Burning Down the House — The Talking Heads

Today’s featured property is a very rare find in Irvine — a vacant lot on which you can do what you want. You wouldn’t have total freedom, this is still Irvine, and you would have to deal with the Turtle Rock HOA, but you would not have to deal with the Irvine Company or one of its approved builders. You could create a custom home exactly the way you want it, without having to buy an existing house and demolish it. Our challenge today is to figure out what this lot is worth.

Asking Price: $549,900

Income Requirement: Depends on Structure

Downpayment Needed: $549,900

Address: 19441 Sierra Chula Road, Irvine, CA 92603

First, a refresher on how to value a lot from Land Value 101:

Individual Lots

The market value of a individual lot is equal to the revenue it
could generate minus the cost of creating that revenue. Sounds simple
enough, but what is the potential revenue and what are the costs?

Sales revenue will largely be determined by what can be built on the
lot and how much that house would sell for in the market. The
dimensions of the lot, building codes, and the local zoning ordinances
will all create constraints on what can be built. Most often there will
be some variety in choices available to construct on a given lot. Each
of these options will have a potential revenue and an estimated cost.
The combination which yields the greatest profit is the product that
should be built.

Imagine a 6,000 Square Foot lot that is 60′ wide by 100′ deep. A
typical lot such as this would have a front setback of 20′, side
setbacks of 5′, and a rear setback of 30′ leaving a 50′ wide by 50′
deep envelope for the house foundation. This site could comfortably
accommodate a 2,000 SF house (some area is lost by not making the house
a perfect rectangle.) For the sake of making the calculations easy,
let’s say this house could sell for $1,000,000 (peak prices).

An individual speculator would be paying retail prices for house
construction. This would be upwards of $150 SF. The cost of
construction would be around $300,000 (2000 * 150 = $300,000.) There
would be a 6% sales commission (1,000,000 * 0.06 = $60,000), plus
financing costs, overhead costs, and other miscellaneous costs which
will add up to about 10% of the project cost (1,000,000 * 0.1 =
$100,000.)

Therefore,
your revenue minus expenses would be $1,000,000 – $60,000 – $100,000 –
$300,000 = $540,000. This is how much money would be available to pay
for a lot at the breakeven point. Since a speculator would want to make
a profit, the lot is discounted from $540,000 until an amount is
reached to compensate for the risk and the headaches that go along with
the project.

Perhaps the speculator would want to make $120,000 (approximately
12% of sales price) in order to do this work? If so, the speculator
would be able to offer $420,000 ($540,000 – $120,000 = $420,000) for
the lot. If they are the highest bidder, they get the lot, and the
project is theirs. (BTW, this same basic calculation also works for
tear-down projects — often called “scrapers.”)

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Interesting that the example above written almost a year ago is so close to what a buyer would be dealing with on today’s featured property.

To value this lot, the first task is to estimate the final value of the property after the structure is built. IMO, Turtle Rock will hit bottom near $250/SF, maybe $275/SF for a typical 2,000 SF home like the one that could be fit on this lot. New construction might command a premium of $25/SF, but not much more. That would put the final value near $500,000. Of that, $300,000 is going to go for construction of the house. Since this would be an owner-occupant, the remainder could go toward land making this lot worth about $200,000. Of course, you might want to put a larger house on this lot, and that might justify a higher lot price, but the old structure was only 1,796 SF, so a smaller structure might be in order. I suspect the surrounding neighborhood probably averages about 2,000 SF.

The interesting thing about this calculation is that you see just how sensitive the price of the lot is to the price of the house that sits on it. The $549,900 asking price might be warranted in today’s market as houses are still going for $900,000 in the area. As nearby prices fall, the value of this lot will fall right along with them. The difference being, there isn’t much of a floor beneath lot prices. If house prices in Turtle Rock fall $400,000 in this area, so with the value of this lot. If this lot doesn’t sell soon, it may only be worth $150,000 a couple of years from now. If you don’t believe the price of lots can drop that much, I can tell you that lots in Riverside County already have. Finished lots are going for less than replacement cost there. When you are stuck with an asset nobody wants, the price is only what some buyer is willing to pay. With speculative real estate, that isn’t very much right now.

If you really want to drink the kool aid, buy this lot. You will get every dollar of the change in prices in the surrounding neighborhood — up or down, and you wouldn’t have to deal with renters, maintenance, or other issues associated with the “box.” Of course, few lenders will loan money on something like this, so you would probably have to do it with your own cash. At the bottom when they are going for $150,000, finished lot deals like this one will be the real “home runs” of the next speculative real estate cycle.

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Watch out
You might get what youre after
Cool babies
Strange but not a stranger
Im an ordinary guy
Burning down the house

No visible means of support and you have not seen nuthin yet
Everythings stuck together
I dont know what you expect starring into the tv set
Fighting fire with fire

Burning Down the House — The Talking Head