the newsletter of tbd consultants - 4th qtr 2014
Printable PDF version
Condo development was hit badly when the Great Recession hit, as were most other sections of the construction market, but while other sections are rebounding nicely, the condo market is lagging behind. What are the reasons for that?
One item that comes to the forefront is litigation. Unlike an apartment building that has one owner (or one owning corporation) that might instigate legislation for defects, a condo has owners for each individual unit, plus a home owners association, and any of those can bring a case. That has led some people to say that litigation on a condo project is inevitable. And while the case may start out over a specific issue, it is normal for the plaintiff’s lawyers to initiate a survey of the building to ferret out anything that can be classed as a defect or code violation and add it to the case. In some states, the contractor has the right to remedy a defect before litigation is commenced, but that option is not available everywhere despite the efforts of some people to introduce it.
The cost of defending against such litigation can often substantially exceed the cost of repairing any defects, and that fact has been noted by the insurance companies. Consequently, the cost of insurance on a condo project can often be around three times as much as that for a similar sized non-condo construction project. One method that has been used to mitigate this risk is to design the project for future use as condominiums, but initially market the project as apartments until the statute of limitations for construction defects has expired.
The availability of financing has been a problem for all forms of construction projects since the financial meltdown occurred, but while banks are starting to move back into the market, they tend to be more reticent with regards to condo projects because of the higher risks involved. Where commercial banks are starting to consider construction loans for condo projects, they tend to require that the developers and contractors be long established, stable corporations, well used to this market sector. That is a good practice that we will return to later.
One method that developers have come up with to solve their financing problems is to demand higher deposit payments during the construction phase from potential owners. Whereas in the past a buyer might have had to put up 10% - 20% before the unit was ready, now it can easily range from 30% through 80%. This is good for the developer, because he may not need bank financing at all, or at least only at the later stages of construction. The buyer does run the risk of potentially losing a substantial amount if the development is not completed for any reason.
When litigation does occur, the contractor and the developer are obvious immediate targets, but the design team are also almost inevitably brought into the case as well. A case in California ended up involving the design team even when the contractual documents between the architect and the developer specifically excluded liability to subsequent building owners. But having clauses in the contract that define the design team’s responsibilities and limiting liability to third parties is certainly recommended. It must be remembered that projects like condos have a lot of repetitive elements, so the design team may be paid for doing one detail that gets repeated hundreds of time, and if there is one problem in the design, it can lead to hundreds of identical problems in the building.
The practice that the banks have, of ensuring that the developer and contractor are long established, stable corporations, with a good history of condo projects, is one that the design team should use as well. If the developer is an LLC set up specifically for this project and is disbanded on completion, and the contractor has either gone bankrupt or otherwise closed up shop, the design team can be left as the only party the home owners association (HOA) can take legal action against.
Since code issues are obvious points for an HOA and its lawyers to pick on, having a code consultant on board for the duration of the project is advisable, and making sure all design consultants are current on codes for the state the project is in, is also essential. Ensuring that the budget is adequate for the project will help ensure that defects are less likely to be caused by cost-cutting methods.
It is possible that apparent defects are actually the result of poor maintenance of the building, so ensuring that the HOA is given a comprehensive maintenance manual, and is obliged to comply with it, is another good risk mitigation practice.
Using tried and tested building practices is one way of reducing the risk of construction defects, but the demands for energy conservation and other green building practices are pushing construction into new territory. For something like a condominium, the use of systems that require correct manual use by the residents is almost certainly going to result in problems sooner, rather than later. For instance, if providing adequate ventilation requires opening windows, then it is only a matter of time before mold starts to occur in some units.
Now that the economy is improving and more people have jobs, home ownership is becoming more fashionable and the condo market is becoming attractive and profitable once again. But good risk management is essential to ensure that profit is not only for the lawyers. The AIA has a white paper that includes ‘risk management recommendations for condominium projects’ available on its Web site.
New from abroad has been hitting the headlines a lot recently. In this article we look at how events at home and abroad are likely to affect the construction market.
California Schools Energy Boost
In this article we take a look at California's Clean Energy Jobs Creation Fund, which provides finance for energy-efficiency projects at schools and community colleges, helping them to reduce running costs, improve the environment, and create jobs.
Design consultant: Katie Levine of Vallance, Inc.