Dropping prices, new construction and the inherent risk in a changing market

A client sent me a link to this story in the Washington Post that discusses something that is happening with more frequency. A buyer contracts on a new construction property, and by the time closing comes around, the value has dropped. What do you do?

From my perspective as a Buyer-Broker, looking out solely for my buyer-clients’ best interests, I wonder whether builders would consider:

1) Put a contingency in the offer that the offer is contingent on an appraisal two weeks prior to closing of at least the contract price.
2) A contingency that should the developer drop the price on other homes between contract and closing, the purchaser’s contract price will be reduced the same amount.
3) From the Washington Post story: “The buyer should ensure that the deposit is put into an interest-earning escrow account, perhaps with a settlement company, and is not being used by the developer as working capital, Antonoplos said. To do so, a buyer should ask for written verification when the funds are deposited. That will make it easier to recoup the money if the project hits a snag.”
4) Put down a smaller earnest money deposit.
5) Make sure that you have done your due diligence and that you love your soon-to-be new home.

One aspect of this new environment that I have been wrestling with is how to ensure the soundness of developers. How is a buyer to judge this? How does one effectively represent buyers in the face of an unknown – that unknown being the fiscal ability of the developer/builder?

Calculated Risk covered this story as well as Phil’s excellent analysis of a related story (h/t: Dustin)

From Inman (behind a subscriber wall) in response to a question of what to do should the price go down on other, competing homes between your contract and closing:

One common thread that runs through real estate law is that real estate values are unpredictable and that no one can guarantee escalation of prices. If property values go up, you cannot be ordered to give all or some of your gain back to the developer. Similarly, if values go down, why should the developer be required to pay you any money?

The builders’ and the buyers’ choices may be reduced to renegotiate or lose the deal – both sides lose if they don’t negotiate.

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  1. Rick Marnon, Howell December 18, 2007 at 23:39

    I like the idea of the appraisal just prior to the closing of the deal. Do you think that this is unjust to builders in that people may be putting too high end of products in their home and this may have put them upside down. I know that when I looked at building that this can become a real problem, because if you do higher end materials you may eat up your equity.

  2. Jim Duncan December 19, 2007 at 08:41

    Rick – thanks for the comment and I’m sorry your comment went to spam.

    It may be unjust, but so is the buyer not being able to get a loan because the house they contracted for is no longer worth what they contracted to pay.

    If you contract on a $400k house and then six months later, it’s worth $320k – what options are there other than walk away or renegotiate?

    The builder surely can’t sell it for $400k when the competing houses are now priced at $330k, and the buyer doesn’t have %80k to make up the difference, because she’s getting a 90% loan …

  3. Tony Arko December 19, 2007 at 09:29

    Good Luck trying to get a builder to change anything in their contracts. We have never had any luck protecting a buyer from a declining market price with builders here in Northern Virginia. Although they use to take contingent contracts, that backfired when people couldn’t sell their houses for enough money to buy the new construction and now they don’t do it anymore. We advise our clients that if they want to get a great deal from a builder, buy a spec home. You get a few less choices but you usually get a lot more home for the money and you close much quicker so there is little chance of price declines and loan issues.

  4. Rick Marnon, Howell December 20, 2007 at 09:01

    I guess people should think about this before they start building. You have to have a budget in mind and not get spend happy, which is what a number of people do. Ultimately people blame builders for their decisions. He may not be involved in the financing other than getting a check from the bank to move forward with the project.

    What would a builder be able to change in the contract? He can’t speculate that the market is going to take a dump, and with build jobs taking typically 4-6 months, depending on the type of home being built, a lot can happen in that timeframe. At this point I think the only thing that he could change is how much he will make, and why would he do that.

    As a real estate agent I have not had to negotiate my commissions yet, but my client wanted a home and I told him I would negotiate my commissions down if it would help the deal. He ended up saying that if I did that he was going to come up and was willing to spend a little more because of this, but the listing agent wasn’t going to move, so obviously the home didn’t sell and now the home is still on the market. She has called numerous times now trying to get my guy to buy it. He’s livid with her. Too bad for her.