The economics of spec |

The economics of spec

John Colson

A tour of Aspen neighborhoods is an exercise in wonder for all but the wealthiest of people. Some might wonder about the people who buy these seven-figure mansions – and then keep them empty for much of the year. Who are these people? How did they make their money? Others wonder about the people who build these mansions – particularly the spec homes, houses built for millions of dollars on the speculation that someone else will come along and buy them. Who are the builders? How did they get into this risky business? And, by the way, how risky is it? And, how profitable? Some of the builders, it turns out, just wandered into the field by accident. For others, it was a calculated move into what experts say has been one of the hottest real estate markets in the world for a number of years. Yes, it is risky. And, yes, it can be very profitable.

Some in the industry talk about the rule of thirds, under which a builder buys a lot, builds a home for roughly the same amount as the lot price, and then adds in that same amount again to get the final selling price. In other words, one-third for the lot, one-third for the house and one-third for profit. A nice equation when you are talking about a 2 million lot, 2 million in construction costs and 2 million in profit. But, according to two builders active in the valley today, that rule does not really hold here. Profit margins are well below 33 percent, they say, but once you figure out the market, there is money to be made. Benson Design and Building Inc. Jim Benson says that, if a builder cannot make at least a 20-percent profit on a spec home, he might as well go out and shoot himself, or at least find another career. Benson came to the Roaring Fork Valley fresh out of college back in 1972, with degrees in business administration and design and summertime construction experience.

It was in 1975, after he had spent some time designing and making leather wear and had made a small pot of money by selling his designs to chain stores, that he decided to design and build his own home in Snowmass Village. He bought a lot at Sinclair Road and Summit Lane for 22,500, designed the house himself and, doing everything but the plumbing basically on his own, came up with a house he figured cost him 79,500, or roughly 23 per square foot, to build. And while he figured he would live in it for the rest of his life, he said, people started knocking on the door and wanting to buy it. So he sold it at what he said was a really good percentage and embarked on a new career as a spec-home builder Ñ although the price for the second lot he bought was three times that of the first, giving him his first lesson in resort economics.

I thought, well, this is easier than everything else I am doing, he remembered. He ultimately got his real estate brokers license and now co-lists with another broker, Terry Morse, so he makes money on the sale as well as the construction.

At first he built just one home during one construction season, then returned to his ski-instructor job every winter. Most people in the trades did the same thing, he said, so there were no carpenters, plumbers, electricians and such around in the winter, even if he had wanted to go into spec-home building year-round. But all that changed in the mid-1980s when the building boom kicked into high gear and the industry went full time.

Now, at any given moment, he says he has three to four homes going up, and each of them takes about a year to build. He only works in the upper valley, and he designs houses he thinks will sell quickly and easily. Asked whether he uses the rule of thirds that other spec builders have mentioned as their target, Benson said, No, I never use a formula like that. He said he just looks for the best deal he can get on a lot, designs the home himself and then works with various local architects to produce the actual drawings. I save a lot of money on the architecture, which is all profit, he noted, adding, You have to watch every dime. He is a tough shopper for materials and subcontractors, he said, always looking for the best quality balanced against the lowest possible price. And he is a green builder whenever he can be, always on the lookout for renewable materials and non-polluting technology. You end up making the land more valuable by the quality of architecture you put on it, he said, noting that he sets his prices for his homes based on the cost it has taken to build it, the expected carrying costs of the construction loan, landscape design and engineering, and any marketing he has to do, and by checking out the values of neighboring houses. He said he can spend as much as 200,000 on the landscaping for a house, and as much for the plumbing work and the fixtures. Generally, he said, spec homes cost from 400 per square foot to the mid-500 per square foot to build, and the final price to the buyer includes that amount as well as the other factors – landscaping, stonework, unusual excavation expenses due to steep slopes and others. You can not be outrageously more expensive than the lots around you, he said, noting that he typically builds five-bedroom houses that sell for around 5 million to 6 million, with a profit margin of about 20 percent. Asked whether the spec-home business is tougher than it was in the early days, he responded instantly, Oh, yeah, it is much more risky. He said costs for everything have skyrocketed, from land and materials to hiring people to do the work. And, he said, buyers are a lot more finicky, more demanding. You really have to know the market, he explained. They [customers] are very picky about the layout, the way it flows. If you blow the kitchen, or the master bedroom suite, you might as well just hang it up, because you will end up sitting on a property for too long, and your profits will be eaten up by the interest payments on your debt. If you screw up, you can lost a lot of money real fast, Benson said, noting that a 4 million loan translates into 30,000 per month in interest payments alone, so if you sit on a house for a year or more, your profit is out the window.

Recommended Stories For You

As for whether the business is being overrun by out-of-state companies moving in on the locals territory, Benson said he does not think it is a problem. There are a lot of builders from out of state, but they are some of the ones that they are still sitting on spec houses, he said, explaining that out-of-state builders often stick to the formulas that worked for them in other markets, such as Florida and California. I think some of these guys have had a rough time, not knowing the market, trying to do what works in their home state and finding out it does not work here, he continued. The key here, he said, is the view, as much as the home itself, and each bedroom has to have the killer view. Benson also likes to be sure the house fits into the surrounding landscape, along the lines of the works of the late architectural genius, Frank Lloyd Wright, whom Benson admired. He says he once considered becoming a student at Wrights school, Taliesen West in Scottsdale, but came to Aspen instead.

Go back to article