Little Competition, Big Profits: Why Spec Home Investing Could Be Right for You

Real estate investors have multiple options for getting into the game. The most popular investment strategies are fix and flip and long-term rentals, with fix and flip getting the most publicity.

But another option that doesn’t get nearly the amount of press is spec houses. As with any real estate investment, there are pros and cons when it comes to spec houses. I’ll walk through a few of each to help you determine if spec house investing is right for you.

What Are Spec Houses?

A spec home is basically what it sounds like: building a single family or multifamily property without having a buyer lined up (speculation). Spec homes can be a risky venture, but with that risk comes an upside potential that can be very attractive.

Investors typically make their money on spec homes in one of two ways. They can finance a percentage of the construction costs (lend money to a builder) and earn interest or share in the profits once the home is sold.

In the latter case, you or the builder may also borrow money from a bank or private lender to pay for some of the construction costs. Sharing in the profits is often called “equity investing” and is potentially riskier but also more rewarding than lending money to a builder.

Pros & Cons of Investing in Spec Homes

Now that we have the basics down, let’s look at a few of the pros and cons of investing in spec homes.

Pros of Investing in Spec Homes

The upside on spec house investments is generally higher than fix and flip. It is becoming more and more difficult to find good fix and flip properties, making spec houses a good alternative.
The competition is less for spec housing development versus fix and flip.
Spec houses can be considered a medium-term project. Investors will realize their gains faster than with long-term rentals but longer versus the typical fix and flip project due to longer construction time.
With spec houses, you avoid the costly surprises that flippers often encounter (termite damage, mold, etc.).
More and more spec builders have become accustomed to seeking out private investments.

Cons of Investing in Spec Homes

Spec houses are inherently riskier than fix and flip or long-term rentals.

The market could tank between the time the deal is financed and the time the property is ready to sell.
Market needs/trends could change between the time the deal is financed and the time the property is ready to sell.
The project could run into unforeseen problems, causing delays and cost overruns.

Depending on how much “skin in the game” the builder has, they have less to lose than the investor. If the home doesn’t sell, the builder typically has little or even nothing to lose, but the investor can be stuck with the house and holding costs. Builders make money on the construction draws.

Mitigating the Risks of Spec House Investing

While spec housing development involves risk, there are several steps you can take to lessen the downside in the event things don’t go as planned.

Start at the beginning. In most spec building projects, much of the profit will come from the lot acquisition. Make certain the land acquisition is a good deal before you go any further.

Partner wisely. Becoming a savvy spec home investor means choosing your partners carefully. Only work with builders who have a long track record of success and you can trust.

Do your research. Even if you are working with an experienced and trusted builder, do your own research. Make sure the deal makes sense after you’ve researched critical factors such as the area’s absorption rate, employment stats, median price, time on market, and competition.

Assess others’ skin in the game. Make sure you are comfortable with how much skin in the game the builder has.

The Bottom Line

Given the intense competition for and increasing price of good fix and flip projects, now might be a great time to consider investing in spec homes. They can offer the investor an attractive upside, but it’s of course one that comes with risk.

Do your homework and choose your project wisely.

Would you consider investing in spec homes? Or have you in the past? Why or why not?

Leave a comment below!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.