Who Pays: Builder or Buyer?

Who Pays: Builder or Buyer?

By David R. Corder

Associate Editor

After four hurricanes struck the state last summer, homebuilders in Florida experienced an unwelcome reality. They had to compete with reconstruction efforts for already scarce building materials and labor. Construction costs increased even more, project delays ensued.

Last November, for instance, homebuilding giant Pulte Homes Inc. advised its stockholders the storms delayed the opening of several new communities in Florida. It cost the Michigan-based homebuilder about $13 million in pretax income.

Those storms also affected smaller-scale builders such as Whitehall Quality Homes Inc., the operating subsidiary of Sarasota's Whitehall Ltd. Earlier this year, the publicly traded parent company blamed the storms for a decrease in revenue of almost $4.8 million in the third quarter ended Dec. 31. Costs of sales alone increased nearly 64% to $35.9 million for the nine months ended Dec. 31.

This problem put Whitehall in a delicate situation. Costs had increased beyond budget on some of the homes it had under contract, the company advised some of its customers. It left Ron Mustari, the company's president and CEO, with two difficult alternatives: either absorb the cost or pass it on to his customers. He chose the latter.

Last month, Mustari sent warning letters to at least 11 individuals and couples who had signed contracts on new homes in Waterchase, a gated subdivision off Race Track Road in northwest Hillsborough County. He told them he regretted the action.

"The hurricanes of 2004, higher interest rates along with material price increases have placed all builders and developers in a perilous position," Mustari advised the Waterchase customers. "The allocations of cement compiled with the shortage of labor have forced builders into paying subcontractors and suppliers higher cost, which must be recognized."

That was not good news for customers such as Perikles and Melissa Kranias, who had hired Whitehall to build a single-family home for $303,461 on Mirasol Manor Court. Theirs is one of several homes Whitehall has under construction in this tranquil neighborhood.

"We regret the necessity of increasing the cost of your new home," Mustari advised the Kraniases. "Please be advised the cost of your increase will be $60,000" - a 20% increase.

The price hike also shocked Whitehall customers William Hartwig and Seth and Erin Kautz. The company sought an 18% increase on the contract on Hartwig's $337,448 home and a 15% increase on the Kautzes' $302,574 home contract.

Clause in contract

Despite his regrets, Mustari left no room for negotiation. Whitehall gave his customers 10 business days to respond. "No response by you within the given timeframe will automatically cancel your contract, and we will refund your deposits," he warned.

In response, 11 of the Waterchase customers sued Whitehall last month in the Hillsborough courts. They want a judge to enforce the contracts.

"I don't how far (Mustari's) going to try and go with this," says Brian Deeb, the St. Petersburg attorney who represents the 11 Waterchase homebuyers. "We're going to fight it all the way. There is an enforceable contract for a set price."

Although he declined an interview request, Mustari says in a prepared statement those contracts contain a legally binding clause that permits him to raise costs.

"In our contract, which is prepared by legal counsel, the builder has a right to increase home prices to cover material and labor increases builders incur in the process of developing and building new homes if delays occur no fault of the contractor," Mustari writes. "These clauses appear in all our contracts and are normally discussed when contracts are being implemented."

Mustari's contention is disputable, Deeb argues. He agrees that homebuilders have the right to pass on costs to the homebuyer if the contract specifically mentions which costs.

"There may be provisions in contracts where the homeowner agrees to (the increases)," Deeb says. "That's simply not the case here. (Mustari's) relying on provisions for owner delays and owner issues that have nothing to do with builder delays and all the things that are happening in this contract.

"I don't know what is his motivation," Deeb adds. "Obviously, something is going on at their end because they haven't been keeping the construction timetable they promised in the original contracts. Obviously, my clients are not going to bear the expense because of Whitehall's fiscal mismanagement."

Volatile pricing problems

The issue of material price increases has become a major concern throughout the homebuilding industry.

"Pricing has been extremely volatile and unpredictable," says Joseph Narkiewicz, executive vice president of the Tampa Bay Builders Association. "Price increases on materials have gone up so much that something needed to be done to make the customer aware of pricing and to protect the integrity of the contract. So many builders have updated their contracts to reflect these prices increases."

About a year or so ago, Land O'Lakes homebuilder Doug Tripp modified his home sales contracts to include unexpected price increases. Unlike Whitehall, however, his Tripp Trademark Homes only demands a price adjustment prior to the start of construction.

"It gives three days notice and a full refund of the deposit," says Tripp, whose company is ranked by Builder Magazine as one of the fastest growing U.S. homebuilders. "Having said that, I've never raised the price on a customer."

To avoid such cost overruns, Tripp tries to stagger his construction schedules. "I haven't heard of midstream builders saying their budgets are off and (the customer) has to pay the price increase," he says. "Yes, you have to make a fair profit. But it's not the customer's fault if you didn't hit the mark. They didn't create the price. You did. You hope you just don't make the same mistake again."

It's not just the Hillsborough customers who have complained about Whitehall's price increases. Two customers in Manatee County have sued the homebuilder over pricing disputes. They signed contracts on their homes prior to last year's storms.

Sarasota attorney Bill Fuller III has questioned the authenticity of Whitehall's contracts. He claims Whitehall was not a licensed general contractor at the time company officials negotiated the contracts. If so, he says that makes the contracts null and void.

"When you recover damages against an unlicensed contractor you can recover treble damages," he says.

In the Manatee lawsuits, Fuller argues Whitehall didn't even own the lots when it signed the contracts. The judge assigned to these lawsuits has ordered the parties to mediate a resolution prior to litigation.

"If there are delays beyond (Whitehall's) control they have rights under the contract," Fuller says. "However, in both of my cases, the contractor did not even own the lots they were going to build on until six months after they signed the contracts. After waiting six months to pull permits and buy the land, they demanded more money."

On the other hand, Mustari describes the complaints against his company as isolated matters.

"A group of homeowners, 11 to be exact, have decided to challenge our contract right to secure material price increases while building their new homes," he writes. "Thus, we are in the process of handling their complaints. These material price increases have been accepted by the majority of our homeowners who, together with their respective attorneys, have agreed that the price increases are justified."

Whitehall Ltd.

Financial Statement

(Nine months ended Dec. 31).

2003 2004

Revenue

Home and lot sales $28,054,658 $44,486,519

Other income $71,965 $77,307

Total $28,126,623 $44,563,826

Costs & Expenses

Cost of sales $22,007,244 $35,984,686

Selling $2,428,391 $3,410,210

General/admin $1,063,702 $1,650,309

Interest $143,839 $136,971

Total $25,643,176 $41,182,176

Income from operations $2,483,447 $3,381,650

Income applicable to interest

of joint venture partners $286,823 $1,860,267

Income before taxes $2,196,624 $1,521,383

Provision for income taxes $846,300 $613,000

Net income $1,350,324 $908,383

Earnings per share $0.09 $0.06

Shares outstanding $14,291,059 $14,182,977

Source: U.S. Securities and Exchange Commission