The housing market has changed a lot over the past couple of years, and it’s forced builders and real estate investors to adapt their strategies to be successful.
Builders are beginning to pivot their strategies to focus from building spec homes to emphasizing presale homes.
Spec home building is the process of building a home without a buyer lined up in advance. The builder takes on all the risk, but they also have the potential for a larger ROI if they can sell the home for more than it costs to build. This strategy proliferated in 2020-22 when home prices were rising at near-record rates.
Preselling is the process of selling a home before it is built. The builder typically has a contract with a buyer in place before they even break ground on the project. This gives the builder a guaranteed sale, but it also limits their flexibility in terms of the design and construction process and puts a cap on potential profit.
So, how do investors determine which strategy is right for them? Is the investor comfortable with taking on some risk, and do they have the financial resources to weather potential setbacks? If so, spec home building can be a great way to turn a profit.
However, if they’re more risk-averse or don’t have the financial resources to build a home without a buyer lined up, then preselling may be a better option—especially in a market where home prices are flat or slipping.
Pros & Cons of Building Spec Homes
There are several advantages to spec home building.
- Spec home builders have more control over the design and construction process. They can build homes they know will be in demand and use the latest materials and techniques.
- They’re affordable. With spec home builds, builders usually have more ability to control the costs when they build, accounting for things like location, design, and the quality of materials used in the construction.
- There is little to no wait time for construction. Builders can complete spec homes quickly, helping them to meet the growing demand for new homes.
However, there are also some disadvantages to spec home building.
- There is always a risk that the builder will not be able to sell the home at the projected cost, which could impact profit margins. This has especially been the case in the flat home price appreciation environment of the past year or so.
- Spec home builders need to have a good understanding of the local real estate market to make sure they are building homes people want in the places people want to live.
- Spec home builders need to have a strong financial cushion in case they experience a downturn in the market that causes it to take longer to sell homes.
Pros & Cons of Preselling and Building Presale Homes
There are several advantages to preselling.
- New home presales give builders a guaranteed source of income.
- It allows the builder to lock in prices, which protects them in case home prices slip in a specific market.
- Builders can start and complete construction quickly, which helps them meet the growing demand for new homes.
However, there are also some disadvantages to preselling.
- The builder is at the mercy of the buyer. If the buyer changes their mind, the builder may be stuck with an unfinished home with expensive customizations.
- Preselling limits profit potential by locking in a price now vs. later. If home prices in a market rise, the builder is leaving money on the table for the sake of certainty.
Choosing the Right Home Building Strategy
In today’s evolving housing market, there is no one-size-fits-all strategy when it comes to choosing the right home construction strategy.
Consider all the relevant factors and remember that it’s crucial to have the right lender on your team. Private lenders like Lima One offer spec home financing through a variety of new construction loans.
Whether you’re interested in builder spec home financing or building presale homes, Lima One has the ground-up construction financing options you’re looking for.