Bruce Norris is joined this week by Alex Serrato. Alex is a local builder in Riverside who he has partnered with on many deals. One of the reasons Bruce wanted him to come in is they have had a good experience working with each other, and his niche is one that might be an advantage to other investors. It is hard for them to find deals right now, but working from scratch might be another niche they can employ.
Episode Highlights
- How long has Alex been a builder in Riverside, and what did he do prior?
- What is the inventory like today compared to 2005?
- What is the square footage and price range with which he prefers to work?
- How long does it take to build after obtaining a permit?
- How does price volatility work as far as costs go?
- How does he monitor what other cities do in terms of fees?
- What liability do you have if you hire a sub and something goes wrong?
Bruce asked Alex how long he has been a builder. He said it was on and off for about 12 years, which takes us back to the middle to end of the boom, around 2004. Prior to that, he was flipping homes, doing rehabs of existing homes. He would buy auction properties, fix them, and sell them. He worked with HUD auctions as well as trustee sales. Bruce wondered also if he ever expanded existing structures since he had a contractor background. Alex said he had, including room additions. In this case, they would take a small 600-800 square foot home and add less than 500 square foot.
Bruce wondered why he made the transition back in 2004-2005 to building and whether it was because it was harder to find existing inventory. Alex said yes and that the market dictates what is best. In Quadrant 4, you don’t go to auctions anymore nor have a lot of trustee sales. You have to start either talking to owners directly or start from scratch. The auction properties go from 100 properties to ten properties, and then there is 100 buyers. You have more interest with a lot less properties, and the margin disappears. You start looking around to make a decision, whether you like to build or go in that direction. He has a passion for building; so he started this and has enjoyed it ever since.
This happened back in 2004 when everything was completely gangbusters. The hard part would have been to get dirt. However, Alex said he had an in with a family that owned a lot of land in Riverside. They sold one parcel to him, and from there they would reach out and offer him more. They gave him about 6 parcels of land during a time of 2-3 years. Bruce asked if these were lots he needed to divide himself or if they were individual lots. Alex said they were infill lots in the Downtown Riverside area. Some had a home in it that had been removed, so this is a whole different niche.
If you have an existing sewer you can reconnect or a water meter, then you could save some money. The city, or whatever entity you are working with, can give you a credit for square footage as well. There is a lot of savings involved. If you have a house burn down in a neighborhood, it is a lot cheaper to build on that existing lot.
When Alex got involved, it was crazy and good at the same time. Everything he did was successful, and he did not have any experience with a down market as a builder. He did not hit a 1990-1995 with all the wrong things. Unfortunately, when he got to 2007 and 2008 the music stopped. In 2008, they were trying to sell a new house in downtown Riverside and having a hard time getting people to qualify. They were able to find buyers, but the lenders kept getting nervous and pulling out at the last minute. Every time they would get a new lender, the market would adjust and they would go down and down on price. In Riverside, it was about 3% a month.
The key is to not get stuck with this, but the scary part about being a builder is that there is a lot of lead time required. You have to have a good view of what is next; and with land it is really hard, especially when it is a tract. Bruce asked him if he had ever done a project that required map work, which he said he had. This takes a long time and gets very expensive. This is something you won’t really know how to calculate since you won’t know how many engineers will be required by somebody who needs one thing or another. Satisfying one condition can lead to another condition with which you may not have been aware. All of this can get expensive.
Bruce asked if he approached something like this again, would he prefer to get stuck with a house that did not sell or a piece of dirt he could not use. Alex said a house since there are options once you have the house. You can rent it, discount it, or whatever you want. One time before working with Alex, Bruce needed some weeds removed and didn’t know you needed a permit. The person working on it caught fire to the land, and the whole area burnt. Because they had pulled the permit and he had a contractor’s license, they did not get fined or have to pay the bill. He called Bruce up and told him everything had been taken care of, he just used a different method.
Bruce asked if he sees a difference in the inventory of new homes today compared to 2005. Alex said he sees this a lot. He is seeing a lot of stick built homes and trailers, especially in the Perris area. People bring in mobile homes and do the permanent foundation. Bruce asked if 2005 was crazier than now with more competition. Alex said it is hard to gauge, but he is seeing a lot of infield lots being developed, both at the county and city levels. This puts pressure on trying to find the dirt, and prices are steadily going up on vacant land.
Bruce asked if he has a preferable square footage and price range. Alex said it depends on the neighborhood. In Downtown Riverside, he has scaled down from 1900 to 1500. These are smaller homes currently under construction, and he is trying to keep them in the FHA price range. In different neighborhoods where you are approaching the half million value, square footage is about 2800. Bruce asked Alex if it is his preference to push the limit on pricing in an area. He said no and that it is quite the opposite. He tries to be conservative since you will have more potential buyers at the conservative price range than you do when you try to max it out, and it is quite a gamble.
Bruce asked how appraising has been. When selling homes, Bruce said he has not had comps often other than for new homes. Occasionally it is with their own home, which just happened. However, you are normally being compared to used inventory. They will credit you for the new factors, including new construction. It is not much, but still a little.
Bruce asked how many models he had that he repetitively built, which he said it was three. Depending on the neighborhood, this is what he is comfortable with and builds this. Bruce asked if it has changed over time as far as what he decided to land on and make the adjustments. Alex said they have changed very little, and he makes the adjustments based on available material for price. You can buy a 2-3 inch base board that looks entry level. Alex found a six inch one, for which he paid just a few cents more. Once you find those materials that are priced comparable to entry level, it does not make much sense not to use them. You will get feedback from customers as they walk through and decide what to keep and not to keep.
Alex gets a lot of feedback on base boards and crown molding. Alex also likes to use the tile roof since it looks nice and gives it the superior look. Bruce asked how often he uses the same subs. Alex said it is often, although lately the industry is booming and they are busy. He is having to reach out when before he would count a particular sub. Now he needs to have 2-3 that do this same job. When one sub is busy, you reach out and call another. He is having to wait.
Bruce asked if it helps if they built the same house before, which Alex said it does. He asked him what the process he puts people through as far as saying they can bid his work. Alex said they have to look at the plans, do a takeoff list, and itemize every cost material and labor. A lot of times he will buy the material, and they provide the labor. Once you start doing that, you have to also understand the material. This includes what material you need, where to buy it, how to get the best price. You will then need to know when to provide it to the sub and bring it to the job site. You do not want your material sitting there for too long.
Alex has a list for what he uses on every house since it is primarily the same. He needs so many pieces of 2x4s or so much tile. Bruce said in some ways this would be easier for the subcontractor. He asked if there is a disappointment sometimes they do not get to mark the material up if they are not connected to it. Alex said there is if this causes them to not make the job, but they have to work it this way in order to make it profitable.
Bruce asked Alex how long it typically takes him to build after getting his permit. He said it could take 3-6 months depending on the project. During each process, you go through a building and safety inspection. Depending on if you pass or have corrections, all those can set you back. There were times an inspector said he did not understand the plans and needed clarification. Now you have to go back to the engineer or record and have him clarify whatever detail the inspector does not understand. Afterwards, you go back to the city to get it approved, and you just burned a month of time.
Just because you have done the exact same house and the exact same city, it is a whole new ball game when you have a different inspector. It was just like the situation where the inspector did not understand the details, so now they have to provide the information to where he understands it. Bruce asked him what can happen during the course of construction that can have a big impact on time. He actually answered himself by saying it is the wild cards. He had just had some in Norco that were a rollercoaster. Alex said the street improvements were not done until they were about 6 months into building. They had actually already built the house, they were just working on the street improvements. There were 3 or 4 times it was resubmitted and came back with corrections. At the end of the day, they accomplished the job.
They had to remove and replace a storm drain, do curve and gutter, and they had to install the gas, sewer lateral, and water. It took a while to get to the point where they were done with the house, so all the street improvements were in process for that time. It drives you crazy because prior to that, even several months prior to construction, they knew this would be in place. These are the things that just kill you since this was not a little bit of money, but rather a big chunk. He had already budgeted a certain amount, and it exceeded it because of some nonsense. When you have your permit in place and taking the right precautions, it is hard not to do it right because you go through so many inspections. You get the county out there to check on your temporary fencing or toilet and making sure you are not creating dust. You go through a lot of inspections, and it is hard to mess it up.
Bruce asked Alex about price volatility as far as costs. This is great when the price of the house goes up, but he wondered about cement and wood. As they go forward, prices are increasing along with the value of real estate. You cannot really contract that in, but you do have a margin for those unexpected scenarios. It could be $3,000-$13,000 for unexpected or miscellaneous. Doing the business teaches you to have a margin in those categories.
Bruce wanted to know from Alex if he had built during the other booms or bust cycles. Right now we are in Quadrant 4, which is still a booming time. What you always have to be careful of is once this ends and goes to the other side, you do not want to own dirt or spec houses at the top of the market.
Aaron asked how he monitored what cities are doing. Depending on how it is structured, you have county, unincorporated county, city, and all with different protocols for fees. Sometimes they raise them depending on if they need to raise money. School fees just increased by a few cents, and there is no prior notice. Yesterday you paid $350, today you are paying $375. They do not grandfather you in if you have already submitted.
Water meters are crazy expensive and can vary depending on the city. Aaron asked if you can go to a city to get a list and see what it will cost in terms of city fees. Alex said yes and that you can go to Land Use at the county. They will provide a general list, but there are other departments outside of the land use, such as school and water, who you have to know exist to go ask them those questions. This can vary a great deal depending on the city’s structure.
In the next segment, they will talk about land and the process of getting through all of it before you get to the permit. Bruce asked Alex about when someone buys a house from him and what type of warranties are provided. He said they generally buy a homeowner’s warranty that generally covers a year. They also buy a foundation structural insurance that covers the slab and framing for 7 years. There is also a 10-year warranty that covers windows and cracking of the walls.
Alex said he heard from a lawyer friend that the builder is given the opportunity to fix the problem before it goes to court. This is something that is new that will stop a lot of the lawsuit. Bruce said he just went through this with Rosamond, but he was never given this opportunity since there was nothing to fix. Aaron said it is cheap money since most builders settle, although Bruce said he paid $700,000 for an insurance policy. He had the property inspected by not only the city but an inspection company.
To keep that in mind, you want to buy quality material. Windows are very delicate, and Alex used to buy them from a certain store. Now he has upgraded to Milgard, which has a lifetime warranty. He paid a little extra, but he knew he would not have a problem in the future.
Bruce ended by asking about the subs. If he hires a sub, and something goes wrong with the A/C that is under warranty, then what liability do you have? Alex said if the sub does not perform, then the home warranty will kick in. Usually, they are supposed to call the home warranty; but sometimes they call Alex, who then calls the sub. Sometimes the sub takes care of it. If he does not, he then has to make the decision whether to hire somebody else to take care of the problem or another means. It is not so much a warranty from the builder, but rather an insurance policy being bought for a certain event. Alex said does buy the insurance policy, such as what you can get when you provide a home on a resale
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