Buying New Construction in the DC Area

My first job in real estate was working for a land developer. After two years, I went to work for a national builder (D.R. Horton.) After that mess of a couple years I went to another builder. Even though they were, at the time, a top 10 builder, you haven’t heard of them because they are now out of business. Thanks 2008 Housing Bubble. When it comes to new construction, I know a few things. The tricks I learned from being on the inside of working for builders have served me well. I’ll share some of the top things with you so that you are prepared before you buy a new home. Everything we’re going to cover here applies to large national builders and smaller builders who may do 5 to 10 homes a year.

1) Beware Buying Without an Agent Experienced With New Home Sales

This is very important: If you have any intention of being represented by a real estate agent, don’t pop into the model just on a whim. Even if you’re driving by, resist the urge to go inside. Why? Because I said so, that’s why. (I’m a mom, I’m bossy, what did you expect?)

Here’s the deal – many buyers will go direct to the sales office. That’s fine – if you know what you’re doing. Other buyers will bring any agent with them which is okay but it may not really help. You really must have someone represent you who is familiar with how builders work. They don’t need to have worked for builders, but they need to know where to interject their input to help protect you, the buyer. Regardless of which route you choose, you must have the real estate agent with you at the first visit. There are no exceptions to this rule. Don’t think you can give them a fake name because they ask for your identification.

For those who think, “How hard can this be? If I go without an agent, they might give me that commission.” First, they won’t. We’re going to cover negotiation next, but they will not give that commission money to you as a buyer. And they don’t give it to the builder’s sales agent either – it goes back in their pocket. Second, they love when you come in without a knowledgeable agent because they can upsell you in services and upgrades – all of which we’re going to cover next.

2) Beware: No Negotiations

Builders have their own contracts. There is no form contract that we will be filling out together like we would if you bought a resale. These contracts are going to protect the builder and they are not going to protect you – at all. The price is the price, there is no negotiating that you can do on the price. If you don’t like the price, they will sell it to someone else.

The more you understand their rationale for why they don’t negotiate the better prepared you will be. There are several reasons. First, prices are the lowest when a community first opens for sale. This is a way to “train the market” and thus, train customers they should buy-in early. The truth is, there is a method to all this madness.

Builders release the less desirable lots first, while the waiting list is long, and the buzz is high. When you first visit the community, the sales rep will tell you that the future lot releases will come with higher prices. Buyers panic and decide to lock up a home now, while prices are lowest. What buyers don’t know is the reason the prices only go up is because the builder is selling the least desirable lots first while demand is high. Those future lots would naturally come with a “premium.” You can see how they engineer this initial demand, and claim that strong sales justified higher prices. The reality is, behind the scenes, they are releasing additional lots at higher prices because they were deemed to be more desirable anyway. And to satisfy their lender, they need a mad rush of initial sales to ensure the payback on their loans will be timely.

The second reason builders do not negotiate is that builders cannot sell homes for less money than their original prices. Why? Because it pisses people off and it “trains” them that waiting is better. When the housing market turned in 2007, this happened where some builders were reducing prices to sell quickly. This did not go over well with the buyers who bought in to the community early. If you have a reputation for lowering prices down the road, you would essentially train the public to wait. This is why builders will never lower prices.

Let’s talk about other things to negotiate. There will a deposit required of you. Sometimes there is a deposit to hold your lot. In other cases, they will go straight to contract and require a deposit of 5% or 10%. They may have a fixed deposit as well or a combination of all these scenarios. Just know that you’re going to part with a serious chunk of cash. I have managed to negotiate the deposit for two separate clients who just purchased new homes. In one case, they just weren’t putting as much down as the deposit the builder wanted. In another case, they didn’t have that much cash in a liquid form and it wasn’t the right time to sell stocks from investment accounts. The builder’s sales representative took this information to the powers that be, and they approved the lower deposit.

3) Beware the Builder Contract

The contract is very long. It’s going to stipulate that you can’t go into your home while it’s under construction unless the builder has a set appointment with you like the pre-drywall walkthrough. It will outline where your deposit will be held which is important. A small builder may not have enough money and they use your deposit for their construction. You never ever want to agree to this. Large and national builders will hold your deposit in escrow, but smaller builders may not. If you find a builder who needs your deposit to build the house, you need to walk away. That is not good.

The contract will not include a financing contingency. This is important because from the time you contract with the builder to the time your house is built and ready to close on, many things could change. Interest rates could rise sharply, you could have an emergency that requires you to use funds you planned to use for the home, you could lose your job. Each builder will handle this differently, but in most cases, you will lose your deposit. This is very scary for people to commit to.

The contract may also limit your ability to turn around and immediately sell your home. Most builders will reserve the right to buy the home back within a year or two because they would not want to be in competition with you while they are still trying to sell homes in the community.

4) Beware the Builder Credit

Every builder offers a closing cost credit if you use their preferred lender and title company. It’s usually in your best interest to just use their title company because they have run title on the property. You should capture at least some cost savings since they have title insurance already on the property from the builder’s original purchase. They should be able to pass on a savings on title insurance for you. That may not always happen though so it’s worth asking the question.

I’ve seen builder credits of $15,000 where my clients priced it out with the builder’s preferred lender and another lender that I recommended, and my lender was still a better deal. A side-by-side comparison revealed that the interest rate was much higher with the preferred lender, and then they used most of the credit to buy down the interest rate. And the preferred lender’s rate after the buydown still wasn’t as low as what my recommended lender offered.

As my clients astutely noted, what’s the point of a credit if they are just going to jack the fees up and then use the whole credit to offset those fees? That’s what I call “fake money.”

In some cases, the builder also owns the mortgage company. This means they are making money on you from not only the house, but also the loan. This is how they can pass a substantial cost savings to you. Always price it out with other lenders though. It is always worth shopping around.

There are positives to using the preferred lender. Once they run your financing and share that with the builder, it’s highly unlikely that your financing wouldn’t go through. If it does, but you can get approved with another lender, some of the really good builders will still give you the credit too. The other reason is that the builder has a lot more comfort with your loan if they know that it’s with their lender. This could mean the difference between getting the home and losing out to another buyer.

5) Beware the Closing Costs

Generally, in the metro DC Area we have what we call transfer taxes and recordation taxes. The contracts call for the sellers to pay “transfer” and the buyer to pay “recordation” and those numbers are usually equal. Builders used to pay their own closing costs for their side.

Sometime in the past decade, builders in certain geographic areas started passing 100% of the closing costs over to the buyers. I believe this was a discrimination suit that the State of Maryland missed. This was happening for a few years only in areas where the average income was lower, the minority population was above 50% and where there were many more first-time buyers. Now all the builders in all locations are passing closing costs on to buyers in full. Their answer for why they do it is “That’s what the credit can be used for.”

6) Beware the Options and Upgrades

The model home is alluring, sexy and very enticing. It begs you to come in, coo at the features, swoon at the fixtures and decide you need things that you never knew existed. I promise that there is a ton of buyer psychology behind why the model homes are decorated the way they are. The designers who have this job are highly skilled at working on your senses to make you want this home. And this home likely has $250,000 of options and upgrades.

When you price out all the options and upgrades you want, it will be a shock. I highly recommend you focus on the structural items that you want and leave the non-structural options for another day. You should know that the builder’s profits are directly tied to the upgrades. If you bought the base house, their profit on the home would be 18-20% if they are lucky. The profit margin on most options and upgrades are 50%. That’s a high markup. If you buy a ton of options and upgrades, their profit could move closer toward 30%. Choose wisely on the upgrades. I would honestly say this is one of the areas where a skilled agent can really assist you.

7) Understand the Differences between Large Builders and Small Builders

Large homebuilders are typically less flexible than smaller builders, but it also depends on the builder. Large builders have a process and rules and they tend to not stray from their process and rules. The ones who own their own mortgage and title companies are really going to have you over a barrel, but the consolation is you’re going to get a great home from a builder with a high standard and great reputation.

Mid-size builders are going to have pros and cons. But in my opinion, this can be the hardest of the builders to work with. They may not have the years of experience or the deep pockets to employ the best of the best. Sometimes parts of the process can feel a little slack. This could be to your advantage, like when one sales rep took my clients on their word that they were going to buy a certain home. They did, but it took a few days to get the contract and paperwork together and most large builders would not give you that much of a grace period.

Smaller builders may be more flexible. But, if they are only building a few houses a year, their flexibility will not be financial. They may be willing to add or change things in the home, but they can’t wait around for your deposits and loan to be funded. This is typically their own business, but the ones who are great at this will really care for their product and for their buyers and they will do whatever they can to make you happy.

This was a lot, and I could go on about this forever! I hope this helped clear up some of the myths and secrets about new construction.