Homebuilders Undermined by Cost of Construction Boom's Flaws

Homebuilders Undermined by Cost of Construction Boom's Flaws (Seattle)

By Kathleen M. Howley and Peter Robison
Saturday, February 12, 2011

SEATTLE - Seattle city planner Alan Justad is reviewing a project that will bring back the cranes, dust and noise absent since the real estate bust. But this project will subtract from the skyline rather than add to it.

The owners of McGuire Apartments opted to tear the 10-year- old tower down after discovering corroded support cables and other faults that would cost $60 million to repair, almost double the tab to build it. "We've never had anything like this happen before," said Justad, who expects demolition of the 25- story structure to begin later this year.

The construction boom between 2000 and 2005 added more than 10 million apartments, condominiums and single-family homes to the nation's housing stock. It is still generating a repair bill for construction flaws that may hamper the industry's recovery, as homes with cracked foundations and sagging ceilings add to the supply of hard-to-sell properties.

The rush to meet demand fueled by low interest rates and liberal lending resulted in a doubling of defects per unit from 2000 through 2005 compared with the previous six-year period, according to International Association of Certified Home Inspectors estimates. Add to that the litigation legacy of allegedly dangerous Chinese drywall imports, and builders are facing a growing liability headache.

"It's yet another detriment to real estate values,'' said Vicki Bryan, an analyst at Gimme Credit in New York. "Homebuilders don't want to draw attention to it, but they've got creeping costs for construction defects.''

PulteGroup, the largest U.S. homebuilder, recorded a one-time expense of $272.2 million in the third quarter, or 25 percent of its revenue in the period, to increase the reserves that cover losses when homeowners demand repairs to new houses. Chief Financial Officer Roger Cregg told analysts on a Nov. 3 conference call that there were a "greater frequency of newly reported claims'' by people with company-provided warranties against defects.

Claims for defects can take time to surface, because typical construction warranties are good for a decade - which is also the amount of time many states allow for filing lawsuits for alleged defects.

That could mean some builders will need to set aside more money for repairs and legal claims in years to come, said Ron Kozlowski, a Hong Kong-based senior actuary at Towers Watson, a consultant to insurers.

"Their liabilities are underfunded," he said, not specifying the builders. "They have their heads in the sand."

Replacing faulty Chinese drywall in U.S. homes may cost more than $15 billion alone, Kozlowski estimated. He said he has reviewed claims for other failings totaling $15 billion to $20 billion, including the kind of water intrusion that doomed the Seattle apartment building.

"The whole construction defect issue is multiples" of the drywall amount, Kozlowski said.

Last year, new home sales totaled 321,000, the lowest level in data dating to 1963, according to the Commerce Department. This year, weak demand and foreclosures may make it harder for builders to maintain profits, Michael Widner, an analyst with Stifel Nicolaus in Baltimore, wrote in a Jan. 27 note to investors.

Lawsuits over defects in states where homes went up most quickly may be years from peaking, said Paul Amirata, chief executive officer of Amirata Claims Consulting in Livingston, N.J.

Horton, the second-largest homebuilder, put its net liabilities for construction defects and other claims at $319.8 million on Sept. 30, more than double the $137.2 million on Sept. 30, 2003. The increase was due to the number of homes built, not any decline in quality, said Horton spokeswoman Jessica Hansen.

The availability of general liability insurance for homebuilders and subcontractors has become increasingly limited and more expensive in recent years, according to Pulte's third-quarter filing with the Securities and Exchange Commission, which didn't provide pricing details.

The companies are finding it more difficult than five years ago to tap insurance to cover payments to homeowners because insurers have added so many exceptions, said Dave Stern, vice president at West Coast Casualty Service, an insurance adjuster in Westlake Village, Calif.

In California, "basically, the thing leaks, it's the builder that's liable," Stern said.

At Pulte, most of the claims in the third quarter were related to water intrusion, Chief Executive Officer Richard Dugas said on the Nov. 3 call with analysts.

- Bloomberg News
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