New build vs. resale debate: The secret to finding the right answer for you

New build vs. resale debate: The secret to finding the right answer for you
by Dena Landon, posted in Investment Strategy

Are new developments springing up around your city, and you see potential? Or, is there a shortage of single-family rentals in desirable neighborhoods? If you’re planning on acquiring real estate this year, you could have a choice between buying a resale or a new build.

You’ll find plenty of arguments on both sides of the long-standing debate between new builds versus resales, but which type of property will best meet your investment goals? We’re going to break down the pros and cons of both investment options to help you decide.

3 pros to buying a resale investment property

If you’re thinking of buying an older home, possibly one that’s already a rental, here are some of the pluses to consider.

#1 Buy at a discount

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There are more opportunities to get a deal in the resale market. Home prices fluctuate more, even on the same block, because the homes aren’t the same. They’ll have different features, like an attached garage versus detached, or have been maintained differently. Whether you’re buying from a homeowner or an investor, there is more variability in pricing than with a new build.

There are more foreclosures and short sales in the resale market, which can also be bargains. You will run into distressed properties that require work to make livable, however.

If you follow a buy and hold investment strategy to take advantage of value appreciation, look at resale investment properties where you can buy at a discount and sell higher.

#2 History of cash flow

When you buy a resale property, it has a rental history that will help you more accurately project cash flow. You can use it when calculating the cap rate to compare different investments. With some lenders, this history helps you qualify for a lower interest rate if you’re financing your purchase. If the property is currently rented and the tenants are paying on time, they know that the investment will cash flow immediately.

Examining a building’s history will also reveal red flags. A lot of vacancies and evictions in the property’s past should be a warning sign. Do tenants always turnover at one year? Dig deeper to find out why. Rental history could help you avoid adding a dud to your portfolio.

#3 Established neighborhoods

Established neighborhoods appeal to renters who want to be closer to a city’s downtown, restaurants, and entertainment. When you buy a resale property, the area and the tenants it will attract are a known quantity. It will have a reputation as the neighborhood for families, college students, or hipsters, which does some of your marketing for you.

Because a neighborhood can always go into decline, investors should keep an eye on both short and long-term trends.

3 cons of buying a resale investment property

Time, money, and tenants are the top three drawbacks to buying a resale investment property.

#1 Pay for the property upfront

If you’re buying a foreclosure at an auction or a property unable to qualify for traditional financing, you’ll likely have to pay 100% of the purchase price of a resale property upfront in cash. Going this route ties up a lot of capital and leaves you exposed if anything goes wrong. If you discover that an “as is” home needs more work than you’d anticipated, but you’ve exhausted your cash reserves, you’re now in a difficult position.

If you’re looking at resale homes to get a deal, some of the best deals are only available if you can pay for the property in full. This could be out of reach or an undesirable option for many investors.

#2 Inherit another landlord’s problems

If you’re buying a resale investment property that’s already occupied, you could be inheriting the landlord’s problems. You didn’t select or screen the tenants. Their behavior and how they treat the property will become your issue as of the closing date.

Look up city records to see if any noise or nuisance complaints have been filed against the property recently. Drive by several different times during the day to see who is out in the yard, or talk to the neighbors about the people currently living in the home.

An eviction can cost up to $5,000 if you hire a lawyer, so ask for proof that tenants have been paying on time before you close on the house. Leases stay with the property, so you’ll have to perform due diligence on the tenants when buying in the resale market.

#3 Expensive and constant repairs

If a previous landlord didn’t take good care of the house, you would have to devote capital to catch up on repairs and maintenance. If you buy a resale, there’s the potential for expensive repairs to take over your life and destroy your profit margins.

Systems will break down more frequently in an older home, especially if it’s been a long-term rental and gone through several tenants. While you can set aside money for planned updates, you can’t prepare for emergencies. An expensive plumbing leak can wipe out a month or a year’s profit. Resale properties often require significant time and resources to maintain.

Three pros of buying a new build

Now that we’ve examined resale properties let’s look at why some investors prefer the benefits of buying a new construction house over dealing with the hassles of a resale. You have more control over your investment from the beginning, from choosing the first tenant to scheduling routine maintenance. But, like any investment, there are pros and cons of buying a new build.

#1 Location and better tenants

Builders pick locations with low crime, great schools, good roads, or at least an area that’s up-and-coming. If you buy into the development, you’re buying into an area that you know will attract quality tenants. You’ll have fewer worries about missed or late rent payments, and they probably won’t trash the home.

The builder has essentially done the location scouting for you, saving you a step in evaluating a new investment. However, unlike an established neighborhood, you’ll likely be further from an urban center, with fewer public transportation options. Some tenants will view this as a negative.

#2 Warranties and new systems

Builders offer home warranties that typically cover workmanship and materials for one to two years and define how repairs will be made. Major structural defects are usually covered up to ten years. These warranties could protect you from having to cover a major repair shortly after purchasing the property.

New plumbing, HVAC, and electrical systems should remain trouble-free for a few years. These warranties protect both your investment and your cash flow from unexpected repairs. However, if the builder goes out of business, the warranty could be worthless.

Potential graphic – bar chart representing how many builders have gone out of business each year for the past five years.

#3 Buyer incentives

Builders use incentives to attract qualified buyers. They could offer to pay your closing costs, which will have a positive impact on your cash-on-cash return. Or, you could negotiate for an extended home warranty, features which you know will appeal to renters or higher-end appliances.

Depending on what they give you, buyer incentives could turn a new build into a better investment from both a financial and a quality of property perspective.

3 cons of buying a new build

The downsides to buying a new build for investment all boils down to the numbers, whether it’s the purchase price or a lack of rental history.

#1 Pay full market price

In a new development, home prices are rarely negotiable. Comps are right there in the house next door, and there’s not a lot of wiggle room with a lender. Whereas it’s common to negotiate with the owner of a resale property, you don’t have that flexibility in a new build.

Instead, builders negotiate with the buyer on upgrades. They’ll offer to put in a granite countertop instead of laminate to sweeten the deal. These upgrades aren’t as useful for investors. Indeed, you may not want high-end features and fixtures in a rental property because they cost more to fix or replace.

#2 HOA costs

If the development includes a playground, pool, or other amenities, the neighborhood association might charge HOA fees. These fees cover upkeep and maintenance, but they’ll eat into your profits. Even if you include them in your profit and return calculations when buying, you can’t always plan for increases. And the dues will increase over time.

The only plus to HOA costs is that they could cover items like snow removal or lawn cutting, saving you money. As well, they are tax-deductible. But if the association is poorly run, you could find yourself unexpectedly hit with special assessments or a sharp increase in dues.

#3 Restrictions on rentals and no rental history

Homeowners don’t usually want to live next door to a rental. They want to know their neighbors and have a sense of community. Because allowing too many investors to buy into a development might hurt other home sales, some developers place limits on selling homes to investors.

These restrictions could make it difficult to both buy and sell a new build. As well, homeowner’s association documents could also set restrictions on the number and type of tenants you’re allowed to have in your property. Since you’ll have no rental history, either for the home or for the area, setting your asking rents is tricky.

In summary:

Resale properties

  • Buy at a discount, but might have to pay cash upfront.
  • Known rental history, but could inherit a previous landlord’s issues
  • Established neighborhoods which appeal to a known type of tenant
  • Expensive and constant repairs and maintenance

New builds

  • Good locations and better tenants, but possibly pay HOA dues
  • Homes come with warranties and have new systems
  • Buyer incentives can reduce your costs, but little flexibility on price
  • Possible restrictions on rentals and no rental history