Last week, I came across a clause in a purchase contract that caused me some angst.
My client is in the midst of buying a pre-build. The clause is itemized on the contract as “cost escalation adjustment.” Exactly as this sounds, it is a clause that allows the builder to increase the cost beyond the amount agreed to in the original purchase contract.
Shortening it up, part of the clause reads as follows:
“The builder and the purchaser agree that if, at or prior to the excavation date, the aggregate construction prices have increased by an amount greater than four per cent (4%), than the construction prices, as of the date of this agreement, as determined in the builder’s sole discretion, then the builder may either:
• Commence construction, whereby the purchaser’s price of land and residential unit (as described in clause No. 5 herein) and accordingly the apportionment of price to construction (as specified in clause No. 20 herein) shall increase by an amount not to exceed the price increase cap;
• Renegotiate the terms of this agreement with the purchaser in good faith; or
• Cancel this agreement”
This paragraph is about one-quarter of the whole cost escalation adjustment clause. It goes on to explain the various points during the build where the developer has the ability to increase the price of the home or cancel the agreement altogether.
So a few big things here:
• This clause is a perfect example of why it is so important that you read and understand the entire contract you are signing.
• This clause highlights why it is essential that you have your legal representative review your purchase contract before removing all of your subjects and making your purchase a firm agreement.
• This clause means you would not to write an offer anywhere near the top of your maximum mortgage amount to allow for any potential increases in price
Why does this even matter? From the mortgage perspective, often my clients write offers at the absolute top of their price point. I’d rather they didn’t but in our market finding a more affordable home isn’t always an option.
Sometimes clients are stretching just to get their minimum down payment together. Facing a significant price increase will likely mean they will need to come up with more of a down payment.
As an example, I’m working with a young couple in northern B.C. who have written an offer on a new home that is set to be completed in August. This clause is not in their agreement but if it had been, they might find themselves looking for a different home if they couldn’t find additional down-payment money.
They are at the absolute top end of what they qualify for in terms of a mortgage. Their purchase price is $740,000. If the cost of their build increased by even three per cent, they would need to come up with an additional $22,200 because they do not qualify for a higher mortgage amount.
As well, changing the price point might have other, more expensive implications.
In B.C., for new builds up to $750,000, buyers are exempt from paying the Property Transfer Tax. In this same example, if the price of the home increased to $762,200 they would also be liable for paying the Property Transfer Tax. In their case it would be $13,244.
Now they would be scrambling to come up with an additional $35,444. For many clients this is not something they can pull out of a hat.
It’s a complex issue because builders are facing crazy increases in costs and lengthy delays.
I’m working on two files right now where clients have sold their pre-build contracts (called an assignment) because the sellers’ circumstances have changed and they want to walk away from their agreements.
If you are considering purchasing a pre-build, I encourage you to read and understand the entire contract before signing. Make sure your legal representative reviews it for you and with you so you are clear on what you are signing. Doing your due diligence may save some serious heartache down the road.
This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.