where the developer has escrowed 2 years
worth of payments. In this case, we invest a total of
$29,000 with a total, out the door profit before taxes
of $81,625 thus providing a total return of 281%. If
you then extend that to Case 3, where only 5% down is
required, then the return goes off the charts.
The biggest variable here is our assumed appreciation
rate: we choose 25%. Of course this depends on the
general market, the local market, the project, etc. and
NOBODY can predict this going forward. So what happens
as the assumed level goes from -5%/Yr to 50%/Yr which
hopefully will be a good bracket. The chart below shows
the results.
In the very near future, there will be some
opportunities on pre-construction land similar to what
is described here. If this type of investment may be of
interest to you, then your job becomes deciding these 3
factors:
·
Is it low risk for YOU?
·
Is it good investment returns for YOU?;
·
Is it an acceptable use of YOUR capital;
To assist, we will try to present enough information
about the project/locale to for you to assess your own
risk and projected growth rates: what you assume may be
quite different from what I assume and that is ok.
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