Problems that have sunk a new construciton project.

[Joshua Berube]

Hi all.

 I just finished listening to J Scott's second interview and he was talking about the problems he experienced while doing a spec build at a distance. he mentioned that he didn't have any problems which would sink a new build, and since I am planning on building soon I was wondering,

What problems are out there that can sink a new construction project? Have you experienced this at all?

I imagine scenarios like

-losing financing half way through construction (how can that happen anyway? poor planning?/)

-mistake on the pilings/foundations

-thief?

-fire

I feel like Im starting to reach here... if there are any out there who have stories to tell, I would love to hear them

joshua

[John Blackman]

Sink is a powerful word.  When budgeting your project you should create multiple layers of protection financially.  The quick formula is 

(land + development cost + closing costs) * 1.20 = Target sales price

You should be able to come up with equity equal to or greater than 20% of the (land + development costs)

This means that if prices drop by 20% you will break even.  If they drop another 20% you will loose your equity but the bank will get paid.  This will keep your credit alive in a worst case scenario.  In such an event, your target price would have to be 40% lower than what you expected.

Do not assume the market will appreciate from when you buy the land to when you sell the property.  Assume prices will be flat.

1) Paying too much for the land

This can be mitigated a little by dialing back on the finish outs, but be careful you don't under build for your market.  Know what sells well where you are building, sqft matter, but finish outs do too.

2) Market down turn

This is hard to predict, but you should be able to absorb a 20% price hit and get out with your shirt on.

3) Builder runs off with a draw*

This should not happen if your builder fronts the first draw and you pay for everything in arrears.  Banks prefer this too, however builder's that are using their credit on your behalf can only do a few at a time and aren't likely to use their credit for you and thus will cost more.  It is more likely that you will have to risk some of your own equity and be reimbursed by the bank.  If you have enough equity in the project, a bank may advance funds but the land needs to be expensive enough that a bank feels secure doing this (75% LTC usually).

#3 is where I have been burned the most, and only a few times, but it does happen.  You have to go through bad builders to find the good ones.  Watch the numbers like a hawk.  There is truth in accounting, and you will find out real fast if something isn't right if you are counting receipts.  

Never give a builder more than one project at a time until they have proved themselves on one project end-to-end.  This takes a while to vet a builder, but the alternative can kill your business if you are stuck with a builder that has multiple projects and he is over spending all of them before you can rein him in.

So to close

1) Don't pay too much for the land!  Be patient.  Wait until you get a lot that meets the rules above.

2) Watch the books like a mamma watches her eggs.  The money is your first warning sign that something is going wrong.  You should set your budgets so the build works and so that you can reasonably beat each category by 5-10% under budget.  Don't get tempted by shinny upgrades.  Respect your budget, hit it.

Do this a few times and you'll figure out what works.  I learn something new from every project and so will you.

Good luck.