Custom Builder Looking for Alternative

General Real Estate Investing
1

Howdy,

My sister recommended this site to me the other day, and I’m glad she did…

She is relatively new REI herself, and she is extremely optimistic about her quest for success, and this site was a major tool in opening her eyes to the opportunities in REI.

Your site has been a great source of practical “real-world” experience and I have checked in daily for the past week for articles and advice while trying to learn as much as I can.

My brother and I have owned a successful custom homebuilding business for the past several years and have come to a point where we are simply burned out with the day to day stress of the emotions associated with dealing with impossible homeowners for 6-8 months, and then for years thereafter. The liability is unbelieveable and profits are much less than you might think. In short, the risk and stress don’t = the reward.

Although the potential is there to make a substantial income as a true custom builder, we both have decided that we are not willing to do so at the expense of our famlies or our quality of life. It’s truly not a business that I would recommend to anyone.

My brother and I want to build a business that we can enjoy first and foremost. We want to include our wives in our deals and projects, and we want to have some fun from 8-5. We might even like to take a day off every six months or so…

With our construction experience, we basically have the machine in place for rehabbing, and are interested in beginning there. As a builder, dealing with homeowners, title companies, attorneys and bankers is not that big of a deal. We deal with them every day. Our weakness (or “newbieness” if you will) is that we have dealt stricly with conventional lending and traditional real estate transactions. We would appreciate any suggestions on lenders and deal structuring.

We have already made the decision to wean ourselves off of our most demanding and time consuming projects (custom builds), and have made adjustments that will free me up to scout and learn as much as possible, in the shortest amount of time. We’d like to initiate our first deal within a month, but need to cross a few bridges before we do.

A few questions that we need answered:

1.) Our currrent company is a C Corp and is backed by personal assets. I assume that most would recommend creating a seperate company for our REI? If so, what is recommended…LLC, LLP, C Corp??? Attorney recommendations (those who are familiar with REI)???

2.) Do you recommend one of us obtaining a RE License? Benifits??? Liability??? How do you effectively scout vacant or MLS property if you are not able to access it? Saving commissions on the sale by listing it your self???

3.) Has anyone bought incomplete new homes where a builder has gone broke and the bank owns them? I know of 4 specs that a local builder went broke on and they have been boarded up for 6 months. Values range from $150,000 to $350,000.

I’m sure I will have more questions in the coming weeks. Thanks for letting me introduce myself and I look forward to your responses.

If any of you rehabbers need any assistance in the Austin area for trade contractor recommendations, let me know. I can give you a pretty good idea of who to use and who to stay away from.

Again, Thanks…

Scott

2

Hi Scott -

I’ve built a few homes myself over the years and I can certainly understand your frustration with the biz.

A couple of points:

Have you thought of moving into commercial property? Less headaches, more bang for the buck and loads of opportunity. Slightly different skillset (new game, new rules) but your talent and experience should also prove to be quite helpful.

Years ago I use to specialize in “lender problems” such as unfinished projects. It was a profitable area for quite some time. These days, changing regs and fear of litigation (real or imagined) may have curtailed many of those opportunities – who knows?

But I do know this – all lenders (large or small) have things on their books that they would like to see gone – immediately, if possible. If you can show them you have the ability and expertise to solve some of those problems, the sky’s the limit.

As far as the brokerage license goes – I guess it depends. My brother has been a broker for many years and yet I can’t really say that it’s been helpful.

One point about the “family thing” – make sure that everyone is onboard here. Take the time to develop a business plan even if you aren’t going to present it to a lender. Each person needs to be realistic and honest about their expectations. Just because it’s “family” doesn’t mean you shouldn’t employ the best practices regarding entity formation (and dissolution) and governance issues.

The single family house biz is one of scale; just as you couldn’t live off the proceeds of one custom house forever (especially if the profit was divided among family members), the same is true here. Numbers matter.

Develop a workable plan. Work that plan. Modify as necessary. Repeat.
Keep your eye on your goals and make sure that you have a good grasp of when “enough is enough”.

Take care,

Eric C

PS - I’m assuming here that you have already taken advantage (and are aware) of the tremendous tax free profits available to you when you sell your personal residence – $250,000 for a single person and $500,000 for a married couple.

If you have not – why not?

These rules are a contractor’s dream. Don’t miss out (you can be sure that Congress will eventually rewrite the rule).

3

About that tax free money…

far too many people focus on the maximum amount ($250K-$500K depending on your marital status) rather than what is practical (and achievable).

I would think that most contractors (and others for that matter) should be able to engineer a situation whereby they could at least put $50K or so away tax free every few years. And while that may not sound like much, it’s better than most people ever do.

Think about it.

Eric C

PS - and I don’t want to hear any whining about the tribulations of moving either.

4

ScottC,

I toss these out just as concepts you might consider:

  1. What about shifting your target market a bit and build specifically for rental through your C Corp, then sell a couple to your new LLC and hold for rentals. These homes probably are smaller and simpler than what you’re doing now, maybe a 3/2/2 around 1400 - 1700 sq ft deoending on neighborhood. Make the inside nice but not upscale and focus on long lasting, low maintenance cost materials and design elements.

I don’t know the scale of your operation but you should save some $ by knocking out a few of the same design & apply the savings to buying one for the LLC (at cost, of course). Rental income pays for it and provides some cash flow, LLC gains appreciation of both builder profit and property over time, re-fi it in a couple years at 80% of market value and use that to cover cost of another new one. You’d still be in the building biz but investors are a lot less difficult than picky homeowners–all we want is sturdy construction that appeals to renters and minimizes our maintenance expenses.

  1. Bank REO’s, HUD homes, pre-foreclosures in poor shape, and other distressed situations all are opportunities for your current team/skill set–both buying & flipping yourselves and providing repair services for other investors with more deals than construction skills. Research the various types of distressed property situations and see if any fit the interests of the family. If the wives are interested in being your bird dogs, this may be a way to get everyone involved with meaningful contributions to the team.

Also, Eric C’s advice is excellent in my opinion–especially the part about the business plan for family purposes. Don’t skip this critical step!!

Good luck,

Steve

5

I would be most interested in talking with you about rhab jobs … I am in the process of moving from California so it will be a couple of months… I have a lot of knowledge about setting up different business entities and creative ideas for buying property, private mortgages.

I just took an extensive course on how to find abandoned properties and find their owners, buy them and fix them up … that is where you would come in!

Here is my contact information
Hugh Morrison
888 892-2559 toll free
hugh@sharperimpressions.com

6

Hey Scott -

I liked what Steve had to say and I’ve always leaned to the “buy and hold” side of the biz myself – I still own one of my original investments purchased in the '70s.

He’s absolutely correct in stating that investors are far less picky than are home owners.

One other point, building sfhs to suit investors (corporate or other) is a great way to get to know your bankers better – and on someone else’s dime.

The use of some simple takeout agreements coupled with some form of compensating balance account will make any banker sit up and take notice. You will come across as thoughtful, prudent and… highly liquid.

What bank or banker won’t love that combination?

Take care,

Eric C[/i]

7

Eric, Steve & Hugh,

Thanks for your thoughtful responses. It’s great that this forum exists and that experienced investors like yourselves take the time to share your knowledge.

A little more background first…

My brother, Dad and myself started our custom building business 3 years ago. We have built about 30 homes with only 5 being specs. Our custom projects have ranged from $200,000 to $700,000 and all of our specs have been under $230,000. We’ve come to find that the stress and liability of custom building is simply not worth it, as I stated above. We have outstanding relationships with all but about 3 or 4 of our customers, but those 3 or 4 simply scare us to death and could take our livelihood away without batting an eye. 30 more years of that doesn’t appeal to me.

“Picky” doesn’t bother me Steve, as I am picky myself. What bothers me are opportunists who are looking for a way to get me to build them a house for free. Finding out after you have built a home for someone that they have sued and put 3 other builders out of business in the past 8 years is a wee bit worrysome…

We have built a reputation of building a top quality product with competitive pricing. My brother and I enjoy the satisfaction of building beautiful homes, but when 90% of your volume depends on other people making decisions on when to build, It takes the ability to control starts out ouf our hands.

On to your comments…

I have/am seriously considering getting involved in light commercial projects, as well as building rental properties to suit for investors.

We have established a great relationship with our bank, but a top level shake-up recently has us worried. Our experience thus far has been strictly with them, using strictly conventional lending methods, with no experience with unconventional lending options or individual investors.

In dealing strictly with a conventional lender, our borrowing capacity seems limited, despite our success. Our bank deals with over 140 builders and obviously has limits on how many projects they can support. As it stands now, they will only get behind two specs at a time. Problem is, there are too many specs on the ground today and prices are dropping fast.

Finding private money and taking on other projects is what appeals most to us at this point. We are looking at rehabs (both as a company venture and as a personal income source that my wife and I can enjoy together), building rental properties to sell (both SF and MF), light commercial to sell to investors, office condos, etc.

Eric, explain the “tax-free profits” as you understand them. I think I know what you are talking about, but would appreciate your explanation.

Hugh, I’d be happy to discuss your rehab projects. Feel free to contact me either by e-mail srcunningham@earthlink.net or by phone @ 512-848-8898. Welcome to Texas. I spent 4 years in southern California as a Marine in the mid 90’s. It was nice, but I’m glad I settled back in Texas. Hope you enjoy it.

Again, Thanks gentlemen for your thoughts and advice. You have been a great help in my attemt to restructure and diversify my company, as well as open my eyes to opportunities for personal REI for my wife and I.

I look forward to your responses.

Sincerely,

ScottC

8

Hi -

Before I start, I should take the time to point out that I am not an accountant nor do I play one on the Internet. You need to study the IRS code (and other relevant items) yourself and always get the benefit of professional advice.

In other words, this is the specific code as I understand it. My interpretation only – you are on your own. Got it?

OK.

Section 121 allows a taxpayer (or taxpayers) to exclude from income up to $250,000 of gain (for a single taxpayer) or up to $500,000 (for a married couple filing jointly).

There some rules. You must meet the tests for usage, ownership, and frequency.

Ownership and usage: taxpayer(s) must have owned and used the the home as a principal residence for at least two out of the five years prior to the sale. Any two years is OK – it’s not necessary that they be consecutive. (there are some rules regarding divorce, but I won’t go into that here).

Frequency: the exclusion only applies to one sale every two years.

There are also some “reduced” exclusion rules which apply when either (or both) of the two previous rules are not met.

These “reduced” exclusion rules apply when the taxpayer sold a home due to:

Job relocation,
Health, or
Unforseen Circumstances (which means the Service will be releasing more qualifying rules in the near future).

Here’s a simplified way to calculate the reduced exclusion:

Total up the number of days the home was owned and used as a primary residence and divide that by 730 (the number of days in two year period).

Multiply that by the dollar amount of the maximum exclusion ($250K for a single TP, $500K for a married couple).

Example: After living in their home one calendar year, Bob&Carol sold their home and moved to another city. They can exclude up to $250,000 of gain.

(365/730)*500,000= $250,000.

Realizing that this is a simplified version, I still can’t imagine why a competent builder (or other RE professional) can’t see their way clear to make use of this Code section. And they should use it more than once. Understand?

In my opinion, too many focus on the maximum exclusion rather than what is readily achievable in their marketplace.

One more point – if your bank curently has 140 builders as customers, you’re dealing with the wrong bank. Period.

Find a place where you are valued when the RE market is doing well and when it isn’t.

Take care,

Eric C

PS – any mistakes made in this “interpretation” were unintentional and I welcome corrections.

9

Well Scott, You’re post produced some lively discussion. Thanks! I’m pretty new to this site as well. I’d like to contact you when I have my next rehab project. I’m between houses right now. Just finished my first rehab project. Made some mistakes, did some things right, learned a lot, and got it sold quickly…but…I found there are consequences in saying “How hard can it be?” My consequence was holding on to it too long…ie. reducing profit. I need to be in and out in under 90 days. (mine took 5 months) I’ve also lost contact with the contractor I was using. I’ve learned that the cheap contractors are here today and gone tomorrow but I was trying to keep my costs as low as possible. I can do the paint,tile,cosmetic stuff but I need someone involved to do the structural things. Roof, Siding, Wood work, etc. I’m focusing on SFH < $150K mostly for financial reasons. (I jumped into this feet first last fall and bought 4 rentals) These guys are right. Those of us who are holding rentals are faaaarrr less picky than the custom home owner. I wouldn’t want your stress either!
Once I get some cash I also have a house in north Austin with a huge lot that I want to add a little SFH rental on to and a house in Taylor that needs a large detached garage rebuilt.
Let me know if any of these avenues would be of interest to you. Feel free to contact me any time at ski@austin.rr.com or 512-680-3663. Good Luck in your RE ventures. Kathy