Subordinate Lot to Contractor - Deal Structure?

Question

I bought two lots via cash in 2016, the one lot I built my primary home on financing the construction loan and hiring a contractor.

Now I have the second lot and trying to determine what I can do with it.

I recently learned about subordination, in that I can have a contractor use the equity in my lot to help secure financing on a construction loan. I would then place a lien on the property for the value of the lot.

I would normally try and finance the construction loan myself, but my DTI is at 43% between my primary home and my investment property.

But besides the value of the lot I'd get back when the home is sold, I would like to get some of, if not all of the proceeds from the sale (after build costs, etc).

How would I structure this deal to have that outcome?

I already have a plan/design in mind and would like to have some say in features/finishes.

Are contactors willing to have this kind of arrangement?

Anyone with experience or suggestions would be greatly appreciated.

Mike Smith · Answer

@Alex Brandt I don't think you will find any builders interested in your scenario.  It would be much easier to just sell the lot and put the money towards a more normal real estate investment.

Mike Smith · Answer

Most builders are going to want to pay market rate for the lots and keep the profits from building the homes.  Unless you have enormous equity in the lots, builders won't want to split with you.  Also, it would be very easy for a non-trustworthy builder to "cook the books" and show a much reduced profit on each home, leaving you with a very reduced payout.

Don't make it more complicated than it needs to be.  Sell your lots for market rate and use the profits to pay a builder market rate for the two personal homes you want built.  Potentially you could sell the lots to the same builder that builds the two residences and work out some sort of trade.  However, you are going to have to debate about market rate for the lots and market rate for the homes.

Taylor Roberts · Answer

Would it be reasonable for builder to split profits 50/50? I’m new to this, but looking for a builder to build 5 spec homes and 2 personal homes. We own land and are building the sites (road, utilities, etc.). After developing, each lot will have cost us roughly 185k to develop. I realize the cost to build 2500-3500 sq ft homes will cost more than that, but given the time spent on development and the prime location of our lots, we would like to maximize profits and build on the lots. With construction for the sites over $800k, we want to find a builder that would do a land subordination and work with us to build spec homes and split the profits. Is it likely we will be able find someone that would be willing to do this deal?

@Wayne Brooks

Alex Brandt · Answer

Thank you for replying! I was thinking since the general contractor would still be making a profit just from building the home  - I don't see why a builder wouldn't want to do this.

Wayne Brooks · Answer

This usually only happens when a builder Wants to buy your lot and build a home either for spec or for a contracted buyer. In that case the builder is actually buying the lot, you are financing the sale to him but you’d have to subordinate your loan to the bank giving the construction loan with them in 1st position and you in 2nd position.

It sounds you are trying to get the builder to finance the construction not for himself as the owner but for You as the owner. I doubt you’ll find a contractor to do this and if so they will want a healthy premium for the risk.