Even Though You're Smitten With the House, Take the 'Real Estate Prenup' Seriously

Reprinted from

By Katherine Salant
Saturday, July 18, 2009

With the endless media coverage of celebrity marriages and divorces, once-obscure legal terms like "prenuptial agreement," or "prenup" for short, have become common parlance.

Most people understand the legal premise. It is designed to protect the assets of one party by requiring that the other agree to relinquish property rights to which he or she may be legally entitled should the marriage dissolve.

We all know from the tabs, not to mention from movie plot lines, that a sensible person should seek the advice of a lawyer before signing a prenup. If the terms of the prenup are onerous, the sensible person will try to negotiate more favorable ones.

What's far less well appreciated by the public, however, is that a prenup is a contract. And a sensible person should seek legal counsel before signing any contract -- especially one that entails a big financial risk, such as when buying a new house.

The comparison between prenups and sales contracts with home builders is not as big a stretch as you might think. New home buyers can be as starry-eyed as a besotted fiance, several real estate lawyers said in recent interviews. Many buyers are so focused on the breathtaking furnished model and how they are going to live in one just like it that they barely glance at the contract before signing it.

In most cases, the deal goes smoothly and the buyers are happy with their new house. But if trouble develops during construction or after the buyers move in, the homeowners can be in for a rude awakening, the lawyers said. Like all contracts, including a prenup, home builders' sales contracts are heavily biased in the writer's favor.

In certain situations, the bias of the writer is understandable. Just like a divorcee who wants to protect her assets the second time around, home builders that have had more than one deal go south want some protection from future risk. The problem, lawyers said, is that production home builders often refuse to negotiate and their contracts are egregiously one-sided -- so much so that Beau Brincefield, a lawyer in Alexandria, and Dennis Haber, a lawyer in Miami, said they would never consider buying a new house.

If some aspects of a production home builder's sales contract could be changed to make it more equitable, what would these experts suggest?

Brincefield said that, in his experience, the date of completion is the number one problem with new-home sales contracts. While it's reasonable to give a builder extra time for delays over weather or building-material shortages, the language in many contracts can leave the delivery date open-ended, allowing the builder to tie up the buyers' money and personal lives almost indefinitely. In the worst cases, he said, the builder hasn't even broken ground.

A more equitably written contract sets a fixed termination date, Brincefield said. He suggests two years. If the house cannot be completed within that period, the buyer should get his money back and walk away.

Brincefield said the second major problem with builder sales contracts is buyers' deposits. The contract will stipulate that the deposit, which can be 5 to 10 percent of a purchase price, be given directly to the builder rather than escrowed with a third party until the deal is completed, as it would be in a resale transaction.

Unfortunately, any money paid to the builder is gone if the builder goes under, as has frequently happened in the current market, Brincefield said. If the buyers want to press ahead and finish the house, they will be competing with others at a foreclosure auction organized by the holder of the builder's construction loan. If they win, they will be starting over financially because no credit is granted for anything paid to the original builder. To finish the house, they will have to engage a second builder at a far higher price because few builders are willing to complete another's work.

Such a heartbreaking scenario could be avoided by putting the new-home buyers' deposits into an escrow account, Brincefield said.

Another important contractual issue for new-home buyers is financing, said Jim Savitz, a lawyer in Gaithersburg.

Almost every home builder now has a preferred lender and a preferred settlement company, Savitz said. To induce buyers to use them, the builder offers financial incentives toward closing costs. In a market like Montgomery County, closing costs are high and a builder's incentive could be $10,000 or more.

But the true value of those incentives can be offset by hidden costs to the buyer, Savitz said. Often, the lender and the settlement firm charge above-normal fees, change the loan terms, demand higher down payments and require buyers to pay more points. (A point is 1 percent of the loan amount.) Once a buyer agrees in writing to use the builder's financial agents, he's locked in and can't look around for a better deal.

While savvy buyers will ask upfront for a list of all the fees in writing and then comparison-shop with other lenders before signing a sales contract, most new-home buyers are novices and don't think to do this, Savitz said. To remind buyers to do their homework, the sales contract should clearly state that the builder's offer may not be competitive.

The contract should also be transparent regarding the home builder's relationship with its preferred lender and settlement firm. The builder gets a financial reward for locking buyers into using its preferred agents, Savitz said.

Another issue raised by all three lawyers is identifying the corporate entity that is responsible for building your house. A builder may have advertised itself heavily as a "builder of integrity" and plastered its brand all over the sales materials, but the company name will not appear anywhere in the sales contract. Instead, buyers will see a counterparty with an unfamiliar name, such as "Silver Pine LLC." This is a limited liability company, set up for the sole purpose of building houses in one subdivision. When all the houses are completed, Silver Pine will fold its tent.

However, if you have a problem a few years down the line or the builder goes under before finishing your house, you will find yourself chasing a no-longer-existing company with no assets.

To make this more equitable for buyers, the company that markets itself as the builder of the house should be listed a "co-obligator" on the sales contract, the lawyers said.

Knowing that home builders are a powerful lobby at both the national and state levels, the lawyers were not optimistic that any aspect of production-home-builder contracts would ever be changed. But, they said, new-home buyers would be in a much better position if they educate themselves more about the nuances and realities of a new-home purchase.

A buyer's first move should be to read the contract carefully. Buyers will find it straightforward and shockingly one-sided.

The second step is knowing the difference between a sales pitch, often called "puffing," and a contract. The builder is not required to deliver on any verbal promise. He's responsible only for what is written.

And the third step is to consult with a knowledgeable real estate lawyer before signing anything, just as the sensible person facing a prenup should do.

Katherine Salant can be contacted via her Web site, http://www.katherinesalant.com.

© 2009 Katherine Salant

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