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Kevin J. Daum
This article was originally published in the April 18th,
2003 edition of the East Bay Business Times.
Interest rates are low. The economy is unsettled. The direction
of the housing market is uncertain, particularly in the upper
price range. Yet there is still demand and many executives
have decided it's time for a bigger home. There are a number
of custom homes on the market but they aren't quality or just
don't fit quite right. Tract houses don't have the prestige
and individuality worthy of an accomplished executive.
It is time to consider building over buying. Aside from the
fun and satisfaction of picking every detail of the house
including floor plan and finish materials, building can bring
significant cost and tax benefits as well as a hedge against
depreciation.
Finding the lot can be time consuming since most real estate
agents consider lot sales too much work for too little commission.
However, construction costs generally decrease in a declining
market so purchasing land can offer protection from depreciation.
Gone are the days when one needed to spend a ton of cash to
build a home. Today there are lot loans allowing for a low
20% down payment. Many lot loans today are available with
No Income Verification and with 5+ year terms, allowing you
to take your time in designing the home. After owning the
lot for a year, many construction lenders will not require
any additional cash into the project if the numbers work to
their satisfaction.
Construction financing is also more flexible. Large institutions
like Washington Mutual and Bank One are now beating out local
banks for construction loan business with convenient All-in-One
loans. Instead of taking a short construction loan and worrying
if you and the house will qualify for a refinance at completion,
these programs have a construction loan that automatically
rolls into permanent financing. Many programs can lock your
rate at start and assure you of a fixed loan regardless of
interest rate increases or declining real estate values. Low
down payments and No Income Verification make the financial
part of the build more affordable and less risky. These loans
generally cost no more than construction-only loans offered
by small local banks.
The caveat with construction financing is the lending institutions'
inexperience and apathy regarding your best interests. The
banks, large and small, are focused on cherry picking loans
to make high yield for their true customers, their investors.
They generally won't guide you through the multi-year process
of correctly designing your build finances to meet their criteria.
Since construction loans require 100% of project monies to
be accounted for upon funding, it is important for you to
understand bank-underwriting criteria relative to your financial
position. Otherwise at the last minute you could be turned
down or required to inject hundreds of thousands of dollars
to start your project.
Many institutional Loan Officers cannot explain the steps
necessary to prepare your project finances over time. There
are many variables in budgeting and underwriting resulting
in a meager 50% funding rate among most banks. Protect yourself
by doing your homework and using experienced resources. Some
architects and builders have financing referrals but many
are untested. The ideal financing partner is a specialized
Mortgage Broker with hundreds of construction loans completed.
They can provide a broad range of programs, and experience
in financially positioning the project from day one.
The brass ring on the custom home carousel is tax deduction.
When buying a home from a builder, you not only reimburse
them for all their expensive commercial financing and carry
costs but you lose out on the deductibility in the build process.
Depending upon your financial status relative to liabilities
and income, by building yourself, you may be able to deduct
the interest and points on the land and construction loans
as well as any property taxes paid along the way. A project
with a total cost of $1,250,000 over two years from start
to finish could yield as much as $80,000 in tax deduction
netting almost $32,000 in potential tax savings, enough to
furnish a few rooms.
It's not all perfect. Everyone has heard a horror story about
the project that took too long and cost too much. Building
a custom home requires attention and discipline. It is a long
term, wholly involving, emotional and physical process that
properly executed can be financially and emotionally rewarding.
Done right, there can be significant profit in building as
well; otherwise spec builders wouldn't be doing it. You must
ultimately make the decision whether you are willing to carefully
manage a $1mm+ project while still doing the job that gave
you this opportunity in the first place.
Kevin Daum is the Founder and CEO of Stratford Financial
Services, a Real Estate finance and education company, founded
in 1989. Stratford specializes in Purchase loans, Refinance
loans and Custom Home Construction finance and has successfully
financed thousands of clients. He is the author of "Building
Your Own Home for Dummies" (Wiley), as well as "What
the Banks Won’t Tell You." Mr. Daum was an Underwriter
for Plaza Savings and Loan and Key Bank of New York. He is
an INC 500 CEO and has been listed as one the 40 Most Influential
People Under 40 in the San Francisco Bay Area. He is the Global
Chair for the Edison Innovation Program with the Young Entrepreneurs'
Organization (YEO) and is a founding Board member of the Bay
Area Chapter of YEO.
Mr. Daum is a frequent contributor to numerous business
publications on the subjects of Real Estate and Small Business
leadership and speaks regularly on both subjects. He can be
contacted at kevin@stratfordfinancial.com.
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