Can Home Builder Be Trusted?

A reader is tempted to enter a model lease-back deal, but wonders about the builders' financial volatility.

Q: I keep seeing model lease-back offers from builders. Most of them pay enough rent to more than cover the monthly cost, but my biggest concern is about the builder's financial viability, since so many of them have gone bankrupt. Are there any particular things one should watch out for?

A: Builder lease-backs, in which the buyer rents a home to the builder who uses it as a model home, are generally great deals for all concerned. Builders get an early sale. Buyers get an upgraded home at a discount price, and a tenant who won't be calling in the middle of the night to complain about a clogged toilet.

But in these uncertain times, I can understand your caution. Since last year, an .estimated 20% of builders went out of business, according to Gopal Ahluwalia, director of research for the National Association of Home Builders. Most were small or mid-sized builders who didn't have enough cash in reserve to cushion them through a downturn.

Associated Press

You can analyze the earnings, debt and cash flow of a public company to determine its long-term financial health, but you can't do that with a small, privately-held one. You can talk to suppliers and subcontractors to see if they're being paid promptly, to recent buyers to see if they are satisfied and to local regulatory and consumer agencies to see if any complaints have been filed against the company. If you're still concerned, you can try to negotiate a lump-sum rather than a month-to-month lease payment, payable at closing.

Keep in mind that when the lease is up, you won't be getting a brand-new home. Although builders usually make an effort to keep models looking fresh, as they cut back on expenses they may cut down on the number of times carpets are shampooed and paint scuffs are touched up. In downturns, builders also sometimes make one model home complex serve several different communities, which means more wear and tear on each unit. I recently visited a model home in Prince William County, Virginia that was being used this way. It was only one year old, but felt much older. Visitors had slammed a kitchen drawer so often that the front was coming loose and had broken a closet light switch. The gray, opaque stain on the deck had worn through in spots.

A builder will often promise to repair and repaint a model at the end of the lease, to convert the sales office to a garage and to re-route sidewalks and fences running through the model-home complex. If you're worried that the builder will go belly-up before all this happens, get an estimate from an independent contractor of what it could cost to perform these necessary fixes. Have the builder deposit the funds to cover them in an escrow account. It's smart to hire an experienced real estate attorney to represent you during all these discussions.

Finally, don't just consider the builder's financial staying power -- think about your own. If home prices fall while the project is being built out, are you prepared to hold on until the market recovers? What if there's a delay in building planned community amenities like pools and clubhouses, a situation that's sure to hurt your ability to attract buyers or renters? As scary as it may be to think about these possibilities, planning for worst-case scenarios is the best way to avoid being overcome by them.

Write to June Fletcher at fletcher.june@gmail.com

source: wsj

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Rory Vanucchi
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