Understanding New Construction Investments
A Challenge Well Worth its Rewards
by Andy Bates
Navigating today’s market often requires a sense of dynamism. Working between flipping properties and rental holds has helped many investors maintain and grow their business, but these are not the only kinds of investments available to the savvy investor. New construction is another lucrative investment type but its distinction from an existing property comes with significant process changes for the investor.
Understanding additional factors that play into a new construction investment and the best practices for them will illustrate a path to success for investors with this strategy.
Building on Purpose
As with any investment, before financial commitments are made, it is always advisable to thoroughly understand the undertaking at hand. Newly constructed properties serve a primary function of adding inventory to the markets in which they are built.
When acquiring funding to construct new residences as investments, it’s important to consider the structure of those loans.
While conventional lending can be used for the building of a new primary residence, investment financing is, by definition, commercial in its structure. The most important distinction here being that commercial loans cannot be used for primary residences.
Such a use case would result in default on the loan. Instead, private funding focuses on investments, so any newly constructed residences would need to be sold or held for cashflow.
Project Scope
Beyond discerning their exit strategy, investors must also be aware of the scope of their upcoming project. It is one thing to build a new, one-unit or even four-unit property where a neighborhood already exists. It is quite another to consider the building of dozens or even hundreds of units.
While different lenders will focus on, and provide for, projects of all scales that fit their buy-box, development, at any scale, requires an understanding of horizontals which may or may not already be in place.
Horizontals are all installations which “attach” to a property or properties in an area, outside of the structures themselves. Roads, pavement, sidewalks, water and waste lines, gas and power are all examples of infrastructure that is imperative for a new build, even if they are not directly part of the cost and construction of an investment.
Some lenders will only provide for new construction projects in which horizontals like these are already established. These can look like undeveloped lots in existing neighborhoods. In urban settings, “in-fill” projects are those that position new builds between existing structures in an established neighborhood. As the establishment of horizontals in areas without such infrastructure demand significantly more time, capital, planning and resources, opting instead to build on a parcel of land where horizontals are already in place can make it easier to acquire plans and permits for the build or even access financing.
All in its Proper Place
While the notions of obtaining approved plans and keeping up to code are not new to any experienced real estate investor, new construction comes with more groundwork in these areas.
While an investor might be able to secure funding for light or even heavy rehab projects with as little as a scope of work or line-item rehab list, for new construction, plans and permits must be in place before funding can be secured and building can begin. Fortunately, even with an increase in paperwork comparative to other investment types, these documents tend to be fairly standardized across all US housing markets. Entitlement letters, zoning verification letters, and compliance reports are all examples of common documents investors can expect to work with on a new construction project.
Many lenders servicing new construction investments will want to ensure they are executed by an experienced hand. In this way, it is important for the average investor to work with experienced builders and general contractors not only to secure necessary funding but also to ensure that the structure to be is sound.
These professionals have verifiable credentials like references, project history and up-to-date licensing which can indicate to both lenders and municipalities that the project will be completed in accordance with code and compliance.
If acquiring plans, permits, and approvals for a standard renovation takes time, then it stands to reason they might take much more time for a fresh build. Keeping on top of documentation is its own skillset and with more moving parts on a new construction comparative to other investments, it is imperative that investors keep on top of, and plan around timelines for approval.
If an investor should find themselves without plans and permits in place prior to closing, all is not necessarily lost. Investors can leverage verifications on proposed plans with third party architects working within the local municipality. Additionally, investors may acquire formal confirmation of proposed plans from a state or local council where ordinances allow for these exceptions.
Nothing Ventured, Nothing Gained
With private lending, it’s common for construction and renovation projects to be funded under a reimbursement structure. This means that builds are planned in phases. Once a phase of work has been completed, it is reported to the lender who then sends out a third-party inspector to verify the work and materials used. With confirmation from the inspection, the lender releases funds to reimburse investors for each phase of work as it is completed.
Reimbursements, alongside plans and permits, reinforce the need for investors to have a firm understanding of the scope of work for their construction investments. This includes what may impact timelines and how delays might impact the build overall, including the investors exit strategy.
Opportunity for the Tactful
In a housing market in need of inventory, a build-to-sell approach may seem like the obvious path for new construction investors. However, investors should be as thorough in their investigation of an exit strategy as they were when developing plans and acquiring permits. Market area indicators like housing starts, homes sales, and employment statistics are all useful metrics when considering the most favorable course of action in a given market.
