The hot market (in most areas) is causing real estate investors to ask one particular question with high frequency. Real estate investors are in a debate over whether it’s better to build a rental home or buy and rehab what is already on the market. As an investor— looking to create new investment properties or in the process of renovating existing ones— the equation to remember is, "What move will put you in the best position to make a profit?"
Build Or Buy?
Some ask whether it’s better to build now, because rental properties are currently on the pricey side. There is a point to this logic. I’ve seen investors from other countries buy properties here in the states, for next to nothing, in positive cash flow. That being said, many investors in the states are discovering that the numbers on available rental properties do not balance out positively. There are cases where an investor doesn’t adjust and innovate as the market changes. Good real estate investors maintain a sense of awareness and adaptability based on what the market and economy are doing. Others experience the challenge of rising prices and demand, creating a scenario where positive cash flow cannot be achieved when using financing. This is when investors need to be patient till they find the right deal and execute quickly once it comes.
The Truth About The Numbers?
You may be wondering if it is true that, in some markets, real estate agents and home sellers are setting the property prices at a point where it seems that it is cheaper to build. Realistically, you can make a new home for less than the price of one that is ten to twenty years old. Doing this could mean better cash flow in the long run, however, the equation isn’t finished. As an investor, what else do you need to consider?
The Challenges Of New Construction As An Investment
If you choose to build a new home and use that as an investment property, there are three aspects you need to consider.
Time Required To Build— It is not uncommon for a home to take twelve months or longer to build. Twelve months is an accurate time estimate for construction time (if everything goes right). Let's take a second to consider how much longer construction will take if there are issues with building codes, inspections, or unexpected problems? During a build, there is no cash flow coming in— NONE whatsoever! No positive cash flow as an investor means no positive returns. Any holding costs incurred will need to be out of pocket.
Risk— Building property yields a fair degree of risk that buying an existing building does not. Anything can happen to the market during the time of construction., Also, you are speculating on what rents you might get from the building; not what you for sure will get.
No Leverage— When building, you will be required to place a larger down payment (generally the case). You will have to come up with upfront cash. Cash for the land. Cash for the labor and materials. Cash for plans, permits, and holding costs. Cash, cash, cash! If you compare that with spreading your capital across three or four rentals that are bringing in money, it makes a significant difference.
Rehab Existing Rentals
I’m the type of person who LOVES new properties, and there are many beautiful ones. I also have a thing for historic homes, but I do understand why some buyers gravitate towards bright new properties. That being said, it takes time as an investor to build a new home and duplex. You could be building a fancy new condo while Mr. Investor A has acquired ten new properties that are delivering significant returns every month. The leveraged path that Investor A chose means that he is earning, appreciating, and building up equity on a diversified group of properties all at once. Think about this. If you are an investor who is planning to hold assets for ten years, but is spending a lot of cash to build and a lot of time to find a tenant, you have already lost a percentage of your returns in comparison to what an existing property would bring in.
As a real estate investor, it’s most likely that you will face a situation where building a new property will be necessary. Still, there are so many vacant homes that exist. Last summer alone, data showed that the split between empty homes to homeless individuals was 6 to 1. There are sprawling mansions— empty— that could house multiple families, and yet, we continue to build. That is something to think about.
The main point is— new homes are great. In some cases, new homes are needed, but it is unnecessary for investors to build when there are well-priced rental units in the area. The less you speculate, the better. For me, this means buying based on current rents and cash flow numbers. I don’t roll a dice and “hope for the best.”