Clients often ask me what my thoughts are about investing in new construction homes purchased from the builder or developer. As with most other nuances of real estate investing, this strategy has its pros and cons. A prudent real estate investor needs to clearly understand what they are and how they can potentially impact their success. Then and only then, that investor can determine if this strategy is a good fit with their long term goals.
Pros of investing in new construction homes
Investing in new homes reduces maintenance over time
Inexperienced investors without proper guidance often disregard this principle at their own peril. If you think that the built in equity more than makes up for the fact that the home was built when Mick Jagger was a chap, I have a bridge to sell you in Alaska. The fact is, if you invest in a new home today, ten years later, that home is just ten years old. Obvious, I know. But it’s critical in the context of long term investing. As you are executing your long term Blueprint, it’s important that maintenance issues don’t undo the good progress you make increasing your capital base.
Builders incentives can be used to lower the capital invested
In an attempt to drive sales, Builders sometimes offer flexible incentives that can allow a real estate investor to limit his cash out of pocket investment to just the down payment. For instance, the asking price on a new construction property I showed last week was $133k but the Builder was offering $16k in incentives to be used however the investor sees fit. My advice to the client was to use about a fourth of that amount to cover closing costs and apply the rest toward the purchase price. That way he cuts his out of pocket investment by 30%. That doesn’t sound like much but it would allow the investor to purchase an additional home for every four homes acquired and that’s worth hundreds of thousands in the long run.
Ample supply avoids bidding wars and frustration
Unlike foreclosures or short sale listings, well priced inventory homes are plentiful so the investor can focus on which asset offers the best package of location, price, amenities and incentives, instead of getting into an ego war with twelve other bidders. The ability to acquire assets on demand can make a world of difference if say, you miss buying that house because you were chasing that great foreclosure deal that never materialized. Or if you missed out on that low interest rate for the same reason.
Buying new offers convenience and faster turnaround
When you close on a new home, you can swap the builders sign for a “For Lease” sign that same day. If instead you opt for a distressed type asset, chances are some repairs will need to be completed prior to the home being rent ready. No matter how cosmetic they might be, they do take time and they take time away from the property being available for showing to tenants. The overall process is more seamless and the experience is drastically better especially for a first time real estate investor.
Higher quality new construction attracts higher quality tenants
In our experience, high quality new construction homes with upgrades such as granite, stainless appliances and energy star ratings tend to attract higher quality tenants that won’t mind paying premium rent. So instead of renting an average property for average rent you offer a premium property for premium rent. Plus, this type of tenant tends to have higher credit scores, stable employments and won’t mind signing longer term leases. Plus, offering a property that is under builder warranty on most items for 1-2 years is a big plus to them as well. And last but not least, 10 years from now, that higher quality will translate to higher appreciation and ultimately higher returns.
Cons of investing in new construction homes
Paying retail prices
Even after taking into consideration the “rich” incentives builders offer, the price you ultimately pay for the property is the retail market value of the home or pretty damn close to it. Some investors are bothered by that fact even though to a long term real estate investor equity doesn’t matter because it’s just an indication of what would happen if you sold the property right now. Essentially you are trading off money for time: you are paying a little more for the home but you are gaining a seamless, hassle free process. Also, paying retail prices makes the investor more susceptible to strong emotions during market cycles. Here’s what I mean: Many out of state investors (primarily from California) purchased new homes from builders at the top of the market in 2003-2005 for $120-$130k. Five years later, bank owned properties next to them were selling for 20-30k less. Things have stabilized in those neighborhoods now but it was hard to see that coming in 08 when it was all doom and gloom. So, the investor has to truly be committed to the investment long term to ride out market value swings. Remember, the only market value that matters, is the one when you sell. The rest is just fiction.
The Unknowns
When you purchase a home that was built 4-5 years ago, you know exactly what the property taxes will be in the coming year and you can run your cashflow analysis with certainty. In new construction homes, the first year you own the property taxes are very low since the property is being taxes just on the land. The following year you don’t know for certain what the county will appraise the property for tax purposes so you have to estimate it. However, there are certain steps we can take to limit this uncertainty. Worst case scenario, the taxes will be the price paid for the property times the tax rate which is known at the time of purchase. Typically though, the country appraisal for tax purposes is lower than the price paid for the property. So we can run several scenarios and see if the deal makes sense. Lastly, we can see examples of properties sold by the Builder in the past couple of years and check the tax valuations of those homes for a clearer idea.
There you have it folks. Investing in new construction homes certainly has its positives and negatives. But for the real estate investor that understands them, that has a well laid out long term Blueprint and has the discipline to execute the plan it can be a very successful strategy.
Having build house by construction is more favourable by people who want to have custom build the way they want it. However I agree it might not be the quickest return of investment. You can often buy house 20-30 off the market value from auction and foreclosure. And then do little construction work on it. Then sell it. Where by building and sell it would take more time and a lot more hassle to deal with builders etc