Purchase Money Mortgage for Construction Loan

[Matthew Harper]

Hi all,

I have been speaking with the inheritor of a home in a high end neighborhood in Birmingham, Alabama (more specifically, Mountain Brook).  The home is in a prime location, but is beyond the scope of repair for what would be desired in the area.  It makes the most sense to tear down and rebuild.

I am new to investing, so my resources are fairly thin.  I have been working with a partner for this deal who has built homes in the area before.  Our initial idea was to suggest a purchase money mortgage in which we use seller financing as a down payment on a construction loan.  The seller is open and excited about the ideas we have discussed but is a bit worried about being subordinate to the construction loan.

Since I have not done this before, what assurances can be made to the seller and what collateral would he have in this situation that would make him feel more at ease?

Are there other options that I may not be aware of that would facilitate a large, new construction project in a case like this?

Thanks,

[Brian Gibbons]

Hi @Matthew Harper 

It is always good to know the basics, as in the ARV and basic repairs costs and existing financing.

I have no idea what the numbers are here but an option is:

Joint Venture with the seller

1. Buy on Sub2 then give a note for their equity. Draw up the JV Agreement.

2. Perform the rehab and list for resale with an agent.

3. From the proceeds pay the seller. The JV Agreement can stipulate minimum net profits for you.

[Matthew Harper]

Thanks @Brian Gibbons 

The home is free and clear, so would Sub2 come into play? I am not too familiar with joint Venture Agreement, though maybe just in terminology. I assume that is just the agreement of terms we set up regarding compensation (price of note, interest, share of profits)?

I am not sure of the repair costs to the home as it is, but from our initial assessment, it seems like a greater return to tear down and rebuild the lot to the standard of the homes surrounding it.  The current state of the home is not the desired style of the neighborhood.

We estimate that our new construction would sell around $1.25 million, with construction costs between $600k and $700k.  

The heirs sold a side lot next to this home for the low $200ks, which is well below market price for the area.  

Our goal is to obtain the lot for a similar price, offering 10% interest on the seller mortgage for a minimum of one year, with options to extend.  We would then need for the seller to subordinate his loan to our construction loan, and I am not sure how to explain how that will benefit the seller or still protect him, if it even does.  

The seller in this case is house poor.  He has no job but inherited a lot of property and is looking for a good out.  Here are some of the advantages I can think to suggest that our offer would include:

1. Home is sold at no commission
2. Home is sold "as is"
3. Never have to show the house
4. Never have to deal with buyers
5. Never have to deal with agents
6. Premium interest on the loan
7. Flexible moving terms
8. Can take all fixtures, and everything else
9. Cost plus 12 months 10% interest at a minimum to count on

[Brian Gibbons]

You could partner in an LLC and do a percentage over a certain amount, say $200K note (land) plus 10% of the net on resale after all costs. Seller would wait for any profits, and you could just provide the funds to rehab.

If you spent $750K and grossed 1.15K, sales costs at 100K, you net would be $300K, pay seller 10% of that or $30K.

@Will Barnard has done many 1 - 2 mil residential.  Not in 'Bama tho.

[Will Barnard]

Sub2 only comes into play if the seller had a mortgage.

How many square feet is the existing home? How many square feet do you expect to build if you tear down?

Based on numbers given, you are slightly over what I would consider a deal based on the higher cost you put for construction and an exit of $1.25M.

The seller being concerned with a second position is valid so to overcome that, you must show that the combined LTV (loan to value) is safe and that the exit price is easily obtained in your market and not a best case scenario.

Bring in a JV partner who can fund the whole thing would be another option and take the seller out completely.

[Matthew Harper]

Thanks @Brian Gibbons and @Will Barnard 

The current home is a crookedly L-shaped one level built in the 50s around 2800 sq ft.    

We have continued to look into the market in the area and spoken with many appraisers and agents that are concerned about the location of the home as a fit for the style of construction we had planned.  What has been suggested is an empty nester rebuild between 2800-3200 sq ft that would sell up to 950k.

An initial worst case estimate of 450k for construction, 250k for the lot, 70k closing, 50k loan interest = 820k

We spoke with the owner for a couple hours yesterday, and it seems we are pretty far off on what he values the lot and home to be worth in its current state. Even if we were to purchase the lot outright and remove the seller from the picture by using a JV, I do not think at this point that we will obtain the lot for a price that leaves us enough room to comfortably make a profit.

At this point, he knows where we stand and may change his mind, but we are sitting on it.

[Brian Gibbons]

Follow up, follow up, follow up.

Offer $10K less in a new written offer every month.

Good luck!

Its their problem, and it is your opportunity.

[Matthew Harper]

Good idea!  So far it has all been talks.  I think a written offer may jolt him out of his indecision, or at least make the offer seem more concrete and an actual option for him to put it behind him while also making a great profit.

Will definitely continue to follow up and I will keep you updated.

Thanks again for the advice guys.