Posted on Thursday, June 30, 2011
With Naples housing inventories on the decrease coupled with a 6% year on year price increase the practice of speculative home buying is again heard around town – not that it ever stopped completely but clients are once again saying, “hey why not plunk some money down, borrow, and see if we cannot build a sell a place for a profit.” Well a few words on this topic – a little finance, a little risk, and a few entry point thoughts.
The rules of finance still apply. Quite simply it is all about return over time. How many times have we heard “wow, i turned a profit on that spec home” – well maybe, but do your homework. Common mistakes are to ignore the costs of carrying the project, like insurance, taxes, commissions, closing costs, and more. Just make sure you have all the costs on your ledger to go along with that nice “profit.” And don’t forget about time. How long did all this take? A twelve month build, tear down, build and sell cycle is one thing – but stretch it 18-24 months and watch what your real return does. Know your true costs, know your time frames, and your real return. Can you make a good return? It depends on the property and your approach but, sometimes yes you can. Just make sure you understand the math.
And then there is risk. What if the place doesn’t sell, it takes too long to build, the costs are wrong, etc. Sure there are risks but so what? The “so what” is investors want compensation for risks. Why make x% in real estate when I can make the same x% on a less risky venture? A good approach is to document each risk, lay out a game plan if the risks actually turn up (and a few always do) and then judge the adequacy of your return. Speculative real estate always has a certain charm and makes good clubhouse conversation – just have a risk management approach you can rest on.
Entry points. Surprisingly some people think you need to find or build a big place to make a big profit – what you should care about is the percentage for the risk. If you make 10% routinely in one part of the market and 5% in another, with the same risk, then you take 10% – even if it is all small stuff. There is nothing here that says you have to go big.
One example of an entry point – a builder int own Gary Gebelhoff will propose to you the “Kiwi Cottage” – under $200,000 to build a 1,598 square foot, three bedroom, attached garage cottage. Block on slab. Buyers like new vs. old. Some buyers might take a look at this one. If you found the right lot or tear down, had Gary build this one for you, and sell or rent it – it might just work for some of our buyers.
And we can go up from there. The cost to tear down a home is relatively cheap. Find a good location, buy it right, remove the old place and build something the market likes right now and your can have something.
Talk to us about the speculative home building. Know the math, have a plan for the risks, and find the right entry point for you. It might make sense.