Homebuilders, Their Business, and Third Party Escrow Companies

I think it is a known fact that all homebuilders are feeling the pain of this severe real estate downturn. Why does this matter? Well, most builders require a buyer to write an earnest money check directly to them to start construction of a home. If the builder goes out of business, your earnest money may be lost, and depending upon the situation, you may never get your home completed. See why this is an important issue right now? Since some builders require $10k to 10% of the price of the home as earnest money, it could be a major loss of money if the builder goes out of business while your home is being built. So, should you purchase a new home with the current builders all losing hundreds of millions of dollars per quarter?

Most national homebuilders are extremely large mega-corporations worth billions of dollars. This translates into less risk. But what about the local, privately held builders? Well, this is a tough question. A few years ago, an agent I knew represented a buyer on a 1.2 million dollar home by a small local (Phoenix, Tucson, and Prescott) builder called Townsend Homes. This builder required the buyer to put down a 10% deposit ($120,000). About two months into construction, Townsend went out of business. What happened to the earnest money? As far as I know, it has never been returned and the home still has not been built. That buyer essentially had a direct loss of $120k AND NO HOME! Now, this is an extreme example but it happens, and in this market, buyers should be wary of local builders. Across the country (not just Tucson AZ), local builders do not have the capital-raising ability of a large publicly traded company like KB Home, Lennar, Meritage, Richmond American, DR Horton, Toll Brothers, etc.

In Tucson, Arizona, over the past few years, we have seen several homebuilders go under, including Townsend, Ameribuilt, Pathway Developments, and Santa Rita Acre Estates. The list will continue to grow if this real estate market stays as soft as it has been for the past two and a half years. So what do you do if you want to buy a local builder’s home and are worried about this?

1) You should be worried; it is a very real situation.

2) Make sure the real estate agent working to represent you negotiates with the builder to make all earnest monies payable to a THIRD PARTY ESCROW COMPANY. This way, if a homebuilder goes under, your money will be in a safe escrow account. It doesn’t matter if it’s First American, Fidelity, or Lawyers Title, as long as it’s in escrow where the builder can’t spend it. This protects you against the builder burning through your earnest money and having nothing left when they declare bankruptcy.

3) If a small homebuilder is solvent and wants your business, there should be no objection to your use of a third party escrow company for your earnest money deposit. Now, my bet is they will not want to do it. However, with the correct negotiation setup, you should be able to get this concession.

Buyers looking for a new construction home rarely consider this issue. Instead, they worry about incentives, incentives, incentives. But what good are all the incentives if you give a builder $120k deposit and they spend your money to run their business and then leave you with no house and no earnest money? Protect yourself by using a third party escrow company, and this will not be a problem.

This entry was posted on Monday, June 30th, 2008 at 10:18 pm and is filed under New Construction. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.