Model Home leaseback - is this good?

Question

Curious about this opportunity that came across my desk.

a high quality builder in Phoenix area.

$922k purchase price.

8% leaseback for 18 months, with options to extend leaseback for up to 4 years.

over $100k in upgrades for this one model home.

What do yall think?

Chris Gray · Answer

Having overseen the sale of many model homes at many new home developments, I agree with Kris' comments and would add the following:

* Warranty: Make sure you have a clear understanding with the builder regarding when your warranty period will start on the home.  Most of the time the warranty kicks in at the close of escrow, but since it is the builder using the home you may be able to get them to cover any repair issues and offer you some sort of extended warranty or additional coverage that starts when they return the home to you.

* Lease terms: Have a clear understanding of the builder's obligations under the lease.  For example, are they simply required to clean the home before handing it over to you or are they obligated to make repairs?

* Value of Upgrades: In my experience, the builder markup on upgrades/options is typically 20%-30%, so they likely paid considerably less than the number being quoted.  That said, when pricing a model home, we also typically depreciate the cost of those options/upgrades based on the length of time that the particular home is being used as a model so the future buyer usually ends up paying roughly "cost" for those finishes.

* Appraisal: Will the home appraise "at value" given the price of other homes sold/closed in the community or is it so much of a showpiece that the value can't be justified and you will be left covering any appraisal short-fall...of have potential issues when your future buyer needs to get an appraisal.  Most builders keep an eye on this, but I have seen issues in the past.

* Builder Why: If you can get some insight into why the builder wants to offer the sale-leaseback (as opposed to not selling the model until the end of the project), you may be able to leverage their pain points into better terms for yourself.  For example, do they need the revenue from the sale to fund future phases? Do they need a closing to pad their numbers so that their construction lender or development partner will allow them to begin the next phase of construction? Do they think the market is going to dip and they won't be able to sell the home for as much in 18 months? Etc.

Zitka Ferreira · Answer

This is a interesting thread. I also have an opportunity to buy a model Leaseback to builder. They will lease at 7% of home value for 18 months. I have been pre-approved. The down payment is killing me. They want 25%. I can only do 15%. Not sure how much margin For negotiations I have. This is my first time investing in this type of scenario.

Dave Foster · Answer

@Adam L., Model home lease backs have been a golden goose for a number of my clients.  Light wear and tear, a handy tenant who fixes everything, better than market lease, rehab to near new at the end, and very easy to coordinate with a 1031 going in and coming out!!!  Obviously, they have to stay solvent.  But if they don't then you simply evict and rent to someone else.

This leads to the one caution - Make sure that the lease they offer you isn't too good to be a regular market lease.  This is counterintuitive because everyone wants to make as much in cash flow as they can.  But if your numbers only pencil out with their high lease then you'll be in a world of hurt trying to rent it out if they go belly up.

I love model lease backs - where the builder is solid and the lease at market makes sense and is replicable on the open market (otherwise I'll negotiate a lower selling price and put the risk on them)>

Kris Kraatz · Answer

Hello Adam,

Your opportunity brings to light some pivotal considerations, particularly for those who've had an inside look at the home building industry. Drawing from personal experience working at a home builder, there are a few nuances to be cognizant of when it comes to model leasebacks.

**True Cost of Model Homes**: Model homes are often the most expensive job cost in a community, primarily due to their showcase nature. It's typical for builders to factor in the potential costs of retrofitting these models into the initial price. With that in mind, could the $922k purchase price already include these eventual costs of adapting the property for standard residential use? If you're considering this investment, it's crucial to clarify this aspect, especially given the implications it has on the actual value you're getting.

**Maintenance and Upkeep**: With the frequent foot traffic associated with model homes, wear and tear is considerably more than in a standard residential property. Over the leaseback period, while the property might appear well-maintained on the surface, underlying issues might manifest later, resulting in potentially unforeseen expenses.

**True Value of Upgrades**: The $100k in upgrades, while sounding impressive on the outset, might require a closer examination. Often, builders have the advantage of leveraging in-house trade labor, which could substantially reduce the actual cost of these upgrades. If one were to replicate these enhancements independently, the cost could likely be half or even less of the quoted price.

**Transaction Costs**: At a purchase price of $922k, it's imperative to understand the full spectrum of transaction costs. These may include closing costs, commissions, inspection fees, and potentially more, which can significantly affect your overall return on investment.

Additionally, I'm curious about the acquisition strategy for the model home. Are you considering a cash purchase, or are you leveraging financing? Understanding the financing dynamics could provide more clarity for those of us evaluating the nuances of this opportunity.

If it's a cash purchase you're contemplating, have you ever considered diversifying with new builds in the DFW area? We've witnessed notable price appreciation and the inherent benefits of low maintenance that come with new construction. I genuinely believe there's robust potential there, especially with the prospect of acquiring multiple properties. It's a thought worth pondering, in my opinion.

Wishing you judicious decision-making!

Best regards,

Kris

Bill B. · Answer

It’s only a good deal if…

1) you would buy a normal one with a guaranteed renter at that rate.

Or

2) you’d want to move in to it as your new primary after renting it for a year, especially good if you can do a 1031 to buy it.

I’ve done this twice and I’d love to do it now as I just bought a property in a new community and asked several times if they’d do it with their models. DR Horton wasn’t excited about it. I hope to hit them up again as they get closer to filling up. They might say it had $50k plus in additions (they don’t do upgrades, all homes are sold complete.) but really I’d just be getting a completed backyard and a bunch of accent walls. I just like the location in the complex. So I certainly wouldn’t pay extra.

Don’t get hung up on the upgrades, especially on a higher end home. It might add $20-$30k today if they are generic enough not to turn buyers off. But 5-10 years from now EV probably don’t add much/value as they’ve aged out of fashion/function.