We are so excited by a potential opportunity we were just presented with but we are also new to this area need your advice and thoughts on things to watch out for!
We have a great relationship with the builder of our own personal home we built 4 years ago. The builder and his dad are partners in a local construction company that has a very good reputation in our area. In all our dealings with them and in what we hear, they are men that operate with high integrity. Their company has been growing and they are on track to build 40 homes this year. The builder also has 12 rental properties of his own.
I found 2 open lots in our 25 year old development that have a similar layout to the lot my wife and I purchased for our home. Lots and homes in our immediate area are flying off the shelves. We just purchased our first buy and hold property and are working on that. But when we found the lots I asked the builder to come look at it and give me his opinion on its viability to buy the lots and build 2 homes for flip or rent. He told me the lots looked great and he encouraged me to buy them. After more research, I was feeling a bit intimidated by doing this project all on my own as everything would be new.
The builder approached me and asked if it would be something I would be interested in doing together. The plan would be that I negotiate the purchase of the land (which I did) and then we would obtain a construction loan. He would handle the contraction side, build the home in about 5 months (he has a long proven track record with his spec homes) and then we would market the home and sell it ourselves (he also has a long proven track record with this aspect as well). We would split the profits on a percentage TBD after all the purchase related expenses are subtracted.
This is appealing because we KNOW the neighborhood, we KNOW the market and the demand. We feel great about being able to learn a LOT from the builder in the course of this project that would help us out on our rental and on future deals and rehabs. And of course, the realistic profit we are looking at would be a great deal for us. In a lot of ways this deal would be a comparatively low risk one.
We also have seen the ugly side of legal issues and relationships gone wrong through our day job. We are always working to mitigate and/or lower risk, think all scenarios through, etc. But, we also know that you can't succeed without taking some calculated risks. And we don't want to walk away from a great deal financially and to learn more of the business from someone who has had a lot of valuable experience and can and is more than willing to act as a kind of mentor in the process.
Wanted to throw this out to see what red flags if any you see that maybe we haven't considered! We know there are always potential issues with partners. Would you be scared off by this kind of partnership where our name is on contracts and his construction company is on the line?
Personally I think it sounds like a good start to investing, especially if you trust him and he has a proven track record. What I would encourage you to do is to be sure to make you know what the exact split will be on the profit beforehand. For example is he going to get paid for being the contractor on the home and get a profit in the end or just profit in the end. Also if he has done this a long time, what is the Cost Estimate to build the home and is he willing to guarantee that price. If the build cost goes over does that come out of his profit?
As a builder on several homes I know that the "unseen" costs will eat your profit quickly. Iron these things out and it sounds like a good deal.
Best of luck to you.
@Aaron Wyssmann thank you very much for your input. I will ask more about the profit question. Since you are a builder, how do we ask these questions without offending him and still maintaing a trust factor? He is the one who approached us because he knew that I found the land for very very cheap and even though I was not going to move on it, he easily could of but he came to me out of integrity. I definitely want to ask him these questions but I am not exactly sure how to say it. Does that make sense?
@Jonathan Gregori If he is a business guy, which he is, he will get that you just want to understand the deal. Then I would simply write down some of the concerns that you have and talk with him face-to-face about them.
I would start by saying that you hope this to be the beginning of a long relationship of working together on deals.
Questions I would ask:
How much will it cost to build an average home and will you guarantee that price? I know that costs on projects are the part that is most difficult to manage and just want to know your comfort level on this very important issue.
Will you be taking a contractors fee for building the home or will you be paid from the profit on the home?
Are you good with a 50/50 split on the profit?
How shall we go about putting all this in a written form? (I so wish deals like this could be handshake deals but this day image you just can't do it that way)
That's all I can think of right now but I'll add to it if I think of others.
@Aaron Wyssmann , Wow, thank you so much for laying out those questions for me. I am meeting with him tomorrow and will definitely throw these at him. We are going to the bank together after we talk to talk with a banker that I have a contact with.
Make sure you spell out who does and pays for what, and how things will be handled. Ask him what he expects in the way of profits. If he is being paid as the contractor, then splitting the profits 50/50 would be unfair to you. Will both of you be signing on the loan? As for design, etc. will you be using one of the plans he already has or will you need to pay to have a new set drawn, etc.?
The devil is in the details. Things usually go wrong when there's no agreement with everything covered in writing and signed by all parties.
@Karen Margrave & @Aaron Wyssmann Just got done meeting with our partner and it went great! We thru a lot of questions at him. He has tons of spec homes in his arsenal so we will be using one that he is very familiar with, that he understands the costs and timeline. He is not adding in his contractor fees- all his profit will come out at the end and we will split the profits on the first deal 60-40 (me). The next deal we will be moving towards a 50-50 split with me providing a lot of the negotiations for lots we have our eye on. I think we have a really good idea on what will make this a good deal for both of us- beyond the profit. The plan is for me to sign the loan, but if the bank needs he would cosign. We will be working to come up with something in writing to outline the agreement. I think this will be a great thing! Thank you for all your input it really helps. Looking forward to this relationship!
@Aaron Wyssmann & @Karen Margrave Since you guys have experience in developing and contracting, if you have any other advice as to how I can show my value and contribute (and how i cannot contribute by interfering on preferences of paint colors :)) so he sees value in this relationship so it can pave the way for more opportunities down the road, I would greatly appreciate any input on that as well. Thank you all again!
As many have previously mentioned before starting be clear on your general budget upfront (it's going to change... material costs have been unstable), and spell out specifically who is writing what checks. With SFD new construction, there is often less meat on the bone than with rehabs (in my experience, could be different in your market). In some markets, there is not enough to make it worthwhile to split (risk vs reward). Be confident in your comparable and keep in mind... you are over 7 months away from closing.
Make sure you understand the approval process for new construction from development perspective. It sounds like you are flush but never assume. Raw land often needs to be rezoned, plans approved by the city (based on town / local ordinances), and you may have to present to a neighborhood board with plans that conform to covenants as laid out in the bylaw. For example: minimum sq footage, 10' interior ceilings, cannot exceed 45' building height, percentage of exterior brick/stone, no vinyl siding allowed etc. These can rapidly change a build cost, but more importantly, every step of confirmation requires a scheduled meeting... Some towns meet once a month and that may not be in conjunction with your neighborhood review board.
Utility easements can be a real bear as well. If these lots are already in a developed area, you likely have the suitable taps on site. But... because they are there does not mean you can access them without fee! Someone else likely paid to develop those subdivision roads/utilities and was required to bond over their use... make sure you understand the sewer tap fees and city permits required.
Lastly, be clear on your holding costs and perspective days on market. Every area has different seasons (I cannot speak to Texas at all) but I know in the Midwest, new construction sales traditionally slow down after August. You will want to position yourself to hit the best resale times (backward plan from the peak of your market. If April is prime, you want to start showing right before then... which means you need to break ground in Nov/Oct assuming a 5 month build schedule, which means land rezoning and plan approval needs to happen before than.)
Again... all of this is from my perspective in NW Indiana, Texas is a different beast. I wish you the best in your partnership, please keep me posted on the outcome.
@Jonathan Gregori Well that is awesome that the meeting went so well. A 60/40 split is a great deal on a first property. When I first read about RE deals one strategy is to have Finder and a Funder. In this one you gotten to play a bit of both but now sounds more like the Funder.
You partner sounds as though he is very good at his craft so I think I'd probably let him do his thing. When I've had Funders it was fun to just sit down and talk about how the project was going but I love talking about those kind of things :) I bet he would be more than willing to share if you simply approach him with the attitude of wanting to learn. Most people are move than willing to teach/help/coach...at least that's my experience.
I'm excited to see how it turns out. Keep me posted.
To the OP- what was your arrangement with the builder in the construction of your current residence? Cost plus arrangements are most common in my neck of the woods-- full transparency and accounting of all costs with a 15 percent mark-up. What risk is the builder sharing with you to earn 40 percent profit? They don't seem to be sharing any of the downside with you assuming all financing. If this builder operates on a cost plus basis I don't see how your spec build is any different than your current home that was built with them other than you are checking a different box on a mortgage application. How is the builder partnering with you and earning a profit split? It seems like they are performing the same service they did in your original build. my two cents- I don't like the arrangement...you found the lots that you can monetize...you assume all the risk... and someone gets to GC the job and earn 40 percent profit?
Account Closed is the one getting the 40%, is that correct Jonathan? If so, I have to agree that you should be getting more. The builder is taking no risk. If you found the lot, and are obtaining the financing, the only thing he's putting in is his value as the contractor. That has value, and you need to know exactly what value he is attaching to that, and do the split accordingly.
Also, how will materials, subs, etc. be paid? If you are on the loan, you need to be the one controlling the money. If things were to go over budget, what happens, etc.?
Be sure to have everything down in writing, drawn up by your attorney, BEFORE you start doing any work, etc.
Account Closed the good thing also is he is more then willing to take me through the whole building process and said he would have no problem at all showing me how it all comes together. I think this will be good for many reasons thus I suggested 60/40 for the first and then 45/55 for the second. I want him to see that I value his relationship as well as his mentorship. Most people never get a chance to make a contact like this without paying major dues.
So in the beginning I would of had to come with close to $35,000 down and then he would of built it for $140,000 while I got a loan for $180,000 with the 25% down and then either of sold it for maybe $3,000 more, highly unlikely or used it as a buy and hold, which probably would not of been the best use of my $35,000. With this scenario I am not putting anything down and we will both split the spread. Let me know if this makes more sense.
@Jonathan Gregori It sounds like you two have worked out a win/win for you both. As builders ourselves, I can tell you that teaching someone else the business and taking them through the process is a big undertaking on its own, and it will have a lot of value to you in the future, and you are right, having a reputable builder working with you has real monetary value than many people do not understand.
My biggest thing is to always caution everyone to get things in writing, and cover every contingency that may come up, for both of your sake, because we read on BP all the time of when that doesn't happen, something goes wrong, and one party is on here asking what to do!
Please keep us posted on how your houses are going, post pics, etc. All of us like to peek in on others jobs! Have fun and welcome to the construction biz!! I love it!
I have thought about doing my first spec build with the builder that will be building our personal residence. Similar situation in that I would find the lot and obtain financing; however, the builder would work on a cost-plus basis (15 percent margin). Maybe this is a regional thing. Under this arrangement I would have never considered splitting the value or profit created in development. After running the numbers though the arrangement your describing it would result in the builder capturing more profit than my scenario. As an example: Cost plus-- 300k land + 450k construction costs (150/ sq ft inlcd builder margin)+ 50k soft costs= 800 all-in cost. 900k fair value (300/ sq ft) for a total personal gain of 100k. Partnering--300k land + 390 construction costs (builders cost) + 50k softs costs= 740 all-in cost. 900k FV for a personal gain of 70k and builder gain of 70k (profits 50/50).
If the variable fee based build isn't a possibility (cost-plus) than partnering may be the best alternative to doing nothing. Assuming the risk tolerance is acceptable. I will be curious to hear how things progress if you are inclined to share!
@Karen Margrave This is the post I was referring to in my message to you. Thank you again.
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