The Economist: Constructive criticism in order

According to Rent.com, Denver has the sixth highest lease costs in the nation behind four California cities and New York. Given housing is a large percentage of personal budgets, high housing costs will ultimately create wage pressures in the area and make much of Colorado’s economy less competitive. Construction defect litigation not only helps drive up the price of housing; it virtually eliminates the construction of moderate priced condos and townhomes.

My dad was a construction contractor who refused to build homes. He concluded emotions are too high when it’s someone’s “dream” house. Completion is in the eye of the beholder and there is nothing worse than working for someone with little sense of reason or fairness. Actually there is something worse – becoming the target of a group with far greater power seeking substantial personal gain. This is the current state of homebuilding in communities that do not limit construction defect litigation. There is always a “defect” if one is incentivized to look hard enough. We have all heard of the over-exuberant lawyers pursuing medical malpractice and driving up costs. Now we have construction malpractice. Why? 

The United States has always been a nation of lawyers – and we benefitted greatly from their pursuit of a “more just” society. In 1890 there was one lawyer per 700 people according to the American Bar Association. By 2013 the number increased to one for every 250 people. By comparison, there is one dentist per 1,635 people. The relative number of lawyers almost tripled as the baby boomer generation entered the labor force from 1970 to 1990. One would assume that as the number of lawyers grew dramatically, the attractiveness of the legal profession would erode and fewer people would enter the profession. Last year was the first year since the 1970s that the number of students entering law school actually declined, and the number of lawyers per capita has remained pretty steady since 1990. In the world of economics, it appears demand for legal services kept up with the rapid supply growth. And this makes sense given the nature of the law. The legal profession has more latitude when it comes to creating demand, especially when almost 50 percent of American politicians are lawyers.

Now, this is not to say construction defect litigation is unwarranted. Producers of any product are aware they must hit the “sweet spot” between cost to produce and the price they can charge, which is predicated on perceived value. This formula is especially relevant in housing because there can be many hidden construction issues, despite a surface product that appears flawless. The operation creates the potential for what economists call “asymmetric information,” where the seller fabricates a false perception of top quality. 

While there were egregious instances of defects historically, it was by no means the norm – possibly due to the threat of litigation as a deterrent. As is often the case, legislation tends to follow litigation and an extensive system of building codes developed along with government structuring  oversight departments with frequent inspections. New home construction may be the most highly regulated small business sector today. One could argue regulated standardization combined with inspections justifies eliminating litigation unless a homebuilder intentionally deceives inspectors. Clearly the pendulum has swung too far in favor of lawyers and both home buyers and builders are incurring the cost.

Construction defect litigation is a major issue in Colorado. It impacts housing costs and choice. Strong household growth and changing preferences are driving new housing demand along with declining interest rates, lower down payments for first-time homebuyers and lower mortgage insurance premiums. Clearly pent-up demand exists for more affordable, higher density new housing – and that demand is getting stronger. The problem is there will be little new supply of condos and townhomes for purchase. The risk of litigation is just too great for homebuilders. As such, rents will continue increasing and Colorado’s competitiveness will erode. Something must be done.