By Katherine Salant
What is the defining difference between custom home building and production home building?
"It's your land and someone is about to build a house on it," explains Gaithersburg, Md., attorney Jim Savitz. "You take out the construction loan and pay the builder in incremental draws."
That several hundred thousand dollars that you're borrowing puts the risk squarely in your corner. With this much at stake, you need to have the contract with your builder reviewed by an experienced real estate attorney.
The cost for an attorney's review of a custom home contract can range from about $1,000 to $3,000 or more, depending on how many revisions the attorney needs to make. Unlike the consistency that characterizes sales contracts for production homebuilders across the country, custom home building contracts can be all over the map, said lawyers from across the country in recent interviews.
In many cases, the contracts are cobbled together from several documents. "They are often poorly drafted, inconsistent, vague and almost always one-sided," said Ann Arbor, Mich., attorney Sherry Chin.
Judith Deming, an attorney in Orange County, Calif., said in her experience, "The builder's contracts are skeletal. I've never seen one end up as a final contract. They're more of a starting point. The contractor wants four pages; the attorney wants to expand it to cover every risk. Usually an attorney is brought in after the construction has started, when there's a dispute or a crisis. Every time you always wish you had drafted the contract initially, so that it would have included a remedy for the crisis at hand."
Miami attorney Dennis Haber noted the contract can be a good indicator of the contractors' business experience. "You can have contractors with dirt under their nails who know how to put a house together but they haven't thought through a good contract. A more experienced contractor will have a more comprehensive contract and a less sophisticated contractor will have a less developed contract.
"Many times the contracts can be wide open. They are full of holes for both sides; they're more like a 'handshake deal' and that can be dangerous. The more holes there are, the more opportunity for both sides to get trapped by the vagaries and what the contract doesn't say."
The American Institute of Architects has a standard General Conditions of the Contract for Construction (A201-1997) and a Standard Form of Agreement Between Owner and Contractor (A101-1997). These are not very widely used because most custom homebuilders have their own contract. However, Haber recommended using it as the basis for a drafting a sound contract because "it's more balanced and not designed solely from a builder perspective. It protects both sides and it's designed with more sense of fairness."
But Newport Beach, Calif., attorney James M. Parker offered a word of caution regarding the AIA contracts. Characterizing them as "one size fits nothing," he said they still need "doctoring for your specific situation with amendments and attachments."
The three areas of a custom homebuilding contract that cause the most problems, the attorneys said, are allowances, change orders and construction delays.
Allowances
Rather than specifying many items that often are a matter of personal taste such as carpets and floor finishes, cabinets and counter top materials, light fixtures and appliances, a custom builder will allocate a fixed dollar amount in the budget - an allowance - and leave it to the buyer to choose the item. The problem comes when the dollar amounts are inadequate. "If the allowance is not hammered out in advance, it gets people in trouble," Haber said. "This is why houses never cost what owners expect."
Determining the adequacy of the allowance is more than just knowing prices. You have to know which prices the builder is quoting - a builder's discounted wholesale price or the full retail price? You also have to verify how the builder is accounting for the labor cost to install the allowance item. Is it included in the price of the house or in the allowance? If it's the latter, you will end up with lesser quality than you expect, Chin said.
Clearly, the more items that you can select and price out before the contract is finalized, the better off you are. But many people lack the confidence to make a selection on the basis of only a few floor tiles or a small sample, pointed out Carol Stream, Ill., attorney Robert McNees. "Some people have a clear idea at the outset; other people must get into the project and see something before they can pin down the floor tile. I would have a hard time visualizing off a set of plans and making those aesthetic choices."
Change Orders
The house goes up and the owners finally begin to see what their new house will look like. Invariably, they want to change things. The first problem is nailing down the cost of the change order.
"If you want to make a change, only do it if you can agree what is to be changed and its price," McNees advised. "This must be in writing and both you and the builder must sign. Don't make a change on a 'handshake.'"
Otherwise you could face thousands in extra charges at closing. For example, "the builder estimates that it will cost $8,000 to finish the basement, and then it turns out to be $15,000," said Bloomington, Ill., attorney Terry Eland.
Typically a builder will charge you $200 to $300 in "administrative fees" for all change orders. You also have to understand that the builder is not obligated to honor a change order and you are at his mercy on the cost, Chin said.
If the change is minor, such as moving a door, the additional cost should be paid for at the end of the job. But if the change adds a substantial amount of money to the job, the builder may ask to be paid for the change on the spot. Within the contract, "you need a formula for dealing with this," Deming said.
As a practical matter, you need to have a change order "contingency cushion" available to be tapped if necessary. One source that McNees recommends: a home equity line of credit on your existing house.
Besides the cost, a change can also delay construction. "One hundred per cent of the time, if there's a delay in completion, the builder will say, 'Well it's your fault because you made so many changes.' To avoid any misunderstandings, the contract should stipulate that every change order include the price and the added construction time, if any, and it must be signed by both parties," Savitz said.
Construction Delays
As Parker noted, "when you build a new house, the only two things you can count on are that it will cost more than you expect and it will take longer than you expect."
In Deming's experience, the culprit is the weather. "No matter how tightly the builder co-ordinates his subs, you cannot count on the weather." Construction delays can also be stressful. "It tests a marriage very harshly," she added.
How should the delays be addressed in the contract? Most of the lawyers said that builders will refuse to accept a financial penalty for lateness, but Savitz has a carrot and stick approach that he said has usually been accepted.
Savitz's formula: If the house is finished early, the buyers will give the builder a bonus. If the house is finished late, the builder pays the interest on the construction loan that the buyers are paying.
"Your position is 'I carry the loan on this property. When will you complete the job?'" Savitz said. "Give a little wiggle room. If the builder says eight to ten months to finish, penalize in the eleventh month and require the builder to pay one-half of the construction loan interest. In the twelfth month, the builder pays all the construction loan interest. I have had great success with this because the builder wants to get in and out.
"If you push the penalty far enough in the future, you can get it accepted."
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