THINKtank - Investing in New Construction
Panel of Experts
By Jeff Cornelius - September 5, 2019
On August 27th, we hosted another full house for our THINKtank: Investing in New Construction. We had a great audience of guests ranging from realtors to investors to developers that made for a dynamic Q&A and conversation. Our esteemed panel consisted of Justin Cooper from Pine Financial Group, Gilda Zaragoza of Invalesco Real Estate and Ben and John Henry from Henry Development.
Below, we’ve attributed answers with the initials of each panelist who addressed the question and summarized their answers for purposes of this post.
Q. What do you first do when you are evaluating a piece of land or a deal?
JC. The Big 3. Purchase Price, Construction Costs, Sales Price.
GZ. One of the things that will help you the most before you ever get to a deal stage is being well-connected. Finding out about off-market deals, especially in a hot market like Denver, is a great start to setting up a good new construction project.
JH. What is the end game? I look at where the competition is priced. A lot of times you have to start with the end and work backwards. Take your target sales price minus construction, the level of finish, what will the neighborhood support, what is the purchase price of the land or existing home? When you see that profit margin, if it makes sense, then you can go forward.
Q. What are the typical costs do you need to consider?
GZ. The survey. Environmental testing. Soils report. Legal costs – maybe for a party-wall agreement. Then, talk to the GC about their costs: insurance, etc. It’s also important to verify zoning and easements with the city – don’t go only by the listing.
JC. Before we get to contract, must understand the zoning and make sure what you want to build will comply with that zoning. Absolutely key to have an out-clause in the contract in case you can’t build what you want despite the zoning.
JH. You should put your team together early so you’re ready to go when a property you like becomes available. Time is of the essence.
Q. What would a team like that look like?
GZ. An architect, general contractor, lender, interior designer, realtor, surveyor, soils engineer, asbestos tester, abatement contractor. You can also ask this team early about value engineering to get comfortable with the numbers quickly.
JH. The team can help figure out the return rate as well. Some investors must be at 20% ROI so it’s important to understand the numbers up front. A swing of $50-100K could make a huge difference on whether or not you want to move forward.
BH. It’s important to have a contingency as well. If you have to upgrade the water tap, it’s a $6,500 swing.
Q. How much is a good contingency?
JH. If its bank financing, they will require a certain amount – could be up to 20-25%. On a remodel or pop-top, we put $10-15,000 in a contingency.
JC. we like to see 10% of construction costs put aside for contingency.
Q. Are there certain cities that are easier to work with than others?
JH. All the municipalities are different. Denver seems like they take longer, but we don’t see that one city is necessarily easier than another.
JC. If you are in a historic zone or landmark area, you need to pay attention because some of these groups only meet once a month and if you need a quick answer on something, you may not be able to get it.
Q. From the audience. We hear that hard money lenders charge a lot – is that true?
JC. The 100% financing can cover 100% of the Purchase price, the construction and the closing costs, including our points. So yes the interest might seem high but it is a very different loan from a bank, you are getting a lot more money from us and will have a lot less out of pocket at closing.
Q. From the audience. John – how do you work with investors?
JH. We can be hired just as a GC or be part of a deal. Investor clients are different because it’s about their return – you often see this in finish selection, etc. Sometimes we partner with investors and will have skin in the game. In this case, we charge a GC fee to build the home, but it’s often reduced. The % participation varies depend on the project.
Sometimes we’ll find the deal and bring it to an investor to bring them as a partner. Our fees typically range 10-12% of construction costs if I’m just the GC. If the scope changes, we address that and will charge them for that extra work. We don’t do Cost-Plus – too much accounting. We are 100% transparent. We do a monthly draw on the first of each month for costs and fees. We also account for allowances for more savvy clients – they can find the deals on finishes, flooring, etc. - our job is just to install what they buy.
GZ. There are lots of different ways to structure your contract. It’s really up to what you and your GC agree on. You can do a maximum project cost, too.
Q. John - Who does your estimating?
JH. I do all the estimating. We’ve worked with most of our subs for 10+ years. I send projects out for bid and get estimates from multiple subs. We have about 84 line items on our bids. When you work with a GC, it’s important to get as many costs detailed up front – we don’t like to lump things together – transparency on all line items is best.
Q. What types of loans are available for new builds and remodels?
JC. We cover 100% of the costs, up to 70% of as-built value. You must show 15% of total loan amount in the bank to make sure you have money to fund the monthly statements. We look at income as well for a backstop.
GZ. When you are starting, a lender like Pine Financial is critical, but you want to work towards bank financing. My last bank construction loan interest rate was 5.5%.
Q. What kind of insurance is required?
JH. Builders Risk insurance
GZ. Property Insurance. Warranty companies are also good to look into. Foundation warranties, etc.
JC. We’ve seen a lot of people getting a ‘wrap policy’ that will continue through the construction defect period – up to 5 years after completion. It’s not cheap - $5,000-7,000 a door, but you are covered, especially with everything we’ve seen lately from lawsuits.
Q. From the audience - Why do architects charge almost the same amount for similar plans they’ve already done?
JH. there are some architects that will re-sell plans for a reduced fee – like duplex designs, etc. You can make minor adjustments like change the façade, etc.
Q. What other contracts do you have in place?
JH. We require our subs to sign a sub-contractor contract that requires liability insurance and worker’s comp insurance, it outlines our draw process, what we will provide vs. what they need to bring to the job site in terms of tools, etc.
JC. It’s absolutely critical to read every contract. As an investor, how are you going to work with your GC – are they going to call you on every change order?
Q. What curve-balls would you look out for?
JC. Zoning! Ability to build 6 vs 7 vs 8 on a lot make a huge difference. Have the right team up front to work with the city.
GZ. power poles in alleys that need to be moved. Trees that have to be relocated. The more you do, the more you learn. In Englewood right now, the city is requiring developers to pave the alleys from their project to the end of the alley. They keep changing their mind, so it’s hard to plan for future projects.