Pre-Construction Deals Create a Dishonesty Option

If you buy a pre-construction home, both you and the builder are committing to a price in advance.  This can be a good deal for both parties in that you and the builder get some certainty in the price you’ll pay.  However, once the home is built and we see which direction housing prices moved during construction, we find out whether you or the builder came out ahead on the fixed price agreed in advance.  This creates incentives for dishonesty.

If housing prices rise before construction is finished, the builder would rather cancel the deal with you and sell the home to someone else for a higher price.  In theory, the contract you have in place prevents the builder from getting out of the deal.  In practice, there are manoeuvres the builder can try to get out of the deal with you.  The more housing prices rise, the greater the builder’s incentive to break the deal.

This creates a “dishonesty option.”  For a builder prepared to get out of the deal with manoeuvres of questionable legality if there’s enough money at stake, the original deal with you looks like a financial option, similar to a stock option.  If housing prices are flat or fall, the builder just fulfills the contract with you.  But if housing prices rise sufficiently, the builder plays games to get out of the deal.  So, from the beginning, the contract with you came with a dishonesty option to get either the contracted price or more.

This is just one of the many reasons it makes sense to do business with honest people.  I’ll leave it as an exercise for the reader to decide which recent headlines inspired this article.