Big Mistake #19: Failing to Understand the Additional Risks in Buying a New Home from a Builder
The typical form contracts used by real estate brokerage firms in the resale of a previously owned home are heavily slanted in favor of the seller. The typical form contracts used by builders are even more favorable to the seller builder and, therefore, even worse for a purchaser. Among the more common “Big Mistakes” to watch out for in builder contracts are the following:
Deposits. Any deposits or other advance payments which you are required to make under the contract should be placed in a separate escrow account that is not under the builder’s control. It is not just small builders who have financial problems before they complete homes and pay all of the mechanics and materialmen. Some of the biggest homebuilders in the country have gone under leaving homes unfinished and liens unsatisfied. If the builder has had access to your money you may rest assured that it will be you who is left empty handed, with neither the house built nor the subcontractors paid nor your money returned.
Delivery Date. Builder contracts never require the builder to deliver the house when promised. Nor do they permit recovery of any damages for the builder’s failure to deliver on time. If your move-in date is critically important to you, either write into the contract monetary or other penalties for failure to deliver on time (to pay you for having to make two moves or for making other arrangements to accommodate the late delivery of the new home) or purchase a previously owned home.
Specifications and Substitutions. Most builders have preprinted contract addendum forms which provide some measure of detail concerning things like the orientation of the home on the lot, the floor plan of the home (that is, the layout of the various rooms and spaces within the home) and the type of materials, equipment and other building specifications that apply to the home which the purchaser is buying (which home, of course, may not even be under construction yet). Obviously, it is important for a purchaser to be able to evaluate all of these specifications, both in general and in particular, in order to determine whether or not the purchaser is getting real “value” in the home she is purchasing. Although I have seen very few purchasers do so, I would always recommend that any purchaser buying a new home consult with a professional home inspector with respect to the specifications contained in the original contract between the buyer and the builder.
As noted in the discussion of Integration clauses (see Big Mistake #18), the careful purchaser will make sure that the contract incorporates by reference any advertising or marketing materials (such as newspaper ads, pamphlets, brochures, etc.) which contain specifications or representations concerning the house or the subdivision that are not included in the sales contract.
Assuming that the purchaser has made sure that the initial contract adequately specifies the materials, equipment, etc., that are to be included in the home, the purchaser also needs to make sure that another commonly used provision in builder contracts will not take away what those specifications have given. Builder contracts invariably allow the builder to substitute, for a wide variety of reasons, other material and equipment for the material and equipment originally specified in the contract. There are lots of reasons why builders want such provisions in their contracts. For example, as time goes by, certain equipment or materials may no longer be available or may become significantly more expensive to purchase. For whatever reason, the builder may wish to make substitutions which may not be entirely consistent with the purchaser’s tastes or preferences.
To protect against such eventualities, the purchaser should provide that the seller must disclose to the purchaser, in writing, any substitutions made in place of the specifications originally agreed upon, that any substitutions must be made with equivalent or better materials, equipment and workmanship and, finally, that the purchaser shall have the option of canceling the contract if the substitutions are not acceptable to the purchaser.
Even if the purchaser does not wish to cancel the contract as the result of an unacceptable substitution by the builder, such a provision gives the purchaser considerable leverage in negotiating some kind of mutually acceptable compromise (such as a reduction in price or adding some other betterment to make up for the substitution).
Proper Completion. Most builder contracts provide that the builder’s architect (or some other person under the builder’s control) will be the “arbitrator” if there is any dispute as to whether or not the house has been properly completed. Do not agree to that. How can such a person be an unbiased and impartial arbitrator in such disputes with the builder?
Most builder contracts also require the purchaser to settle and pay the contract price in full, with no deductions and no escrows, once the seller gets a certificate of occupancy or residential use permit for the home. COs and RUPs are routinely obtained by builders even though a house is far from what the typical purchaser would call “complete.” The prudent purchaser should insert more reasonable provisions into the contract for determining whether or not the home has been properly completed and for escrowing appropriate amounts of money (or getting other adequate protection) until the home has been properly completed. Remember, once the settlement on your new home has been completed, you have lost a significant amount of leverage against the builder to compel him to complete the home properly. Once you have signed the papers and the builder has been paid in full, you may find it difficult to get a return phone call responding to your complaints of incomplete or improperly completed items.
Reservations of Rights. Some builder contracts actually authorize the builder to create additional easements or rights of way across a purchaser’s lot even after settlement. Such a contract provision would allow the builder to decide, after the purchaser has gone to settlement on his new home, that the bike path for the subdivision should run through the middle of the purchaser’s front yard! A prudent purchaser would never allow a seller to retain such rights after the execution of a purchase agreement. In any circumstance in which a builder can demonstrate a good reason for reserving any such rights, you should make certain to strictly limit the exercise of those rights in such a way as not to adversely affect the property you are buying.
The sales representatives for most knowledgeable and reputable builders realize how one sided their contract forms are and they are usually willing to make reasonable modifications when an informed buyer objects to contract provisions which are obviously unfair and inequitable. For the uninformed purchaser, however, the builder’s printed form contract that is presented to them is the one that they sign and they never find out just how bad their legal position is until it is too late.
Accepting the Builder’s Settlement Agent. Builder Sellers frequently try to persuade purchasers to accept a settlement agent designated by the seller. Sometimes the seller will even offer to pay some or all of the purchaser’s settlement costs if the purchaser will agree to settle with the seller’s designated settlement agent. There is nothing wrong with accepting this offer so long as the purchaser makes sure to retain his own experienced real estate attorney to protect his interests at the settlement.
Where the seller designates the settlement agent, it is important for the purchaser to remember two things: First, no settlement agent designated by the seller is going to do anything contrary to the seller’s best interests. Second, most builder contracts define very narrowly the actual “settlement costs” which the builder will pay for the purchaser. Consequently, the dollar amount which the purchaser will save by going to settlement with the seller’s settlement agent is usually far less than the purchaser expects.