I’m going to start out talking about a Winner. In a future article, I’ll show you how it can easily become a Loser. First, look at the example below. Not only are modular loft conversions Sydney faster and more convenient but they are also designed and constructed to the highest standard.
Job Analysis – A Winner
Sale Price [Fair Market Appraised Value]
(2,500 square feet X $100/square foot) $250,000.00
Less: Lot Cost – 35,000.00
Less: Selling Commission
(Sale Price X 5%) – 12,500.00
(Hard Cost + Overhead + Contingency) – 160,000.00
Closing Cost on Construction Loan*
($175,000 @ 2%) – 3,500.00
Interest on Construction Loan**
($175,000 @ 6% for 4 months) – 3,500.00
Closing Costs on Permanent Loan***
($200,000 @ 3%) – 6,000.00
Profit $ 29,500.00
Profit/Margin [10% Minimum] ($29,500/$250,000) = 11.8%
* Assume Construction Loan @ 70% of Appraised Value
** Assume Construction Interest @ Prime Rate + 2%
Assume Prime Rate to be 4%
Assume 4 months to build + 2 months to sell
*** Assume Permanent Loan @ 80% of Appraised Value
With the right tools, you can come up with these numbers in a matter of minutes in the comfort of your home or office. I’ll go through this process of determining whether I want to build a home or not, or whether I want to even spend any time thinking about it or not.
Let’s pretend that you come into my office and you say, “Tom, I’ve got a great deal. I’d like us to go in together and build this home. We’re going to get rich!” I calm you down and I say, “Okay let’s go through the numbers.”
Let’s assume that you want to build a 2,500 square foot home. You tell me that in this particular subdivision where you’d like to build, the fair market appraisals are running about $100 a square foot. You found this by talking to real estate agents or you just know the area. The fair market appraisal, as you remember from the How To Build A Home course, is pretty much the sale price. Don’t ever count on selling it for more than the fair market appraised value. So 2,500 square feet times $100 per square foot comes to a total sale price for the home and lot of $250,000.
You now tell me that the lot is going to cost $35,000. So we subtract the land from the sale price and we have a balance of $215,000.
Next we subtract all the different costs we’ll incur. The first is the real estate sales commission, which on new construction, in most areas, is 5%. So 5% of $250,000 is $12,500. Always put a selling fee in the calculations. As I’ve tried to stress to you in previous articles, those agents are going to be working nights and weekends when you don’t want to work. If you sit there and think you’re going to try and beat the agents out of a commission, then you’re being a hog. Remember, pigs get fat and hogs get butchered. Even if you do sell it yourself, nine times out of ten you’re going to split a commission with a real estate agent, because 98% of all homes sold are sold through a real estate agent. So go ahead and factor it in the numbers. If you sell the home yourself, then pay yourself the commission. But it needs to be in these figures.
Next, subtract the direct cost. The direct cost is your hard costs plus overhead plus contingency. Based on estimating manuals, like R.S. Means – Residential Cost Data, which I recommend, or your general knowledge of construction cost you’ve estimated the direct cost to be approximately $160,000.00.
Next, calculate the lender fees. To calculate these fees I’ve made a couple of assumptions. Look at the notes at the bottom of the chart. On average, the lenders will loan you 70% of the appraisal for construction money. So use the estimated appraised value of $250,000 multiplied by.7. That equals a construction loan of $175,000.
To calculate the permanent loan, let us assume you’ll deal with a standard conventional loan of 80% of the appraised value. Multiply the estimated appraised value of $250,000 by.8, and that equals a permanent loan of $200,000.
These are the two loan amounts we will work with.
Go back up the chart and find closing costs on the construction loan. You can verify these numbers with your local lenders, but let us assume that your closing cost will be 2% of the construction loan amount. Multiply your construction loan of $175,0000 times 2% or.02. That equals $3,500 in closing costs on the construction loan.
You now see interest on the construction loan. Let me show you how I calculate the projected interest I’ll be paying. I’m sure there is formula or some kind of software program to do this. I have not seen it. If you come across one, please contact me and let me know. This simple system has always worked for me and I think it should work for you until you find a better way of doing it.
Take half of the f Estimated Construction Time 94 Months/2) = 2 Months
Add the Estimated Marketing and Selling Time = 2 Months
This is the amount of time to Calculate Construction Loan Interest = 4 Months
The reason I only used half the construction time is because when you borrow money you only pay interest on the outstanding balance. So in theory, on day one you’re not paying any interest. And during construction bankers are paying you money via what they call draws, based on the work you’ve completed, and the amount of interest you pay increases. When you have completely finished the home, you’ve drawn all the money from the bank and you’re now paying interest on the full amount until you sell the home. Let us assume that based on market research you conclude that you’ll sell and close on the house in two months. You may estimate this figure based on talking to selling agents in a given subdivision. In some areas you will find companies that can provide this kind of information to the building industry.
The interest rate on construction money is normally the prime interest rate plus 2%. Let us assume that the prime rate is at 4%. 4% plus 2% equals a rate of 6%. Going back to our Winner Chart, take the construction loan of $175,000 multiply it by 6% or.06. Then divide that number by twelve [twelve months] and multiply that number by four [the projection from Exhibit “A”]. This equals $3,500 in construction interest that you will have to pay on the construction loan.
The next item you’ll encounter is closing cost on the permanent loan. If the market is really good and there are a lot of buyers, you may not incur any closing cost on the permanent loan. The purchaser will pay it. It’s a negotiable figure.
But when you begin construction of a home, because of the length of time involved, the market could easily change and you’ve always got to look at the downside. The downside may very well be the builder paying at least 3% of the closing cost on the permanent loan in order to entice the buyer to buy. Take the assumed permanent loan of $200,000; multiply it by 3% or.03 and that equals $6,000 that you, the builder, will pay toward closing cost on the permanent loan. Always expect the downside.
When you subtract all those items from the balance, what is left is net profit, which in this example is $26,500. Divide that amount by the sales price of $250,000 and you see a profit of 13.72%. If that figure is less than 10%, my recommendation to you is “Don’t build it”. Say, “I’m not interested. Go talk about it with somebody else.” Don’t spend any more time on it. In this example, the figure is greater than 10%, so you may be interested and will take it to the next step. What do I do now? Answer: verify as many of my estimated figures before actually spending any money. Verify that it looks like we can purchase the land for $35,000. Check with real estate agents or appraisers to see if it would appraise in that area for about $100 a square foot. If no one can give me some firm figures, I may pay an appraiser a small fee just to verbally tell me what appraisals are going for in a given area. I can call the banks and verify current closing fees for construction and permanent loans. I can verify current interest rates the bank will charge on construction money. If everything still checks out okay then I will now spend money on a set of drawings. I may tie the land up under contract, subject to many factors by which I can get my earnest money deposit back if these things don’t work out. When I get the drawings, I will determine what it will actually cost to build the home. I should know before construction pretty much what the actual numbers would be.
Let’s assume after you do these calculations the profit is below 10% or shows a loss. And for some strange reason, because of the emotional side of this industry, you play some form of mental gymnastics with these figures, you say to yourself, “I’ll sell it myself so I won’t have a real estate commission. I know it won’t cost $160,000 to build. The market is going to stay good, so I won’t have closing costs on the permanent loan. I know it won’t take me six months to build this home and sell it, so I’ll pay less interest.” If you play this kind of game, you’re only fooling yourself.
If you find yourself weak and tempted to do this, you’d be better off to come to Atlanta. Pay me $5,000. Let me beat you on the head with a 2×4 and talk you out of it. Not only would you save thousands of dollars but you’d also save over six months of your life.
If you always figure the downside – then if indeed there is a downside, you’ll come out OK. You can get creative and offer second mortgage financing, or other incentives to sell the home. You can even cut the price, which I never recommend, if you have to.
If the market is good, then you’ll probably earn more profit than we calculated.
When you build a home going in with a slim margin of profit and no consideration for the downside, if the market goes bad, you’re in deep, deep trouble. I know. I’ve been there.
So run through your numbers like I’ve shown you. If it’s a winner, go for it. If it’s a loser, forget it and go to the next deal.
Tom Harrison is the Founder of The National Institute of Home Building in Atlanta, Georgia. http://www.nihb.com Tom is a native of Atlanta and a graduate of Georgia Tech. Tom has taught over 8,000 people how to build their own home without doing the physical work and about 30% of those students went on to become professional home builders.
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