Investor/Builder arrangement - advice/best practices?

Question

Hello, I am exploring being an investor in new single-family home construction in a busy/in-demand metropolitan area.  I had a home built by a local builder a few years ago and have been interested in getting into being an investor for a home builder.

While I believe a typical arrangement is a profit sharing type of arrangement, I had a few questions:

1.  If I 100% fund the project (purchasing the land, securing the construction loan, etc.), would a 50/50 profit sharing scenario be common/acceptable? If so, is that assuming that the builder builds at cost (and "proves" it by providing invoices/etc. by the subs)?

2.  If #1 above is correct, how does the builder handle their overhead, i.e., salaries for staff, etc.?

3.  Is an alternative arrangement where the builder builds at a discounted rate, and then the investor handles selling the property + gets all profit?

Any insight or advice would be greatly appreciated.  Thanks in advance.

Andrew W. · Answer

If you are funding the entire project, I am curious why you would want to share profits.  I have recently begun my first project as the investor/developer.  I considered similar types of arrangements but in the end went with a cost-plus contract.  One of the potential issues with a cost plus is that the interests of the investor and builder are not aligned.  There is no incentive by the builder to keep costs down.  In my case, I have relatives who are builders (in a different state) but have good connections with subs, etc. and I am spending the time to personally review all proposals (obtaining some on my own as a check), etc. so that I am confident that the cost incurred is appropriate.  Just looking at my situation, I am paying the contractor cost plus 10%.  The 10% of total cost is significantly less than what 50% of the estimated profit would be.  To give you some perspective, 50% of the profit would be around 25% of total cost, significantly higher that what I am paying.  So, while there isn't incentive by the contractor to keep costs down, even if I am paying a few more % in costs, I am still significantly better off than splitting the profit. Personally, I would start by getting a proposal from a builder to build the home and compare that to your estimated selling price to see what your profit would be.  My guess is that you will be better off just paying a builder their normal profit on the construction than with a 50/50 profit split arrangement.  Also, this could change based on the cost of the home, etc.  I am building a high-end home, so the dollars are bigger, etc.  Additionally, I own the land so theoretically the builder would be getting the benefit of the land location, etc. since this increases the sales value and related profit on sale.  Good luck.  I'd be curious to see what you decide.

Ryan Cheek · Answer

Hey there,

It’s great to hear that you’re exploring the idea of becoming an investor in new single-family home construction! Your experience with having a home built by a local builder puts you in a good position to understand the process, and it's smart to ask these questions before diving in.

• Profit Sharing (50/50 Split): Yes, a 50/50 profit-sharing arrangement is fairly common when the investor funds the entire project. In this scenario, the builder typically constructs the property at cost and provides transparency by sharing invoices and costs from subcontractors. This arrangement aligns the interests of both parties, as the builder is motivated to keep costs down and ensure a profitable outcome.
• Builder's Overhead: The builder’s overhead, including staff salaries and administrative costs, can be a bit more complex. Some builders may include these costs in the construction budget, while others might factor it into their profit-sharing arrangement. It’s crucial to have a detailed discussion with the builder to clearly outline what’s included in the "cost" and what isn’t. This way, you can ensure that all parties are on the same page.
• Alternative Arrangement: Another viable option is the one you mentioned—where the builder constructs the home at a discounted rate, and you, as the investor, handle the sale and retain all profits. This scenario might appeal to builders who prefer a guaranteed fee over the uncertainty of profit-sharing, and it gives you more control over the sales process. However, keep in mind that this arrangement may require more involvement from you, especially when it comes to marketing and selling the property.

If you're exploring specific markets, I’d recommend looking into areas with strong demand for new homes. In places like Indianapolis, for example, we’re seeing significant interest in build-to-rent (BTR) projects that offer consistent cash flow and long-term appreciation. I work with Neu Real Estate Group, where we specialize in new construction multi-family units, and we’d be happy to share insights if you’re interested.

Feel free to reach out if you have any more questions or if you'd like to discuss your investment strategy further. I'm here to help!

Best of luck,
Ryan Cheek