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I'm seeing an old house in Union City, NJ, that I'd like to buy to tear it down and create a 3 family one to generate income. What are the steps to take in this process and what kind of contract should I use with the bank? PS: I'm a first time home buyer and I don't have a lot of money to give up front.

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    Have you checked to see if zoning ever permits this? Every town has its own zoning rules, minimum land to build a certain size house. The land my house is on can't be used to build a multi family house for example. It seems to me this is the very first step. – JTP - Apologise to Monica Nov 5 '15 at 3:38
  • Yes, it's allowed if I live in the building, that's my plan, create a 3 family house with the help of a partner and live in one of the units. – Arthur Accioly Nov 5 '15 at 18:26
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By process, I assume you mean the financial process. Financially, this doesn't look any different to me than buying an empty lot to build a rental unit, with the added expense (potentially significant) of doing the tear-down. Given your lack of experience and capital, I would be very hesitant to jump in like this. You are going to have to spend a lot of time managing the build process, or pay someone else to do it for you. And expect everything to take twice as long and cost twice as much as you expect. If you really want to get into the landlord business, I would suggest starting with a structurally sound building that needs some renovation work and start there. One you have that up and running, you can use the cash flow and equity to finance something more aggressive.

If you still think you want to do this, the first thing to do is figure out if the financials make sense. How much will it cost to do the tear-down and rebuild, plus the typical rental expenses:ongoing maintenance, taxes, insurance, vacancy rates and compare that to the expected rental rates in the area to see how long it will take to 1) achieve a positive cash flow, and 2) break even. There are a lot of good questions on this site related to rentals that go into much more detail about how to approach this.

  • Also, you would probably need to hire someone to check the zoning to see if you can even tear down and/or rebuild how you want. I would start recommend starting as mentioned above in the first paragraph. – Ross Nov 5 '15 at 15:44
  • Financially I see one potentially significant difference. If user179589 needs to borrow money to buy the property being demolished, when he destroys the old home the value of the property the initial loan is against would drop significantly. If that resulted in the outstanding loan balance being more than the value of the empty lot I could see the bank being unhappy. – Dan Neely Nov 5 '15 at 16:40
  • I assume this is something that could be negotiated when taking the loan out; but would need to be brought up in advance to avoid problems. – Dan Neely Nov 5 '15 at 16:45
  • Also more generally you do need to be on the alert about the loan terms. If you are getting a loan for the property, banks are likely to view it differently depending on whether you're planning to live there yourself, rent it out, or both. – BrenBarn Nov 5 '15 at 20:29
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Thank you for your response KeithB and Ross. I was researching more about this and looks like I have to follow all these steps (please, correct me if I'm wrong):

  1. first search for a good real state broker dealer and explain my plan. Probably he's going to suggest using the "construction-to-perm" type of contract. In New Jersey we also have incentive for first-time home buyers, not sure if it's applicable here.
  2. with the letter of credit approved, make a bid to the homeowner and buy the house
  3. choose a builder and an architect
  4. work up house design with the builder/architect
  5. tear the home down.
  6. draw the money and receive inspections from the bank at specific milestones (the money is not paid in advance)
  7. pay interest to the bank meanwhile the construction it's in progress
  8. after completion, conversion to permanent mortgage financing
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    Many of the first time home buyer plans require you to live in the property for a specific amount of time. knowing the plan is to tear down, rebuild and rent out would likely make this project ineligible. – mhoran_psprep Nov 5 '15 at 16:15
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    You need a step 0 in there, which is to read @JoeTaxpayer's comment on the original question and then investigate if this will even be allowed. Zoning and land use regulations (and if the home is in some kind of historic district) may preclude doing this at all. – blm Nov 5 '15 at 17:16
  • Sorry, I should had mentioned that part. I'm planning to live in one of the units and rent the rest. Doing this I can fit the requirements. – Arthur Accioly Nov 5 '15 at 18:25
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    @user179589 You'll have to double-check that. Even living in the property may not allow you to use a first-time home buyer plan. The property would have to be zoned R-2 to allow a multi-family dwelling. – mkennedy Nov 5 '15 at 18:29
  • Thank you, I'm going to check that. I'll comment my answer later when I find all the information. – Arthur Accioly Nov 5 '15 at 20:58

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