Spec Homes and Investor Relationship

[Kresh Shehu]

Just recently I have come in contact with builders looking for private investors to finance spec homes. Since the housing market around Austin is very good at the moment, they are offering 10-12% interest. Seems very enticing but I don't have experience on how the legal process would be to set it up so the investor is strongly protected. I know that the best way would be is to set up a 'draw' schedule, etc. However, I am looking for some advice on the details. How is the investor protected if the builder leaves town? What liability coverage does the investor need to see from the builder so the investment is protected as it is getting built? Your advice is greatly appreciated. 

[Roger O.]

I would only do it if I have the first trust deed and the loan in your name.  All draws need to be paid and lien releases from the vendor and or supplier before the next draw is taken.  An honest ethical builder should have no problem with this.  A separate account for the property so there is no co-mingling of funds.  I know of 3 builders that took money up front, pulled draws, received investor money, and didn't put the money in the appropriate areas.  All the investors can do is sue the builder who spent everything.

Make sure there is a market for the spec home and that it will sell for the right price, after lot, build and holding costs.  The builder has nothing to loose if it doesn't sell, but you can be stuck with the house and holding costs.  They factor in their margin and make money on the construction draws.

Another way to do it is a profit sharing agreement, where you get 30% and they get 70% of the true costs, be aware it is easy to pad building costs on a project

It does work and can be very profitable.

DO YOUR HOMEWORK AND DUE DILIGENCE!!

Myself and other investors got burned from a builder pretty bad on spec homes.  The builder really had nothing in it but was reaping the rewards.  At the end there were numerous houses that were getting liens, and all the draws were exhausted.  The investors have to get more loans to pay off the vendors and finish the houses.

I received an expensive education from this and hopefully it will help others