Last week, I came across a clause in the purchase contract that raised some concern.
My client is in the middle of a pre-construction purchase. The clause in the contract is categorized as a “cost escalation adjustment”. Exactly as this sounds, it is a clause that allows the constructor to increase the cost beyond the amount agreed upon in the original purchase contract.
In short, text part of the sentence as follows:
“Both the Builder and the Buyer agree that if, on or before the date of excavation, the aggregate construction prices increase by more than four percent (4%) of the construction prices, as of the date of this Agreement, as determined in the builder’s sole discretion, the Builder and the Buyer may For the constructor either:
• Starting construction, as the purchaser’s price for the land and housing unit must increase (as explained in Clause 5 of this document) and thus distribute the price to the building (as specified in Clause No. 20 here) by an amount that does not exceed the price increase ceiling
• Re-negotiate the terms of this Agreement with the Buyer in good faith. or
• Cancellation of this Agreement”
This paragraph represents a quarter of the entire cost escalation adjustment line item. He goes on to explain the various points during construction where the developer has the ability to increase the price of the home or cancel the agreement altogether.
So some big things here:
• This paragraph is an excellent example of the importance of fully reading and understanding the contract you are signing.
• This clause highlights why your legal representative should review the purchase contract before removing all of your subjects and making a confirmed purchase agreement.
• This clause means that you will not write an offer anywhere near the maximum mortgage amount to allow for any potential price increases
Why is this even important? From a mortgage perspective, my clients often write offers at their highest price point. I would have preferred that they did not but in our market finding an affordable home is not always an option.
Sometimes clients just expand to get the minimum down payment together. Facing a significant price increase will likely mean that they will need to make more of their down payment.
For example, I’m working with a young couple in northern British Columbia who have written a proposal for a new home due for completion in August. This clause is not in their agreement but if it is, they may find themselves looking for a different home if they cannot find additional funds for the down payment.
They are at the absolute high end of what they qualify for in terms of a mortgage. The purchase price is $740,000. If their construction cost increases by three percent, they will need to file an additional $22,200 because they do not qualify for a higher mortgage amount.
Also, changing the price point may have other, more costly effects.
In British Columbia, for new buildings worth up to $750,000, buyers are exempt from paying transfer tax. In this same example, if the price of the house goes up to $762,200, they will also be liable to pay the transfer tax. In their case it would be 13,244 dollars.
Now they’ll be scrambling for an extra $35,444. For many clients, this is not something they can pull off the hat.
It’s a complex problem because builders face crazy cost increases and long delays.
I’m now working on two files where clients have sold pre-build contracts (called a job) because sellers’ circumstances have changed and they want to move away from their agreements.
If you are considering purchasing an advance edition, 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 about what you are signing. Doing due diligence may save some serious heartache down the road.
This article was written by or on behalf of an outside columnist and does not necessarily reflect the views of Castanet.