Purchasing a Model Home and Leasing Back?

Question

Hey Y'all,

I had a conversation earlier today with a builder regarding his model home. It's a new neighborhood - the model isn't even completely finished yet.

I was initially looking at home prices and considering buying in this neighborhood now, and banking on the forced appreciation as the neighborhood gets built out over the next few decades (a LARGE neighborhood). Builders regularly increase the base price of the model, so I wanted to explore this possibility...and appreciation is STRONG in North Carolina, particularky around the triangle and Raleigh - Durham - Chapel Hill.

Anyway, after mentioning that I'm a real estate investor, the sales agent told me the builder is looking for an investor to purchase the model now, and then allow the builder to sign a 4 year lease-back.  She gave me the builder's contact information, and took mine to pass along.

Does anyone have experience with this type of deal?  Purchasing a model home at the start of a new neighnorhood and then leasing back to the builder?  Seems like a great deal - since it's the model, it'll be kept in peak condition and yet no one will be living there, putting wear/tear on the house, the appliances, etc.

Again, seems like a great deal opportunity. What am I missing?  Does anyone have experience with this, and/or can share other considerations or things to watch out for? I'm planning to call the builder tomorrow or Monday to get some hard numbers, so any advice is welcome!

Greg Dickerson · Answer

This is a very common practice that builders use all over the country. One thing to keep in mind is location. Often builders will use the worst lot or one of the worst for a model so you will may be buying a tricked out model at top dollar in a less than desirable location. Also there are no guarantees values will hold up over the long run as it al depends on interest rates. If rates rise values will drop fast. Values are at peak levels right now due to rates and construction costs so you need to make sure your buying for cashflow, equity build through principal pay down and not appreciation.

Chris Martin · Answer

As @Greg Dickerson posted, a builder selling and leasing back the model home during development is not uncommon. Some builders, like DR Horton, spell their model home policies out in their SEC filings (last 10-K, page 8): "We typically conduct home sales from sales offices located in furnished model homes in each subdivision, and we generally do not offer our model homes for sale until the completion of a subdivision." So builder DR Horton seems less likely.

My only experience with a model sale/lease back was in 2005, and the numbers weren't all that great compared to distress sale properties that we bought at the courthouse steps. So we didn't close with that developer. I have never really spent any time after that looking for opportunities in this niche market. You may have something.

Kristofer Mendoza · Answer

I buy model leasebacks at every opportunity and it has proven a lucrative strategy for me

Steven Griffith · Answer

That's a great point, @Matt R..  Honestly, I walked away.  800K is too much to spend on a SFH investment property, in my opinion.  The guaranteed income is nice, but at 4K*24mo = 96K over 2 years.  At today's rates, debt service alone on something like that with 20% down at 3.625% interest for 30 years (what i bought my last investment property for in April) would be around ~3k for P&I alone...so 72,000 over 24 months.  Then add on property taxes, insurance, HOA, etc. I don't think it makes sense for me...but if you're interested, send me a message and I'm happy to pass on the developer's name and contact!

Will Kaufmann · Answer

It sounds like an interesting opportunity. Personally I do not invest based on appreciation and consider it only an added bonus, but to each his own. The risk that I am currently concerned with is that supply is currently lagging demand here in the Triangle, but at some point that will flip and house prices will stop rising (they will have to correct). Good luck figuring out if or when it happens!

Matt R. · Answer

@Steven Griffith I appreciate the offer!  I can't swing a note that big, though.  :)

Matt R. · Answer

Disclaimer: I've never actually done this before.

The as-is term in the deal probably covers this, but you might need to plan for a little money to "turn it back into a house" when they're done using it as a model.  Sometimes they just put a desk in the corner of the living room, but sometimes they do something like finish the garage all the way and put the "office" in there.  Sometimes they go as far as walling off where the garage doors are supposed to be, so you'd have to demo that and put in garage doors.

I know some people who have a former model home as their residence, and the downstairs living area has a whole bunch more can lights in the ceiling than you would ever normally put in that size room.  Looking at the pattern, there were probably a few different desks for the sales agents in that room.  *Some* of them still work, and it's not just the bulbs; they think there used to be more switches than normal, but when the model was sold, the builder took out the extra switches and rewired some of the lights to one switch.  They got a good enough deal on the house to not care about it, but on an $800K house, you might want to pull out the extra lights, patch the drywall, paint, etc.

I would also wonder about the possibility of your model home becoming a "parts bin" for the rest of the development.  If they have to get the fixtures installed in another house, with a buyer breathing down their neck, and they unbox the toilet and it's cracked... it's real easy to run over to the model home and steal the $300 toilet from your upstairs bathroom to get that house done, and then replace it with a $79 Home Depot special later.  :)

Steven Griffith · Answer

Thanks @Chris Martin!

Indeed, I finally managed to get the numbers and they and they don't look as great as I had initially hoped.

For anyone who is interested in the numbers of this particular deal:

Purchase price:   $805,000

Leaseback for 18 months, with a possible 6-month extension, for $4,000/month.

We will credit your monthly utilities and landscaping

House transfers as-is (no conversion of the driveway), with normal wear and tear.

We will repair any damages.

Purchasing a Model Home and Leasing Back?

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