Buyers who made deposits on new construction homes being built by Levitt and Sons, a well-known construction company, received an unpleasant surprise when the company filed for Chapter 11 bankruptcy protection Nov. 9. Levitt is not the only builder to have filed for bankruptcy recently—The Wall Street Journal lists four others—and, with the housing market being how it is, it is unlikely it will be the last. Investors acquiring new construction homes would be wise to take precautionary measures and exercise proper due diligence before making any purchases.
“In August, [Paul Singerman, Levitt and Sons’ bankruptcy lawyer] said, the company offered prospective buyers the option to place their deposits in escrow accounts that would protect them in case the company went down,” according to The St. Petersburg Times. But Levitt’s offer was too late for some, and the company’s efforts to protect its consumers are not the norm, according to The St. Petersburg Times.
“Some states, such as California, require that homeowner deposits be held in escrow or that the builder post a bond. But in other cases, the builder may be able to tap the money, which may make it harder to recover,” according to The Wall Street Journal.
Because companies are more likely to be strapped for cash in this struggling market, and are finding it harder to get loans to cover their expenses, allowing them to use deposit money to fund construction could prove damaging to buyers’ pocketbooks.
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Investors are encouraged to have their deposits put into escrow and held there until closing to protect themselves in case the builder goes under. Carefully read over sales contracts for clauses stating that deposit money can be pulled from escrow for construction purposes. Investors should shy away from companies requiring these sorts of arrangements.
Because of surplus inventories, falling prices and a high number of cancellations, it’s no wonder builders are struggling to maintain a decent cash flow. And because of the hardships, and the defaults that result, banks are beginning to tighten the restrictions on builder loans.
“IndyMac Bancorp Inc., which lends to small and midsize builders, said earlier this month that it expected 30 [percent] of its home-builder loans to be delinquent by the fourth quarter. The company says that it stopped making new construction loans to builders in August,” according to The Wall Street Journal.
A builder low on funds and unable to obtain a loan could run out of money and leave homes unfinished. And if the builder used up all the deposit money as well, buyers could find themselves with no house and no money. Investors should be sure to put their deposits in escrow, and should not agree to release their deposits until closing. If a company resists this, that ought to send up a red flag and require some in-depth due diligence on the buyers’ part.