If you want to make lots of money in real estate, you need to focus on expansion. If you can reclaim livable space or expand your property's livable space outside its footprint, you will almost always make more money.
The key is in comparing your building cost to your property's selling cost on a price per square foot basis. If you can build much cheaper than the current market selling price, then you've got yourself a great way to make lots of money in real estate.
The reason why remodeling and expanding is so popular in expensive cities is exactly due to this pricing arbitrage. Let me share with you an example of how I made money in real estate by expanding the livable square footage of a house.
How To Make Lots Of Money In Real Estate: Expand
In 2014, I bought a fixer for about $714 / square a square foot in the Golden Gate Heights neighborhood of San Francisco. Nobody really knows where the neighborhood is, and that's just the way I like it because everybody eventually will! Golden Gate Heights is just several blocks west of UCSF and has homes facing the Pacific Ocean.
Real estate is my favorite asset class to build wealth because it is tangible, inflates with inflation, has preferential tax benefits, and provides an income stream if rented out.
Be The CEO Of Your Property
When I buy real estate, I'm the CEO of the property. When I buy a stock, I've got to trust the CEO and his or her management team to execute. Sometimes the CEO is great, sometimes the CEO sucks wind, yet still gets a multi-million dollar exit package that makes me sick.
Nobody cares more about your money than you. Hence, the goal for wealth builders is to own investments where you can better control the outcome. And if you can't own investments that you control, let someone you trust manage your money if you don't have confidence in managing your money yourself.
I trust myself to work harder and scrutinize expenses and revenue more than anybody. My bottleneck is time.
In this post, I'd like to point out a very important rule before buying any single family home. If you follow this rule, I'm confident with the right execution, you will be able to make far more money than if you didn't.
Buy Property With Expansion Potential
Buying in the best location possible is the most often sited home buying rule. But the thing is, great locations are expensive. If you can't afford a property in a prime location, then look for property in an “undiscovered” or “up and coming” location that you think will be in high demand.
10 years ago, nobody really wanted to live in the Mission District, San Francisco. Now, the Mission District is at the center of the San Francisco real estate conflict between techies and long-term residents. Rental and property prices have skyrocketed.
Besides buying in a good location, I think an equally important rule is to buy a home with expansion potential. A lot of people get carried away with the cosmetics of a home. They get “fooled” by the fancy staging, nice floors, and brushed nickel.
But if you've ever remodeled a home, you will know that everything is replaceable, and doesn't cost too much. If your home burns down, not to worry. You've got home insurance to help you with the rebuilding cost. No? Call your insurance company ASAP!
Not only should you buy a home with expansion potential, you should consider buying a home in the most expensive neighborhood with the largest expansion potential possible. Let me explain two very real examples of how to make lots of money in real estate.
How To Make Lots Of Money In Real Estate Example #1: Golden Gate Heights neighborhood in San Francisco
Value: Back in 2014, most GGH homes sold for between $650 – $850 / square foot, depending on location and view. The price is relatively inexpensive compared to everywhere else in the city. If I was a real estate agent, I'd use my language skills to convince every foreigner to buy in this neighborhood, especially the Chinese.
Cost: The building cost per square foot can be as low as $150 a square foot up to $350 a square foot. $150 a square foot is for a simple room with electricity and no plumbing. $350 a square foot is for bathrooms and kitchens. According to the National Association Of Homebuilders, the national cost per square foot to build is only $80. But I challenge anybody to get a price that low and be happy with the results.
Profit: $650 (low end selling) – $350 (high end construction) = $300 for an 85% profit. $850 (high end selling) – $150 (low end construction) = $700 for a whopping 467% return. Just to be conservative, always add 50% more time and cost to your project to stay sane and conservative. Even if costs balloon to $525 / sqft, the low end return would still be $125 or 24% ($650 – $525).
How To Make Lots Of Money In Real Estate Example #2: The Marina neighborhood, San Francisco
Value: Back in 2017, most Marina homes sell for $900 – $1,200 a square foot, depending on location and view. The prices are high, but still so much cheaper than prime property in Manhattan, Hong Kong, Singapore, and London where price per square foot are in the $2,000 – $3,000+ range. San Francisco is one of the cheapest international city in the world.
Cost: The cost should theoretically be the same $150 – $350 in the Marina as it is in GGH. They are only 3.5 miles away from each other. A tub costs the same online wherever you order. Imported Spanish porcelain tiles are also the same. Lumber, sheetrock, copper pipes, and paint all cost the same! Unfortunately, contractors tend to charge more for their labor when they know you have a more expensive home. This is one of the reasons why some contractors gain a poor reputation. The build price per square foot in the north end of San Francisco is closer to $300 – $500 a square foot.
Profit: Let's say you go high-end and spend $500 a square foot and sell your house for the low end of the range at $900 a square foot. Your profit is $400 a square foot, or a 80% return on your money. If you're able to build at the low end for $300 and sell for $1,200, then your profit is $900 a square foot, or a 300% return on your money.
Make Money In Real Estate Through Property Value Arbitrage
I'm currently working on example #1 by expanding my old bathroom from a tiny 36 square feet (6 feet X 6 feet) to a large 165 square feet master bathroom. Yes, 165 square feet for even a master bathroom sounds a little absurd given average master bathroom sizes are usually under 120 square feet, but hear me out.
I've got a 33 foot long garage that can only accommodate one car. I could fit in a mini and a compact car, but I don't want two cars, and there is plenty of street parking.
As a result, I decided to reclaim as much of the garage space (not livable space) as the Department of Building Inspection allows to build my master bathroom (livable space that gets included in the sale).
Cost To Expand And Build New Bathroom
I'm currently spending around $310 a square foot all-in to build the master bathroom. I've decided to go all out with dual 10″ rain showers, a six foot long 10-jet blogging hot tub, an electric toilet seat with water spray, some nice Spanish tiles and fixtures, a seating area, and a large closet.
This is going to be the bathroom of my dreams where I can hang out for hours on end. When I left Corporate America in 2012, I would spend easily 2-4 hours a day in my old jacuzzi tub writing and reading. It was something I truly enjoyed.
To improve the value of your home, you should try and create as many sanctuaries as possible. This is especially true since we're all spending so much more time at home post-pandemic.
Good Value In Expanding In Real Estate
At a $310 per square foot build cost, I will end up spending roughly $51,150 for the bathroom. Although this may sound like a lot of money given it's $31,000 more than my car, I'm creating an extra 129 square feet of living space (165 – 36).
Even if my sell my home for a static $714 / sqft, I've created an estimated $92,364 in value for a $42,364 profit in the three months it takes to build. A 85% return is pretty darn good for such a short period of time.
Once I'm done with the bathroom build, I am strongly considering building out another 750 square feet out back on two levels. My lot is very deep, and San Francisco allows you to build up to around half the area size of your lot.
What's the obvious problem? MONEY!
Building out 750 square feet of living area will cost me roughly $150,000 in extra cash. But if I succeed in the grand expansion, then I will have created an extra $535,500 (750 sqft X $714) in value to my house for a profit of $385,500 or a 257% return in what will probably take 7-11 months.
Of course, I may not want to sell, and just enjoy the view and hot tub forever.
What goes into the cost of remodeling?
- Architectural and engineering drawingsElectrical, building, plumbing, mechanical permits
- Material costs such as lumber, paint, doors, windows
- Overages because something always comes up
What are the downsides to expanding?
Higher property taxes: Once your project is finished, you will be assessed property taxes based on the construction cost of your expansion / remodel for as long as you own the home. The upside is that the construction cost is cheaper than the purchase cost as I've demonstrated. There's no escaping taxes! Well, if you remodel without permits, then you can probably avoid paying more property taxes. However, you will also get a discounted price on the work done when it comes time to sell.
Cash flow risk: Be careful not to take on too big of a project. The worst is if you run out of money and another downturn strikes that forces you to sell. Manage your liquidity like a scrupulous financier. If you get in trouble, you may have to take out a HELOC, borrow from friends, or try to at the very lease, refinance your mortgage to improve cash flow before giving your property up to vultures.
Usually Better To Expand And Remodel Than Buy
Dealing with contractors is a tricky business. Once you get a solid contractor who is reasonably priced, on-time, and does good work, don't ever let him go. He is like a trusty auto mechanic who will give you priceless peace of mind as you work on building your real estate empire.
When you're looking to buy property, look for underdeveloped lots and much larger neighbors that provide precedence for you to build. Spend hours and hours researching the average selling price per square foot in your neighborhood, and down to your very block. The closer the comparable, the better.
Once you've done your research, make sure that the selling price per square foot is at least 50% more than the realistic construction cost, just in case you run into trouble.
Alternatively, you can buy homes that have inaccurate square footage compared to the official tax records. This way, you can make money on homes by just paying attention to detail! That's much easier than doing a home expansion.
Living In An Expensive City Can Pay Off For Expansion
Although living in an expensive part of the country can be painful, the great thing is that construction costs don't follow the cost of housing – costs are relatively stable. As a result, real estate development returns will usually be much greater in places like San Francisco, Washington DC, and New York City vs. less expensive places like Houston, Portland, or Orlando.
If you can build for X and sell for 100% more with a high degree of certainty, it behooves you to build as much as your city will allow. If you need any more incentive to save more money, making a large return by developing a property you enjoy is a big one.
Latest Real Estate Expansion Project
Hopefully by now you agree that expansion is the best way to make lots of money in real estate. It takes capital, organization, and commitment. However, once your real estate expansion remodeling project is done, you will really appreciate all the sweat equity you put in.
For my latest expansion project, I'm turning 300 square feet of living space into 600 square feet of living space. I've blown out a funny sized room and old half bathroom. In its place, I'm building a living room, bedroom, closet, fourth full bathroom, hallway, and laundry room.
Overall, this expansion project should create an additional $300,000 in value after costs. The cost is about $300 / sqft while the average selling cost in my neighborhood is about $1,150 / sqft for newly remodeled properties.
A Long Remodel
In the end, this real estate expansion remodeling project took two-and-a-half years to complete! I started in the beginning of 2020 and got all the final permits approved in August 2022.
The downstairs looks great with a new bedroom, living room, bathroom, laundry room, hallway, and closet. I also built a deck off the living room for $22,000. The dining room window was failing anyway, so I decided to cut it out, install a French Door to the deck with a view of the ocean.
Instead of selling the property, I ended up raising the rent to $8,200 from $6,700, bringing in a 13% gross annual return on my remodel. Not bad. Remodeling your rental property for more income makes sense for long-term landlords.
Invest In Real Estate Passively
If you don't have the downpayment to buy a property, don't want to deal with the hassle of managing real estate, or don't want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.
Fundrise manages over $3.3 billion in assets and is vertically integrated. It invests in single-family and multi-family homes to capture rent and property price appreciation in this inflationary environment. For most people, investing in a diversified fund is the smart way to go.
Another great real estate investing platform is CrowdStreet. CrowdStreet mainly focuses on individual real estate opportunities in 18-hour cities. 18-hour cities tend to have faster growth rates, lower valuations, and higher yields. You can build your own select fund with CrowdStreet. Although CrowdStreet also has funds as well.
I’ve personally invested $954,000 in real estate crowdfunding since 2016 to diversify and earn more passive income. So far, I've earned over $680,000 in distributions.
Shop Around For A Mortgage
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The more lenders compete for your business, the lower your rate. Take advantage.
How To Make Lots Of Money In Real Estate – Focus On Expansion is a FS original post. Today, the average price/sqft in Golden Gate Heights is now between $1,000 – $1,200, while the cost to expand or remodel has risen to $300 – $500 / sqft. The price difference is still huge. However, it may take longer to remodel or expand due to supply chain issues. Make sure you do your own calculations as well.