The first thing that catches the eye in ads for houses in the Middle Plantation development near Williamsburg, Va., is the mortgage interest rate -- 9 7/8 percent.
Given the current state of the mortgage market, some builders have gone bankrupt or fishing. Others are trying to sell houses through inducements such as paid closing costs, monthly subsidies of $100 for a year and a half, or interest rates lowered to 11 1/2 percent for the first two years.
But Middle Plantation developer Hab Baker III says he is selling houses. Middle Plantation is a planned community of luxury houses in a wooded area three miles from Williamsburg. The houses, built in a variety of styles on half-acre lots, range in price from $80,000 to $160,000. They have amenities such as hot tubs and solar heating, but it's the low interest rate that may be the real selling point.
A 9 7/8 percent rate -- with a 25 percent down payment -- on a conventional 30-year loan is almost unbelievable these days. Almost equally unbelievable is that the rate stood at 7 3/4 until just a month or so ago.
How does Baker do it? Why does he do it? Why don't others do it?
The method in Baker's seeming madness is called vertical integration. By wearing all the hats of those involved in the housing construction and sale process -- developer, builder, sales agent and financing processor -- he has been able to cut out the middlemen -- and the middlemen's profits.
Rather than subtract the saving from the sale price of the house, he has used the extra funds to "buy down" the mortgage. In other words, Middle Plantation Inc. will make up the difference between the regular rate charged by the bank or savings and loan and that charged the buyer.
Baker contends lowering the finance charges is preferable to lowering the cost of the house because the original price affects the resale value. If all the 1,800 houses planned for the 1,417-acre Middle Plantation site originally sold under their market value, an appraiser would keep the resale price of one home down in line with those around it.
Baker explained the way his method works by demonstrating how generally makes what profit from a typical $100,000 house.The potential maximum profit built into that house by the developer, builder, sales agents and financing processor amount to $33,900. Baker's profit amounts to $10,900. aThe estimates were based on industry averages supplied by the National Association of Home Builders and the Urban Land Institute.
A developer who improves raw land expects a 20 percent profit on a developed lot. If the lot of the hypothetical $100,000 house were valued at $20,000, the developer's profit would represent $4,000 of the sale prices.
The builder counts on an average of 10 percent profit, or $10,000. In addition to building materials, the builder also has overhead costs that come to another $7,500.
If the house is sold by a real estate agent, a commission of approximately 6 percent would be added to the cost. If the house is sold by the developer, the additional cost comes to about 5 percent.
Until recently, if the house were sold with FHA insurance, 8 points or $6,400 (based on a 20 percent down payment) also would be included. Baker, who makes only conventional loans, contends tht if the builder has no points or real estate commission to pay, he will pocket the difference as profit rather than lower the house price.
Baker takes all his profit as the developer. On a $100,000 house, Baker takes a $7,400 profit. Overhead costs, have been reduced to $1,500 and what Baker calls "uncertainty costs" are eliminated.
Baker spends $2,000 on marketing expenses to sell the house, and no points are paid. Middle Plantation uses nonunion labor and hires its own plumber and electrician rather than subcontracting the jobs. Total profit and overhead come to $10,900, or $23,000 less than the traditional operation.
This $23,000 is applied to buying down the mortgage rate from 15 1/2 to 9 7/8 percent. Baker claims to have worked another bit of magic by persuading lenders to take lower rates in exchange for a quicker turnover of funds in seven years rather than the 12 years that the Federal Home Loan Mortgage Corp. and the Federal National Mortgage Association use to calculate secondary market yields.
Baker, 34, is an Air Force veteran, with a masters in business administration from the University of California at Los Angeles, who got into real estate speculation in 1976. More successful at pyramiding than politicking -- he was defeated in a run for a Congressional seat from Virginia -- Baker formed his own development corporation in late 1977 with three partners.
After negotiating for a year to buy the bankrupt Middle Plantation at a low price, they sold $2.8 million worth of lots in 75 days. Then he searched until he found a mortgage banker, Community Mortgage Corp. of Miami, interested in his buy-down, quick turnover scheme.
Baker and partners have sold eight of the 11 houses they have built. Total debt on the project is $1.5 million, on which they pay 8 percent interest. Baker is currently winding up negotiations on an agreement with American Realty Trust of Arlington to finance construction of the golf course promised by his predecessor at Middle Plantation.
Because the Middle Plantation name has historical significance, Baker chose not to change it when he bought out the bankrupt previous owner. Yet he found the name carries with it a certain stigma: his competitors suggest Baker is using the buy-down technique because he is in financial trouble himself.
"Not true," Baker responds. He is convinced his method can be used successfully at other times and places, not just in days of distress sales. He is currently considering another scheme whereby a lender who would offer pass-through securities based on his mortgages.
If none of Baker's ideas is revolutionary or even original -- he says he merely put it all together -- why aren't his methods used more widely? An official of the National Association of Home Builders, who asked for anonymity because Baker is not a member, said a few builders have tried them in large markets, and cited one company in Texas that he said had introduced the buy-down technique very successfully. But, he added, no large builder has adopted totally the vertical integration concept.
But vertical integration is not the traditional system in which there are tremendous capital investments and risks involved. Neither is foregoing profits traditional during good years, because the profits help to shield against the boom-and-bust cycle of the housing industry.