Buying Multi-Family Entitled Land to Build

If you are a participant in the commercial real estate market, you have probably noticed improvements in leasing activity in all products and the return of capital to the investment property market. While increased market participation has fueled positive feelings about the current state of the commercial real estate market in several areas, there are still some that are weak. However, the improvement in multifamily has been almost universal.

The problems with higher investor demand in multifamily is that as a result the prices have increased substantially, and made acquisition much more expensive. This has driven investors looking for a good deal to approach lenders in hopes of buying foreclosed multifamily properties. Nevertheless, they have usually found that good properties are the object of several bids, and that lenders are reluctant to lower their asking price significantly.

Another way to participate in the upside is to buy land entitled for multi-family. This investment theory works as long as there is a disconnect between the asking price for entitled land, and the value of multi-family rental property.

Let’s use a real life example {names changed to protect the innocent}. We recently financed a portfolio of properties that included a 10-unit building apartment building. The building was composed of ten 1/1 apartments renting for $1,000 a month. According to the rent-rolls it was fully occupied, and the demand for units in the area was high and confirmed by the appraiser. Operating expenses were approximately 40% of Gross Income with a resulting NOI of  $66,000. Assuming a CAP rate of 7% we can come up with a $943,000 estimate of value. Value is arrived at by dividing NOI by the CAP rate.

If we have an idea of the cost to build multi-family apartments, we can estimate the value of a lot. Multi-family two-story construction costs differ from place to place. Some of our borrowers have been able to construct for as low as $75 S/F, but a smaller player might have to pay more. Assuming an 8,000 S/F building and a construction cost of $85 S/F. It is possible to work out the maximum amount to be paid for land.

Of course, the above is an overly simplified approach, there are a lot of other factors to take into consideration, such as:

- The carrying costs associated with a land investment with no immediate development plans.

- Other soft costs/financing costs associated with the construction of a new building. Such as inspection and testing fees, permits, impact fees, professional fees, lender’s attorney fees, loan fees, loan interest or marketing expenses to fill up the new building with paying tenants.

- It also does not take into consideration the benefit of owning a new building, which should decrease your maintenance expenses and lessen the need to fund reserves for a while.

You can learn more about land development by buying the following books Land Development Handbook or The Real Estate Developer’s Handbook: How to Set Up, Operate, and Manage a Financially Successful Real Estate Development With Companion CD-ROM

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