Want to start Spec Build before closing??
Full-Time Investor · Charlotte, NC · Member since 2009 · 2k+ posts · 1k+ votes
I have a lot under contract that the seller can not sell until July 10. Seller bought the lot last summer before things picked up, and now realizes he can make a small gain by selling on long term capital gains. He currently has no mortgage on the property. Is there a legal way to structure this so that all three parties (buyer, seller, and lender) all are safe? I would like to start the build asap. Thanks.
Bryan A. - I assume the seller does not want to sell until July 10 so as to keep things as long term capital gains, as opposed to the seller can't sell because of some deed restriction (or redemption period); is that correct?
If so, then you also have to be certain that whatever approach is taken does not fall under "disguised sales" to the IRS. I think this is where it may get difficult.
I'd be careful. There's always a chance the deal won't close, and you'll be the one who's out the most cash/effort if that's the case.
If you really want to get started, I imagine you probably have at least a month or two of getting drawings, engineering, surveys, getting take-offs/bids, starting the permit process, etc. Why don't you work on that stuff (which is relatively inexpensive) in preparation for the July closing?
J, thanks for your advice...everything except permit process is finished. to get permit is 2-3 weeks. that still leaves 4-6 weeks sitting while market is hot. a creative investor friend of mine suggested having the seller sign a mortgage to me, to encumber his title. I'm not a creative investor-- I just build/fix up homes :) It was over my head, but I thought it was worth a shot to put it on here to see if there is a solution. For what it's worth, it's a private lender (not a bank), and the seller and I are friendly. I know circumstances change when things are out of our control (death, divorce, etc.), but barring that, I feel confident he wouldn't screw me. In my opinion, the hard part is getting everyone on board. Well, everyone is open to the idea--we're all just wondering if there is a way to do it and protect everyone? The simple answer says no, just wait for July 10. We may have to do that, but if there is a way, I'd sure like to know! Thanks again :)
Pretty simple solution, you could get the docs done by Friday, start the permit process Friday afternoon and be on your way with what you want....
The lender is secured, the owner is secured and closes in July, you get the money to build, is that what you need?
I really only hesitate because, as I recall, I've had alot of grief over remarks made in the past and you arguing with me Bryan, correct me if I'm wrong.... so it seems I ought to get a little something out of this one;
Like at least ten "you da man Bill"s on posts I make in the future and an agreement that I not be harrassed in the future, so if you can stomach the pain that goes with that, I'll tell you how to accomplsih what you want.... LOL
This is fun.... :))
Bryan A. - I assume the seller does not want to sell until July 10 so as to keep things as long term capital gains, as opposed to the seller can't sell because of some deed restriction (or redemption period); is that correct?
If so, then you also have to be certain that whatever approach is taken does not fall under "disguised sales" to the IRS. I think this is where it may get difficult.
Good point Steve, like a sham transaction with a note that isn't funded made by the property owner to encumber the property or some such thing.
That adds to the mistry.... :)
Like at least ten "you da man Bill"s on posts I make in the future and an agreement that I not be harrassed in the future, so if you can stomach the pain that goes with that, I'll tell you how to accomplsih what you want.... LOL
This is fun.... :))
Hahaha I couldn't help buy laugh and enjoy that Bill. Well played.
Okay, I don't have much more time before I head out. Bryan hasn't replied so I assume he's busy making money like everone else should be doing LOL.
I'll trust that he finds the assistance valauble enough for most if not all of my requested compensation, being a stand upguy and all.
Bryan, you need a Subordination Agreement for the property owner to subordinate the lot to the lender for the construction loan. This is usual and customary for contract builds or lot sales at future closings.
The lender makes you the loan and it is then secured by the lot, I suggest both you and the owner sign the deed of trust and only you need to sign the note.
You get a contract to build. That will put you as the contractor to pull permits, or should.
The property owner contracts for the sale of the lot on July 10th, this is well within 90 days, (actually like 60 days) absolutely no problem as custom homes contract lot sales up to a year off.
If you buy prior to selling or completion, the owner grants the deed and you close on the lot subject to the existing loan secured.
You can also contract for the lot to be sold at the same closing when the house is sold, see you title company/closing agent, That takes a contract build agreement between you and the owner, he sells the lot you sell the house.
You might get a subordination agreement from a bank telling them you have a contract job, which is true BTW, and if you know the loan officer they might dig one up for you. A title company that does construction disbursements may let you have one, if all else, see your attorney.
So, yes, there is merit to the old man with expierence, LOL. Good luck! :)
thanks all for the replies..i gave everyone a vote (even you bill--actually you got a few for multiple responses)
Steve Babiak, you hit the nail on the head.. my big fear would be an IRS lien or something crazy that would go in front of any layer of protection I could come up with...
Bill Gulley, you're right, i do plan on arguing with everything you say. As much as you drive me nuts, you're a brilliant and creative thinker when it comes to real estate. I'll look to you for answers on tough questions like this. This property is a big deal for me, and I don't want to screw it up. Thus, if anyone can come up with an idea, I do plan on poking holes through it until all three of us (buyer, seller, and lender) feel comfortable. So far that isn't happening....
This most likely can not be accomplished, but I thought I'd ask the great thinkers on BP. As for the sham insult, I think you know I'm not trying to accomplish any crap like that. Thanks again for any input, and if anyone else would like to discuss, i'm all ears :)
Bill Gulley, thanks for the ideas...i follow the 2nd part about buying subject to the finanching. I don't get the purpose of the subordination agreement. Could you elaborate on that? This wouldn't protect me or the lender from something crazy happening like divorce, bankruptcy, IRS lien, etc..would it?
Bryan A. - simple solution is to figure out what the short term tax bill would be - and offer to compensate him for that, if your holding costs / opportunity costs seem that they would be higher than just paying his tax bill.
Bryan, a "sham transaction" is not an unsult it's a term used by the IRS, making a note without funding it is a sham transaction.
What I outlined above IS the customary way to accomplish what you want. This is NOT new, it's done all the time. An owner wants a home built and he contracts, the contractor gets the loan, the lender requires the subordination of the property, so the CG can get funding. Done the same way when the CG to builds specs.
If this deal is important to all three of you, all 3 go to an attorney and read what I've suggested to him, that is the way he/she will do it as it is exactly how banks do it.
I can't take credit for this method I didn't dream it up. Contractors have been doing this before I was born, it keeps them from having to buy the land and allows the bank to have a good lien on the property for the home to be built.
I'm now getting a little confused, Bryan you're speaking of risks of BK, divorce, etc. and Steve had issues with taxes and a delayed sale. Is this July 10 of this year, like 61 days away or another year?
Most construction builds/contracts are for 120 days! Construction loans go for 6 months to a year. Unless you're building a pretty small house on a blitz build, you won't even have the house completed when the land owner wnats his money, the house doen't have to be finished either.
A subordination agreement is made by the owner of a property allowing a property to be used as collateral it grants the property for the security interest as a first lien. (If there is ever existing financing on a property then that existing loan is paid off by the construction loan as construction loans just aren't made as seconds for a new home.) Subordinate means to be at a lower status of another, it places the interests of the lender in a senior position for collateral purposes only, just as any other mortgage, it doesn't change owner's rights. It gives the lender permission to use the property as collateral by a non-owner. I guess you might get a better expanation if you google "subordination agreement for loan".
Bryan, you said "I just build/fix up houses" have you built a house before as the GC? Sounds like this is your first time being so concerned about risks like BK, divorce or an IRS lien, those are normal issues, all having solutions by law, you forgot death. I'm not picking at you, I just don't see being overly concerned about who could take BK, file for divorce or have a tax lien filed in 61 days....really. The real risk is selling a spec house that you own!
BTW, your private lender obviously has money, they must have a good banking relationship somewhere, since this is thier loan, have the lender call his bank about a subordination agreement, that's really his job to get if he's lending (I understand he may not be a real lender (or he'd know this stuff) and that you are putting it together).
Let's bring in a couple builders for you Bryan, Rich Weese and Karen Margrave, they are probably familiar with subordinations for funding.
Steve, the only holding costs the owner will have will be for the land only for 61 days, shouldn't be much.
Again, I assume this was to br July 10, 2013! :)
thanks for the more in depth replies...
Steve Babiak, that does seem like a simple solution (one I hadn't even thought of), but I don't want to increase my lot cost either. If that were the only option, I'd just wait it out :)
Bill Gulley, thanks for the reply. It helped immensely. That being said, I still worry about death, divorce, bankruptcy, etc. If I do not have title, I am susceptible to anything that could happen to the seller in the next 61 days, correct? I understand the subordination now (thanks for the explanation), but if something crazy would happen in the next 2 months where the IRS wants to lien the property, that would still go ahead of the lender in lien priority, correct? Death could complicate things with estate issues. Maybe I misread your post, but just to be clear, I'm NOT worried about my filing bankruptcy or divorce. I wonder if the seller were to do that in the next 61 days how that would complicate issues since I don't have title into my company name. The build will take 4 months BTW. Also, I'm not one to put my resume out there, but I owned a pretty substantial rental portfolio up until a year or 2 ago when I decided to split with a partner and sell most of what I owned individually to get bigger into the retail market. All the rentals were rehabs. I have been flipping homes as well for the past few years, including some very large additions. As the market continues to change, so will my model, and thus, I got into spec building late last year. This will be my 2nd or 3rd spec (depending on which one I can start first). Not that I think any of that is relevant, but you asked, and I'm not one to hide :)
Bryan A. re-read what I suggested - I suggested to pick the thing that will give you lowest cost. If the opportunity cost is high enough, then paying the guy a bit more can end up netting you more (or netting you your payday sooner).
Bill Gulley - I don't have tax issues; Bryan's seller is trying to hold for a year and a day to get the sale into long term capital gains; that's where the tax issues came from. I concur that hold costs for the couple of months should be small; I don't know the opportunity costs (will the market for this spec build be stronger by building now than later, for example).
Bryan A. I'm a little late to the party I see. But.. Bill Gulley gave you the answer. You can ask the seller to subordinate (take 2nd position to the construction loan), title transfers, but money doesn't. When the house is completed; and permanent financing goes on, the construction loan and note to the seller gets paid.
If you are inexperienced, you may need to put up a healthy non refundable deposit to be released in July, and put a limit on the amount of the construction loan. However; make sure that you can build it for what you limit yourself to, otherwise you have a big problem. Since the seller will be in 2nd position if you don't perform, he has a note on the property ahead of him that has to be dealt with, plus would have to finish the house out of his pocket, so it is a risk to the seller. You probably would need to do a personal guarantee too.
It's a common practice, but there are risks, therefore, if you have experience, and a track record it makes it an easier sell.
Otherwise, just have a rock solid contract that ties the seller down and close in July. Good luck!
LOL, my point was that you're new to spec building. If you're going to eat you need to cook your meal which means you need to stand close enough to the stove by the fire. I have never heard of a seller of a residential deal having life insurance to cover any risk of death, I have in commercial deals over a million, same with borrowers.
You seem way overly concerned about these life risks. I realize your concerns are with the seller. Perhaps what I have said in the past which is what's usually said, that you can't force a seller to sell but you can make them wish they had, needs a little tweaking; in a construction build where an owner refuses or can't sell for some issue, it comes down to the equity held in the property, a builder holds the largest lien, with the lender, and a builder can certainly force sale by court order. Workman's liens have priority, often ahead of tax liens, same in BK. You are totally in the driver's seat. A property owner and a lender have many more risks assumed with a builder than a builder has with an owner or his lender.
Trust me, if that seller subordinates his property, he's the one at risk as your lender can foreclose, between the two of you, you control that property and both of you have a greater equity interest in the land than the owner does. Could something happen that could prolong holding the property? Yes, will he cheat you out of it or prevent you from getting the property? No, I've never seen that happen in my 40+ years or even heard of such a thing......LOL, make sure you put the deed of trsut on the righ lot....and sale contract....LOL!
The only way a BK holds up a builder in a deal like this is if the owner has a greater equity in the land than it's contracted for. If the sale price is at market value, reasonable, the Trustee will almsot always allow the sale before the discharge in order to get the money to pay other debts. Same is pretty much the case with an executor or adminsitrator of an estate, a divorce sells and splits the proceeds, all courts understand that time is of the essence. What really ties up a property is when a builder takes Bk or dies, having the greatest equity and an unfinished project can really be a problem.
In your builds, you should have figured contingencies, price of materials going up, etc. part of that should be about 3% for attorney fees to clear up any issues, not that it will be needed, but reserved for unforseen issues on any job.
You also have to assume the seller is acting in good faith. If there is some issue with that assumption wait and buy it. It sometimes takes 60 days to just get a house to closing, normal stuff like loan delays, I just don't see this time frame being an issue. Good luck! :)
Karen Margrave just gave the response for a contract build, but very much the same as a spec build.
Karen, the owner subordinates but is not getting an end loan, Bryan is, but it appears the lender, being private money, will just stay put as a construction loan that continues until Bryan sells.
Thany you for your reply, I know those first builds are nail biters! :)
Bill Gulley You're right, and that's what I was talking about. I should have clarified that it would be the loan going on from either the builder or the new buyer for permanent financing that would provide the payoff to the original seller.
...
The problem that Bryan and his seller are trying to solve is in bold within Karen's quote. The day title transfers is the day that the sale occurs for income tax purposes, regardless of whether funds also transferred. Because the seller is trying to get into the long term capital gains tax rate for the gain on the sale of the lot, the recording of the sale cannot happen until one year and a day after the seller's buy date.
So Bryan needs alternatives that allow for the sale (transfer of title) of the lot to happen after the construction gets underway.
Just to be clear, title does not transfer with a subordination agreement, just as title doesn't transfer in getting any other loan secured by a property that is given by the owner (given, meaning the security interest given). Yes, Karen was speaking of a cotract build by an owner, not the case here. Confusing maybe.... :)
Hi Bryan, just curious... what's the turnaround that you expect for completion of build from start to finish? I'm assuming to complete / list ready
You've gotten great responses so far and how much covered for the other concerns you posed:
death (i think you mentioned insurance?),
divorce, bankruptcy - (this can be covered by a legal contract, yes? i dunno - just asking)
etc. [Natural disaster, huge sinkhole where earth swallows it all up, etc] - insurance?
to summarize my query:
1. Where are you in terms CYA for subject property?
2. What's the estimate for build for your ideal ready to list time (or at least before offseason)?
3. How open is the seller to options presented so far?
I hope this pulls thru for you!
Thanks for sticking it out with me so far. I threw this out to a few intelligent people at a REIA meeting last night. A few options were proposed:
1. Purchase a 1% share of property and reimburse the seller for short term gains on that 1% that he's selling. Purchase the other 99% in July when long term gains come in to play.
2. Lease option and record the option. Someone also recommended recording the option with a mortgage, which I didn't know you could do.
Would anyone care to poke holes through these ideas, or support them? Thanks :)
again, how are you covered in the (unlikely?) event of (what you originally mentioned) death, divorce, bankruptcy/foreclosure? the latter 2 of the three seem to be challenging.
HOWEVER, if that's no longer a concern, the above mentioned are certainly clever ways to get in and worth consulting a local RE atty.
1. Purchase a 1% share of property and reimburse the seller for short term gains on that 1% that he's selling. Purchase the other 99% in July when long term gains come in to play.
2. Lease option and record the option. Someone also recommended recording the option with a mortgage, which I didn't know you could do.
Would anyone care to poke holes through these ideas, or support them? Thanks :)
As`Steve pointed out before, since the owner is at the threshold of the tax treatment, selling 1% is pretty much showing an intent to sell and tossing the 99% over to be treated differently, doubt seriously if the IRS would buy that if audited. There is no tax issue with a clean subordination and sale later as it is customary to beigin building before a property is sold. That is the way it's done.
No, you can not file a mortgage with an option, that has no basis in reality of the obligations/rights involved. That's just totally without merit.
Bryan, if this really is importnat to you, get to an attorney and ask for the subordination and get the deal moving along. If you're having cold feet over remote risks like divorce issues, wait to do it.
I'm pretty confident that there is not a reasonable person on this site that can punch holes in the advice I gave you as that is the industry accepted practice.
I hope you'll get moving on your deal and stop seeking advice from obviously unqualified people, consider...they have nothing to lose in giving wild or crazy advice to see if thier scheme works....that mortgage/option was a doosey! :)
Since I was mentioned in this thread, I'll give my one penny worth of information. As many others have so correctly stated in this thread, there would be a lot of concerns in my mind about trying to build on something that I don't own. There are problems that could develop for a rise that could make a mess. I try not to do messes up my age anymore!
A simple subordination type deal is neither risky or disconcerting to me. I mentioned recently that I was driving around with another BP member and actually call on a lot for sale. In follow-up posts here on BP, I mention I have to close on that lot in already started work on it. The seller was a definite motivated seller and agreed to sell at a price of $35,000 with $5000 down and subordinate to a construction loan. I have a private party to make the loan, and my $30,000 note carries a 6% interest rate within 18 months due date. I'm very confident that my rate of return on this spec home will be extremely high due to the very low cost of funds out-of-pocket. I will try to do other subordination loan agreements in the future. Again, there wasn't a problem with moving into title on the property as Brian seems to be trying to circumvent in my opinion. Rich
thanks guys! I think I've decided the easiest thing to do is get the ball rolling with my money until July 10th, and do the closing with the lender then What do yall say to that? Any things I could do to protect myself in the meantime? I appreciate everyone's input, as I've learned a lot :)