Model Home Leasebacks

Security for Long Distance Investing
By: Ron Black - Professional Real Estate Investor
Texas Realtor - President, Texas Investor Homes
Dallas/Ft Worth, TX - 972-897-6190

Ok, so you know your local real estate market is on the skids but you know you need to look at new investment opportunities so what do you do? All the Gurus are saying you should invest "nationally" but you just have not found the right vehicle that gives you the warm fuzzies. You have heard that long distance real estate investing can be a nightmare. I mean, let's face it, even managing your rental properties locally can be a pain much less 2,000 miles away. There is a solution to easing into a market in another state without the traditional start-up bumps and bruises or expenses associated with traditional rental property, it's called Model Home Leasebacks.

Overall, the model home leaseback program should likely be part of any good real estate investment portfolio, especially if you plan on investing in another state. The key is that you have a measured risk with stable income for a time period, more than almost any other real estate investment. After the builder's lease is over, you have an exit strategy pre-planned for rental or resale. This type of investment can have very strong cash on cash returns. Add a little appreciation, low expenses and the tax benefits and your total return could be staggering.

Frequently Asked Questions

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What are model home leasebacks?

Model home leasebacks in most cases are homes that are occupied and maintained by the builder's sales staff. They use the home as a tool to sell and showcase their products. The model homes include all the amenities, features and upgrades available by the builder to entice potential buyers to build in their community. Typically, the upgrades can add an additional 20-30% to the base price of a home. You can buy the model home as equipped and then lease it back to the builder for a period of time, usually until the development is completed several years down the road.

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Why model home leasebacks?

Hopefully you are seated while reading this because these facts will astound you. With most model home leaseback programs there are no property management fees, no maintenance costs, no repair fees, no tenant turnover, no utility deposits or payments, immediate tenant, reliable rent payments, fully loaded homes at today's prices, exquisitely maintained home, easy exit strategy, and in some cases...NO TAXES or Home Owner's Association fees to pay!

Is it any wonder why many long distance investors lick their lips when they hear the term "model home leaseback"? If you are looking for a simple way to invest long distance it will be hard to beat model home leasebacks. It's really a very simple and more secure way to invest in real estate, especially if you are risk averse. If you have ever taken a pencil to the fees and expenses you incur for a typical rental home over 2 years then you know where most of you cash flow actually flows...right out of your pocket.

With model home leasebacks the cash flow you earn is the cash flow you actually keep. Some of the builders also pay taxes and home owner's association fees in addition to above average market rent. Those deals are rare but are out there if you dig deep enough, or better yet, know someone who has those connections.

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Who is buying the model home leasebacks?

My company will sell well over 100 properties to Investors this year. A large portion of them are sold to out-of state buyers. Most of the investors I sold single family rental properties in years past are converting to model home leasebacks almost exclusively. They tell me that they know they are paying more for the models than they were with empty rental homes but will have more secure cash flow and a higher total return over the long haul. No expenses related to the stopped up plumbing, leasing fees, re-key fees, repainting, or not to mention worries about the tenant paying or vacancy! They love the fact that the builder maintains the complete home, in some cases even for acts of vandalism that may occur. It's really more like a triple net commercial lease more than a residential lease. In fact, this is really more of a hybrid type of real estate purchase, a cross between a residential investment property and a commercial building. Every Investor looking for a secure, stable entry into a market should consider model home leasebacks when available.

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What is the model home pricing strategy?

This is one of the most difficult areas for a new investor of model home leasebacks to understand, or at least to accept. The model homes in most states are not heavily discounted. To get an understanding of why this is, you need to understand why the builder wants to sell his prized model homes in the first place and how his motivation can play into your future. The builder sells his models for basically 3 reasons. Number one is to improve his cash flow. Number two is to relieve his credit line of the cost of the home allowing him/her to build more homes. Number three is to provide a built-in exit strategy. Since the model home is one of the very first homes built in a new community, if a builder heavily discounts the home to you then all of the builder's future sales in the development could suffer. Appraisers use most recent sales prices and closest comparable sales in a community to determine the prices of future home sales. As the first buyer in a new community you are in fact setting the market price for homes built there for quite some time. And in turn, you are likely setting your future resell baseline price in a domino-effect sort of way. The end result of a discount on a model home is lower overall historical values for the community which in turn could mean a lower overall selling price for your model home down the road.

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Where is the value if not in the upfront model home discounted price?

Other than price appreciation over time which can be significant, the added value is in the specifics of the lease and purchase contract itself. The terms can widely vary per builder. Do they pay taxes? Do they pay HOA. Do they pay for all maintenance/repairs? Do they help me resell the home at lease end? Do they pay above market rent? Do they assist with my closing costs? Do they leave all the appliances and window treatments? Do they convert the garage at lease end? When totaled, all these items can add up to several thousand dollars over the term of the lease. In a nutshell, the hidden value of the model home leaseback program is the total of all the incentives, the lease rates and the expense shifting that occurs in the structure of the lease. .

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What are the model home leaseback risks?

"Ok, this model home leaseback thing sounds too good to be true. Where can I get burned?" I cannot count the times I have been asked that question. And savvy investors should always be skeptical. Some risks are obvious. The builder could go bankrupt or the builder could decide not to finish out the community. Those risks are not too bad because you still have control of your asset in superb condition. Since you own it, you can rent it or sell it any time after the lease ends. If the builder defaults the same options are available. And you won't likely have a scenario where the tenant has left the property trashed and slipped out in the middle of the night! Most builders give anywhere from 60 days to 6 months termination notice. No, you won't have the same tenant paying a premium rent any more but if you financed correctly then you are prepared for the worst. And if your long term business plan is to buy and hold you are still in great shape. If you financed incorrectly then you can rent it for a period of time to minimize your loss. Even in a worst case scenario what you have done is have someone else pay your expenses to purchase and maintain a high demand home for a period of time. It may not be the complete term you hoped for but it is certainly better than buying an empty rental home on speculation that you will get a quality tenant for 1 to 5 years that will pay every month on time, vacuum the carpets weekly, touch up the paint monthly, mow and water the yard weekly and never sneak a pet into your home!

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What is the model home upside?

If you believe that one of the best ways to buy a home is to buy early in the life of a community then model homes are for you. You can actually buy THE first home and ride the appreciation and builder price increases throughout the life of the community to the very end. The builder has paid most of your closing costs, your mortgage for a few years and given you a decent price on his highest demand home. And just to repeat myself, you never had a missed rent payment, never turned over a tenant, never had any expenses other than mortgage related expenses and at the very end, the tenant touched up and repainted the home to look exactly like it was when it was brand new.

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What is the model home exit strategy?

If you are seriously intrigued at this point by the model home leaseback program, I challenge you to go to new home community and just hang out in the model home on a Saturday or Sunday afternoon. Make friends with the sales staff and ask them about which home they have more requests to build in the community. Chances are it is the model home plan. You will hear customers popping in to view the model ask the same question over and over, "Is the Model for sale?" About one out of 3 visitors ask that question. The model home is the easiest home to sell in the community. You have a fully staged home being shown to your eventual buyers by a salesperson that you probably are paying very little for the referral. Many builders will actually forward the names of interested buyers to you at the end of their lease. All eventual model home buyers want to brag to their neighbors that they bought the builder's model home. And what's better is that they are willing to pay a premium for your model home. If you are a long term buy and hold investor then you should be buying a model home in a way that will allow you to get market rent and meet your goals.

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What about model home financing?

Try to make a decision prior to financing regarding your hold time for the model home investment. If you are planning on selling the home at the end of the lease then most Investors will tell you to go with as little down payment as possible. If you are a long term Investor, you should consider 20-30% depending on the market. In Texas you can actually buy a model home and have it cash flow with just 10% down while the builder is renting. After the builder has ended the lease, the models typically cash flow with 15-20% down. Markets do vary but you get the picture. There are many lenders that will not finance a model home so ask the question of your lender very early. We have access to lenders that are model home friendly. Rates are no different than any investment purchase. This type of loan does not fit in the very tight and narrow box for some lender portfolios even though it is less risky than a typical empty rental home purchase. Go figure!

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How do lease terms vary?

Most builders will only sign a renewable 1 year lease. There are a couple of reasons for this. One is that many of their accounting policies require them to accrue the full term of the lease in the year it is written. So if you had a 4 year lease, the builder would need to set aside all the lease payment for 4 years. That is not likely to happen. Another reason is exit strategy. The builder may sell out the community 6 months earlier than planned and may need to exit early. That is part of the risk you assume as an Investor with the leaseback program. You may lose his rent earlier than planned but you still have the high demand asset for rent or sale. And if the builder gives you the typical 60 day move out notice then you have plenty of time to chart a course of action.

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Can I keep the furniture and accessories?

The short answer is no. You really don't want the furniture anyway, well maybe the barbecue grill. Most of the furniture is really "stage" furniture, fairly inexpensive but looks like it cost a fortune kind-of-look. I have seen Investors insist that the builder include furniture with the deal. The builder finally relented and when the builder moved out, the tenant that wanted to rent the home hated the style and wanted it removed before renting. The investor ended up paying to store the furniture for 6 months and then decided to sell it for pennies to a second hand furniture store.

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How do I find model home leasebacks?

Model home leasebacks are really sweetheart deals. At least the ones that are located in growing real estate markets. Be careful of states that have troubled real estate economies trying to "pay" you to take them off their hands. My motto is, "If it's easy to buy, it's probably hard to sell". In good markets like Texas and some other States, it is extremely difficult to do on your own. Many builders do not sell their models at all. The ones that do, usually require some convincing because of the risk to the builder. That's right, "risk to the builder". Imagine their sales counselors showing up for work at the model home one day to find that the model has been foreclosed because the Investor went bankrupt! So, as you can imagine the builders are naturally a little picky about the quality of Investors buying their homes. They want to know who they are selling to and what their level of investment experience is. Many of the builders designate certain models for sale to their friends, employees or family members in some cases. At the end of the day there are usually a handful of models available as leasebacks on the open market every year in most states. They will require some research, time and luck to find. You need to establish a relationship with someone in the builder community to get the leasebacks.