Welcome to Part 2 in my series about protecting yourself as an investor from having a builder go broke on you. (If you missed part 1, you can watch it here.)
So let’s get right into it:
(scroll down to read the text version of this video)
How To Avoid Builders Going Broke On You – starting with the fundamental things.
The first thing you can do is just avoiding the process altogether.
Buying established.
Now, I know what you’re probably thinking.
“Nhan, isn’t that against your philosophy of buying wholesale… ‘you making money when you buy’… all that stuff?”
Not really.
If you’re open to it, and you use your brain, there are a couple of ways you can do this:
- You could buy an owner-occupied renovated house. If the house is done already, obviously, there’s less moving parts. Or no moving parts whatsoever.
- You can apply that to units and apartments, as well.
Here’s another application of this idea. One that I’m doing at the moment. This does involve some risk and some skill. But less involvement with contractors and builders. And that’s flicking sites with approvals.
That’s what I’ve done earlier this year.
Bought it for $1.2 million dollars… flicked it for $2.1 million dollars!
That was pretty cool. And I’ve got another site going at the moment in a similar vein.
We’ll see how that goes. But getting approvals and flicking the site is definitely profitable and can be done skipping the builder.
Want another variation of the same idea?
You got it!
Sell the land in a land subdivision, WITHOUT the full kit and caboodle!
That’s a big thing I’ve learned early in my career when my builder went broke. We were doing spec homes. Buy land, build houses with a discount, trying to get the margins that way.
And look, there is a time when getting your margin this way works. Over the last two years for example. But out of a 10-year cycle, you might only have two years where you can do that. Because you need both land prices and building prices to be going up. What happens is you lock in your land, you lock in the build price, and voilà!
Because the market has gone up over the 6 to 8 months you were building, now you’ve made $500k.
And yes, there has been a fair bit of money to be made that way.
But it’s not a sustainable model!
People argue with me on this one. Saying “look, that guy made money.”
Well, I’ve made money doing that strategy too. HOWEVER… You better be doing bulks of it. I’m talking 50s, 100, 1000 of them.
Not many people that can sustain that kind of leverage without being hit with variations. You’d have to be doing it with cash.
OK, so the guys and girls who are doing that, they’re in a different ballgame. If you’re debt-free, you’re cashed up, you’ve got monster cash flow coming in, you’re in a different league.
Forget about that category of investors.
They’re not relevant to what regular people are facing and will be facing in the next 12-24 months.
Typical mom and dad investors need debt to get in the game. You need to borrow the $500k, the million bucks. And that’s fine!
But If you’ve very little cash to play with and you’re going to borrow. I recommend you completely avoid (or at least partially avoid) the construction process.
You can focus on getting approvals and flicking it. You can buy complete. You can subdivide land and sell without build. Or you can just sit tight and wait for the market to go through this period.
All of which are viable options… and here’s more!
When you’re doing house and land, building house and land. There are two types of contracts:
First, the fixed contract.
As the name implies, this is where you page a fixed price.
And this is definitely preferred…
…usually!
Why usually? Because in a market like this, that’s where builders get hurt. For example, it might cost them $150k to build. They price it to you at $200k. Then a year or two later they start building. If you look at 2022, that $150k cost of theirs is probably $240k now. You have a fixed price deal, but now the builder is losing money.
If he has a lot of these contracts, he goes bust.
And you lose too.
So I say that in all market conditions except for the current market, you want a fixed contract.
In the current market, you may consider contract option #2…
The Cost-plus contract:
Cost-plus is basically whatever it cost the builder, they pass it on to you, plus a percentage margin. Call it 10%, 15%, whatever it is.
Obviously, this is not financial advice, not legal advice. Go get financial legal advice for yourself!!!
But with a cost-plus contract in the current market,
It’s less likely the builder will go broke on you!
Look, when you have a contractor who’s on the job, it is vital that they make a profit. Why? Because you want them to sustain their business throughout your project and still be alive and kicking for another 5-6 years… because they generally have a 6-year warranty after the build is complete!!!
So even though a cost-plus contract is not ideal, it will sustain the survivability of the builder. Which, as we’ve just concluded, is very important to us investors.
The issue with that, to be clear with you, is that most people want the best price. They don’t want variations.
They want to know what’s the price, and that’s it. No more costs. you want to know, “Okay, I’m paying $190k, $250k, then that’s it. There’s no going to be more cost.”
Because when you go to the bank, you borrow a percentage of that. Call it 80%. And then if you need more money later to pay for extras, you’re going to have to come up with your own cash. Because the bank is very unlikely to give you that extra $50k variation just because the builder had some extras there.
So from a customer’s point of view, fixed price is absolutely ideal. However, from a volatility point of view, for those who want to survive, you really should consider cost-plus contracts.
By the way, all these things are a big part of why I haven’t developed anything personally in the last 12 months. There’s been opportunities for me to just to get approvals and flick my sites, and I’ve taken those opportunities. Moving on. Cashing up. Without the headache.
Doesn’t that mean I’m out of the development industry completely?
No!
But for now I’m focusing on getting sites that are profitable. And the key is buying right.
On the next couple of videos, I’ll talk more about my strategies for that.
Catch you later & thanks for watching!
Nhan
