Questions to ask builder & realtor about spec home?

Question

I'm meeting with a builder Tuesday morning about building two spec homes. My listing agent for another deal bought a house with four extra lots on it. She said she has another money person who wants to build on two and do I want to do the other two? I do not know this agent well.  She suggested the builder.

I'm naturally cautious about these things, but want to check out what they are proposing.

What questions should I be asking during this meeting?

Here are a few details. The lots are worth about 30K each (i'm sure of this). The area is desirable with new homes being built on infill lots. These lots are flat with street frontage in the city.  Almost all the new homes built in this area are 'green'. The price extremes are 175K to 350K.  Most new home sell for 225-275 and are in the 1300-1600sqft range.  I had previously talked with a different builder- who has a excellent reputation from multiple trusted sources and builds in the area- about building a green home with low grade but acceptable finishes. He quoted 100-105sq ft. This is lower than the finishes you would want for the best sale.

The builder I'm meeting is based in the next county over (30-40 min driving). This market is devastated compared to mine.  His website shows high end homes built for a different older, more conservative buyer. No mention of green. This makes sense for that market and that my realtor would have a relationship with him, she was based in that county for many years.

My realtor mentioned a 50-50 split and that I would not pay for the lot until closing. This was in passing while we were talking other unrelated matters, so I didn't get the details. I don't like the sound of it.

What criteria would you need to go forward with this deal?

Thanks for the help. If you send me the questions, I promise I will ask every one and report back on what they say. That should be a good learning experience!

Brian Levredge · Answer

You definitely need to factor in your soft costs on this.  Those include plans, engineering, plan review, and permits among others.  If you already have ready made plans, then all the better.  If you don't, you'll need to either find some or have some drafted up to fit the lot accordingly.  The additional fees for new construction can sometimes change the equation more than you think.  For instance, Los Angeles charges a $5/sq ft school fee, which can add quite a bit to the bill, and that is in addition to the plan check and permit fees.  You also need to account for the time, which can add weeks or months to your completion schedule even though you will have to invest funds up front.

With the contractor, not only do you want him to have insurance but you want to be named as an additional insured for the projects.  With the subs, you may (most people don't ask for it) want to see proof of worker's comp or an affidavit from them saying they are exempt, which single employer companies usually are.

While new construction is much easier to budget for since there are usually no surprises, you may want to have the contractor include a gray clause in the contract.  This is money that is set aside for unforeseen circumstances or for changes the owner might make during construction.  The unused portion of money can be refundable to you if not used.  As a contractor, I insisted on these clauses as even spec developers changed their mind on finishes or something else during the course of the work.  They provide a nice buffer and allow you to stay within budget even if you make a couple changes.  I would typically make them for 5% of the total bid.

Karen Margrave · Answer

I have to question the 50/50 split, what's that about? I think you'd be better off controlling the deal by buying the lots yourself if you're comfortable with the area, and hiring your own contractor. However; before getting into contract, talk to a few other contractors and get an estimate on what they think the cost to build will be. Regarding "green" that's a very open ended term. What exactly do you think "green" is? Is it blown in insulation, low e windows, energy efficient heating/air and appliances, tankless water heater, etc.? Know what you're paying for, and don't get charged more just because somebody tells you it's green construction.

Whatever you do... CHECK REFERENCES, LICENSES, BONDS, INSURANCE. You or your bank control the funding. Have a system for releasing money in increments based on work done on the job.

Will Barnard · Answer

As others stated, you shouldbe able to do this for closer to $80 per sq. ft (however, that does not take into account green building costs which are often more costly).
Also, avoid (if you can) cost plus as such a format provides 0 incentive for builder to keep costs down, in fact, the higher the costs in that format, the more he makes. 
I always did flar rate fee on top of a set in stone cost factor, if contractor goes over that, he eats it. If he goes over deadline, he pays penalty. Also get lein releases not only from the general, but from each sub. I know in TX that a sub can file a lien on a property if he has not been paid, even after you sell the property and then the buyer will be coming after YOU! (Check with your state on these laws)

Make sure you get a completed environmental report on the lots (developer should be able to provide this to you).

For infill projects, be very careful on lot location and the surrounding properties. Just as with rehab flips, you don't want to buy next to or near some other junkers!

I would advise that you bring in your own crew for building (assumming you have one) and get your bids from him/her to compare to this agent's crew.

Bill Gulley · Answer

This is a topic for another book! I won't attempt an indepth strategy but touch on some key points.

First some questions for you to get better comments; what % is the neighborhood completed? Any associations? Is it restricted?

Now, will the contractor build on a cost plus basis or a flat price based on plans and specs? Does he obtain financing or do you? Does he have a problem with any deadline penalty (as most small contracts drag their feet if they get busy) and if so, what would be acceptable to ensure a turn key build on time? Does his price include insurance? Will he have a foreman with employees or does he sub out the phases and rely on the subs? (Good subs are fine in most cases, ask who they are, but will he have a foreman or he himself on site or does he let a sub simply come in and work without direct supervision?)

It's clear already that the builder and the agent are a team, she is picking up a profit on the lots as well as the commissions if she assigns the lot to him,  he builds and you buy.

Kama Ward · Answer

@Rich - Good to hear from you! I want to do my first spec near to home. Infill (city) specs are good here. You can get up to 195sqft if you do it right- this is for smallish homes say under 2000 sqft.  Rehabs sell for up to 175sqft. (My last one sold for 164sqft.). This is all for stuff under 370k. I do not know what goes on above that. Still seems all frozen up.
 
I am willing to look elsewhere to invest, and even move as you have suggested- but not for a while. Right now there are more opportunities here than I have the capacity to take advantage of.

@Steve K - I'm sure there is 40k or more to be made- but I doubt I would be the one making it! Ha.

@Josh D- How do you make the @someones hot on an iPhone?

Steve K · Answer

It's pretty unlikely that you'd ever get to $40k in profit based on the above scenario.

Steve Babiak · Answer

Get lien releases from material suppliers as well, in addition to what Will has mentioned.

Rich Weese · Answer

Kama,
this is the first time that I have been on BP for a while and I think you made the right decision. I have found general contractors in both areas I'm building in that don't require anywhere near what you were going to be splitting and I have found realtors that will list my completed homes for a lot less than 3% listing. You just need to hunt around and do some comparison shopping.

Are you area bound? It is not always the best of times to build spec homes in every area. Sometimes it is beneficial to look outside your immediate area or even state if you have the contacts. Good luck. Rich

Kama Ward · Answer

Here's my update. The first meeting I had was pretty much meet and greet with no nitty gritty. 
 
We finally had the second meeting last week.  The realtor now wanted 40k for the lots (instead of 35k).  I would have to pay for the lot up front- different from before.
The builder brought a detailed breakdown of costs- about 100 line items. I looked over them them and they looked decent. I only know some of the costs- the ones that overlap with rehabs.

The build cost ended up being 98.57sq ft.  This was supposed to be the 'at cost' price, but I'm not sure what that means. He doesn't pay himself for four months?  Then we would split the profit 50/50 for the first 40K and negotiable after that.

So the total I would have in it would be about 190K. The house would sell for 249K lightning fast (before finish most likely). Or we could list at 269K for a (i'm guessing) 2 month sell time.

The conclusion is I decided to pass on this deal. One of the main reasons is that the realtor and builder are new to this market (from county next door). They have done specs before, but I rather not be in with two other "first timers". I did say I'd like to follow along with what goes on there.  Maybe if it goes well I will invest in the future.

If I am going to put up all the money, I want the profit. My plan is to break off a lot in the next fixer I run across that will allow for it. Then hire a builder who has been doing specs in the area. That's the right pace for me.

Steve K · Answer

There is a lot of good advice in this thread.  The only thing I'd add is to learn the lien rights / laws in your state.

Questions to ask builder & realtor about spec home?

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