Real Estate Investing Basics

Little Competition, Big Profits: Why Spec Home Investing Could Be Right for You

Expertise:
12 Articles Written

Real estate investors have multiple options for getting into the game. The most popular investment strategies are fix and flip and long-term rentals, with fix and flip getting the most publicity.

Want more articles like this?

Create an account today to get BiggerPocket's best blog articles delivered to your inbox

Sign up for free

But another option that doesn’t get nearly the amount of press is spec houses. As with any real estate investment, there are pros and cons when it comes to spec houses. I’ll walk through a few of each to help you determine if spec house investing is right for you.

What Are Spec Houses?

A spec home is basically what it sounds like: building a single family or multifamily property without having a buyer lined up (speculation). Spec homes can be a risky venture, but with that risk comes an upside potential that can be very attractive.

Investors typically make their money on spec homes in one of two ways. They can finance a percentage of the construction costs (lend money to a builder) and earn interest or share in the profits once the home is sold.

In the latter case, you or the builder may also borrow money from a bank or private lender to pay for some of the construction costs.  Sharing in the profits is often called “equity investing” and is potentially riskier but also more rewarding than lending money to a builder.

home framing during home construction against cloudy sky

Pros & Cons of Investing in Spec Homes

Now that we have the basics down, let’s look at a few of the pros and cons of investing in spec homes.

Pros of Investing in Spec Homes

  • The upside on spec house investments is generally higher than fix and flip. It is becoming more and more difficult to find good fix and flip properties, making spec houses a good alternative.
  • The competition is less for spec housing development versus fix and flip.
  • Spec houses can be considered a medium-term project. Investors will realize their gains faster than with long-term rentals but longer versus the typical fix and flip project due to longer construction time.
  • With spec houses, you avoid the costly surprises that flippers often encounter (termite damage, mold, etc.).
  • More and more spec builders have become accustomed to seeking out private investments.

Related: BiggerPockets Podcast 046—Six Figure Profit Spec Building and Marketing for Incredible Deals with Jon Klaus

Cons of Investing in Spec Homes

Spec houses are inherently riskier than fix and flip or long-term rentals.

  • The market could tank between the time the deal is financed and the time the property is ready to sell.
  • Market needs/trends could change between the time the deal is financed and the time the property is ready to sell.
  • The project could run into unforeseen problems, causing delays and cost overruns.

Depending on how much “skin in the game” the builder has, they have less to lose than the investor. If the home doesn’t sell, the builder typically has little or even nothing to lose, but the investor can be stuck with the house and holding costs. Builders make money on the construction draws.

Brand new houses just after construction on real estate market.

Related: The Advantages of Spec Building: 3 on 3 Interview Series

Mitigating the Risks of Spec House Investing

While spec housing development involves risk, there are several steps you can take to lessen the downside in the event things don’t go as planned.

Start at the beginning. In most spec building projects, much of the profit will come from the lot acquisition. Make certain the land acquisition is a good deal before you go any further.

Partner wisely. Becoming a savvy spec home investor means choosing your partners carefully. Only work with builders who have a long track record of success and you can trust.

Do your research. Even if you are working with an experienced and trusted builder, do your own research. Make sure the deal makes sense after you’ve researched critical factors such as the area’s absorption rate, employment stats, median price, time on market, and competition.

Assess others’ skin in the game. Make sure you are comfortable with how much skin in the game the builder has.

The Bottom Line

Given the intense competition for and increasing price of good fix and flip projects, now might be a great time to consider investing in spec homes. They can offer the investor an attractive upside, but it’s of course one that comes with risk.

Do your homework and choose your project wisely.

Would you consider investing in spec homes? Or have you in the past? Why or why not? 

Leave a comment below!

 

Ian Colville is the Managing Partner of CCM Finance. Ian is a native of Minnesota (born in Rochester). He brings both a formal education (BA in Economics and MBA) as well as industry experience to CCM Finance. Ian is passionate about the many opportunities that real estate investments offer for both short-term and long-term financial gains. He is committed to helping local real estate investors turn those opportunities into profits. When not doing real estate deals Ian enjoys – well mostly he enjoys working on real estate deals. But if he does break away he is likely spending time with family or at the gym. Find out more about CCM-Finance and Ian here.

    Steven Call
    Replied about 1 month ago
    I am in the DFW market and just getting into realestate. I am very interested in the spec investing and looking for some ideas and possibly someone to partner up with. I have some personal funds and wanting to start out slow. I plan on reinvesting all of my profits back in for the next couple of years, maby longer. I have alot of free time and am currently driving around and looking for bare land and knocking doors. If anyone has some advice or possibly looking to partner up on a few deals, please let me know. I am not a hard money lenders and will be involved in every step of the build.
    Shalon Palmer from Nashville, TN
    Replied about 1 month ago
    Hey Steven, the enthusiasm you have is great. From my point of view as a co-owner of a home construction company, we would be wary of someone with no experience telling us they “want to be involved in every step of the build.” We would probably seek funds elsewhere. We have the experience and knowledge and that would just slow us down. I would come at is as more of “You guys do what you are good at, but I’m here willing and wanting to learn…” Maybe you’re looking for more of a mentorship type opportunity? Determine what value you are bringing and sell yourself, otherwise, it’s easier for us to just go with a hard money lender or bank financing. Just wanted to offer some insight. Good luck on your journey!
    Steven Call
    Replied about 1 month ago
    I said that wrong or maby you took it the wrong way. By being involved I want to watch over the project and learn as much as possible. Eventually I want to be able to go about it on my own. Every buisness I’ve been in, I made sure to know exactly how to do every step. I’m wanting to learn, not micromanage. Thanks for the advice.
    Kelsy White from Scottsdale, AZ
    Replied about 1 month ago
    I've never heard of spec investing, but I'm definitely intrigued. I live in the Scottsdale/Phoenix area and am looking to get involved in real estate investing soon. The housing prices in my area are pretty high and there seems to be a lot of investors snagging up the deals quickly. With this being the case, do you think spec investing would be a good option in a market like Phoenix?
    Michael Baum from Olympia, Washington
    Replied about 1 month ago
    And here I thought Spec house meant Built to Spec. As in built to a specific spec over and over. I knew that Spec also meant speculation. So I guess a spec house can be a custom house. Nice to know.
    Michael Baum from Olympia, Washington
    Replied about 1 month ago
    Also, other cons would be dealing with the permitting process, LID's (possible), ecological surveys etc etc. Depending on the area, it could be a nightmare.
    Lance Goldbridge
    Replied 22 days ago
    From the article, "spec home investing" sounds like land development, then partnering with a builder to build the residential units for sale, For newer investors that do not have construction and land development experience, perhaps forming a group of investors would spread the risk and increase the skill set. Another option could be to consider a "simpler" rural land development project where you buy a larger tract, then subdivide into smaller lots. Once subdivided, you could either sell the raw land to homebuyers or partner with a builder(s). This usually means subordinating your land loan to the builder as a second mortgage behind his construction loan. If the builder will be using his cash (no construction loan) much less risk for the developer.
    Lance Goldbridge
    Replied 22 days ago
    The above scenario assume the land developer owns the property free and clear.