To Buy or Not to Buy from a Troubled New Home Builder?

As we see numerous homebuilders and communities descend into financial insolvency within the Phoenix real estate market, I thought it might be good to expand on what homeowners may face when their neighborhood is impacted by a builder going out of business.  This is a discussion based on the earlier Homebuilders in Trouble post.

But first, some explanations.

Chapter 7 & Chapter 11 Bankruptcy

Chapter 11 bankruptcy is used when a builder or company cannot meet its financial obligations but is trying to reorganize and hopefully reemerge out of bankruptcy.  The bankruptcy gives certain protections and allows the home builder to potentially renegotiate debt instruments and other obligations it may have.  But, the builder also needs to show that it can be viable coming out of bankruptcy.  Given the current climate, a home builder will have to come out of Chapter 11 with its assets intact, its liabilities minimized and its cash flow maximized.

Chapter 7 bankruptcy entails the complete liquidation of the company.  The builder is not no longer viable in this case.  Assets will be disposed of to meet any obligations the company might have had.

Mechanics Liens

The presence of mechanics liens may indicate that the builder is not paying its subcontractors for work being performed.  The mechanics lien gives contractors a financial remedy against a builder without having to pursue payment through more costly legal devices.  So, if a builder has these piling up against it, it’s a good sign that something is financially wrong with the builder.

What Can Happen When the Builder Goes Out of Business

• Loss of Property Value - The worst issue for a community is when the builder becomes insolvent when the project is unfinished.  For existing homeowners, a community could only be partially completed.  For some communities, the builder may still be in business but only halt construction until a better economic climate.  For others, the builder is completely gone and the community’s future is completely in question.

In this case, it’s hard to calculate the impact to property values for existing homes in an unfinished community but one can bet it’s high.  Buyers don’t want to buy into an unfinished community.  There is no plan to finish the community at that point and any future development could put homes in that are inconsistent with the rest of the community.  Overall, this is one of the worst things that can happen with homeowners in a neighborhood.

• Higher HOA-related fees and assessments - From a Homeowner’s Association perspective, the demise of the builder’s project can spell additional complications and costs for the individual homeowner.  For example, AZCentral.com reported in “HOA seeks more fees from residents” on the circumstances of San Tan Heights as builders left the community there only half-finished.  Between the developer shorting the HOA and a high number of existing homeowners not paying their HOA dues, the HOA felt compelled to call for a $750 assessment on current residents in addition to their monthly HOA fees.

• Loss of builder warranties - Even if the builder goes into Chapter 11 protection and reemerges, you likely can expect that the builder warranty is gone for the home.  On a positive note, the actual contractors involved in the specific projects of the construction of the home may be liable for warranty work.  Unfortunately, getting the names of the contractors who did the work may be difficult to find and there is a strong likelihood that some of them are themselves out of business.  So, a home buyer should assume that their builder warranty may not be valid in the future despite assurances to the contrary from the home builder.

Tips & Suggestions When Buying a Brand New Home In This Market

If you are currently looking to buy in a new build community where the builder’s overall financial health may be in question:

First, consider whether it is a good idea for you to go ahead with the purchase in the first place.  Ask questions of the home builder such as:

• Do you have company financial information that I can review?
• How is the Homeowner’s Association currently funded?  What happens to the HOA if the community is not finished?
• How many homes are currently under contract for purchase?
• Have any other home buyers recently cancelled their contracts and if so, what were the reasons?
• Does the company have any mechanics liens filed against this community or any others?
• Is the company in default or similar hardship with any other project it manages?

Second, do your own research as well.

• Google the home builder on the internet to look for obvious and obscure references to experiences with the home builder.
• Contact the Arizona Registrar of Contractors locally to inquire about the builder and specific projects.
• Contact the Arizona Department of Real Estate for any complaints or other filings against the builder or its sales representatives.
• Take time to talk to residents (at least 3 residents) within the community and ask them about what they have heard about the developer or builder.  Ask them if they have received any notices either from the builder or from the HOA organization for the community.

Third, if you do decide to go ahead with the purchase, then insist on the following:

• Instruct the builder that you want to place any earnest deposit money with an independent title company for safekeeping.  I don’t recommend a builder-affiliated title company for this purpose.
• Negotiate the earnest deposit.  Get it as low as you can.  This will be helpful should you later opt out of the purchase so you have less money to lose.  By the way, unlike real estate resale contracts, a home builder contract will leave very little chance of getting any earnest deposit back from the builder if you decide to pull out.  However, if it is a matter of insolvency, having your money with a separate title company can help here.

Now, many builders may not be agreeable to these terms.  However, in the current sales climate, many will be flexible here.  If a builder is not reasonable with these terms, especially the use of an independent title company, then you may want to again evaluate the risks of the transaction.

Finally, during the escrow process, keep tabs on the builder.  Again, do your research to find out if any circumstances have changed with the financial state of the developer.  If you find that the builder’s future is now in question, you may want to seriously balance the risk of continuing with the purchase versus the possible loss of earnest deposit.

Now, these recommendations focus on buying a new build home.  However, if a home buyer is looking at a resale home in a community that is beset by some of the issues mentioned above, the home buyer should think long and hard about whether the home is worth the potential headaches involved.

I’ve touched on some of the issues homeowners in affected communities face when the developer or builder halts construction or altogether disappears.  If you find yourself in this situation and are looking to sell, feel free to Contact Us with questions and we will do our best to help in any way we can.

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Tagged as: arizona registrar of contractors, buying a new build, homebuilders, phoenix real estate