Deconstructing New Construction – The Caveats for Buyers

By Douglas Katz – 06/30/2022

HIGHLIGHTS
  • New construction has many important considerations that add cost and stress to a deal.
  • Buyers have very little control and bear most of the risk for higher costs, higher rates and an extended timeline.
  • Planning and understanding if the important variables will assist you in having a good transaction and less sleepless nights.

In the face of short housing supply, there are many prospective buyers that turned to new construction to meet their housing needs.  NPR actually had a great piece today about how many who chose the new construction route are now dealing with the typical new construction challenges which have been amplified by this unprecedented market.  Rapidly rising interest rates, inflation, material and labor shortages and record rental prices are all making this a colossal headache for new construction buyers.  So, what are the main concerns and considerations that you should  address before buying new construction.

  • TIMELINE – This is the number one thing to think about.  Long timelines mean uncertainty.  In their article, NPR referenced the experience of a couple who entered into a purchase of a new construction home.  They were expecting a 9 month timeline and at the time of the article they were approximately twice that.  Now this is a very uncommon and drastic example, but only because of the length of the delays.  Delays are common and buyers should always add their own buffer on to their personal timeline.  The contractor will not necessarily lie, but they may be overly optimistic in their capabilities.  When this is compounded by unplanned market factors, the outcome can be brutal and add cost and stress to the transaction.
  • RATE FORECASTS – Rates fluctuate with the market.  Normally, changes are minor and the buyers can plan within a range, but again this is not always the case.  Most lenders do offer long term locks, as defined typically by over 90 days, but this comes at a cost.  The same way a buyer is trying to minimize uncertainty with a long term lock, the lender is doing the same only their calculus is the opposite.  They are analyzing the opportunity cost of offering a market rate for a long period of time.  For them locking a rate takes away their ability to charge more if rates move higher, so they will charge you for the opportunity cost.  This tug of war make planning tough and, based on the fact that extensions cost a lot and may be limited in duration, buyers get stuck spending more up front to cover the planned timeline with a buffer or not locking and stressing as rates move without the ability to pull the trigger.  With a market like we are seeing today with rates jumping by points at a time, anxiety and sometimes non-viability can become an unintended consequence of buying your dream home.  In short, be prepared to pay more and lose some sleep.
  • OVERALL ECONOMIC CONDITIONS – I touched on this earlier as tangential component of the other considerations, but it also deserves its own deliberate analysis.  I am not inferring that anyone take a class in economics, but rather take the time to read and research.  There is a ton of approachable information written in an easily understood form that can help you plan.  Things that we are seeing now like inflation, labor challenges and material shortages are being written about and reported on regularly.  If you are going to buy something in a transaction that has a lot of variables which are dependent on the economy, you should know, understand and accept how the market will impact you.  If there is an inflection point where you can no longer afford the home, you absolutely need to evaluate the possibility of this occurring and your plan if it does.  If you are on the bubble and their is a high enough probability that this can occur, I would consult your team of professionals to have contingency plans or even maybe decide against the purchase.
  • HOME PRICES – Like everything, home prices fluctuate with the market.  More often than not, buyers evaluate the future of the home as one of financial gain and appreciation in value.  While a homeowner will likely see their values increase over time, home values are cyclical.  There is always the possibility that a home can drop in value from when a buyer enters into a contract and puts down their deposit to when the home is complete.  This can be a huge issue if your financing is based on a particular value and down payment.  The builder will not likely reduce the price to match the new value and the buyer will need to make up the difference. Like the other considerations, new construction buyers must be able to withstand this uncertainty both financially and emotionally.
  • DEPOSITS – Like earnest money for an existing home, buyers will put down a deposit on new construction. This is typically a percentage of the purchase price and is commonly in the 10’s of thousands of dollars.  This secures the property for you and gives the builder assurances that the home will purchased.  The problem for the buyer is that they are usually if not always at a position of weakness. The builder has their money and, in many cases, they can lose the deposit if they break the contract.  Sometimes builders will return the money, but that will generally be in cases where they know that they can resell the home for the same price or more.  In a tough market, this generosity from the buyers should not be the expectation.

The thing to remember are that all of these are considerations for any deal, BUT they are amplified for new construction.  When your deal is only a 60-day affair, you can weather a volatile and tumultuous market better than a longer timeline where the variables can move at a greater pace and by a more substantial amount.  So be cautious, be deliberate and be smart when buying that shiny new home.

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