Would you run to or from this deal?

Question

So I'm currently looking at a deal for new construction in Alabama. It is a Turnkey company that specializes in new construction. They are the builder, the listing agent, the title company, and the property managers (they have four companies). However, you are not obligated to use their title company or property manager.

If you use their title company, they will cover 2% of the purchase price for closing costs, and if you use their property management, they will provide a 12-month builders warranty plus an up to 12-month lease back if they can't find you a tenant.

They are partnered with a credit union offering a portfolio loan with 0% down (interest rate will probably be 8-10%). It is a 10-year term amortized over 30 years.

Essentially instead of putting a chunk of money down, you are negatively cash-flowing for several years while your equity is building. They increase rents by about 5% each year, so at some point, you will stop negatively cash flowing. When rates improve and you have some equity, you can refinance.

The contract seems pretty aggressive, though, and not many ways that you can back out and recover your earnest money deposit.

Jamie Stone · Answer

Thanks. I keep returning to the line that you make the most money on the day you buy, and this deal feels like rolling the dice on what might happen instead. Also, the negative cash flow that I determined with Deal Check is more significant than they are presenting, especially since rates just went up again on Wednesday.

Corby Goade · Answer

There's really not enough info here to give you a direct answer, but for me, much of this depends on the provider's track record and the projected growth of the area, which will influence the equity build up and potential rent increases.

I know lots of people here on BP say you shouldn't buy anything with negative cash flow, but there are times when that risk can be worth the reward. For instance, let's say this deal is -$200 per month and you project to be that way for 3 years until you break even. That's an out of pocket cost of $7200- BUT, your purchase price is $400k and you project equity growth of 10% and maybe the place appraises for $450K when it's done. You just paid $7200 for $170k in equity over three years and then you start cash flowing. I'd probaby do a deal like that. Lots of ways to skin a cat!

Anyhow-I wouldn't RUN away, but I'd dig deeper, especially if you can do it with zero down and it's totally passive. I'd be weighing my decision heavily on projected equity build up and the providers reputation.

Best of luck!

Nathan Gesner · Answer

Builders should give a 12-month warranty, period. The warranty shouldn't be tied to whether you use their management. That's a red flag that their builder can't back up his work.

I'm always cautious of companies that build, then finance, then manage. You don't have anyone to cross-check the work of the other. They're just churning out homes and making a profit on the build, the sale, the management, and the on-going maintenance. I've heard more horror stories than success stories.

It could be 100% legit, but I would carefully read the fine print and keep a close eye on them every step of the way.

The biggest red flag? 0% down financing. That's a risky venture, particularly when the market just peaked.

Ray Hage · Answer

@Jamie Stone and @Mark S.

Both those types of deals sound like they wouldn't be worth it. I'd suggest finding an experienced Realtor/Investor (not an "investor-friendly realtor") like myself for whichever market you plan to be in. These companies have way too many red flags for me to even consider.

I am based in Fort Lauderdale so if you (Mark) happen to be looking in south Florida, I can help on every level as I have my own LTR properties.

Chris Seveney · Answer

@Jamie Stone

How many other communities have they built last five years? Talk to those owners. I never like to be the Guinea pig and be the first one.

Konstantin Ginzburg · Answer

As some others have said: it's hard to give a definite opinion without seeing the actual numbers involved in the deal. Due to there being no down payment, then no initial cash flow wouldn't be a deal breaker (assuming you factored in every cost such as capX, maintenance, vacancy, management, ect.) but if the negative cash flow is very substantial, than I would say it is better to walk away from the deal and find a better option on the market. This is especially true since the internet rate on the deal is 8-10% which is quite high.

I have not looked into the Alabama market too often but I am nearby in the Louisiana market so there may be some overlap in those markets. One thing I have learned in the Louisiana market is that new construction rarely were able to cash flow since the higher rent they brought in did not offset the increased monthly payments that came with their higher purchase prices. However, I was able to find several used homes within the same market that were able to cash flow on day 1 and I viewed as better long term investment options. From my experience, the southeast is also not an area were you can depend on high appreciation to quickly improve a non-ideal real estate purchase. Both home appreciation and rental prices will increase over time but it might not occur as quickly as you anticipate so ensuring your property has a high initial cash flow would be in your best interest for your first property in my opinion.

Jon Kelly · Answer

@Jamie Stone hard to provide any reasonable feedback without seeing the purchase price, down payment, monthly rent, expected ROI, etc.

Can you speak to someone that's used the company before?

Do you have better options with higher returns?

I would understand your timelines better. 2-3+ years to start cash-flowing without getting the benefits of writing off the construction costs seems that a tough deal to get behind.

Jamie Stone · Answer

I'm going to pass as well. The builder, in this case, is Prominence Homes. I went to their website, and they have pictures of various house models they are building, but only one of them even has a floor plan you can look at for the neighborhood in question. They sent me a contract that stated I would have five days to get pre-approved or lose any EMD. Also, if financing fails on my end, they have to option to find an alternate lender, and I pay the costs, etc., etc. Barring an act of nature, serious supply chain issues that prevent them from finishing the house. I would lose the EMD if I didn't go through with the contract. I didn't sign.

They also are talking up the tax benefits, but these only apply to a real estate professional, which I am not. My losses would be subject to passive loss limitations, and since the properties are negatively cash flow my benefit would be zero in the current year. This deal might make sense if you could write off all the losses and you wanted the property to offset income as a real estate professional.

My numbers painted a picture of -$1500 after all expenses paid per month to start. Best case scenario with refinancing in 5 years, assuming rates are 4.5 or so with 5% yearly rent increases, would not have me being cash flow positive for a decade. With a conservative appreciation of 5% for the area, the equity in my pocket at this point would be less than the money I paid out in negative cash flow.

This was a great practice in using the calculators, though.

Would you run to or from this deal?

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