BUILDING AS A SIDE-HUSTLE TO COME UP WITH YOUR DOWNPAYMENT MONEY
Up until now, I’ve assumed you’ve had some extra money lying around to put your custom home project in motion.
I know from personal experience that’s not always true. It’s necessary to start saving, cutting corners, clipping coupons, whatever’s necessary to come up with downpayment money.
One thing I encourage you to do is start the entire ‘Design and Build Your Own Custom Home’ process by practicing on other people’s houses. It can be a great way to make a serious down payment while you’re still working your 9-to-5, if you do it right.
There are many ways you can do this. Here is one possible method to get you started:
STEP 1 - Find A Potential Project
Go out, just like you were looking for land to build your own custom home, and find some property.
It could be a vacant lot or an old house to knock down; the only thing that matters is that it is in a growing neighborhood. (My general rule of thumb is that it’s within walking distance to one of the national coffee shops. They have already done the homework for you to identify the growing neighborhood.
Tie up the property by either talking the seller into going along with your plan or putting in a contract contingent on a long due diligence period.
STEP 2 - Sketch Out A Potential Plan To Confirm Quanities
Go through the same exercise we discussed in the ‘How To Design Your Own Custom Home’ section, but this time do it more generically. We are designing a ‘spec’ home.
We are designing for the most popular demographic, although my personal opinion is that we want to do something a little more unique then the big production builders.
The goal right now is to block in a ‘nice’ house that fits within the neighborhood and would sell quickly. This exercise should give you a sketch of what the Floor Plan and Front Elevations would look like, along with the size of the home, measured either square feet or square meters, depending on where you live.
STEP 3 - Analyze The Numbers From An Investor's Perspective
The next step is to prepare a profit-and-loss projection for the project (pro forma).
This spreadsheet tallies all project costs: land, soft costs (architectural and engineering), interest carry, permits, hard costs (construction and sitework), and real estate commissions based on a realistic sales price.
This spreadsheet is laid out over the project’s construction period. (We will go into much more detail in future posts and provide free templates to use.)
You are looking for a few numbers in particular:
- The amount of ‘out of pocket’ funds that you need from an investor
- A realistic sales price
- The total anticipated profit from the project.
The combination of these numbers will give a potential investor their ‘Return On Investment’ (ROI)
For this exercise to work, be truthful, thorough, and REALISTIC with your estimates. Don’t be overly optimistic. In fact, I have found that it’s better to under-estimate a few things at this stage. That way, when you come through on budget and on schedule, you’re a hero!
You need to deliver an ROI substantially better than an investor can get from a more established asset class, such as a relatively safe money market or stock.
If the return isn’t competitive, go back to verify the numbers and see if you can negotiate the land price down to make it work. If it still doesn’t work, proceed to the next property. Don’t look back. Don’t massage the numbers to make them work unrealistically.
If you can legitimately give an investor a better return than the stock market, you’ll have them lining up.
STEP 4 - Consider Selling Your Idea To The Land Seller First
There are clear advantages to doing this deal with the land seller, for both you and the seller.
From your standpoint, it takes away some of the hurry to get the plans finished. It reduces the ‘out-of-pocket’ expenses when the land is already under the ‘joint venture’s control.
The seller ultimately earns more from the transaction. They also get to live in the house for a few months longer, which might help with their logistical challenges related to moving.
There are pros and cons, which we will talk about in the future, but please keep it in mind as an option.
STEP 5 - Plan 'B' - Find A Financial Partner
I would pursue a financial partner as follows:
Put together a package of drawings showing as much as possible about the project:
- Site Plan
- Floor Plans
- Front Elevation
- Possibly a 3-D SketchUp model
(This would be the same portfolio that you will show to your banker.)
A detailed pro-forma that realistically demonstrates their potential ROI.
You need to be as complete in your pro-forma as possible. There’s nothing that takes away your credibility (and trustworthiness as a joint-venture partner) than forgetting something like property tax during construction or some crazy utility hook-up fee.
Include a 10% contingency fee to cover unforeseen items.
I will provide a detailed pro-forma and investor/bank worksheet in a future post.
Remember that an investor must secure funding for many of the necessary expenses before the bank is involved. Typically, the first draw will reimburse most of those fees, leaving the investor responsible only for interest payments during construction.
And…although this blog is focused on doing everything yourself…it might be the time to contact an attornety or accountant.
STEP 6 - Go To The Bank, Using Your Investor's Credit Information
The package you submit to your banker will be similar to what you presented to your investor.
Call ahead to request any additional forms and complete them before you meet with your banker.
Be complete and detailed. It’s bad enough if you’re embarrassed by not having all the information. It’s even worse to embarrass you investor.
STEP 7 - Continue As If You Were Building Your Own Home
Okay, if you’ve made it this far, you have found a financial partner and have secured a construction loan.
It’s time to start building!
I will refer you back to the post about building your own home, because to be successful, you need to treat this home as if it were your own.
The concern towards detail and quality will guarentee your success and, the more practice you get before you start on your own home…the better!
STEP 8- How To Design And Build A SPECULATIVE Home
A ‘speculative’ (spec) house is built to sell. The design is based on the demographics and on what the typical buyer might want. If a custom home is similar to a tailored suit, a spec house is like buying it ‘off the rack’.
Here’s my take on designing a spec home if you’re a small builder:
The big production builders will hire marketing firms to survey potential buyers and will base their designs on what the majority of the market wants. (For the sake of this argument, let me use bathtubs as an example. Let’s say the surveys show that 80% of the market wants both a shower and a bathtub in the primary bath. The big production builder will show showers and tubs in all their baths.
Mid-sized regional production builders will copy the big guys because the big builder has hired a marketing firm and identified the need. Having said that, they too will show showers and tubs in their primary bath.
My contrarian viewpoint for the little guy (you) is that you don’t want to compete with everybody else. The big and mid-sized guys can build faster and cheaper. Instead, do something different that appeals to the 20% of the market that didn’t use bathtubs in the primary bath, and build a big, two-person shower. Be different!
(Having said that, if you’ve ever tried giving a baby or dog a shower, I do believe that you want a tub somewhere in the house, maybe in the hall bath. We have a big tub in our bath and have never used it.)
Just don’t do anything completely crazy.
STEP 9 - Consider An 'Infill' Project
When I consider the idea of what I’m going to build, I immediately envision some sort of infill project; a ‘knockdown’ project. That’s been my emphasis for the last several years: gentrifying older neighborhoods, building somewhere with mature trees and within walking distance of amenities.
That said, I would take the first step of designing something that ‘fits in’ with the neighborhood, in a style and scale similar to my neighbors’.
Maximizing the size of the house on an infill lot can justify land cost, but don’t go crazy and build some McMansion. Be ‘Right-sized’.
So, what do you think you could build? What sells? My intention is to get into ‘Infill-development’ in more detail, since it’s been my speicalty for a few years. More posts to follow!
STEP 10 - Selling The Home And Splitting The Profits
Here is how one of these ventures should work.
You build the house with the investor’s help and sell it at market price.
With the proceeds from the sale, make sure all your subs are paid, all real estate commissions are paid, and the investor is repaid for the money they’ve invested.
What’s left is the profit, which you and the investor split 50/50, 60/40, or whatever your original deal was. I don’t want to specify any figures, but I’ve seen both sde-hustle builders and investors make substantial sums. In fact, I’ve worked with several part-time builders who made so much that they quit their 9-5 jobs to go full-time.
Also, keep in mind that it’s possible to plug a monthly construction management fee into the equation to give you a salary during construction. It all depends on how you structure the deal.
Mistakes That You Want To Avoid
I’ve painted such a rosy picture that you have to wonder why more dentists aren’t out there moonlighting as builders.
The fact is that it’s a hard job, harder than I’ve described. Every day, you’ll have a list of problems to solve and some hard phone calls to return. And, although the rewards are big, so are the risks.
I’ve seen builders who cut things so thin that there was nothing left for them after they repaid their investors. Hell, I’ve seen some who couldn’t even fully pay back their investors.
You have to be diligent. You have to be thorough. And, you have to be realistic when you first draw up the deal.
FINAL THOUGHTS:
Build up your downpayment by creating value for both yourself and your investors.