Too Big to Nail: Why Size May

Matter in the Home Building
Industry
(previously appeared in Philadelphia Independent Media Center
and discussed on FPAC, Channel 10)

by Norman Ball, MBA, PMP
info@deckstairity.com
--February 2003
Most new homes offer years of trouble-free enjoyment for their new occupants.
But a significant number are brick-and-mortar disasters waiting to happen.
Recently, industry consultant Alan Mooney estimated that annually,
approximately 150,000 new homes --15% of the new housing stock-- contain
serious building defects. For those whose dream home becomes a personal
version of The Money Pit, this article may only add salt to the wound. But for
prospective buyers, it could be just what the doctor ordered. Remarkably,
housing is one of the least regulated industries in the U.S. --a condition all the
more disturbing when one considers that a home represents the average
person's single largest purchase.
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So how has the industry managed to subvert any meaningful consumer
protections? After all there are lemon laws for cars, but none for homes. Well my
fellow Americans, it often pays to follow the bouncing dollar. According to the
Center for Responsive Politics, the construction industry contributed a
respectable $46 million to congressional campaign coffers in 2002. Of course,
Presidential, state and local campaign contributions are not included in this
figure. But the money flow tells only half the story. Yes, homebuilding is an
engine of job growth and economic activity. But homeownership is also a sacred
tenet of American culture. A house is an emblem of social standing and upward
mobility. For all these reasons, the industry is often regarded with a deference
bordering on religious fervor. From the consumer’s standpoint, the secret to
successful new home buying lies in safeguarding rights while still a prospective
buyer. Because the industry's bad apples only love you until they have your
money, and then they don't love you anymore. Due diligence and the old adage
"buyer beware" are the operative terms here.
Much of the new home buying process is structured like a high-stakes hot potato
game: once the consumer holds title to the house, he inherit the defects,
struggles against limited warranties and fights the builder in a pro-industry, outof-court arbitration forum. Should the consumer prevail (unlikely), the entire
dispute is hidden from public view behind a cloud of confidentiality. In public
disputes, state courts can order the homeowner to correct the construction
defects surfaced in the process of battling the builder even though said building
defects were discovered not to exist in the same legal proceeding. So if you pick
a fight with your builder and lose, keep your checkbook handy because the
building inspector may show up on your doorstep insisting those "non-existent"
building defects meet code. Starting to feel like Julia Roberts in a bad version of
Erin Brockovich? Well it's true. In new home building, it can often seem like
everyone is out to get you.

Title Transfer: The End Game
With passage of title, the unscrupulous builder has achieved his ultimate goal.
Cash in hand, he's out from under another piece of inventory. As evidenced by
the Certificate of Occupancy (basically the county's "ready for sale" stamp),
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latent building defects, if they exist, have escaped the building inspector's notice.
What cannot be disputed is that a construction defect represents either a
detection failure during the inspection process and/or a misrepresentation to the
inspector by the builder. In either case, the homeowner can be left to bear the
ultimate burden. Should a defect emerge outside the warranty coverage
(something we'll explore later in this article), the homeowner must typically
submit to binding arbitration with the homebuilder as stipulated by many current
new home purchase contracts. Many homebuilders will walk away from a sale
before allowing a buyer to strike the arbitration clause in his sales contract (the
legal equivalent of suspending your Seventh Amendment right to trial by a jury
of your peers). The arbitration industry enjoys a thriving business with the
homebuilders. After all, a shoddy homebuilder can be an arbitration cash cow.
As Nancy Seats, President of the industry watchdog group Homeowners Against
Deficient Dwellings (HADD; www.hadd.com) notes, "The American Arbitration
Association has a 'construction defect' arm...that wouldn't even exist if builders
didn't build bad houses." Perhaps it's no accident then that an estimated 70% of
all arbitration decisions favor the industry client over the consumer, according to
a recent Business Week article. Arbitration is, after all, a service, and not, as the
profession would have you believe, a second priesthood. This is not an
indictment of the arbitration industry's integrity necessarily. But arbitration is a
profit-motivated service industry, nothing more, nothing less. Many consumers
have no choice but to walk away from arbitration because the costs can be
prohibitive. Arbitrator's fees can mount rapidly, often exceeding comparable
costs for a court proceeding. There can be one final indignity awaiting
homeowners who opt to air their grievances publicly. The builder can file a
Strategic Litigation Against Public Participation or "SLAPP" suit against the
homeowner. These suits are nothing more than corporate-led retaliatory actions
against individuals with the audacity (and civic-minded astuteness) to exercise
their First Amendment provision which prohibits Congress from "abridging the
right of people to petition the Government for a redress of grievances."
Yes, that's right. In America today, corporations (and not just homebuilders)
routinely threaten citizens with legal action as a means of muzzling civic
discourse. Though the burden of proof for a SLAPP suit is generally very high, as
attorney Lori Potter states, a SLAPP suit plaintiff can prevail if it can be shown "a
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citizen's communications with government agencies were 'objectively baseless'".
To think that a corporation can exert subtle legal blackmail --inhibiting
Constitutionally-protected dialogue between a citizen and his government-- is
an absolutely chilling prospect .Often these suits have no inherent merit and
consist of legal make-work. The whole intent is to frighten consumers with the
prospect of a costly legal battle. However the troubling theme that reverberates
time and again throughout the industry is that, when they impede business, civil
rights are vociferously attacked. Put another way, the efficacy of ones civil rights
are in direct proportion to ones capacity for mounting a costly legal defense.
While this ‘cash and carry’ system of justice may suit the American Bar
Association just fine, something tells me the Founding Fathers would have
qualms.

Pulling Back the Sheet(rock)
The product of some dozen separate sub-contractors, new homes are a marvel
of complementary and interlocking skills. One major area of due diligence
involves understanding precisely who these people are. The builder or his GC is
basically an insured foreman for the many subs who actually erect the frame, lay
the pad, etc. Though the GC's competency is important, building defects are
typically the result of poor workmanship by a tradesman or sub-contractor.
Remarkably, general contractors are licensed in only about half the states.
An excellent web source for determining a particular state's regulatory
framework is www.contractors-license.org where a state-by-state summary is
available. Many regional industry trade groups recommend a pro-active
consumer approach with respect to sub-contractors. In my region for example,
under the "Choosing a Builder" section of its webpage, the Northern Virginia
Building Industry Association (NVBIA) urges prospective buyers to "ascertain
what responsibility the builder assumes for the work of subcontractors and
others who helped to build the house." Incredibly, the NVBIA's on-line
membership form does not request a GC or subcontractor license number. The
national parent association for most regional organizations, the National
Association of Homebuilders (NAHB), conditions its membership upon prior
membership in a regional affiliate. So much for policing the membership ranks
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for reputability. Yes, you too can be an Association member with a credit card
and a mailing address.
As for accessing the NVBIA website for the purpose of locating reputable
businesses, the message here is don't bet the house on the referral’s licensure. A
home built using improperly or unlicensed contractors (no matter the quality of
the underlying work) is in violation of building codes, plain and simple. This is
because licensure represents the legal imprimatur of trade competency by the
controlling legal entity, in Virginia's case, the Department of Professional and
Occupational Regulation. Whatever his state of residency, a prospective
homeowner should investigate sub-contractor licensure status as part of his presale due diligence. Needless to say, even if there is a licensure regime within your
state, not all licensed contractors deliver highly competent work product. Nor are
improperly or unlicensed contractors universally inept or incompetent. However
from a legal standpoint, any work rendered by an unlicensed subcontractor, no
matter how exceptional the work product, is prima facie a code violation. Does
the foundation show evidence of poor workmanship? No. Was it poured by an
unlicensed sub-contractor? Yes. Well then, because the sub did not pass the
state test that --as a pre-requisite to receiving state licensure, legally establishes
his trade competency-- the foundation is improper. End of story.

The GC: Between a Brick and a Hard Place
There is every reason to believe the vast majority of GC's are upstanding and
competent professionals. But from a consumer standpoint, it's important to
understand that the potential for conflict-of-interest can be great, particularly as
the GC can be answerable to two entities with sometimes divergent interests-his employer and his state of licensure. Even a large national homebuilder can't
build without an on-staff, state-licensed GC. As a licensee of the state, the GC
bears special responsibilities to the State and its citizenry for all home building
activities undertaken under his or her licensure. Unfortunately, the practical
reality has the potential for overwhelming --or at least impeding-- this
regulatory responsibility since the GC is compensated by his employer, and not
the state. Often, one of the GC's job responsibilities includes ensuring that a
certain volume of houses is constructed within budget and on time.
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No different from other employees, a GC has an obligation to meet his
employer's objectives. It is entirely conceivable that, by imposing unrealistic
build schedules in an effort to meet aggressive Wall Street growth targets, large
homebuilders may unwittingly encourage unsafe building practices. I'll leave
more cynical observers to speculate on just how unaware the rapid-build, tract
housing companies are to risks of potential corner-cutting amongst their ranks.
For reasons much larger than the home building industry, Wall Street cultivates
a sort of institutionalized myopia with its overriding focus on income, revenues
and volumes. If quarterly numbers disappoint, the financial community simply
rotates into another industry sector. Unfortunately, the recipient of the "units" -the homebuyer-- does not have the same recourse to liquidity. Or, to borrow
an adage, one person's unit of production is another person's hearth and home.
Quality, reputability, i.e. the hard-won standards of excellence achieved over
many years, often succumb to a unit-cost drive aimed at squeezing out
"inefficiencies". Indeed excessive attention to craftsmanship and quality (if there
is such a thing) can be made to look economically unfeasible with the click of a
spreadsheet.
Senior executives of the large publicly traded companies have increasingly
become beneficiaries of the short-term, quantitative orientation. Executive stock
option packages deflate commensurately --and often precipitously-- with drops
in share price. Recent structural changes to the industry have, in a sense, worked
contrary to the interests of the consumer as well. In an effort to equilibrate the
traditional boom/bust cycle of the housing industry, the trend has been towards
consolidation in an effort to "diversify away" regional risk. But while this approach
may stabilize growth, it can also sever top management from an intimate
knowledge of their traditional "home" markets; the very markets where their
reputations were originally established. Here again, what's good for the
shareholder (and option-saddled senior executive) may not be good for the
homebuyer. And herein lies a somewhat heretical notion: Fortune 500
corporations, while perhaps excellent investments, might not be the
homebuilders-of-choice, because home building, when done properly, is a
naturally regional business. Let me hasten to add that your financial advisor still
deserves every credit for including a bunch of NYSE homebuilder stocks in your
portfolio! Remember, this article is intended as a consumer guide and not an
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investment bulletin. Given a residential building environment that so clearly
favors volume, speed of construction and growth, there are probably a few GC's
sweating bullets (or perhaps bricks) as they try to assemble and retain
competent, licensed sub-contractors in an industry already notorious for
unreliability.
A 1999 Better Business Bureau survey found that, as a function of complaint
volume, six of the top 15 industry groups were in the building trades.
Compounding matters further, the current unprecedented building boom is
putting great strain on an already-stretched skilled-labor pool. Any private
individual knows how hard it is to find a reliable contractor. In many ways, the
GC's problem is identical, except multiplied. He must also ensure all subcontractors are properly licensed (and insured), and that all subs' licenses remain
in good standing. So under the best circumstances, the GC's sub-contractor
headaches are daunting indeed. A consumer has no choice but to pull back the
sheets and discover whose physical labors actually contributed to the
construction of his home. The guy with the glossy brochures and his on-staff GC
simply aren't enough. Here again, due diligence may be more urgently required
with the large NYSE firms who, despite their obvious size and "visibility", are
clearly on the Wall Street treadmill and as such have culturally committed --on
some level at least-- to a growth-credo (though hopefully not a "growth at all
costs" credo.) In short, many people naively ascribe credibility to the large
builders simply because "they've been around so long and must be good
because they've built thousands of houses." In fact, the opposite may be true.
Nor is reputability a panacea as we shall soon see.

The Myth of Reputability
Many of the building trade association webpages offer a brief summary outlining
what a consumer should be looking for when qualifying a homebuilder. The term
"reputable" figures prominently in these consumer guides. But in this era of
binding arbitration and confidentiality agreements, reputability has dubious
value. Since many consumer complaints no longer reach the public record or the
court docket, a builder's reputation can be artificially "propped up". Public
reputation can become just another manipulated metric. This process should
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trouble those builders who strive for excellence, and who attempt to earn their
reputation the old-fashioned way. Indeed how many good builders are forced to
relax their own standards in order to compete effectively with the industry's
laggards? But think twice before bad-mouthing a builder to your acquaintances.
He has a public reputation to uphold and besides, you signed a confidentiality
agreement (there’s a good chance it's there in your sales contract.) So when the
next unwitting consumer seeks advice, he too will be urged to choose a
"reputable" builder, perhaps the one you and hundreds of others arbitrated
against unsuccessfully. Recently in Texas, KB Homes agreed to remove a
restriction in one of their Houston sub-division's Declaration of Covenants
preventing homeowners from airing their grievances in public and on the
Internet (a so-called "shut up" clause). Sometimes the Constitution, in this case
the First Amendment, can still carry the day.

Home Warranties: The Emperor's New Clothes
Another unpleasant surprise awaiting new homebuyers who inherit a building
defect is the inadequacy of today's standard home warranty. In their book Your
New House, Alan and Denise Fields estimate that 86% of all warranty claims are
denied by home warranty companies. Indeed the car in your new driveway is
better safeguarded with its industry-standard, bumper-to-bumper protection.
Probably the most prevalent home warranty is the so-called 1-2-10. Ostensibly,
this is a ten-year warranty. But its coverage is more notable for what it excludes.
For example, upon opening the door to your new home, the tile, the paint, and
the dings on the walls are all yours, warranty-free. Typically, year one is covered
by the homebuilder with a warranty product from a third-party warranty
company kicking in during years two-ten. The foundation is not covered during
ANY period. So the underlying cause of wall cracks, a settling foundation for
example, is not covered although crack repair may be covered, provided those
cracks exceed a certain width, often 1/8". Only Major Structural Defects (MSD's)
are covered in years three-ten. In most cases, the MSD bar is set very high.
Typically for MSD qualification, the problem must materially affect the physical
safety of the occupants of the house.

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As HADD's John Cobarruvias bluntly states, "it is difficult to understand how any
damage could be considered for MSD coverage." And even the warranty
companies are on the binding arbitration bandwagon. So your Seventh
Amendment right to a civil trial has been suspended here as well as it often is
with the homebuilders. Despite the "10" in its name, the 1-2-10 is nothing more
than a very limited one-year warranty. Maybe those homeless folk sleeping in
their cars are onto something. State and County Consumer Protections
Hoping to better understand the consumer protections in my own jurisdiction
(Fairfax County, Virginia), I exchanged a few e-mails with Mr. Eric Olson,
Executive Director for Virginia's Board for Contractors who kindly answered all of
my emails promptly and comprehensively. Virginia’s Board for Contractors is a
governor-appointed board of tradesmen, contractors and others under the
auspices of DPOR tasked with regulating "businesses that construct or improve
facilities on property owned by others." As Mr. Olson explained, yes, I could
certainly ask a builder to provide me with a list of his subs. But no, they weren't
required to furnish me with such a list. No, there is no active audit function in
place whereby the state routinely inspects the vendor files of homebuilders to
ensure that sub-contractor licensure compliance is being monitored by the GC.
But yes, if improperly or unlicensed subs were being used, it would constitute a
building code violation. No, the building inspector does not monitor
subcontractor licensure status as a function of inspecting new buildings nor is it
a prerequisite for obtaining a Certificate of Occupancy. But yes, a Certificate
would not be awarded if the inspector became aware of a licensure issue.
Mr. Olson was extremely forthcoming and friendly in his explanations. However
I came away thinking how difficult it would be to nab industry wrongdoers within
such a toothless regulatory regime.

Do It Yourself
In the end, a consumer is well-advised to assume very little has been done to
safeguard his interests. To this end, there are a few things he can ascertain on his
own :

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 Subcontractor transparency. Is sub-contractor information forthcoming
from the builder as the many builder associations imply it should be?
 Binding arbitration. Does the sales contract contain such a clause, and if so,
is it strikable?
 Warranty coverage. Does the builder offer merely a 1-2-10 warranty or
does he go beyond this industry standard? Another wise step is to visit a
development that is at least two years old and knock some doors. See
what the developer’s track record is in terms of responsiveness, warranty
satisfaction and overall post-sales commitment. There’s never a horror
story a neighbor isn’t well-versed in since bad news always travels fast.
An informed consumer makes fewer mistakes. Rarely are the stakes higher than
in a home purchase. So make use of any resources your municipality offer and
undertake a little gumshoe detective work of your own. Your financial well-being
could depend on it.

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