Buying a Dream Home? In This Market? For Some Buyers, a Remodel or Teardown Makes More Sense

Struggling to find your dream home? Join the club. If you can not find the right home in the right location, a teardown might be a viable option. You can also buy a home in need of some love and then remodel it. How to choose?

Even with rising interest rates and slowing demand, the housing market is still on fire. Available homes are scarce in many markets, particularly in neighborhoods with good schools. If you are seeking property in a prime location, such as waterfront or within walking distance of a downtown area, the pickings are even slimmer.

The lack of inventory is causing frustrated buyers who would have preferred to purchase new or recently updated homes to instead consider older homes or those in poor condition. As a result, some real estate agents are marketing their listings as renovation opportunities or as teardowns.

Lauren Ravitz, an agent with Berkshire Hathaway HomeServices in Los Angeles, last year represented the buyer of a home in the Brentwood Park neighborhood listed for $ 6,595 million. It was a 1949 Colonial on a lot with mature trees in proximity to shops and restaurants. The home was marketed as “a rare opportunity to restore / remodel a timeless classic from a bygone era or to build a magnificent estate in one of the west side’s most coveted locations.”

The home sold for $ 6,795 million to a buyer who plans to tear it down. The site is in a neighborhood with homes valued at $ 15 million to $ 20 million, Ms. Ravitz said, so it was “ripe for a teardown.”

Indeed, the value of other homes in the area is one factor buyers should consider to determine whether a teardown makes financial sense.

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“Whether you completely rebuild or remodel, the finished home should be worth no more than three to five times whatever you paid to acquire the teardown,” said Ken H. Johnson, Ph.D., a real-estate economist at Florida Atlantic University in Boca Raton, Fla. “Otherwise, you might develop way too much home for the neighborhood.”

But some homes are in such bad condition or so hopelessly outdated that the cost to remodel them would exceed that formula.

Craig Jones, a broker associate with Premier Sotheby’s International Realty in Naples, Fla., Recently sold a five-bedroom home on a 1.6-acre lot with 189 linear feet on the Gulf of Mexico, for $ 24.5 million. The house was built in 1956 and was not up to current building standards for waterfront homes.

Ms. Jones expects the buyer to demolish the house and replace it with a mansion of at least 7,000 square feet. She said the new home will likely be elevated, consisting of two stories above a garage level.

“The home will need to meet FEMA’s requirements for homes built in flood zones — with pilings of a certain depth and concrete walls — as well as the latest hurricane standards in terms of the materials used and the building techniques for the structure and the roof, Ms. Jones said.

Another alternative is to buy a home in need of repair and renovate it. Some homes have historical value, were designed by a renowned architect or have unique architectural details that should be preserved. The home might even be protected by a historical designation. “By ‘teardown,’ we do not mean a beautiful vintage house that we all wish would stay,” said Andrew Franz, an architect in New York City. “A teardown is not worth saving — either they were built poorly or are not energy-efficient or do not have architectural value.”

Here are some things to consider if you’re thinking of purchasing a home to either tear down or renovate.

Do not forgo an inspection. Do not omit the home inspection, even though you’re planning to renovate or demolish the existing house. Teardowns are typically older homes, and they might have been built with hazardous materials such as asbestos or lead paint. If these materials are present, your demolition and waste-disposal costs will skyrocket. Underground fuel tanks can complicate matters as well. A home inspection will provide you with the information you need to make an informed decision as to the risks and costs of proceeding with the purchase.

Be prepared to pay cash for a teardown. A conventional mortgage on the property you’re purchasing to tear down won’t be available. After all, what bank would lend you money and collateralize a home you plan to demolish? Instead, Patti Lotane, a mortgage loan officer with Cape Cod 5, a state-chartered savings bank in Chatham, Mass., Said that most people pay cash to acquire the teardown property, using either cash on hand or equity tapped from their primary home via a cash-out refinance or home equity line of credit. Then, she said, after the acquisition, the buyers will apply for a construction loan to cover the cost of demolition and construction. Construction financing might be available to cover the initial purchase, Ms. Lotane said, but the buyer would need to have all of the plans and specifications in hand at the time of the mortgage application, as well as a signed agreement with the contractor building the house.

Bone up on local building codes if you plan a major renovation. “In most municipalities in Florida, and probably in most municipalities around the country, if the cost of the improvements you’re making exceeds 50% of the market value of the existing structure preconstruction, you will be required to bring everything up to code, ”Said Brian Grossberg, co-founder of Azure Development in Delray Beach, Fla. So if an existing home (not including the land) had a value of $ 2 million, and you plan to renovate it at a cost of $ 1.1 million, you will be required to bring it up to code. And, Mr. Grossberg said, for a coastal home, that cost might be prohibitive because you’ll need to raise the height of the building. In that case, it makes more sense to rip down the existing structure and start from scratch.

With the average 30-year mortgage rate rising to 5%, home ownership may now be out of reach for millions more Americans. WSJ’s Dion Rabouin explains the impact for potential buyers, sellers and the housing market. Illustration: Adele Morgan

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