How To Underwrite a New Construction Project
In this blog, I’m going to share the numbers behind my very first new construction project.
Today I want to share the pro-forma numbers behind my very first new construction project.
I typically hold most of the properties I buy, but this fix and flip project was too good of an opportunity to pass up.
I bought an up-down duplex that I can't wait to tear down and turn into an awesome single family home with a modern farmhouse aesthetic.
Before we get into the nitty gritty, let me give you a 10,000 foot view of a few key numbers.
I bought the property for $525.000.
I'm expecting to spend another $525,000 on the construction.
Finally, I'm projecting an outsale of $1.5 million dollars.
That leaves my gross margin at $450,000.
Between carrying costs and selling costs, I'll probably spend another $150,000.
Which leaves my net margin at roughly $300.000.
OK, now that we got the back of the napkin math out of the way, let's dive a bit deeper into the purchase price, construction costs, after repair value, and other costs associated with carrying the property for an entire year and ultimately selling it once complete.
In regards to purchase price, we initially submitted an offer for $548,500 but during our due diligence period we found out this property had an oil tank and structural issues so we were able to negotiate a seller credit for $25,000.
That ultimately brought our purchase price down to $525,000.
As far as financing goes, we used a mix of hard and private money lenders to fund 100% of purchase and construction at 8.5% interest only for 12 months.
Before we purchased the house, our hard money lender had the property appraised and the as-is value came back at $575,000, which meant we had $50K of equity on day one.
Another data point that gave me comfort was knowing a new construction house down the street previously sold for $600,000 before the developer put a new house on the lot.
With just these two bits of information, I felt pretty comfortable that if at any point I felt like I was in over my head, I would be able to liquidate the asset for significantly more than I bought it for.
Alright, now let's move on to the construction costs.
There are a few different ways you can underwrite construction costs.
The first way is talking to a local expert. Luckily for me, my mentor does a handful of new construction or add-a-level flips per year and when I told him about this deal he was practically salivating.
His exact words were, "This is a fat spread. You can make all the mistakes in the book, and there's still no way you'll lose money here".
When I asked him his thoughts on construction costs he shot from the hip and said "$450K-500K oughta do it".
The second way to underwrite construction costs is to use the price per foot method.
Based on the finishes required for a house of this caliber, I'm projecting to spend $125 per foot on the first and second floors, $10,000 on the attic with a powder room and $50,000 on the basement. That $50,000 includes digging out the foundation, installing superior walls, and finishing the basement with a bedroom, bathroom, office, kitchenette, and recreational room.
The third, most accurate, way to underwrite construction costs is using actuals from a previous project.
My mentor sold his latest new construction flip about a year ago.
He gave me his profit and loss statement so I could use his numbers as a template for my own construction budget.
If you want to download the template I used to come up with my construction costs, there's a link in the description down below.
The house he built was about 10% larger than what I'm planning to build, but I didn't adjust the numbers down to reflect that. Instead, I went the opposite way and inflated his numbers by 20% because construction costs went up significantly in the past year.
After Repair Value
Now let me tell you how I got to my After Repair Value.
The first step I took was running my own CMA from the data I could find on Zillow.
I found 5 recently sold comps and plotted all their stats.
I found how much they sold for, their bed and bath count, gross livable square feet, lot size, and building description.
Once I had all of that information, I simply took the average of the price per square foot and multiplied it by how many square feet my new construction home was going to be.
That number came out to just over $1.5M.
The second data point I have is the second half of the appraisal commissioned by my hard money lender.
Earlier in the video, I told you my lender had the property appraised and the as-is value came back at $575K, which gave me $50K of instant equity upon purchase.
In that same appraisal, my lender asked the appraiser to predict what the finished product would sell for, and that number came back at exactly $1.5M.
So far, I'm feeling pretty confident in my numbers.
Carrying and Selling Costs
There are two more major line items to account for and that's the carrying costs and selling costs.
Let's start with the cost of the sale. Hiring the best agent for this sale will cost me about 4% of the sales price. Then I'll probably have to pay another 1% of the sales price in costs associated with transferring the property at the closing table.
All in all, I think 5% of the sales price is a fair estimate.
Then finally we have our carrying costs.
My property taxes in as-is condition are roughly $12,000 per year.
The insurance here is roughly $3,000 per year between builder's risk and a standard liability policy.
And the big ticket item is the interest expense.
We'll be paying 8.5% on $525,000 for the entire 12 months, which comes out to $45,000.
Then we'll likely pay another $15-20,000 for the interest on the construction money as we draw the funds from our lender.
Bringing our total carrying costs to just about $75,000.
That puts us at $150.000 for carry and sales costs.
This is a pretty massive project to take on as my first new construction, but I feel confident because I ran the numbers myself and had them validated by multiple people including my lender, a third party appraiser, and my mentor.
Oh and here's a quick reminder: if you want to download this new construction budget template you can find a link to it in the description down below. These construction costs are for a 3.000 square foot custom modern farmhouse built in New Jersey back in 2020 so make sure you keep my 120% multiplier. The cost of construction has probably gone up by at least that much since then.