By Chris Anderson, PhD
Unlike many People, I have a very broad definition of preconstruction investing which can be summarized as follows:
Preconstruction investing is the pursuit of real estate projects that offer the opportunity to ride rapidly increasing prices without the need to put tenants in place to defray costs. Since no tenets are involved, this opens the possibility to making investments in locals that are far removed from where you live.
If you adopt this point of view, then a whole world of "alternative" preconstruction 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 specifics, let's talk about what all investors want:
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:
Now we have to resort to hard analysis. Let's look at the following ASSUMPTIONS:
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 reququire a bit of explanation. There are some early stage 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 spread sheet, we just show 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, beginning 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 year 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 2% 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, ect. and NOBODY can predict this going forward. So what happens as the assumed level goes from -5%/YR to 50%/YRwhich hopefully will be a good bracket. The chart shows the results.
In the very near future, there will be some opportunities on "preconstruction" 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:
Before we get into specifics, let's talk about what all investors want:
- Low Risk
- Good investment returns; and
- Minimal use of their capital
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:
- Carefully select a land project where you are solidly convinced that baby boomers will want to possess it at any costs;
- Make sure that you believe that baby boomers will be AWARE of this project in the future due to somebody's marketing; and
- Manage your finances and investment portfollio so that if you are wrong and you do not a loss, it is not catastropic to you.
Now we have to resort to hard analysis. Let's look at the following ASSUMPTIONS:
- The land project is assumed to increase at least 25%/YR in price;
- We plan on holding the land for 2 yrs and then resell.
- $200,000 purchase price with $5,000 in closing costs.
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 reququire a bit of explanation. There are some early stage 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 spread sheet, we just show 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, beginning 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 year 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 2% 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, ect. and NOBODY can predict this going forward. So what happens as the assumed level goes from -5%/YR to 50%/YRwhich hopefully will be a good bracket. The chart shows the results.
In the very near future, there will be some opportunities on "preconstruction" 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?
