How Do I Get Started as a Developer? –With a Four-Plex.

4F_Elev  11 x 17
Updated june 2, 2016  
NOTE:  The Limit on Nonresidential space in a 1-4 unit home financed with a FHA 203(b) mortgage was increase from 25% to 49% in September of 2015.
A question that I am hearing a lot from prospective developer/builders is “How do I get started?”.  One way to get started is with a Four Plex that you will also live in.
Over the last 10 months I have been digging into the details of the FHA four plex loan program and the FHA 203K Rehab and mortgage program which is available for 1-4 units as vehicles to help people get started.  I will be presenting this Dallas this week at CNU 23 in the session with Monte Anderson at 9am on Thursday morning How to Build & Finance Small-Scale Incremental Urbanism,  but here is the short version:
Goal = A rookie developer builds a 4 plex with a partner and buys it with an FHA 30 year mortgage.  They establish a modest but credible track record while working on a lean project at low risk.
Project costs for the sake of this exercise = $600,000.
  • Conventional 75% Loan To Cost (LTC) construction loan guaranteed by an investor who puts up $150,000 in equity (and has second position on the land and building after the bank’s typical lien position).
  • The rookie developer runs the project and earns a fee,( included in the $600K project cost) to support themselves  for 8-12 months while the project is under construction.
The Investor has a contract to sell the Four Plex to the rookie developer for $650,000 and the rookie developer has pre-qualified for an FHA insured 30 year mortgage (FHA 203-b) with the following underwriting requirements:
  • Borrower has 2 years of employment with stable or rising income.
  • 3.5% down payment (which can be gifted funds).
  • Reserves of 3 months PITI.
  • Credit Score minimum 580 (640 is more the real world score for local bank underwriting with the FHA insurance).
  • PITI cannot exceed 30% of borrower’s gross income which includes 75% of the gross rent on the other three residential units.
  • One of the four-plex units must be occupied by the borrower as their primary residence for at least 12 months.
  • A maximum of 49% of the building floor area can be non-residential use.  Appraiser will verify the non-residential use complies with local zoning.
Assuming a year for construction and lease up, the Investor/Guarantor would see a 35% IRR on an investment in a hard asset with minimal construction and leasing risk.  The 30 year FHA mortgage as the take out loan is really straight forward.  The rookie developer and the investor get to know each other in a low risk deal that takes 8-12 months.
The developer goes through the entire project arc and end up owning a building with some decent equity which they helped create.  The developer has demonstrated their ability to get a project financed, built and occupied.  They can live cheap while pursuing their next project (rent free) in a live/work that showcases what they can do.  PDF of the FHA Underwriting Manual:
The FHA 203K approach could be similar for an existing building.  You can use the FHA 203-k purchase/rehab loan to purchase an existing small apartment building of 5-6 small units that could be converted to a 4 plex as part of the renovation.   FHA 203-k loans are set up to include the cost of renovations.  Small apartment buildings are tough to finance with conventional commercial loans and tend to get rented to death, requiring a lot of work when they go up for sale.  Unfortunately the 203-k loan can take 6-8 months to get approved.
The intent with both of these approaches is a low risk entry into development and building with the rookie developer fully engaged and gaining experience in all aspects of a project in a compressed arc.
1113_160528_4f simple static pro forma

18 thoughts on “How Do I Get Started as a Developer? –With a Four-Plex.

  1. Will Dowdy May 13, 2015 / 4:36 am

    I don’t know if this post seemed revolutionary when you wrote it, but I think this is a critical piece of the rookie developer information. I’ve sent the Dark Arts vimeo to a number of people, but despite the enthusiasm, there has been the nagging question, “Ok, but what’s my first step? No, no… my very first step.” For a lot of people, when you have to ask a question like that, it means that you probably are in over your head. This post breaks down that barrier, and I hope will be a big reason that a lot more people get into the game.

  2. Peter H. June 1, 2016 / 6:11 pm

    Why is this written with the assumption that the LAND is free? Find a lot for the multiplex… whoops, all that profit turned into a loss.

    • rjohnanderson June 1, 2016 / 8:00 pm

      Why did you assume land was free when you read it? That certainly was not my assumption. Land is one of the costs in developing a building. If you can’t get the rent that will support a decent return on a rental building (at any scale), then you can’t build the building.

      • Peter H June 14, 2016 / 9:06 pm

        Thank you for updating the article with a more realistic scenario 🙂

    • Peter H June 14, 2016 / 9:14 pm

      Most states require a 10,000 sqft lot to classify for multifamily housing.. not 5,000 sqft. Also, the $40,000 budgeted for this multifamily lot is about 1/4 of reality in anywhere, but the Midwest.

      • rjohnanderson June 14, 2016 / 9:45 pm

        Minimum lot size is set by local municipalities in their zoning code, not by the state.

      • Upstreamdancer-Loni June 15, 2016 / 12:14 pm

        to Peter – By necessity, cities are getting more accepting and inventive about ways to increase housing , especially when the city is built out and has few parcels large enough for multi-family. Things like shared housing, and ADU’s (accessory dwelling units or in-law flats) ordinances are happening everywhere on single family lots.

        Professionally I transform single family homes into multi-family dwellings, usually 2-4 households. We do not need variances, it happens on small lots and to smaller homes than you think, and can use remodeling dollars from typical sources.

  3. Chris Bailow June 14, 2016 / 5:02 pm

    I really like this post and get a lot from it. What do you suggest as a starting point for someone who is not in a position to live in one of the units? I would have to imagine that a good number of rookie small developers may already own homes and have families?

    • rjohnanderson June 14, 2016 / 8:14 pm

      Just get a construction loan from a small local bank and refinance the building with a 20% down Fannie Mae or Freddie Mac 30 year mortgage. You don’t have to live in the property to qualify for those loans.

  4. Alex Garcia August 13, 2016 / 4:33 pm

    Can you share a little bit more about the land acquisition? I talked to a couple of banks and they would give me a construction loan but I have to own the land (not financed). The banks I talked to do not want to include the purchasing of the land. Also, I found the same with investors, they want me to own tha land first and then they would be open to negotiate the terms of investment and financing. Thank you so much.

    • rjohnanderson August 13, 2016 / 5:10 pm

      You don’t have to own the land to get a construction loan, but you will gavr to have site control(a valid purchase contract) + enough equity to satisfy the bank and a solider guaranty. If you are doing 1-; units with your construction
      Loan and you intend to pay off the construction loan with a 30 year mortgage, get prequalified for the take out mortgage befor discussing the terms of the construction loan. You should off your investor the terms you think are reasonable for your project. You are paying for the use of their capital for some or all of the down payment and the guaranty during the risk of the construction period. You should be the person to map out your deal, the structure you are proffering.

  5. Lemar April 20, 2017 / 2:00 pm

    Hello. I am looking at building a fourplex in Michigan to live in. I want to use my VA or FHA loan for construction. Do you know any lenders that offer this program nationally?

    • rjohnanderson April 20, 2017 / 2:12 pm

      Lemar, The VA and FHA loans are 30 year mortgages. You will need a separate construction loan to fund building the four-plex. Construction loans are typically made by smaller local banks. Go talk with a loan officer in one of these banks and explain that you are looking for a construction loan that will be paid off with a VA or FHA mortgage when the four-plex is completed. They can originate both loans and collect both sets of fees. They should be happy to see you. Here’s the catch. The construction loan will require you to come up with 20%-30% of the cost of the project as a down payment, compared with the 30 VA mortgage which is 0% down or the FHA mortgage at 3.5% down. You may need to find a partner for the construction period to help with the down payment if you don’t have the cash required for the construction loan. An alternative is to find an existing four-plex that needs work or a 5-7 unit building and renovate that building into 4 units using the FHA 203(k) loan program. Again, you need to find a _local_ bank to do the deal, not a national outfit. Email me if you would like to explore this further.

    • rjohnanderson July 5, 2018 / 4:29 pm

      If you stqart with a four-plex you may not need a partner for the long term, just for the construction loan or the purchase and rehab loan. You can refinance the property with a standard 30 year conforming mortgage from the VA, FHA, Fannie Mae or Freddie Mac and pay off the construction loan, your investor partner’s original principal plus a decent return. The construction loan will be a % of the _Cost_ of construction. The refinance will be a % of the _Value_ of the building. The completed building should be worth substantially more that the cost of building/rebuilding it.

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