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ACQUIRING THE BUILDER'S BUSINESS, PART III
By Joel S. Pate
One-time close construction perm loans have long been the bastion of just a few mortgage bankers and brokers. Through this article, and the training we offer, my goal is to increase the number of professional originators that participate in this dynamic niche' in the mortgage industry.
Before we go forward, let's review the highlights from the last few articles.
A builder has several options for financing the construction of homes:
1. Lines of credit where the house is not encumbered
2. Individual construction loans on each house using flimsy pre-qualification letters and end loans
3. Cash
4. One-time close construction perm loans where the customer borrowers the money and the customer's lender advances the money to the builder on a draw schedule
The fourth one is what I specialize in, what I think you should consider becoming a local expert in, and the only one of the four in which you can become THE PREFERRED LENDER FOR THE BUILDER and THE ONE ORIGINATOR THAT THEY THANK EACH CHRISTMAS.
You see, once a builder understands the One-time close construction perm loan and how it fundamentally changes the financial structure of his company, his personal financial liability, the need for retained earnings to grow, the ability to improve his cash flow, and more, he will seek out a local professional loan originator. I want to help you be the person that will convert his operation to the use of OTC-CP loans as fast as possible.
What would COMPEL a builder want to make this change?
1. No personal guarantees
2. Improved profits
3 Improved cash flow
4 Increased opportunity to sell contingent deals (customers that have a house to sell)
5 Nearly unlimited growth potential (banks will not let him grow as fast as OTC-CP lenders)
6 The opportunity to take money out of the business
7 The opportunity for a young builder to grow
8 The opportunity for a superintendent of a big builder to go into business without even a small balance sheet
We have now covered No. 1, No Personal Guarantees, and No. 2, Improved Profits. If you missed those articles or would like to review them, you can visit our archives by clicking on the link at the end of the article.
Today I will discuss No. 3, Improved Cash Flow. A builder's cash comes from many sources, but, ultimately from profits. However, it is not only possible, it is probable that even a profitable builder will run out of money if not careful.
The reason: No other small business in America demands as much capital as home building. Just think about it for a moment: A builder, if lucky, grosses 10% to 20% on the sale of a home. Assuming an average sales price of $200,000, that total is $20,000 to $40,000 per home.
Depending upon the builder's structure, the financing cost will easily equal another 5% and overhead could easily eat up another 5% or more.
That leaves the builder with a profit of as little as 10%, if they make any at all.
If we assume that the builder with 10% profit constructs 20 homes per year, then that builder's profit only totals $400,000.00 before taxes and living expenses.
But that is not the whole story. A builder with the best banking relationships can only borrower approximately 80% of the appraised value of a home and sometimes only 80% of the cost of the lot.
If the builder does not have a 20% gross margin, and most do not, in order to complete the home, the builder must have at least 5% of the value of the home in cash to pay the final bills. In our example, that equals $10,000 per home.
In regard to the lot, the builder would be paying around $30,000 for a lot for a $200,000 home. If the builder can only borrower 80% of the cost of the lot, the builder must have $6,000 out of pocket on every lot. This brings our total cash out of pocket of $16,000 to $20,000 per home.
To make the math easy, let's say $20,000. (For those of you in higher cost areas, just double or even triple the numbers).
So, with $20,000 needed in cash per home, how much would the builder have to have in capital if he had five homes under construction at one time? The answer: At least $100,000.
But that's not all folks. A builder operates on draws. This means the builder gets so many percentage points of the Loan in Process account for work completed. I can tell you from experience, the builder must pay payroll every Friday, regardless of whether or not he has received a draw from the bank on that property.
At the very minimum, the requirement to fund payroll and invoices for the purchase of material doubles the number to at least $200,000 in capital for the builder to successfully build five homes at one time.
Consider this: For this builder to grow his business, go from 20 homes per year to thirty homes per year, how much of his profits must he retain in order to maintain the appropriate level of current assets to current liabilities?
The answer is at least another $60,000 to $100,000 in retained earnings.
Now, back to one of the initial items: Builders that build 20 homes per year are only netting at most $20,000 per home.
If the builder successfully builds and sells twenty homes per year, the gross profit is $400,000 before business and living expenses. Do you know of a builder that doesn't drive a new truck and live in a big house? NO.
So, you can see how hard it will be for the average small builder to actually set aside $100,000 in cash, after taxes, in order to grow his business by 10 houses per year.
Now, with all of that said, if the builder changed his method of financing from utilizing the commercial banks to utilizing your services and the OTC-CP loan, not only could the builder grow his business 10 houses per year, but, he could grow his business perhaps 30 houses per year without any further need for capital.
Next week, I will delve into these details and show you the facts so that you can fully and completely understand this aspect of the OTC-CP loan and the direct and immediate benefit to the average builder.
If you would like to receive additional information regarding One-time close construction permanent lending, or review past articles, visit www.vadiumgroup.com/cpexpert.php.
Dedicated to coaching YOU to CP Loan Success!
Joel S. Pate
Joel S. Pate, a dedicated entrepreneur, has spent more than two decades in the building, mortgage, and real estate industries and has been involved in over $100 million in construction loans and over $1.3 billion of residential lending.
As the CP LOAN EXPERT columnist, Mr. Pate provides straightforward, unbiased advice about every aspect of Construction Permanent Lending. If you ever wanted to unravel the mystery surrounding new construction lending, then you should tune in.
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