Question on building a spec house

[Tim Schneider]

Here is my situation: I own a lot in a subdivision, it has been on the market for 9 months with no offers. Home sales in the subdivision have been consistant, most by the developer. I am considering partnering with a builder to build a spec house to sell.

Does anyone know if a bank will give a constuction loan to a builder to build on a lot that is not owned by the builder? If they would, when we sold it would the buyers lender require the lot to be in the builders name, or could they disperse funds to both me and the builder? Thanks.

 

[alex gilbert]

I have seen equity participation deals in the past, but you and the builder would be far better off going down to a local lender and asking these questions than relying on 2nd hand info here or else where. If you haven't partnered up with a builder yet call a couple of lenders in your area with construction expertise and see how they'd require the deal to be structured. My guess is that either both you and the builder would have to be on the note together or that you would have to sell the lot to the builder, either for a fixed amt or a percentage of the sale proceeds as I doubt the lender would make a loan to an entity who did not own the land.

 

[Ted Martin]

I'd be a little leery of developer sales, what incentives are they offering to make the sales? Will you and the builder the same marketing options and the ability to offer comparable incentives. Are there any resales of properties in this subdivision?

Jumping out of a $##,### lot holding that isn't selling into a $###,### spec house that doesn't sell looks like it has a substantially greater risk to me. A payment of $### is much easier to handle that one of $#,###. It would seem that if the developer thought there was a market for more new homes he would be trying to buy the lot back from you.

 

[Cigar]

Tim:

As a builder I've done this, the way we do it in California is that the owner hypothecates his interest deeding title to the builder, that way the builder holds title and can obtain the construction loan. You're ownership interest then becomes secondary to the bank's loan. I'm sure the language is different in Wisconsin, I'd go to your title company and ask how they do it in Wisconsin. http://en.wikipedia.org/wiki/Hypothecate

 

[ccooper]

Going to bed with builders results in splinters in your derriere

No, No, NO. STOP

I am a real estate professional with 15 years in the biz as an appraiser. My wife is a broker. We just got shucked in this exact type of deal with a builder that we knew and trusted. We formed an LLC and became 50% partners on the construction of a new spec home in a developed neighborhood.

Our trustworthy builder partner took every chance he could get to suck $$$ out of this house under construction. First, he threw invoices from other jobs onto this construction dispersal. Second, he threw in construction draws for his own time which were not justified, in our opinion. Bottom line is, whenever he felt like a 20 day scuba trip to Australia, he went down to the title company and took out a draw. If his girlfriend felt like she needed some chest enhancement, he took out another draw against this house.

About the time we started laying the carpet down (July of '06), we started adding up all of the invoices for the stuff we had paid for out of pocket and the construction draws. With his invoices included, we were 20% over our list price!!!!

We got our magnifying glass out and started calling his B.S.

Guess what...the house still hasn't sold 18 months after the foundation was poured. We really don't expect anything to happen this winter with the morning news screaming negative about the mortgage industry.

After having the house listed at 90% of appraised value all summer, we finally decided to pull the trigger and take over the mortgage ourselves. Our builder partner did not want to make the last 2 (semi-annual) interest payments and wanted to stick the bank with the house. The bank is my best client and I was not about to get upside down with them.

Friday we close on our own loan on this spec house. Monday the movers come to pack up my household goods and move me into this spec. The spec is 3 times the size of the house we've lived in since 1993 and the mortgage is just as big. With a slow down in residential sales expected for the next year at least (possibly 2??), the future does not look good for our "easy investment spec house".

My advice, don't go into partners with a builder. After I jumped into bed with this guy, all I hear about is how builders milk money out of their construction draws to pay their bills due today. I see too many boats on my lake with names of "First Draw" or "Construction Disp".

If you want to expedite the selling of your lot, then the one thing that we are now contemplating is "subordinating" the lot to a builder. That is what we are now thinking about for our 2 remaining vacant lots. Subordinating means that you are willing to take a 2nd Deed of Trust behind the builder's 1st (Construction loan). You sell the lot to the builder but he doesn't pay you for the lot until his spec house is sold. You have a 2nd Deed of Trust behind the banks construction loan. Your deed of trust is "subordinated" to the banks construction loan. The problem with this is that if the bank forecloses, you are out of luck. I've always been told, don't take a second unless you are capable and willing to buy out the first if that happens. Then...that would put you in exactly the situation my wife and I are in now, owning a spec house that is not selling.

Oops, gotta go, I have to go meet some people at the new house to get ready to move in.

 

[Tim Schneider]

Cooper, thanks for your insight, it sounds like terrible situation to be in. As far as Ted's comments about concessions, I know people who have bought from the developer, and that is not the case. I guess the shady deals have not made their way up to my neck of the woods.

I really need to think this over, but I will not make a decision until spring. Now is not a good time of year to start construction in Wisconsin, no one wants to work outside in January. I think as an appriaser, I would have an "upper hand" when it comes to pivking a floor plan, where to spend on upgrades, and pricing, but I'm sure I wouldn't be the first (or last) to make that mistake.

 

[Ken B]

You own the lot? Talk to a lender about a construction-permanent (C-Perm) loan. You retain the deed to the lot, you should be able to act as the general contractor, you hire a GC to supervise, and draws are paid to you so that you can disburse them to the subs. Draws should be paid out based upon percentage of work complete tied to an appraisal of the proposed property.

 

[Doug Meyer]

I have heard and seen similar things happen as the Cooper stated. I would really watch what you do!!

 

[Jerry Dell]

I have heard bad things happen. This is a bad time for spec building

 

[Ted Martin]

I wasn't necessarily throwing any rocks that the developers sales had a shady element. My point was more the ability of a large developer to offer incentives that an individual might not be able to match. Sort of a mom and pop grocery versus Walmart type of situation. A large developer is also going to get financing incentives from the local lender than an individual builder isn't. Sort of a best customer versus a one off customer situation, if the lender is looking a repeat business from the developer they might be willing to take less profit on a single dealing and make it up on the next one. You as a one off builder aren't going to get that perk.

I second Coopers advise if you are willing to take the associated risks. Otherwise my inclination would be to either take a small loss and dump the site or if you think there is little downside risk and that the market will improve then pull the listing and for the demand for vacant lots to catch up with you.