Pre-Construction Flips

[Michael Evans]

I want to get some feedback on an investment strategy I used in 2003-2005 that I call the "pre-construction flip".  It works like this:

• Identify high appreciating markets (greater than 12% annual)
• Identify home builders who don't care if an investor purchases and immediately resells a property in their housing tract.
• Enter into a purchase contract with the builder to buy a house that has not yet been constructed with an "earnest money deposit", usually $1,500 - $3,000.
• Qualify with the home builders preferred lender.
• Wait for the house to be built.
• Upon completion, if the current market value of the house (as determined by the market price that the builder is selling current homes) is at a minimum level (5% higher than your purchase price), then complete the purchase agreement.  Otherwise don't complete the agreement and lose the earnest money deposit.
• Upon close of escrow, immediately list the new house FSBO at the same price that the builder is selling their homes.
• Secure a buyer within 2 weeks and close within 30 days.
• Make profit based on the difference between the purchase costs and the selling proceeds over a 4-6 month period.

Here are some real-life numbers for 2014:

• Purchase price: $300K
• 1st Mortgage = LTV: 96.5% FHA 3.5% down @ 4.5% for 30 years fixed = $289,500
• Upfront points 1%
• Closing Costs = $10,402
• Total Cash Investment = $20,902 (down payment + closing costs)
• 2nd mortgage = $20,902 (equity partner) LTV: 3.5% with $0 down @ 10% interest-only
• 2nd mortgage holding costs = 6 months @ $174/month = $1,045
• Reserves = 2 months of 1st and 2nd mortgage costs = $4,387
• Total Investment = holding costs + reserves = $5,432
• Annual Appreciation = 18% (1.5% per month) for 4 months
• Future Market Value = $318K
• Sales Commissions = $0 (FSBO)
• Sales closing costs = 1.5% -= $4,770 added to sales price
• Final Sales Price = $322,770
• Less closing costs = -$4,770
• Less Loan Payoffs: -$310,402
• Net Proceeds from Sale: $7,598
• Less Total Investment: -$5,432
• Less Deal Management Fee: -$404 (this is my fee for putting this all together)
• Net Profit: $1,762
• Cash on Cash ROI: 32.43%
• Annualized ROI: 97.30%

Please critique the numbers, the assumptions and the requirements. I did three deals like this in 2004-2005 when money was cheaper with less regulations.  We turned $10K into $25K, $12K into $50K and $7K into $180K.  I'm not looking to make a homerun off each deal, just a bunch a singles off each and every deal.  Tell me what you think.

God Bless You!

[David T.]

@Michael Evans , You put up a post and invited a critique, got some great responses and then throw a hissy and treat us as ignorant 'cos you don't like what you hear. Sorry to tell, but you're already doomed as an investor. 

Best of luck to you. 

[Jay Hinrichs]

@Wayne Brooks 

   Wayne my point exactly  no lender in his right mind would sign up for this.  they would be buying loans back as fast as these house's were sold.

Red Flag and know thy customer

[Wayne Brooks]

This is an old strategy of course, but here anyway, the intent was never to close on the buy side.  You'd want a unit that was 8-12 mo.s out from being completed, sell/flip before you ever closed on it.  But, that was in a different universe.

[Michael Evans]

I want to thank everyone for their comments. The intent of putting the investment model out was to receive some constructive criticism from real estate investors, which I did. I know the lending landscape has changed since I used this model n 2005 (and even since I purchased my father's house for him in Dec. 2009 via a Power of Attorney), and I wanted to get some idea from those of you are actively buying and selling houses. I will be buying a house via an FHA loan here within the next couple of weeks (still trying to decide where) so I can go through the experience myself. I have a couple of other deals under management, including an $875K rehab in Sierra Madre, CA to flip for $1.3M (5 bed, 4 bath, 3,324 sf.) as well as my father's house in Palmdale, CA, so the next few weeks will be fun.

I'll keep you posted on how this model works.

God Bless You!

[Phillip Dwyer]

What happens when you're on the hook for a $300k loan, and the market has stagnated without you realizing it?  The new buyer (likely an owner occupant) is going to have to get an appraisal assuming they are financing.  The appraiser will have to mention the 1st sale in the appraisal, which is a deal killer for lots of lenders.  Then you're stuck looking for a cash buyer.  Good luck with that.