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The Next Condo Wave and Risk
Apartments have been the leading project type, particularly in hot markets of Washington, D.C, New York, Chicago, Los Angeles, and Atlanta for the past three or four years. Industry experts expect 285,000 more units in 2013 and 320,000 in 2014. The rental-building boom is leading the way for the next wave of condominium projects. Planning and Zoning Commissions across the country are approving new projects including mixed-use, condos. Adding a risky twist to the most litigious project type, many under-construction apartment projects are expected to convert to for-sale condo units at a future date.
Rents have increased in 82 markets tracked by Reis Inc., a real estate data firm and are at record levels in 74 markets. Los Angeles, occupancy rates are about 98%. New York City had an average rent of $2,950 a month, up 1.7% in one quarter. Conditions that are driving up rents and making purchasing a condo more attractive in today’s market including low interest rates on home loans. One of the nation's largest builders recently introduced a line of homes marketed as being more affordable than monthly rents.
Across the country more condo projects are popping up. High-profile projects across the country that were stalled during the economic downturn are now being restarted. The Planning and Zoning Commission of Westlake, Texas recently gave conceptual approval for an 85-acre, $500 million mixed-use development. The Westlake Entrada project will include 322 residences, made up of townhouses, condos, hotel, restaurants, retail shops and an amphitheater.
In Los Angeles, three Arts District condo developments that recently opened are all completely or nearly sold out. Only 64 condos were recently available on the Multiple Listings Service (MLS), and that many of the residences that hit the market generated multiple offers. Forward-thinking developers recognize the opportunity in the evolving market and are already planning for the next condo wave.
Condos - The Most Litigious Project Type
Condominium projects are by far the most litigious project type for all parties involved; developers, contractors and especially design professionals. Based on industry claims data including a recent SmartRisk Survey of A/E Law Firms across the country that specialize in design and construction litigation, condominium projects continue to be the most litigious project types with 28% of all claims. From an industry wide perspective, multi-family, condo projects constitute five percent (5%) of design fees but account for 20% of the total losses. Frequent categories for condo claims include:
- Foundations
- Roofs
- Waterproofing
- HVAC
- Soundproofing
Causes of Condo Claims
- Condo buyers are often first-time homebuyers, older homeowners or empty nesters that feel they are purchasing maintenance free homes. Based on that assumption, necessary maintenance for units, the complex and common areas are not performed.
- Homeowner's associations (HOAs) do not obtain adequate dues for the inspection and ongoing maintenance of common areas and building exteriors resulting in failure.
- Aggressive law firms target condominium HOA boards for their services. Experts are hired to inspect the condominium property to find any alleged design or construction defects that are used as the basis of a lawsuit.
- A “shotgun” approach is used against all involved in the project including the developer, design firms, and contractors that are named as defendants.
- This all in “shotgun” strategy causes higher defense costs for all parties that scare the parties resulting in usually a settlement instead of an expensive and time consuming legal battle. A pattern that plaintiff attorneys are well aware of.
- Design firms are often not given the opportunity to provide construction phase services.
- Inferior construction, a lack of skilled laborers in the construction process along with builders substituting less expensive, quality materials to save money.
- Developers set up separate limited liability corporations (LLC) for developing a single condo project that is later dissolved. The design firms and their professional liability (PL) policy will be seen as one of the only deep pockets standing that are targets of the plaintiff attorneys.
Condo Conversions
The risk on condo projects increases even further when they are initially designed and built as rental properties and converted to condos at a later date. In most cases, apartments fail to match the construction strength of an originally designed and constructed condominium project. Apartments routinely have thinner walls, smaller separation set out between the floors, and lower quality insulation.
Where a risk and duty was with a single project owner on the apartment project, once a project is converted to condos, you now have a duty and associated risk to numerous condo owners and the HOA. If you are designing a condo project, or an apartment project that has the possibility of being converted into condominiums, there are certain precautions you should take.
Risk Management Strategy
It is important that during your initial discussion with the project owner, discuss the risk of a conversion. Document this discussion and include a provision in your contact agreement that your services and construction documents are intended solely for the design and construction of the apartment project under the agreement. Discuss and document that in the event the project is changed to any other use, including for-sale condo units, you have no responsibility, and will be released from all obligations and liabilities. It is important that the project owner understands and agrees by contract they are prohibited use of the construction documents in the conversion of the project.
For new condo projects, an upfront discussion with the project owner is important about the risks inherent in condominium projects for all parties. Discuss the need for a project specific risk management strategy. There are many considerations, however one important item is the maintenance of the individual units, property and common areas. Specific duties and responsibilities should be clearly stated in the association and homeowner documents binding the homeowners and the HOA. This strategy provides protective and corrective measures for the builder, design firms and contractors. Other topics that should be be included in the homeowner documents; a property inspection by homeowner, acceptance, right to inspect and repair, pre-litigation process, certificate of merit, maintenance manual outlining responsibilities.
Request that the project owner purchase an Owner Controlled Insurance Program (OCIP), also called a wrap policy. The is a general liability (GL) policy providing coverage for the general contractor (GC) and subcontractors for bodily injury (BI) and property damage (PD) on the project. Request that the policy have a "Professional Services Endorsement" for the Design Professionals for BI/PD coverage. The coverage should remain in force for the state statutory limit following the completion of the project.
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