When a developer leases back a model home the lease rate is usually sufficient to cover the entire mortgage payment at 100%. In a good market a model home purchase/leaseback can be the ultimate flip. The property completely services its own debt, it is maintained professionally, and it is maxed out with all the upgrades and options imaginable, including the professional landscaping and yard improvements.
However, if the market goes soft between the time of purchase and the time the lease expires, such an arrangement can be a problem.
One example is what happened over at Bressi Ranch. An investment group bought 18 model homes from Lennar in early 2005, apparently at their retail pricing, which included all the options, upgrades and furniture. Lennar leased them all back while they finished building out their projects. When the leases were finished the LLC got the homes back.
Unfortunately for them by the tme they got the houses back the market had already gone from booming to squishy, and pricing had stabilized out. So they were sitting on 18 top-of-the-line homes, each of which had been priced $150,000 – $200,000 or more above the intial base pricing, but was now only about equal to the base pricing or perhaps only slightly higher.
This LLC was apparently successful in selling off a couple units right off the bat. Who knows, maybe a couple of partners decided to buy them. The other 16 were listed in the MLS for a while, with no success. As time wen’t on they started discounting the pricing but to no avail.
Finally the LLC ran an auction about 9 months ago. There was an article in the Union-Trib on it and a couple of our posters attended. To make a long story short, that auction failed miserably – lots of lookers and no serious buyers.
Since then the LLC has been selling one or two of these units off every month, at reduced prices that are generating outright losses of $50k and up, not counting brokerage fees or the mortgage payments they’ve had to pay while these homes langish on the market.
The last time I looked, there were still a couple of these listed in the MLS, and if the sell within their listing ranges they’ll generate $100,000 – $150,000 in overall losses by the time its all over.
Of the 7 residential “projects” at Bressi, 6 of them were built by Lennar. The 7th one was sold off by Lennar to Barratt, who bought the finished subdivision lots in 2005, apparently for about $500,000/lot. Barratt has been building 4,500 – 6,200 SqFt tract homes on these lots and selling them starting at $1,800,000 and up. I personally saw the appraisals on 3 of those sales, including one of the model homes. In the year that they’ve been selling those homes, it looks like Barratt has been able to sell off 9 of the units, including most or maybe all of the models. They still have another 15 to go, about 5 of which appear to be completed and just standing there.
Inasmuch as Barratt paid so much money for those lots they can’t really go smaller on their homes, They probably have a little room to drop pricing, but if they do so at this point the project will probably turn out to be a loser for them because of the length of time they’ve spent on it and the amount of carrying costs. By the time the model home leases are over I imagine those homes will be worth a lot less than their purchase prices.
The moral of the story is that a model home purchase with leaseback can turn out to be a bad move if the market isn’t booming and you don’t plan to live there when its over.
