I made a simple illustration using a single-family development project.
Consider a single-family home, constructed in the 1950s and nestled in a high-demand neighborhood. There are plenty of those around Bellevue, WA. Such properties are often prime candidates for redevelopment.
In the past, infill builders would be snatching these homes, offering all-cash deals with quick closing times and no inspection contingencies—after all, what’s there to inspect on a teardown?
These builders would then construct a new, approximately 4,000 square-foot home, which could fetch nearly $3,000,000 or more upon sale.
However, the current economic climate has seen a decrease in such aggressive purchasing by builders. This presents a unique value proposition for the property owner.
I’ll use round numbers for simplicity to illustrate:
– The value of a typical teardown house is estimated at $1,000,000.
– Construction costs for a new house are another $1,000,000, with an additional $100,000 in soft costs.
– A conservative sale price for the new home is set at $2,800,000, yielding a profit of about $420,000 after closing costs.
Now, if the property owner opts to finance 80% of the project cost, they would take out a loan of $1,680,000. This allows them to extract $580,000 from the deal before construction even begins.
Here’s the financial breakdown:
– From the $1,000,000 land value, $580,000 is withdrawn, leaving $420,000 invested in the project.
– Upon selling the new house for $2,800,000 and settling the loan and closing costs, the owner is left with $840,000 in net cash.
– This represents a 100% return on investment, effectively doubling the initial stake.
In essence, rather than selling the old house for $1,000,000, the owner leverages the property to collect $580,000 upfront, reinvests the remainder, and ultimately doubles their investment.