How Can I tell If a Homebuilder is Stable or is going Bankrupt?

Question: I'm interested in purchasing a home in Del Webb's Shadow Hills project in Indio, Calif. I note that Pulte Homes, which builds the homes there and may even own Del Webb (or vice versa), is on the danger list on the Home Builder Implode-O-Meter Web site. Any thoughts or recommendations? Should I stay away from this Del Webb community?

Answer: Pulte Homes Inc. owns Del Webb, of that I'm sure. But otherwise, who knows? This is a tough, tough market, and only time will tell which builders survive and which do not. I hesitate to give more than general advice about any particular builder because I have no greater insight than anyone else, save for perhaps a stock analyst, who should be able to go over the company's financials and determine whether or not it has any staying power left. But I will say this, though: Pulte did pretty well in J.D. Power Co.'s most recent home-builder customer satisfaction study. Why is this important? Because in times like these, the first thing many builders cut back is customer service. Once buyers close and move in, they are often forgotten because a troubled builder is concentrating on selling other homes, not making previous buyers happy. But Pulte brands (which besides Del Webb include DiVosta Homes) ranked highest is customer satisfaction in 11 of the 33 markets surveyed. You can find the rankings for all 33 markets here. "In 2008, a wide variety of home builders perform(ed) well," said J.D. Power's Paula Sonkin. "In the midst of the volatility that has defined the overall housing market during the past two years and has caused several home-building companies to go out of business, many local and regional builders have seized the opportunity to attract and serve potential home buyers."

Also, let me point out what the Home Builder Implode-O-Meter itself points out: The builders on its watch list are not necessarily in deep do-do. The companies may have gone through some kind of adverse change -- perhaps a key executive has stepped aside -- but they are still up and running, the Web site notes in its fine print. Other possible setbacks include a steep and rapid decline in the firm's value -- and what big builder hasn't experienced that kind of fall from grace? -- or there may have been a rescue by a parent company.

Beyond that, it's always wise to make sure your prospective builder has a solid foundation, not just in these troubled times but always. Doing this kind of legwork isn't simple, but it is worth it. Otherwise, you could end up going down with the ship. There isn't any precise way to research a builder's staying power, but here are some steps you can take to protect yourself against the possibility the company might fail:

1. Check with your local courthouse to see if any of the builder's subcontractors and material suppliers have filed liens because they have not been paid. "Follow the money," says an Idaho builder who asked to remain anonymous for fear of being ostracized by his colleagues. "Once a lien has been filed, 70% of all builders won't be able to dig out from under. So this rolls right to the issue of stability." It's not uncommon for a builder to use his cash to meet his own payroll before paying any or all the 120 or so vendors who work on a house, hoping he can use cash from the next sale that comes through the door to pay for the work and materials on the previous sale. Subs and suppliers often let a builder slide because they want to keep working too. But only for so long. When it becomes evident to them that the company is in dire straights, they file liens against the builder so they'll be in the line of creditors should the builder file for bankruptcy.

2. Talk with the subcontractors you see working on the project. "We hear from subs about slow pay problems long before a builder files for bankruptcy," a Maryland consumer affairs expert advised me a long time ago. Even if they aren't being paid on time -- a sure sign of cash flow problems -- they might remain mum. But one or two may be angry enough or so far behind that they'll spill the beans. After all, they are consumers too. While you are walking the job, look for tell-tale signs of problems. Lack of activity is one. The absence of building materials is another. Sales are slow these days, to be sure. But if there are no signs of activity, the pace may be too slow to carry the project.

3. Require the builder to provide lien releases signed by every vendor on the job saying they have been paid. This may be a logistical nightmare for the builder, but if he wants your business, he may agree. Sales are hard to come by these days, so a builder who is in good shape may agree to do this just to ease your concerns.

4. Ask for permission to speak with the builder's bankers about his financial strength. Lenders are often the last to know when a builder is in trouble. Still, a builder who balks at your request may or may not be trying to hide his difficulties. But in today's troubled times, a sound company shouldn't have any problem with this request either. And if the builder does agree, the bank has a duty to be honest. If not, it could be held liable if the builder folds.

5. Demand that your deposit money be held in a separate escrow account. In most states, builders are permitted to place earnest monies into their own accounts and use the funds to operate their businesses. But in today's market, some will use your money to finish the previous buyer's house, again hoping to use the next buyer's money to work on yours. Builders may balk at first, but if it means the difference between a sale and no sale, they should cave. "I've never seen a single builder blow a deal over (earnest money), not one," says an Ohio buyer-broker.

6. Ask for the names of the company's most recent buyers to get their take on the builder. One of the first places a builder in trouble will cut is warranty work, so you'll want to know whether or not the company is attending to so-called "punch list" items in a timely manner. Also ask if the builder cut corners, switched suppliers in midstream -- say from one appliance maker to another -- without notice or permission, or has generally failed to be responsive.

7. Add a "springing" provision to the sales contract. This is a clause that allows you to back out of the deal if the builder files for bankruptcy. Builders typically won't let a buyer amend their standard contracts. But today's housing market calls for extraordinary measures, so a sound builder shouldn't have any trouble with this consumer protection.

8. Another place builders tend to cut early is office personnel. If the company lays off construction staff, it could simply be phasing down to get in step with the slowing market. But if there is no one to answer the phone and direct calls, trouble may be brewing. Ditto if the builder has canned project superintendents, estimators or design and sales and marketing staff. These are all "lifeline" positions, so if these key personnel slots are vacant, buyer beware.

9. Consider taking out a construction loan, one that automatically switches to a permanent mortgage when the house is completed, in your name. That way, the builder will be paid in draws only as various phases of construction are completed. If the builder fails, you'll be left with a partially completed house that very likely will cost your more to finish than you originally planned to spend. But at least the unfinished place will be yours. You won't lose your deposit, and your house won't be tied up in legal proceedings.

10. Make sure the builder offers a third-party warranty. This won't protect you if the business goes under while the house is under construction. But if the builders goes belly up after you move in, the warranty company should step forward to make whatever repairs are necessary. Many builders have their own one-year warranties. But they aren't worth a hoot if the builder is no longer around to back it up.

Nationally syndicated columnist Lew Sichelman has been covering the housing market for 35 years. Because of the volume of mail he receives, he cannot answer individual questions, nor can all questions be answered in this space. E-mail lsichelman@aol.com