Purchasing and leasing back a model home with a builder / developer is not a new investment idea nor is the concept brain surgery, but the times have changed. Due to the troubling home building sector and market conditions today, we need to take more precaution when evaluating the feasibility of these investments. Too often, I hear horror stories about income property investments that have gone awry and most of the time it’s because homework wasn’t done at the get-go.
In this three part series, I’ll walk you through why home builders and developers do sale and leasebacks, why this might be an excellent investment opportunity, why it might not, and the trips and traps to avoid when purchasing a builder’s model.
While there is no such thing as guaranteed rent, the little-known concept of purchasing and leasing back a builder model home for a pre-determined time can provide solid hassle-free recurring cash flow. Builders will typically agree to a lease length from a minimum of 12 – 24 months to some lasting as long as 36+ months. Additionally, builders typically prefer to retain the right to extend the contract on a pre-determined basis. You cannot live in the home, rent it out to someone else, or sell it until after the lease is over.
Depending on the agreement you negotiate, typical model home leaseback programs include no property management fees, no maintenance costs, no repair fees, and no utility deposits or payments. You also get the advantage of having an immediate tenant, reliable rent payments, a fully loaded home at a decreased price, an exquisitely maintained home, and in some cases…no home owner’s association fees.
Model homes are usually the first homes built in a new residential community and the builder / developer owns and uses it as a sales office. From a merchandising and selling perspective, models are typically loaded with options so the sale and leaseback concept provides an easy way to show off the highest profit options without the carrying cost. A lot of times, the builder’s trade partners will provide services at a lower cost for the models to show items off. For example, a local granite distributor may provide the granite in the kitchen for free in hopes that the builder will use them for all the sales in the neighborhood. If the appliances, faucets and hardwood floors are top of the line and look gorgeous in the model home, it’s easier for the builder to sell the upgrades to other future home buyers.
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Why do Builders do Leasebacks?
To start, builders promote the program because it lightens the balance sheet for other investments. It is also required by the shareholders at some public builders and the banks backing some private builders. Beyond that, the simple answer is flexibility: It gives builders flexibility to close the model and build another one if the floor plan doesn’t sell and it gives them flexibility to quickly move out of the community if it isn’t selling.
Builders also like the concept because it adds an additional price comparison in the neighborhood. When appraisers are looking for comps in the neighborhood, having a decent comp for the first home built won’t hurt.
While the risks of the concept in this difficult housing market are obvious, in the next two parts, we will discuss trips and traps and how we can potentially turn the builder’s need to reduce risk into a profitable venture.
Photo: Mike Bowler Sr.