Small lot development - Part 4

 

This is Part 4 of the Small Lot Development series. I want to share some information on the financial aspect of small lot developments. Each deal is unique and it is hard to generalize on cost and profit. The information provided here will give you an idea how a project achieves profitability. Please try to focus on the process of how developers create “value” through the development instead of the numbers themselves. Here are two examples: one ground-up condo and the other one rental conversion.

Example 1 (ground-up condo): Existing 20’x100’ vacant land in a mid-block lot on a narrow street in the R7A zoning district. FAR: 4. Zoning floor area: 8,000 SF

The plan is to build a 6-story boutique condo building with a 20’x65’ floor plate. There will be 6 floor-through units and each unit has roughly 1,050 SF saleable space (81% efficiency). Gross floor area 9,300 SF (7,800 SF 6-story + 200 SF penthouse + 1,300 SF basement). Front and backyard is 5’ and 30’, respectively. No setback required.

The 1st floor unit is a duplex with 500 SF recreational space in the windowed basement and a large private backyard.  The 6th floor unit is also a duplex with a 200 SF penthouse bedroom with a private roof deck.  Each unit has a living room facing the street and 2 bedrooms facing the backyard. The living room and master bedroom will each have a balcony.  

A private elevator will land on each floor and open directly to the unit. A separate staircase will be built next to the elevator to serve as a means of egress. A common roof deck will be provided for all residents in the building.

Acquisition
Purchase price ($225 PSF on 8,000 SF zoning floor area)	$1,800,000
Others (due diligence/legal, etc.)	$15,000
Construction
Soft (architect/engineers/special inspections/expeditors/DOB fees/ins. and RE tax/condo offering plan, ops reserve, etc.)	$270,000
Hard ($300 PSF on 9,300 SF gross floor area, plus 10% contingency)	$3,069,000
Financing cost
Mortgage recording tax/appraisal/phase 1/title ins/lawyers/lender fee/mortgage broker fee, etc.	$200,000
Interest reserve (7% interest for 24-month)	$228,000
Developer fee (3% on purchase price and construction)	$154,000
Total Cost	$5.7M
Sources of Capital
Equity (50% of purchase price, construction and developer fee, and 100% of other acquisition cost and financing cost)	$3.1M
Project loan (50% of purchase price, construction and developer fee)	$2.6M
Condo Sale
Gross proceeds ($1,200 PSF on 6,500 saleable SF)	$7.8M
Expenses (broker fee/marketing/transfer tax/legal, etc.)	$0.4M
Net proceeds (gross proceeds - expenses)	$7.4M
Profit (net proceeds - total cost)	$1.7M
Returns
Project return (profit/total cost)	30%
Simple % return (profit/equity)	55%
3-Yr IRR (levered)	25%

Example 2 (rental conversion): Existing 4-story single-family brownstone with a basement in a mid-block lot on a narrow street in the R7-2 zoning district.  It was built in the 1920’s with a roughly 18’ x 55’ footprint on a 18’ x 100’ lot. Total as-built: 3,960 SF (plus basement).  FAR: 3.44.  Zoning floor area: 6,192 SF.

The plan is to enlarge the existing structure by adding a 5th floor and convert the entire building into a 9-unit multifamily rental (all market rate).  Gross floor area: 5,940 SF (3,960 SF as-built + 990 SF 5th floor addition + 990 SF basement).

There will be 2 studios on the 1st floor, 1 studio and 1 one-bedroom apartment on the 2nd floor, 2 one-bedroom apartments on 3rd and 4th floors and 1 three-bedroom apartment on the 5th floor units with a private roof deck. Front and backyard is 5’ and 40’, respectively. No setback required.

The backyard will be converted into recreational space and a trash room will be added on each floor per Quality Housing Program. All first floor units need to be ADA compliant and no elevator is required. One fire escape is existing facing the backyard and one more will be added in the front of the building as the 2nd means of egress. See more details in Part 2 What it looks like and Part 3 How it’s done of the series.

Acquisition
Purchase price ($455 PSF on 3,960 SF as-built area)	$1,800,000
Others (due diligence/mansion & sup taxes/legal, etc.)	$37,000
Construction
Soft (architect/engineers/special inspections/expeditors/DOB fees/ins. and RE taxes, ops reserve, etc.)	$178,000
Hard ($200 PSF on gross floor area, plus 10% contingency)	$1,307,000
Financing cost
Mortgage recording tax/appraisal/phase 1/title ins/lawyers/lender fee/mortgage broker fee, etc.	$175,000
Interest reserve (7% interest for 12-month)	$92,000
Developer fee (3% on purchase price and construction)	$98,000
Total Cost	$3.69M
Sources of Capital
Equity (40% of purchase price, construction and developer fee, and 100% of other acquisition cost and financing cost)	$1.66M
Project loan (60% of purchase price, construction and developer fee)	$2.03M
Rental Income (starting Yr 1.5)
Rents (studio $2,000/month, 1-bedroom $2,500/month and 3-bedroom $5,500/month)	$288,000
NOI (incl. 5% vacancy and 25% operating expenses)	$205,200
Take-out mortgage (Yr 2)
Property valuation (4.5% cap rate on NOI)	$4.6M
Gross proceeds (65% LTV, 4% interest)	$3.0M
Net proceeds (gross proceeds - project loan)	$1.0M
Reversion (Yr 3)
Gross sale proceeds (4.5% cap rate on NOI)	$4.7M
Net sales proceeds (after expenses, capital gain tax, RE transfer taxes, etc.)	$4.2M
Net proceeds after take-out mortgage balance	$1.2M
Profit (net proceeds from take-out mortgage in Yr 2 and reversion in Yr 3, plus NOI less mortgage payment for 1.5 yrs, and minus original equity investment)	$0.5M
Returns
Yield (NOI/cost)	5.6%
ROI (NOI/equity)	12%
Simple % return (profit/equity)	32%
3-Yr IRR (levered)	20%