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How Do Most Builders Currently Spec a House?
First as a spec builder, you identify several vacant lots or under-improved properties. Hopefully you can finance them or purchase them with cash. Two to four months later you are ready to pull permits and begin construction. You then take out a construction loan speculating on what the market and potential sales price will be six months to a year down the line. You pay the closing costs for a construction loan, as well as the carrying cost of interest and taxes. You start paying costs the day you buy the property, and continue throughout the build and the marketing time required to find a buyer. You may also pay to decorate and furnish the property to use as a model. Once a buyer has been found, you pay interest and taxes until escrow closes. At this time, you finally get your cash back and receive your profits.
Why is This a Problem for You, a Spec Builder?
LIMITED CASH - Spec construction loans generally require 15%-25%+ down payment. Land loans can require as much as 50%. As a spec builder, you can only tie up as many projects as your own cash will allow. If you are cash poor or have found too many projects, your only option is to bring in investors, which means giving up your profits.
LIMITED CREDIT - You must fully qualify for every lot and construction loan you take. If you do not have a large income or net worth, you may only be able to start one or two projects at a time. Credit problems may keep you from building at all. If you become over extended with loans, cost overruns or market slow-down can send you spiraling into financial trouble.
VALUE RISK - Everyone knows the market can fluctuate. Signing on to spec projects is a bit like stepping closer and closer to the edge of a cliff. There is no question of if you will fall off the edge, only a question of when. Markets will change. If you are fully extended when values drop, you could go bankrupt as many builders did in 1990.
NEEDLE IN A HAYSTACK MARKETING - You are looking for the buyer who wants your exact house on your exact lot in the exact style you are building. You take a great risk that you may or may not be building exactly what the buyer wants. Therefore you may have to go back and make subsequent changes to the project, possibly at your expense. A buyer may also back out of an escrow leaving you scrambling to find a new buyer while incurring more marketing and carrying costs.
Why is This Method Bad for the Buyers?
All the costs you paid during construction are charged to the buyer in the final sales price. You pay higher commercial rates for loans than buyers do. So the buyers end up paying more than they had to and you don't get a dime of it. They lose out on possible tax deduction. Also, the buyers pay extra for a permanent loan when the home is finished at whatever rates and programs are available. The buyers also risk that if they give you a deposit or upgrade money, the property may not turn out the way they wanted, or you could go broke. To buyers, their worst fears are being locked in a project with no control. If the house isn't what they wanted or the builder goes under, their dream is crushed.
What is Paper-Spec?
Once you have designed your spec project on paper, you can market the house to buyers. Many projects have interested buyers long before ground is broken. You can sell the buyers the property and let them have all the financial worries. They buy the lot and plans and then build at a contract price that still nets you your profits. You close escrow six to twelve months early and build to suit based on your original plan. You get your land cash up front, and since the buyers are now financially responsible, your risk is minimal.
Why Would Buyers Want to Do This?
TAX DEDUCTIONS - Many of the items buyers pay to you such as interest, points and property taxes may be tax deductible if paid directly by the buyers. A $750,000 project may have as much as $45,000 in tax deductions. If they pay you for these items as part of the sales price, they get no deductions.
SAVINGS - Homeowners pay less than a builder in fees and interest on construction loans. Many times, qualifying can also be easier. Since they close escrow before you start building, you can pass on some of your marketing and carrying costs as savings for the buyer. By using a construction and permanent loan all in one, they can save the closing costs for an end loan.
SECURITY - Since the final loan is in place, market value is no longer an issue. If the market changes or you have financial problems, the buyer and the construction lender have the lot and the funds to hire another builder and finish the project.
Why Would You Want to Do This?
Since the buyers actually close escrow on the land right away, you get most of your cash right away. The buyers took the loan, so they have all the financial risk. The take-out loan is already included so you have no market risk. All you have to do is finish the project on time for the contract price that you negotiated with your buyers. You don't use any of your cash or credit so you can build as many houses as you want.
What About Change Orders, Control and Your Risk?
It's a myth that building to suit is harder due to change orders. The truth is when buyers are on the hook for interest and penalties they will compromise to keep the project moving. If you set the ground rules in your contract, upgrades and change orders can even make you money. If the problem is a personality issue, you can more easily leave with the profit you have already made and give the rest of the project to another builder.
How Do You Market a Project Like This?
You obviously need buyers to make this work. If you get buyers interested in a custom build on your lot today, you take them off the market from buying a finished house six months early. If you work with a good Realtor and tie up several properties, you can market to buyers who have trouble qualifying for regular sales. If you work with a Realtor who knows how to market, they can use one of your homes as a model to sell other projects for you.
What is the Role of Stratford Financial?
All buyers would build their dream home if only the process were easy and affordable. Stratford has created this program to remove your risk, grow your profits, and benefit buyers. Stratford's first job is to look at your project from a lender's point of view. Then, using our marketing skills and working with your Real Estate Agent, we help you present it to buyers in an attractive, affordable manner. We use our $250,000,000+ worth of funding experience in construction lending to remove buyer's objections before they begin. We teach the buyers the questions they need to ask regarding the savings, tax, and security benefits. We guide them through the entire purchase, qualification, and construction process. Looking at every detail of the project, we serve as a guide and reference to both buyer and builder helping to facilitate a smooth, affordable, and profitable process for everyone involved.
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