Over the past few years, the demand for real estate has been going strong, with prices soaring in numerous markets across the country. Yet at the at the same time, the supply of available properties has been dwindling. In response, many home buyers and real estate investors have been seeking creative ways to buy into the market. One popular strategy is to purchase an outdated, dilapidated, and even condemned home with the intention of either gutting out the home and renovating it, or raising it completely and building a new custom home in its place.
It’s a phenomenon known as teardown real estate. Not only has this method allowed people to buy into markets they otherwise could not have afforded, but it has been a boon for lenders offering so-called construction loans.
The Appeal of Teardown Real Estate
Teardown real estate tends to attract two very different groups of buyers. On one hand, there are the people who for various reasons want to live in a particular neighborhood. Maybe the area has a good school system, or it would offer a short work commute. Perhaps the community is very strong, or it is located near desirable attractions, such as the beach. Whatever the reason, these buyers may have limited assets, so they search for a rundown house with renovation potential or a nice plot of land where the old house can be demolished and replaced with a new one. Often, in an effort to save money, these people take on a lot of the renovations themselves.
On the other end of the spectrum are the individuals or investors with deeper pockets who seek out these kinds of properties in high end markets. Typically, their intention is to completely raise the home and build a much bigger or better custom home to either rent out or sell at a profit.
Where ever there buyers are coming from, one of the biggest hurdles is figuring out how to pay for it all.
Why Construction Loans are the Natural Fit for Teardown Real Estate
Enter construction loans. Financing a teardown and rebuild or even a major remodel is an expensive endeavor. There is the cost of the existing property, the demolition expenses which may include hazardous waste removal, the construction costs, and finally the long-term mortgage financing. This would be a lot on its own, except this equation leaves out all the other expenses, such as:
- Indirect costs. This includes fees and expenses associated with building a new residence that are not part of the physical construction process, such as fees for permits, engineering costs, and architectural fees.
- Closing costs. These are the myriad costs associated with the closing of the loan, such as lawyer’s fees, title costs, as well as inspection and appraisal fees.
- Extraneous costs. Construction delays due to weather and material/labor availability can and often do happen. will be needed to cover unforeseen cost overruns in the construction of the home.
Construction loans come to the rescue… Home construction loans were designed to cover the costs associated with the renovation and construction of a home. Construction loan lenders also simplify the financial side of home construction by actively managing contractor payments as the construction process hits certain milestones.
Given that the buyers of teardown properties will usually be in the market for long term financing, some lenders also offer a construction-to-permanent loan option. These loans are basically a combination of a standard construction loan and a mortgage. Once the project has completed, and the contractors have been paid in full, then the buyer’s outstanding loan liability rolls over into a standard long term mortgage.
Buyers thinking of knocking down and rebuilding a property will learn very quickly that this is a complicated process requiring many complex steps. Construction loans are a natural fit in this process that can at least simply the financial side. Buyers are thus more free to focus on the things that will help them build the home of their dreams.