[RWS #695] Still Smart to Build New Homes?

Picture of sander for Real Wealth Show Podcast Episode #694

Home sales slowed in the second half of 2018, so much so that new home builders in many areas had to offer price reductions and add-on incentives.

As you may know, RealWealth partners with experienced developers to build out subdivisions nationwide. We have projects in Reno, Tampa, Park City, and Bozeman.

On today’s show, we’ll hear from 40-year veteran developer, Fred Bates, on how those projects are doing, and whether or not it’s still a good time to build new homes.

Fred also acts as my advisor. Whenever another developer brings us a project, I first send it to Fred for review. 90% of the time, Fred gives the project a thumbs down because it’s too risky, often because it’s dependent on too much leverage with tight margins.

Let’s find out what he looks for in a good deal.


Podcast Transcript: Knowing When and Where to Build New Homes

Kathy Fettke: Fred Bates, welcome back to the Real Wealth Show.

Fred Bates: Hi, Kathy. How are you?

Kathy: Wonderful and I love learning from you, so I’m so happy to have you back here. I know that we’re entering into maybe one of the longest expansions in history and you are the guy who is seeing a lot of deals out there, turning down most of them, but still finding great opportunities, so what does your desktop look like lately? Are the deals getting worse that you’re seeing?

Fred: No. I think from the standpoint of economics, maybe. Everybody that has land is very proud of it and they’re asking a lot of money and, consequently, that, along with city and county fees, the cost of entitlement and so on and so forth, it puts the land price up almost too high. We just had a meeting today and we were talking about how we get our construction costs down.

Of course, in a stiff labor market, I think you’re aware that right now there’s a shortage of labor, so consequently, we’re probably paying more in labor than ever before, so how do you get the construction cost down? It’s almost an impossibility. We could create a smaller product and people can live down, as opposed to what we try to do, as you know, in our other projects, where we have people living like millionaires at an affordable price.

It really comes down to land cost, buying the land at an affordable price, getting a good deal on the land and, of course, that takes a great deal of patience and a lot of due diligence. Because if there’s land available at a reasonable price, then the first thing that comes to my mind, “What’s wrong with it?”

How to Find a Good Deal on Real Estate

Kathy: How long typically are you in negotiations over a piece of land? I mean, sometimes it seems like when you bring projects to us, you’ve been negotiating for years.

Fred: That is the case still. We’re looking at projects here in the Reno area, so Northern Nevada. We’re looking at projects in Montana, Colorado, Utah, and Idaho and, in every instance, we’ve been negotiating on some of these for well in excess of a year, but it really comes down to trying to get our price. Of course, in order to get our price, we have to know more than the seller does, because the seller thinks that his land is the best land out there and it’s all ready to go. That you don’t have to address water and sewer issues, you don’t have to address drainage, you don’t have to address flood planes or geotechnical issues, when in fact in every case you have to address them and all of that stuff costs money to mitigate.

The land residual which you pay for the land is probably the most important thing today, and probably staying away I guess from problem sites. I think in the past I told you about a site that another builder bought up here just behind our site, and he ran into extensive costs, probably twice what he estimated it was going to cost him to finish the land. He paid too much for the land because he just wanted to get into Northern Nevada, so he paid a little over twice what we paid for our land, and then it cost him at least twice on what it cost us to finish off the lot. He was in his project basically upside down on close to 300 lots.

Recovering from a Real Estate Mistake

Kathy: Now, is he going to be able to make that up in sales?

Fred: Well, what they’re doing is they built a bunch of homes they weren’t selling, so they’ve discounted them now up to about $135,000. Basically, they’re doing the project now, building out just to get their money back out of the project. They’re not going to make any profit on it.

Kathy: One of the things that you said to me early on is you’re not in this business for practice, right?

Fred: Well, that’s correct. You know, Kathy, we stay small because that’s what we want to do. We can only do so many projects, so every project we do has to be a potential for a home run.

Kathy: Yes, otherwise why bother? I get a lot of people sending me proposals to help raise money for their construction projects, because what we do know is that nationwide there is a shortage of homes, definitely in the Reno area. There’s a massive shortage of homes because of all the job growth, but it’s really a problem across the country, so because we’ve raised so much capital for land development, we have lots of projects come our way. I always send them over to you to take a quick look and you get back to me within minutes as to why it’s not going to work, so what are some of the common themes you’re seeing? Is it too high leverage or not enough profit? Why do you immediately turn these down?

Fred: Well, most of the projects on the face are good projects, and they would be a project that you would want to do, or anybody else would want to do. Most of the times, they’ve done their due diligence and they have satisfied the NAPI requirements, the soils and geotechnical issues, the market, and whatnot. It just comes down that they’re very thin margins, so that if anything goes wrong in the marketplace, there’s no room for them to discount and sell, and still make a profit.

Most of them are leveraged and that’s how they’re making their profit is they’re doing a leveraged development. Of course, during the down market when things turned down the last time, it was the leveraged developers that were going under, giving back the projects to the bank and of course, that meant everything behind the banks lost their money. All the capital, in those cases, were lost. You know my philosophy today as we do unleveraged projects, so we have to have a big margin to give a good return on that much capital, and still make a nice profit. Yes, it’s not easy to find, but they’re still out there.

How  to Deal with Real Estate Market Fluctuation

Kathy: Yes, I brought you one in Salt Lake City. The location was fantastic, but that’s exactly your response, is most people would be okay with a 10% margin, but what if things slow down and you have to discount? I mean, it’s not unheard of that you would have to discount and I know a lot of builders did discount over the last six months because sales slowed. You’ve seen that. You’ve been selling houses for decades, and sometimes in up markets, and sometimes in down markets. Just over the last six months we’ve been selling homes in Reno and there was a slowdown, but how have you been dealing with that and are things picking up?

Fred: Well, things are picking up now, but when things start to pick up then it takes you a while to get the curve going again. What happened during that down market, we went ahead and we locked in interest rates at a little over 4%, so that was one of the reasons why in the downturn, definitely I think people got a little shaken by some of the things that were going on market-wise. It looks like that stability is back. It looks like the Feds are not going to be increasing interest rates.

Mortgage rates have come down, there are mortgage rates below 4% now, at 4% or 4.25%, and just about anybody and everybody can get a mortgage for that, so it’s brought the buyers out in numbers and things are turning for us here. We kept it going with, like I said, locking in the interest rates. Just interest rates for example, if interest rates go up, typically that means your prices are going to have to come down a little bit, or you’re going to have to lock in some rates like we did, if you can. All of that goes against the pro forma, so if you’ve got a thin pro forma, you can see where that would be problematic.

Locking in Low Interest Rates for Loans

Kathy: You know in our first project we did with you in Portland, you were able to get a lender to finance at a time when no banks were financing, it was very difficult to get loans, but you managed to do that. When you say you locked in a loan, are you saying that you’ve worked with a local bank to make sure buyers can get a preset rate?

Fred: That’s what we did on this project up here for our buyers. Our preferred lender on our projects up here right now is US Bank, so anybody that comes to buy a house from us has to pre-qualify with US Bank. That’s the thing that we’re doing right now on these new buyers that come in. They have to pre-qualify with US Bank then only after they’re qualified will we take an offer and a contract from them.

US bank is who we lock that rate in so that we would have money set aside at 4.25% for our buyers. Now, of course, we’re getting to lock in interest rates at 4% for our buyers. It looks like we might not have to, because in talking to US Bank, it may come down again. Whenever they get down at what we think is a good rate, we’ll lock that in if we think there’s any chance it will go up.

Kathy: That’s fantastic. You and I had been looking at an apartment deal in the Reno area. Actually, up near the TRIC Center. It was an Opportunity Zone. It was very exciting. We had a lot of our members at RealWealth interested in that. At the last minute, you decided to back out of it. Why is that?

Fred: We were having numerous conversations at the time Kathy, you and myself. What it really came down to is we were getting ready to ask our investors to put up money into a project that we did not have all of the financial answers to. We had our pro forma done but we didn’t know all of the tax treatment that would be available. We were making some representations that I just didn’t feel comfortable in making.

With the Opportunity Zones, the way I was looking at it, there are certain reporting hurdles that had to be made. We were trying to bring it online for a January project, and we would have to meet I think six-month and nine-month reporting hurdles. If we waited for these answers, would we be able to start it then, and have the proper type of reporting? One of the things that we had to do was to get in the ground I think within nine months.

For us to get in the ground within nine months, we had to get our plan approved and get permitted, and start grading, to be able to meet that hurdle. As time was going by, I just didn’t think we could make the hurdle, and I just didn’t want to take it out to the people without having all of the answers.

Kathy: Well, the Opportunity Zone regulations just came out. Would you think you would reconsider now?

Fred: We might, but as you know, if you lose a year on that, you lose a year of benefit. With every year you lose, it’s less and less desirable. I would have to go back and see what the timing is and see if it would make sense. It’s something that you and I can talk about certainly.

Highlights on the Reno Real Estate Market

Kathy: I think some of those rules were changed, so very exciting. All right. You have actually moved to the Reno area having lived in Carmel Valley for many years. What are you seeing in the Reno area? Is it continuing to grow? Are the jobs still coming? Are you still as confident in the area as you were when you first started there?

Fred: I am. Reno is kind of interesting. I mean, you have four seasons here. They are a mild four seasons. The winter’s not overly aggressive. Certainly, you can go just up the hill and be in the Tahoe area and have snow skiing and everything. Down here in the valley, the snow is not bad. Reno-Sparks area is ranked number 1 for growth and number 11 as the best overall city, and that was in the Milken Report just not too long ago. It was January of 2019.

Nevada ranks third most popular state for movers. People moving into the state, in Reno, seeing a lot of youth influx and that’s nice to be around that. Of course, with the University of Nevada-Reno here, it’s nice to be around that. Of course, it’s the home to the Tesla Gigafactory, Apple, Switch and on and on. Google announced in 2017 that they were going to be coming in. There’s a lot going on here. Nevada is the top state in the Forbes American Dream Index. It just goes on and on. People moving here that we see buying our homes.

Primarily as you know, our stuff in Verdi is the closest development to California. A lot of our buyers are coming in. They’re California people. They still have one foot in California, whether it be grandchildren, or children of their own, or a second house, or whatever, but they’re coming here for tax reasons. The cost of living here is less, from everything from your electric bill, to your income tax, to your property taxes. Just about everything is favorable. If you’re a new business coming in, they have tax incentives for new businesses. They have great property tax exemptions for inventories and things like that for new business. It’s growing.

This is already a major Metropolitan area already between Reno-Sparks. There’s a half million people here, and growing at a rate of 10,000 people a year. That’s 100,000 people in the next 10 years. It’s growing probably faster. I wouldn’t want to say it’s growing faster than some of these major cities, but on a per capita basis, it’s probably one of the fastest-growing places in the country.

Kathy: It’s a difficult place to build because there’s winters and then there’s mountainous terrain. I don’t know how they plan to accommodate all those people.

Fred: Well, that is the problem right now. We feel this is a great market to be in. We’re trying to address affordability. We’re trying to find some projects that we could build more entry-level type housing because that’s where the big deep market is. It’s just very, very difficult. We’ve looked internally to Carson City, Dayton. We’ve got stuff on the books that we’re working on, so you’ll be seeing stuff.

Kathy: There’s a new freeway towards Carson City, is that right?

Fred: Yes. Highway 439 runs in Nicola in Great American Highway. Anyway, it runs south right out of TRIC down the Highway 50 and Highway 50 direct into the Carson City. They’re opening up basically another route to get into TRIC. That opens up that whole south section which would include Dayton, Carson City, and whatnot. In going down that way, we could come up with a great product that you could buy in that $350,000, $450,000 price range, maybe even lower. We’re looking down there obviously very hard.

Kathy: Fantastic. All right. Well, if anybody is interested in learning about Fred’s projects, you do actually need to be a member of RealWealth, that is an SEC rule. We need to get to know you. Have a pre-existing relationship before you can learn about any of Fred’s future deals. You could do that by going to realwealthnetwork.com, joining, it’s free. You’ll be asked to fill out an investor questionnaire, and that will unlock that part of the website that will show you upcoming projects. All right. Fred, thank you so much for joining me here in the Real Wealth Show. It’s always a pleasure to have you here.

Fred: Thanks, Kathy. You have a good day.

Kathy: Thank you for joining me here on the Real Wealth Show. 

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