He’s been looking at homes forever, faithfully doing weekend tours of new and existing homes. But she can’t seem to find what she wants: the right house in the right place. Feeling frustrated and discouraged, he’s thinking that maybe he should buy a vacant lot and have someone build the house he’s always wanted. Is that a lossless proposition? Probably not.

Although it is important to consider several issues, your first question may be how much it will really cost you if you buy a lot and have a house built. He understands from the outset that his expenses will likely be substantially higher than if he purchased an existing home or one in a newly built community from a builder. This is why.

It couldn’t take advantage of the economies of scale of a builder.

You are paying retail price for the lot. When builders buy land for development, they pay wholesale because they subdivide a parcel into multiple lots and spread the purchase price and other costs among all the lots. Because they are building many houses and not just one house, their construction costs per square foot are lower. If you buy a ream of multipurpose paper, you could be paying $6.50 per ream. But if you bought a box of that paper, it would cost you about $4.50 per ream. The same principle applies to buying a lot and building a house.

Your real estate investment involves the financing of three separate phases.

The building lot, home construction, and finished property are essentially separate parts of the project, and you’ll need financing for them. Not all banks and mortgage companies offer lot loans and construction financing. Lenders generally require more money up front for lot loans, so you may need to come up with cash for 20-25% of the lot’s purchase price. I would need a loan for site work and house construction. Once construction is complete, the other two loans would be replaced by a permanent loan or mortgage on the entire property. You would be paying points and other fees for loans and closing costs when you decide on the lot.

You would need a builder, a real estate attorney, and possibly an architect.

Plans for a true custom home designed by an architect can cost thousands of dollars. (You could save money by using plans your builder already has.) If you don’t build houses for a living, this is not the time to start! And don’t use Uncle Charlie unless he’s an experienced home builder. Most production (ie high volume) building organizations will not be interested in building a single house, so you will need a smaller builder. Your relationship with the builder will be established in the construction contract. This should contain all details and specifications for the job and provisions for cost overruns, to-do list items, and deadlines for completion. Enter your lawyer. When interviewing builders, get a copy of their proposed contract so your attorney has time to review it before you have to sign it. Also, you should not purchase a lot until your builder inspects it to estimate construction costs and determine if the lot is suitable.

Consider this real scenario. A builder sells 3,750 m2. sq. ft. homes on lots for $515,950 in a new home community. That’s a combined home and lot purchase price of $138/sq. ft. Each home has a three-car garage, full unfinished basement, fireplace, skylights, cathedral ceilings, back staircase, utilities, central air conditioning, and other bells and whistles. A similar-sized building lot in a comparable area in the same borough is for sale for $225,000 (which doesn’t include about $10,000 for utility hookup and permit fees, lot grading, and other prep costs). Financing, settlement, architectural, and legal costs aside, the only way it would come close to the builder’s package price is if he could build a house for around $75/m2. ft ($225,000 + $10,000 + 3,750 sf x $75 per sf = $516,250). However, you will not be able to duplicate what the builder offers. You would probably end up with a stripped down and basic house.

So what is the solution? Stay tuned for my next article (“Ways to Get a Building Lot for Your Home”).