The Capital Stack
We like the idea of developing a small (6-12 unit) boutique apartment building with the intent to sell it shortly after its completed. The size and price point on exit provide a good opportunity for individuals looking to acquire a turnkey rental property. There are many high W2 earners (doctors, lawyers, etc) who are looking to invest their money in rental properties on their own. In most cases these types of investors are looking for ease of management. A newly developed boutique property ensures maintenance requests are low and when developed in a strong rental market demand a high-quality tenant. Their strategy, if worked perfectly is as simple as paying the down payment and then collect rent as true “passive income”.
We identified a lot in Brighton, it is just over half an acre and the township would allow 6-units if we could get it rezoned too multifamily. The current zoning is residential. After some research we learned the township wants multifamily to be a barrier between single family and commercial properties. The half an acre lot we found would provide this barrier and we believed it would be the perfect site to rezone.
On Aug 18th after a few weeks of negotiation we agreed to a price with the owner of $120k for her lot. I then contacted the township to see what their rezoning process would be. We learned we would need to go through a series of 4 consecutive meetings with the township and county. The meeting would start in November and end in February. The meetings happen only once a month and documents need to be submitted 1 month before. We would submit our documents in October for the township to review our request at the November meeting. The township requests a concept site plan as part of their document package. This site plan costs $2,900. We would also have to pay a fee to Brighton Twp of $1,600 and post a 4×8 sign on site, costing $500. We would be out $5,000 before we even got to the zoning meeting.
Why we decided not to pursue this development:
- Low value add, high opportunity cost.
- We were paying full market price for the lot as if it had already been zoned and approved for the 6-units.
- We had to consider the upfront cost of $5,000 to be high risk as the Twp planners said from the start that they didn’t think we could get the zoning changed and considered it an uphill battle. We took this with a grain of salt because anytime you ask a planner about a rezoning, they will say “it won’t happen” and try to talk you out of it.
- Planned cost was going to be ~$1.3m all in. Planned sale would be ~$1.7m after it’s fully leased.
- Cost $1.3m
- Sale $1.7m
- Investor equity to start $390k.
- Sale costs 4% – $68,000
- Net sale $1,632,000
- Loan payoff $910,000
- Investor equity return $390k
- Remaining profit after sale to distribute $332,000
- The $332,000 would be split with investors 50/50. This ends up being $556,000 net payout to investors and $166,000 payout to us. This is ~43% total return over a 2-year timeline to investors which on the surface looks great. However, when we consider the uncertainty and risk factor involved in this project, we would want to see returns closer to 2x the initial investment. There are many hurdles that can come up with any development and the margin on only 6-units is very small. Something as small as an extra $25k of unplanned cost can throw off projected returns as it represents 7.5% of the profit.
In short, the risk was not worth the reward. Analyzing Risk vs Reward goes beyond the returns shown on any underwriting software. In this case a ~43% return on investment is quite favorable for investors and would generate plenty of interest. It just wasn’t worthwhile for us as we believe we can hit a similar return on total dollar value with a lot less risk.
Major Market News
TheRealDeal’s Instagram recently posted about the continually rise of interest rates. The post quotes Lawrence Yun a chief economist for the National Association of Realtors and says ” if interest rates break the 7 percent threshold, it is likely they will surge all the way to 8.5 percent.”
Check out the post here: https://www.instagram.com/p/Cj0lRhKuW2e/
Tips and Tricks
Stay in your own lane. Sticking to what you know and what has brought you success in the past is very important in the real estate industry. The boutique development we reviewed this week doesn’t really fit our business model. We typically focus on value-add projects with the intent to hold them for many years. This project involved a new development with the intent to sell shortly after completion. Not our bread and butter. With so many options available it can be easy to get distracted but “staying in your own lane” allows us to have a brandable business and helps mitigate risk for our current and future investors.