Oct102014

Is building spec homes for the ultra wealthy a sustainable business?

The market for homes over $10M is very thin, yet some entrepreneurs believe they can operate this as a viable business model. Will it last?

SuperadequacyA sustainable business is one that delivers value to customers in good times and in bad.

Failed business models litter the real estate landscape. Subprime lending is a model that succeeds only when times are good and house prices rise steadily. Real estate sales is a business that attracts flocks of new agents when times are good, and most go back to what they were doing before when times are bad.

Flipping works best when times are good, but rehabbers who deliver value can make a good living in most market conditions because they install improvements that buyers would rather finance than provide themselves with cash. The flipping model focused on low-end properties catering to financed buyers is a sustainable business model.

The most profitable — and most fickle — segment of the market for flipping is at the high end. Most people have watched Flipping Out, the show centered around flipping in the better neighborhoods of LA. It’s not clear whether Jeff Lewis makes more money from flipping or from entertaining, but he’s sustained that business for quite a while.

Others haven’t been so lucky.

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John McMonigle ran a real estate sales empire and also flipped properties to high-end clients. McMonigle is reputed to have sold more than $2.1 billion in real estate over a five-year period. At the peak of his career, he built a spec home worth $87 million, or so he hoped. Villa del Lago was finally sold in a fire-sale for $18.5 million. McMonigle didn’t survive financially from the failed flip.

Speculating at the high end can be brutal.

For Sale: An $85 Million Beverly Hills Spec House

By John Gittelsohn and Nadja Brandt September 25, 2014lovely

The eight-bedroom, 15-bath Beverly Hills mansion has $5,600 toilets, a wall of caramel onyx, and an 18-seat screening room with doors clad in Italian lizard skin. Perched on a hill, it has views that sweep from downtown Los Angeles to the Pacific. Asking price: $85 million.

The property was developed by Bruce Makowsky, who made his fortune selling handbags in department stores and on the QVC cable television channel. “There was a void of homes for superwealthy people, and that’s why I did it,” he says, sitting near a curved 54-foot glass wall that slides open to an infinity pool with iPad-controlled fountains. “I don’t think there’s anybody who’s served up $85 million-to-$100 million homes at this level for somebody to step into and buy.”

There aren’t enough properties for the superwealthy? This is a symptom of the growing inequality of wealth in the United States.

In building mansions on spec—without a buyer lined up—Makowsky is betting on growing demand from billionaires, technology magnates, and entertainers who collect luxury homes in cities where they alight from their yachts and private jets a few times a year.

The reason flipping low-end properties is a sustainable business model is largely because the buyer pool is very large. The worst case scenario for a low-end flip is that the flipper must lower the asking price to find a seller.

Flipping to the superwealthy is very different. First, there aren’t very many of them. What happens if the flipper creates a monstrosity that no wealthy person wants? Anyone remember 2 Angell in Irvine? It’s a failed flip from 2008 that still hasn’t sold.

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The sale of a 45,000-square-foot mansion for $102 million in March is the most expensive on record in Los Angeles. Makowsky’s house in the Trousdale Estates neighborhood of Beverly Hills has drawn interest from shoppers both international and domestic. Jay Z, the musician and entrepreneur, has been there twice, according to two people with knowledge of the tours who asked not to be named because the matter is private. There have already been two offers for the house, says Branden Williams, a real estate agent with Hilton & Hyland, who shares the listing. “There’s a very good chance we could get asking or above.”

What is your opinion of the veracity of that statement?

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…“Clearly, the buyer that I’m trying to attract is a very narrow group of people,” Makowsky says … “It’s the superwealthy people that might own a big megayacht for $250 million, or they own a big Gulfstream plane for $100 million.”

turnkeyYes, this is a very, very small group of people.

I would be thrilled if I could afford the property tax.

In addition to U.S. tech, energy, and entertainment money, Los Angeles has lured investors from China, Indonesia, Russia, Latin America, and the Middle East who use U.S. real estate as a haven from political and economic uncertainty back home, says Alessandro Cajrati Crivelli, the builder of a spec home listed for $45 million in the Holmby Hills area of Los Angeles.

If you buy a house for $50 million, $60 million, and it falls to $40 million, it’s still better than having your money under a dictator who decides that money doesn’t belong to you anymore,” says Cajrati Crivelli. “It’s the return of capital rather than the return on capital.”

There’s a strange logic in that thinking.newer(1)

Makowsky … put money into six residential investment properties in Los Angeles and Beverly Hills. He paid $5.3 million in January 2013 for a house above the Sunset Strip that he renovated and sold for $19 million in April.

He’s updating a Bel Air property, formerly owned by Michael Strahan, the retired New York Giants football player, bought last July for $11 million. And he has three construction projects in the pipeline, each larger and more opulent than the Trousdale home, all being built on spec.

The market is getting crowded. On a lot adjacent to the Trousdale estate, another developer is building a spec mansion, according to Williams, the real estate agent, and several newly built or renovated homes line Hillcrest Road.

The Trousdale neighborhood has 46 construction sites, according to a City of Beverly Hills report. “Yes, there is competition, but nobody will invest this kind of money and build this kind of a house,” says Makowsky, who says he has 150 architects, designers, and other people working on his projects.

This is crazy.great_bones

I worked for a man who sold his beach house in Laguna Beach for $32.5 million. Needless to say, the property was beautiful. The first thing the new owner did was gut the place and completely redo it to his tastes. He bought the property for its location and its “bones.” This is common with high-end properties.

Perhaps for those too busy to go through the design and construction process, buying an off-the-shelf spec home has appeal, but for most buyers in those price ranges, the money a flipper spends on presentation is marketing fluff.

caddyshack_turd_ihbPerhaps this guy will do well. The very wealthy have prospered in the era of asset inflation through cheap debt. He only needs to find a few very rich buyers to make a good living.

When the tide goes out, we’ll see if he’s swimming naked.

[listing mls=”OC14209519″]