Real Estate Investing Basics

Builder Model Home Sale and Leaseback: Terms | Part 3 of 3

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builder model homes leaseback

In our primer to buying and leasing back a builder / developer model home we discussed the advantages of the concept to both the builder and the investor.  Now we will focus on the terms of the deal and items often overlooked.

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Warning!!  Do not proceed with this investment without doing your market research and asking some tough questions.  The sales and leaseback concept can be a good, smart, and even easy investment, but as with any real estate investment, there is certain risk.  That said, consider the following points and questions when doing your research.

Builder Research

Probably the single most important thing you can research is the builder you will be working with.

Ask yourself:

  • Does the builder have a good local reputation?
  • Does the builder have a solid home warranty / good quality?
  • Has the builder built homes in this market segment before?
  • Has the builder built these particular floor plans before?

Tips and Traps:

  • Find builders with strong sales success even in a tough market.
  • The longer a builder has been in the market the better.
  • Ask around, get a real estate agent's perspective.
  • Check with current homeowners that have had a home built by the builder.
  • Find out how committed the builder is to the neighborhood.  Did they buy all the lots?  Are they doing takedowns?  Did the option the land?
  • Working with underfunded start-up builders is very risky.  Find out as much as you can about their financial backing.

Neighborhood Research

Don’t take to large of risk on new communities and ask local real estate agents about the upcoming neighborhood and market segment.

Ask yourself:

  • Has the subdivision been successful?
  • Is the community at an attractive price point to buyers?
  • Are the communities nearby that have been successful?

Tips and Traps:

  • Look for successful neighborhoods / successful neighborhoods in close proximity.
  • Look for strong amenities – pool, playground, etc.
  • Does the house back up to the road?  Builders like sites that back up to the road for better traffic visibility.  Watch out for this as it may delay the time it takes to resell.
  • High taxes.  Make sure to figure in current and future taxes when preparing your analysis

Agreement Terms

Nobody likes surprises, and what the builder promises you with a handshake may be forgotten in two years when the lease is up.  Get everything is writing.

Beyond the terms negotiated in standard real estate sale and lease agreements, here are a few points to clarify when doing your due diligence and negotiating a sale and leaseback.

Price: Know the comps for the area and get real estate agent feedback if you do not know the area well. Remember, the risk is there that a builder will go out of business and / or leave the community. Do what you can to mitigate your risk buy purchasing at a very good price.

Lease Term: The investors I have worked with recently shoot for a minimum for 2 year lease.  Obviously the longer the better to maximize profit potential.

Lease Amount: What are your investment goals?  Work backwards to determine lease amounts after taking into consideration all of your debt and expenses.

Option to Renew: Require that the builder give you a three to six month heads up in writing if they intend vacating at the end of the lease.  The more heads up you can get on whether or not the builder will vacate at the end of the lease term the better.  If they opt to leave at the end of the term, put in writing that you can list the property while they are still utilizing the house.  You can also request that the builder’s sales team lists the property prior to move out.  If that doesn’t happen, you could also give incentive to the sales team for selling the property.   Remember, the first month’s rent should be required at closing.

Maintenance: What repairs will and will not be done during the builder’s occupancy?  The contract needs to be clear that the builder will touch up paint on all walls, repair or replace damaged flooring or appliances, and maintain the home as new while they occupy it.  This usually isn’t an issue as most builder want the models to look spotless.

Move Out: Be sure to request a walk through prior to the hand over at the end of the lease.  Make sure it’s in writing how the sales office will be converted at move out.  Many builders use a garage as the sales office so there can be gray area in how it’s finished after use.  Are there walkways, special fencing, signage, lights, or landscaping that needs to be addressed?  Also, keep in mind that sun damage will occur on hardwood floor with rugs.  Make sure it is agreed upon how to handle these situations.

Taxes: Most likely this will fall in the investors lap but I would imagine there are special circumstances in certain municipalities might have tax incentives to spur development.

HOA Dues: Again, look for opportunities for the builder to pick these up as part of the lease.  Many time the builder runs the association and funds it during start up.

Insurance: Get advice on this and make sure you are properly protected.  The model will need to be added to builder’s liability insurance as well.

Alarm System: Get assurance in writing that the house will be armed when not it use.
Furniture:  Interior designers have a knack for making questionable colors on walls and furniture look outstanding.  If a certain room will not look good without that special piece of furniture or two – ask for it.  Better yet, ask for all the furniture but keep the price where you need it.

Floor Coverings and Window Treatments: Ask for these.  This will make it a bit easier to sell down the road.  A potential buyer will not have to go out and buy all new accessories to match colors.

Personal Guarantees: When possible, for private builders, request personal guarantees for the lease.
Warranty:  Confirm that the builder’s warranty is transferable to the next buyer.

Finding a Builder

How do you find builder sale and leaseback opportunities?  Start by reaching out to builders – Ryan Homes (NVR), MDC / Richmond American (MDC), and Ryland Homes (RYL) are public builders that keep a light balance sheet and might be a good place to start.  Build relationships with builders and the agents that list builder spec homes.  Plus, smaller builders may not have even thought of the idea.  If they have a model, it might mean one less speculative home they can build.  They may just fall in love with the idea.

Photo: Brock Builders

    Connie Bhimireddy Real Estate Agent from Morgantown, West Virginia
    Replied over 2 years ago
    Great, thorough post, Mark. Thank you so much for taking the time to literally spell out all the dynamics and the pitfalls to avoid. Was all very clearly laid out. I’ll link to it in our investors group, b/c I know a builder in town recently approached me to invest in their new community’s model, but it’s priced at 160/sf, whereas nothing else around it has sold for over 140sf…! (That’s a smaller risk at say a 1500sf townhouse, but this was an enormous home.) Great info here. REALLY appreciate it.
    Joseph Morelle Investor from Rochester, New York
    Replied about 2 years ago
    Mark – how are these investments typically financed? Are investors getting conventional loans or are these purely commercial/investment loans?