Firefighters responded to the construction site on River Crest Drive shortly after 3:30 a.m.
"It looked like a volcano," said next-door neighbor Brenda Severson. "It was flying out in our backyard, it was a mess."
The home, which was supposed to be listed for more than $1.2 million, is considered to be a total loss.
Neighbors say construction began in July, and has been a nightmare since. They say they often saw people they didn't recognize seek shelter at the site. Behind the home, there was no fence separating it from the river embankment.
Investigators say the fire started somewhere on the second floor, but it was unknown if it was set by squatters.
"It's common that there are homeless people along the river, yes," said West Sacramento Fire Battalion Chief Mark Cullison. "As for whether or not they were involved in this, I don't know."