Investment with new home builder

[blind_side1]

Newbie here.  Not sure if this is the right place for this post, but here goes.

We have an opportunity to build a home with a reputable local home builder in the Austin, TX area.  We buy the land and put up the money via a construction loan for the home.  He builds the home, and we split the profits.

Anyone have any feedback or experience in working investments with new home builders? 

[propertymanager]

You take all the risk and then split the profits?   No thanks!  You should also consider that this market is very risky right now and has considerable downside risk.

Mike

[blind_side1]

Agreed that we are taken on most of the financial risk, but this seems to be a better strategy for us compared to buying a beat-up old house and trying to rehab it, managing sub-contractors, and dealing with problems unknown at the time of purchase.

I view it as we are the financial side, and they are the sweat equity side.  Anyone put together a deal like this before?

[71tr]

propertymanager is right-on,

the builder is assuming no risk.  you are providing the land and the construction financing and assuming all of the risk of getting the project completed and sold.  to the builder its just another job that he also gets and equity kicker should it sell at a profit, all during construction he and his sub contractors are getting paid via the construction loan financing draws.  if you want a true partnership get him to kick-in the land or a chunk of cash and also get him on the hook to share in the monthly mortgage payments once the home is complete and sitting on the market for sale.

[petemfa]

I'd bet you anything that the builder makes money on this deal even if the house DOESN'T SELL!!!

He'll get HIS guy's to do work for HIS price and then charge you YOUR price. or materals will be handled the same way.   It's not dishonest, it's EXACTLY what a builder is supposed to do.  He works, you pay.

Ask yourself one VERY important question....

WHAT HAPPENS IF IT DOESN'T SELL!!!!!!!!!!!!!!!!!!!!!  Can you pay a mortgage on it for one year? maybe more.  Where I am new homes are sitting on the market at LEAST that long.  Don't take on something in a falling market that could put your fiancial well being at risk.

How much do you plan on netting on this???  after the split?

[Rich_in_CT]

RUN don't walk from this one.

[blind_side1]

petemfa:

We would put up about 50K and our estimated ROI is 20 to 25K.  Of course the builder would make money off us, I wouldn't expect anything less.  Although, I don't expect him to clean up on this type of deal.

This particular builder has done these deals with numerous other investors for several years.  Most of his business comes from repeat investor clients.  I have spoken with some of these investors and most have done well and a few haven't.  All the ones that haven't done well are more on the real high end or low end.

I have been watching closely the markets in the US.    Our market in Austin is still performing well in comparison to other US markets espeically in the home price range of 200 to 600K.

As you indicate, my biggest concern is what happens if it doesn't sell.  My back-up plan would be to move my wife's office to this house and charge her full rent  .  We would then rent her existing office, which is much smaller, to typical home renters.  The net of this would put us at or near cash flow positive until we sell the new house.

[christopher w]

Blind,

The builder should be able to qualify for the financing himself as long as you provide a pre-qualification letter from a mortgage broker stating that they have reviewed your finances. The builder has NO RISK in this transaction, but he gets paid during construction AND gets 50% of the profits. This is not a good deal for you. Your exit strategy is not sound. The Austin market may not be as slow as other areas of the country, but it has slowed. Also, are you taking into account cost over-runs, and carrying costs? With all of the rain we have had here in Texas builders are way behind on their projects because they can't get foundations poured. What if this builder can't get the house done quick enough and you have to roll in 2-3 extra months of interest. Prime plus 1 (normal rate for construction phase) can add up pretty quickly on a high end home. Not to mention if it does not sell and you have to refinance. The closing costs and house payments will eat into that 25K real quick.

What you need to do is sign a contract with the builder, have him carry the financing and you assign the contract aftert the house is done. Builders are doing that all day long here in Dallas. It is a win-win situation because the builders keep there subs busy, and the investor only has to put down a small amount of earnest money to lock in the contract.

[propertymanager]

Blind,

I always think it's interesting when a newbie posts a question and then when everyone says it's a bad deal, the newbie argues for the deal.  Why ask if you didn't want an honest answer?

Mike

[Rich_in_CT]

Blind,

I always think it's interesting when a newbie posts a question and then when everyone says it's a bad deal, the newbie argues for the deal.  Why ask if you didn't want an honest answer?

Mike

I guess all we can do is try.  I'd like to reiterate my previous point:

RUN don't walk from this one.

[blind_side1]

Thanks for the input everyone.

propertymanager:
I am simply providing more details to further along the discussion.  I was asked some questions in a previous post of which I responded.  IMO, I didn't feel as though we were arguing, but to each his own.

So I understand you,  I'm to take your initial response on future threads as your final answer?

[DeeinAustin]

PLEASE DONT MOVE FORWARD ON THIS! My team and I specialize in this area. The problem others have with your "deal" is that you don't have a true partnership. You just have a spec builder. The builder shouldn't split profits because they aren't doing anything except their job. Locating land, building on it and managing the project it is expected.

Important questions for you:

1. Who is representing you and are they connected with the builder? Has a third-party verified the numbers? How solid are the comps? How often does the agent/builder bring a buyer before the project is finished?

2. WHO WROTE YOUR CONTRACT?
- Is the price and contract firm? The builder shouldn't give an "estimate". You need a final price with final numbers stated in your contract. The specs should outlined detailed materials used, etc. so they can't make you pay more if they run out. They need to get an equivalent.
- What happens if the builder takes longer than expected? Are they penalized?
- Under what circumstances do you get your earnest money back?

FYI, here's how spec builds normally work:

Option #1 The builder finances at least part of the project or all and you sign a contract to purchase. If it's such a great deal, they should be able to sell it once it's done and make money. If the builder can't secure financing or doesn't want to, why not when they have a built-in buyer for the property? NOTE: A true partner will at least have some "skin in the game", such as financing the land.

Option#2 If you do all the financing, then the builder just gets paid as a contractor. The folks who gave you advice want the builder to make money. The RED FLAG is why they're asking for a split when they aren't providing anything beyond what they'd provide any buyer.

At the very least, get an experienced Texas real estate lawyer who is board certified in residential real estate. I know at least two who are active investors.

[abc123]

Maybe the builder would split his profit from construction with you, Partner.
Investment 101 (abc's): spec is short for speculation.
Chris

[christopher w]

The borrower is taking all of the risk in this transaction. Why should the profit be split with the builder. What the buyer needs to do is negotiate a fixed fee to pay the builder like cost plus 5%. This way when the house is done the builder has been paid, and the investor makes all the profits. The builder is just doing the job he is paid to do.

[DeeinAustin]

The borrower is taking all of the risk in this transaction. Why should the profit be split with the builder. What the buyer needs to do is negotiate a fixed fee to pay the builder like cost plus 5%. This way when the house is done the builder has been paid, and the investor makes all the profits. The builder is just doing the job he is paid to do.

Exactly.