Real Estate Update in Palo Alto & Los Altos

When a home builder goes bankrupt, the company’s creditors aren’t the only ones who suffer. Oftentimes, those who pay the price are homebuyers who have put down sometimes hefty deposits for houses that remain unbuilt, and new homeowners living in a development with half-built homes and incomplete amenities.

In the past year, the tumbling housing market has claimed large builders, such as Fort Lauderdale, Fla.-based Levitt and Sons, a unit of Levitt Corp.; Elliott Building Group in Pennsylvania; Turner-Dunn Homes Inc. in Arizona; Kara Homes Inc. in New Jersey; and Neumann Homes Inc. in Illinois.

When these builders file for bankruptcy, subcontractors stop working, leaving unfinished homes in various stages dotting communities. Crippling liens are placed on occupied homes, clubhouses are left uncompleted and swimming pools and parks are never built.

People who have placed deposits on homes either never get their money back or face delays of months or years before funds are returned.

And it’s not going to get better anytime soon. Some experts predict that the housing market will not start recovering until the second half of 2009.

“There will be a few more builders that will declare bankruptcy because they have been caught with excess inventory and too much debt,” says Tracy Cross, of Tracy Cross & Associates, a Schaumburg, Illinois-based real estate research firm.

Take Neumann Homes, which had 5,044 units planned for 17 communities in Illinois and Wisconsin.

According to Cross, Neumann Homes has an escrow fund for deposits on new homes or townhomes, and a bankruptcy judge will decide when to release those funds. But those individuals whose houses are under construction will be in limbo for an unknown period of time.

“The houses sit until someone comes in and decides to complete them,” Cross says. The buyers “can’t move in, they can’t get their deposit back and they can’t get out of the contract.”

In November 2007, Levitt and Sons became the nation’s largest builder to file for bankruptcy. In its bankruptcy filing, the company lists assets of less than $1 million and debts of more than $100 million.

Signs were obvious in the final months as Levitt and Sons laid off most of its 400-plus workers and stopped building houses.

Some home builders, such as Centex Corp. and Pulte Homes Inc., aim to survive by selling houses at bargain prices, scrapping growth plans and slashing jobs. But as the housing market continues its downward slide, other home builders could find themselves in jeopardy.

Problems for homeowners and buyers
Attorney Brian Meltzer, of Meltzer, Purtill & Stelle LLC, in Chicago, has represented home builders for more than 30 years. He notes that these bankruptcies create numerous problems for homeowners. One of the most pressing issues will be warranty service issues on their homes.

On its Web site, Neumann Homes offers a 10-year limited structural warranty.

“Any warranty issues which arise within the first two years of coverage are handled by your Neumann Homes Customer Care Team,” the site says.

This means all defects in heating, ventilation and air conditioning systems, plumbing and electrical systems are supposed to be handled by the builder. The Web site states that in the first year under the warranty, claims concerning workmanship and materials issues are to be handled by the builder. It also mentions that in first year after closing there are to be three inspections under the Customer Care Program.

Now, homeowners don’t have this warranty.

In addition, homeowners in Neumann Homes communities in Wisconsin are already having problems with subcontractors not being paid, according to the Racine Journal Times in Wisconsin.

The newspaper described the travails of a Wisconsin woman who closed on a newly constructed three bedroom, 1,800-square-foot ranch house in the Chicory Creek subdivision. Already, a $9,000 lien has been placed on her home from a drywall contractor who wasn’t paid.

She says her neighbor has three liens on her home. The woman has contacted the title company and hired a lawyer.

“We don’t know at this point if we are going to be held liable,” she says.

Sturtevant Village Administrator Mark Janiuk says: “Neumann Homes has completed at least 20 homes, with two in the building process. We expected the company to build on an additional 30 home sites.

“As a town of 6,000 people, there is not much we can do. However, our concern is that a lot of subcontractors are not going to get paid and that can cause possible job loss.”

Almost 400 other customers find themselves facing uncertain living arrangements, while approximately 135 currently have homes under construction, but not yet built. About 130 homes were sold “on spec” but are not yet being finished.

One of the hardest hit communities is in Antioch, Ill. Plans called for 1,500 single-family homes and town houses to be constructed in two subdivisions. So far, 700 homes are built, with many in various stages of completion.

One subdivision was supposed to have an 8,000-square-foot clubhouse and swimming pools. Construction never started on these amenities. An ice skating rink had been installed in the development. Neumann Homes paid the tab for it, but homeowners aren’t sure they want to pick up the roughly $8,000 annual cost of maintaining it.

“Obviously it will take a lot longer than anticipated to build out the clubhouse,” Meltzer says. “But it will get built and finished, and eventually the development will sell out.”

What happens to these developments?
Cross believes that homeowners living in a bankrupted new-home community have few options when their home has a major problem. If the foundation has cracks, the floors aren’t level, the roof is leaking or the foundation is shifting, the homeowner will have to pay for the repairs. If a new entity takes over the development, it can help the homeowner — but it has no obligation to do so.

As for the houses partly under construction, what most likely happens is that the lenders or another entity step in and hire the trades to finish those houses. The homebuyer will then get the house for which he or she contracted. In the meantime, the homebuyer is stuck and can’t get out of the legally binding contract.

City of Kenosha, Wisc., officials are concerned about incomplete infrastructure in developments there, including roads that haven’t yet been deeded to the city.

“Many roads are lacking their final topping,” says Patrick Sheehan, Kenosha’s city attorney. “This is usually done when trucks have left the area. Unfortunately, Neumann has left the area.”

To solve the problem, the city hopes to draw on the existing letters of credit.

“Municipalities have letters of credit that are posted by the builder with 120 percent of the amount estimated to complete the improvements for roads, water, and sewers and storm detention,” says Allen C. Balk, an attorney at Meltzer, Purtill & Stelle LLC.

“These letters of credit are still good because this is money put aside by the lender. It will be the banks that will have to pay for it, and they will have it worse than the consumers.”

How can potential buyers protect themselves?
Both Cross and Balk recommend checking out the builder before purchasing a home. Look at the progress in the subdivision. Drive around. Is anyone working? If it looks like there isn’t that much production, it may be indicative of other issues.

“You can never assume the builder will always be there,” Cross says.

Knock on doors and ask people if they are happy with their home. If you decide you want to live in that community, purchase a completed inventory home, which eliminates much of the risk.

Look up the company on the Internet. If it’s a public company, you’ll be able to find out how it’s doing in different markets. Find out if land is being revalued.

“There is plenty of information out there, but a homebuyer has to do his or her homework,” Balk says.

Buyers should also make sure that their earnest money is in a third-party escrow account, because if there is a bankruptcy, there is a right to terminate the deal.

“If the money is not in such an account, you become an unsecured creditor,” Balk says. However, this provision can vary from state to state, so it’s up to the buyer to find out if this is done in their state.

Buyers sometimes can add a “springing provision” to their contract. This is a clause in the contract that allows the buyer to walk away if the builder files for bankruptcy protection. Most contracts don’t contain them. This clause only “springs” into effect with a bankruptcy filing.

“There is nothing wrong with asking your lawyer to put this in the contract,” says Balk. “It’s important to check with your state to see how enforceable this clause is.”

Still, Meltzer, the attorney who represents home builders, remains optimistic that things will work out.

“Depending how long the development sits there,” he says, “it could have an adverse effect on the value of your home. But if progress is being made and houses are being delivered, it shouldn’t have an effect on the value of your home, meaning it shouldn’t be different than the general marketplace.”

By Vicki Gerson • Bankrate.com