How and When to Buy a Teardown House

Housing prices have increased substantially due to four primary factors: a construction labor shortage, skyrocketing costs of building materials, too few homes on the market and too much demand for these houses. Given the short supply of existing homes on the market, prospective buyers have begun looking for alternative ways to purchase their dream custom homes. One way buyers can become homeowners during a seller’s market such as this is to purchase an abandoned property. During the financial crisis, developers often bought up abandoned, unfinished homes in order to refurbish and flip the properties. Today, purchasing an abandoned incomplete construction remains a viable option. Buyers can either renovate these properties or tear them down and rebuild. While purchasing an unfinished house or teardown property can be an incredible opportunity, it does not come without risks. Follow below to learn how and when to buy a teardown house -- from applying for a mortgage to valuing the property.

How to Value an Abandoned House for Purchase

Before purchasing a teardown or incomplete build, be sure to properly research the home itself and the surrounding neighborhood. Researching unfinished homes properly will help you, your real estate agent and/or your attorney effectively value each property. It will also help you determine the viability of future plans you may have for the build. Depending on the home’s age and location, certain restrictions for renovation, demolition and rebuilding may apply. Not only could these restrictions affect your ability to rebuild, but they might also impact your ability to demolish or renovate the building at all.

Determining Whether an Abandoned House is Worth the Investment

In his article “How to Value an Unfinished House” for SF Gate, Steve Lander writes that “unfinished houses can be an excellent opportunity if you handle both the financial and construction work involved in finishing them.” Before one either cashes in on their investment or moves into their new home, one must determine whether the house and its lot are worth purchasing. Lander advises that buyers value the property by “estimating the value of the house when it is completed” and by multiplying the lot’s square footage “by the market’s price per square foot.” Buyers should also factor in the cost of demolition and/or the “cost of the work that needs to be done to finish the house.” Keep in mind that costs involved in renovating or rebuilding an abandoned house are not solely related to demolition and construction. They may also include a variety of inspection fees, closing costs, insurance fees and legal fees.

To do this, buyers should consult with a general contractor or with a design-build firm for accurate estimates. Lander suggests buyers buffer these estimates by adding “approximately 20% to the cost of the work to protect against overruns.” Finally, buyers should investigate the property’s legal status by requesting records from the county recorder’s office. If possible, buyers should also ask the seller for any building permits he or she applied for. Once the buyer has calculated each of these values, he or she should subtract the estimated cost of work from the anticipated value of the final build. If any of these values is impossible to calculate, buyers can simply offer the value of the underlying lot based on comps in your area.

Deciding Whether to Teardown or Rehabilitate the House

There are many factors to consider when deciding whether to renovate an existing home or build a new one. However, these factors are a bit more limited when one must decide between rehabilitating an unfinished or abandoned home versus fixing up a home that was well-maintained but is simply out-of-date. According to Lee Wallender, Jillian Dara and Deane Biermeier in their article “Should You Remodel or Rebuild Your House?” for The Spruce, rebuilding often makes better financial sense. Biermeier, Dara and Wallender write that “if you plan to be in the house for the long-term and then sell it, it is usually wiser to tear down and rebuild, at least from a purely financial perspective.” According to Dara, Wallender and Biermeier, “physical elements of a home are on a timer” -- no matter how carefully the owners have cared for their house.

They note that “exterior paint might last up to seven years...dishwashers last less than a decade...and three-tab composite shingles are good for about twenty years.” When a home has been left open to the weather, to pests and to other agents of destruction, these physical elements fare even worse. Demolishing and rebuilding is often the best and least expensive choice long-term. This is because -- according to Biermeier, Dara and Wallender -- “you reset the clock in terms of the house's physical nature.”

Common Problems with Vacant Homes

Unfinished homes are often left vacant for weeks or months -- if not years -- after their builders or owners have abandoned them. During this time, utilities are turned off -- if they were ever connected -- and weather, pests and other elements wreak havoc on these structures. Though the Connected Investors editorial team identifies these homes as “the most lucrative and overlooked” type of property in the article “What You Don’t Know about Buying Vacant Houses,” their value lies primarily in the small pool of interested buyers hovering around their property. Few look past overgrown grass, frozen plumbing and pest infestations and consider the value of the foundation, existing structure or underlying and surrounding plot of land.

Unfortunately, there are quite a few problems buyers considering the purchase of an abandoned house must contend with before capitalizing on their investment. Thankfully, many of these issues are of little concern when the buyer plans to demolish their new home before rebuilding another structure in its place. Some issues unrelated to condition, however, could impact the new owner’s ability to build. In their articles for The Wall Street Journal and Realtor.com respectively, June Fletcher and Gina Roberts-Grey elaborate.

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Red Flags to Look Out for When Buying an Unfinished or Abandoned House

Physical Damage

In her article “Should You Buy An Unfinished Home?” for The Wall Street Journal, June Fletcher identifies several potential issues. According to Fletcher, even watertight vacant homes “often have moisture problems, especially if the heating and cooling systems [are no longer] run regularly.” This excess exposure to moisture can “lead to mold, corroded pipes and appliances, and warped floor boards, door frames and trim.” Quoting Cleveland Plumbing Industry training director Jason Shank in her article “4 Things to Watch Out for If You’re Buying a Vacant Home” for Realtor.com, Gina Roberts-Grey agrees. According to Shank, “plumbing is a vacant house’s most vulnerable spot.”

When a home is abandoned due to foreclosure, incompletion or irreparable damage, “many absentee homeowners will simply shut off the water at a toilet or sink valve” rather than “turning off water and draining and treating pipes to prevent catastrophic fractures.” Pests also pose problems for vacant homes. Gina Roberts-Grey writes that “over time, a home without humans can become a refuge for many woodland creatures.” Squirrels, bats, mice, possums, rats and other rodents are common intruders. Many of these pests can easily “chew access holes that they—and many of their critter counterparts—use as a revolving door.” Because of this, careful inspections are necessary for all plumbing, insulation, HVAC, roofing and other functional and structural elements of abandoned homes.

Legal Hurdles

According to Fletcher, vacant homes could have “a clouded title and unpaid liens and taxes.” During the financial crisis, many custom home builders abandoned luxury builds after the economy turned, the housing bubble burst and clients were unable to continue financing their new constructions. Because of this, unfinished homes were common across the US.

In her 2010 article “Half-Built Homes Can Be Bargains, But With Strings Attached” for The Seattle Times, Mary Shanklin noted that any buyer who purchases a home with liens taken against it would “have to repay them or negotiate with the bank.” Shanklin warned buyers to be especially wary of “liens involving the Internal Revenue Service, because those can be difficult to clear.” In general, prospective buyers of unfinished homes are “‘buying a lot of unknowns’” and should “‘take some precautions when considering the purchase of a half-built home.’”

When to Buy an Unfinished Home or Teardown

Buying a teardown or unfinished construction can be well-worth the cost of purchase -- especially when the property is located in a desirable district, neighborhood or subdivision. Buyers can either purchase a teardown or unfinished home to renovate it or to demolish and rebuild it. According to Ken Harney in his New Home Source post “The Tear Down Option: Is it for You?,” local governments in some communities “encourage substantial renovations over demolitions by making the permitting easier and faster.” Local governments might encourage minor renovations to make the property habitable or full renovations -- e.g. bringing the home down to its studs. Harney notes that buyers might “be able to retain the existing foundation… [or] to retain a portion of an existing wall or incorporate part of the old structure into your new design, and thereby sidestep local restrictions on total demolitions.” Homes that have been vacant for an extended period of time -- such as those that have been condemned or those that were never occupied -- might be impossible to renovate. In these cases, buyers would need to fully demolish the existing structure.

Purchasing a Home with Intent to Rebuild

According to Thompson, “teardowns are almost always small, outdated or defective homes in desirable neighborhoods.” Because the condition of both unfinished homes and teardowns is typically dilapidated due to negligence, “the bulk of the property's value lies in the land, which means they tend to be priced below the average for their location.”

Buyers can determine whether a list price is fair by subtracting the cost to demolish said structure from the value of the land. Thompson notes that the cost to demolish a residential property is “typically $5,000 to $20,000 for a 1,500 square foot house.” Homeowners should only purchase teardowns or unfinished homes if the property is able to “support a new house worth two to three times more than the sale price of the teardown.” Before purchasing a teardown, buyers should ensure that the land is suitable for construction by ordering soil tests and examining prior permits.

Do Teardowns and Unfinished Houses Qualify for Mortgages?

In our article “How to Build a Custom Home Hassle-Free,” we noted that lenders are often hesitant to finance either land purchases or new builds because they face greater risk of default. This hesitancy also extends to distressed properties like teardowns and unfinished builds. To protect lenders, the federal government and some state governments have established certain criteria for extending loans or lines of credit against distressed properties. Writing for Investopedia in their article “The FHA’s Minimum Property Standards,” Amy Fontinelle and Marguerita Cheng elaborate. Amy Fontinelle writes that FHA loans and some other mortgage loans “must meet safety, security and soundness standards which include areas like roofs, electrical, water heaters and property access.”

These standards do not apply to cosmetic concerns or “minor defects” that do not threaten the buyer’s health or safety. To prove that a property meets these standards, the current owner must typically produce a “certificate of occupancy.” In her article “What Is a Certificate of Occupancy?” for Million Acres, Maurie Backman writes that a certificate of occupancy is a document “issued by a local zoning or building department stating that a home or property is suitable for occupancy.” In order for a property to be considered suitable for occupancy, “it needs to be compliant with the building code that applies in that area (which means it needs to adhere to safety standards).” Most banks across the country require buyers to secure a certificate of occupancy from the seller before approving a mortgage on the house in question. Those who purchase a teardown or incomplete construction with the intention of renovating or adding on to the property may also need a certificate of occupancy to begin custom home construction.

Alternative Financing for Teardowns or Incomplete Builds

Financing with FHA 203(k) Loans

Unfortunately, in many cases, neither teardowns nor unfinished constructions will meet these minimum property standards. Writing for Investopedia, Fontinelle notes that those wishing to purchase a home that fails to meet minimum property standards should “ask the seller to make the needed repairs.” Similarly, homeowners who have conducted unpermitted renovations should offer buyers a credit to bring their remodels up to code. This step is generally unavailable to buyers hoping to secure a mortgage on teardowns or incomplete constructions because the current owner is clearly unable or unwilling to address such issues.

On the other hand, properties that do not meet minimum property standards could qualify for certain loans -- such as FHA 203(k) loans -- that are designed to help homebuyers rehabilitate older distressed properties.

However, according to HUD, “the total rehabilitation cost must not exceed $35,000” in a limited loan. A single major renovation -- much less multiple -- can easily surpass this bound. Sadly, distressed properties -- such as teardowns or incomplete constructions -- in some areas of the US without a certificate of occupancy do not qualify for rehab loans. No matter where the property is located within the US, HUD criteria for FHA 203(k) loans require the home to be at least ten years old. Because of this, new builds that were never finished -- either due to lack of financing or some other reason -- do not qualify.

Converting a Construction Loan into a Mortgage

In their article “How To Use A Land Loan To Finance A Property Purchase” for Forbes, Casey Bond and Mike Cetera outline alternative ways to finance a teardown or incomplete build. According to Cetera and Bond, “buying a teardown [is] one workaround to securing an actual mortgage loan for a land purchase.” After the new construction is complete, homeowners might be able to convert their construction loan into a mortgage.

This conversion would save homeowners from having to pay back the construction loan at high interest within a short period of time. In some cases, banks might acknowledge an incomplete construction as a teardown and offer the lendee similar terms. In our upcoming article “Financing Your Demolition and New Construction Project,” we offer additional resources.

Working with Element on Your Knock-Down and Rebuild Project

As one of California’s premier design-build firms, Element Homes not only has years of experience in the custom home design field, but also understands the unique challenges facing California home buyers. Our team of industry experts understands local laws, regulations, building codes and permitting requirements. The Element Homes team also understands the California climate, which is vital to designing and building a custom home that can withstand earthquakes, wildfires and winds.

Perhaps best of all, Element Homes offers each client access to our cutting-edge project tracking software. Especially important in complex projects like those involving demolition, our project tracking software allows clients to monitor every stage of their build. Schedule a consultation with our team by calling or reaching out via our website. We are happy to answer any questions you may have about our custom home building process.

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