As small-scale infill developers, our primary strategy is to buy property with an existing building, sever the lot and build, rather than purchasing raw land to build on. We then seek to improve the condition of the existing property, rather than tear it down and rebuild. This would apply to both residential or commercial properties.
There are 3 main reasons for this approach, and these are items that are very important for most real estate investors who are starting to get into small-scale infill development for the first time.
Let discuss these 3 reasons:
1. Standard Financing - It is much easier to obtain financing for an existing property than it is to obtain financing for raw land. Once you sever the lot, you would need to "partially discharge" the mortgage for lost value in the land. In many cases, you may be able to make up some of this value by improving the condition of the existing property. Financing is also one of the reasons why we don't like to demolish the existing property, as the lender would not typically allow that under their policies. Therefore retaining the existing property for financing is most viable.
2. Sustaining Value - A property's value consists of both the building and the land. In many of the markets where we engage in small-scale infill developments, the land value is only approximately 25% to 40% of the property's value. By demolishing a building, we effectively destroy 60 to 75% of the property's value immediately before any development is completed. For a profitable project, we then need to recover these losses in the development and construction. This is not to say that it never makes sense to tear down a house and rebuild more units. But you will need to justify it typically with higher density, which can be difficult. For those starting out, it makes sense to keep the existing property as a means of sustaining a properties value.
3. Income During Approvals - The approval process for a development can take between 6 months to a year, and possibly even longer. If you are trying to get approvals for a new project, this can significantly eat into your cash flow situation. If you have a house on the property, even if it is moderately producing negative cash flow (ie. higher expenses compared to income), it is much more favourable than if it was only extracting funds and not producing any revenue. This scenario can make things challenging for the investor.
This is not to say that you can never buy raw land or demolish a property. However, for those starting out in infill development, it is a much better strategy to purchase property with an existing house. They should then try to improve its condition, sever the land, and build on the newly severed property.
There are a host of other reasons why keeping the existing house makes a lot sense. These are just 3 that we keep top of mind.
These topics will be discussed in detail in our upcoming training program on May 23/24. If interested, you can sign up at www.InfillDevelopments.com/training.
