New Construction Condo 10% holdback Legislation

THE NEED FOR A NEW CONSTRUCTION CONDO BUILDING
10% DEVELOPER SALE ESCROW HOLDBACK
UNTIL THE DEVELOPER TRANSFERS AUTHORITY
TO THE NEW CONDO ASSOCIATION
AND ALL CONSTRUCTION COMPLETION IS VERIFIED

WHY LEGISLATION?

The intent of this article is to set out the case for State and/or local Municipal legislation requiring essentially the title of this article. Full State legislation is the goal and the better option. Having the types of requirements, as outlined in this article, only present on a Municipal level could result in economic disadvantage for those Municipalities. In high development demand municipalities this would likely be less of an issue than in other locations. If the legislation were to end up overly cumbersome to deal with, housing development could be negatively impacted beyond reason. I bring this up as a cautionary note; not as a negative point of the legislation.

The need for this type of legislation has shown itself time and again during inspection of new construction condo buildings during the homebuyer buying process and post purchase Condo Association consulting work.

This proposal is unlikely to be popular among Developers and others in the real estate industry. Obviously anytime someone is potentially looking at having their money held back for a while rather than immediately in their pockets, someone isn’t going to be happy. There would likely be heavy opposition to such a requirement. Nonetheless field experience has shown that it is a needed piece of legislation that should be considered in order to protect the public and maintain housing stability. This is about protecting the home buying public from suffering due to the profits of others that did not meet their obligations as advertised or implied. While the demographics will obviously vary, from my experience, many of the effected buyers tend to be younger 1st time buyers who can ill afford additional costs related to an incomplete Condo building.

OUTLINE OF LEGISLATION

o Body of Legislation; Purpose, Intent & Clarifications

o Reporting requirements by Developers

o Condominium Association rights and redress

o Escrow rules and final distribution

o Inspection guidelines and approvals

o Penalties for non-compliance

o Authority Having Jurisdiction (AHJ)

o Building types, limitations and exclusions

THE EXTENT OF THE PROBLEM

Over the years I’ve inspected a lot of new construction Condo buildings for buyers. Some of this work has come from direct calls from buyers; some of it comes from referrals by other inspectors due to my experience in this field. Other inspectors I know have also had to deal with this issue.

The problem essentially is this, not all developers finish all the ‘Building common elements’ of a new construction building. The ‘common elements’ are essentially all the parts of the building outside of the ‘Condo unit and any related unit owned amenities’ that would be the responsibility of a unit owner. Unit owner responsibilities might include their basement storage locker or rear deck. Common elements that sometimes don’t get finished by developers would include such items as not installing the heaters in the garage that were advertised, insulation, painting or caulking of exterior components, finishing floor coverings, advertised amenities and roof components. There are of course many more such items but you probably get the idea.

At some buildings we have inspected the Developer has done a very good job of completing common elements in a good sustainable workmanlike manner. I say ‘sustainable’ because one of the common issues is ‘poor installations that result in significantly reduced life span of components’. This often involves exterior common elements. As an example a well installed flashing or caulk joint could keep water out of the building for many years. A missing flashing or caulking done during very cold weather can fail within only a couple short years or less. This of course can lead to premature repair or maintenance costs for an Association.

At other buildings with less conscientious developers a fair amount of work is left incomplete or not installed at all. Sometimes this is something as simple as the developer never coming back once the weather gets warm to finish landscaping. Landscaping may not sound like a big deal but costs can add up. Especially for new Condo unit owners who don’t have landscaping experience, don’t know who to call and aren’t sure exactly what should be done. As a side note, installing landscaping one way can lead to recurring costs. Doing landscaping another way can provide for much more sustainable conditions that have minimal recurring costs. A developer typically takes the cheaper route but at least the landscaping was done.

More substantial costs occur to a new Association when Developers don’t finish a lot of smaller issues in multiple trades or a few costly technical items. If a Developer doesn’t finish a few electrical items, a few plumbing items, a few stairwell items, etc. then an Association has to get proposals from multiple contractors. This can be very time consuming and costly for inexperienced unit owners. Or in the case of not installing garage heaters or finishing roof top decks and amenities, costs add up not just for work but also for materials. Once again, an Association ends up having to significantly adjust their financial outlook and monthly assessments. Unrealistically low initial monthly assessments can also be an issue for a new Association over time but that’s another problem altogether.

There can be of course multiple reasons for a developer to not entirely finish a project. The Developer doesn’t care, he ran out of money or there were financial missteps during the project. Inexperienced planning or contractor issues are also some of the common reasons.

These may sound like pesky little grievances. However they are common incompletion issues in new Condominium buildings. Granted, mistakes happen on jobsites and contractors forget to finish some things. But an incomplete job can also be a financial benefit to the developer. Not pushing subcontractors to get all the pesky little common area details done can save a Developer a good amount of money at the end of a project. There is no absolute way to ensure or control if building common elements are completed. However, this legislation would be a great step in that direction.

When looking at a Condo purchase it is important to not only look at the Condo itself but also assess general building conditions. Has exterior concrete been completed; is there any landscaping; are porches complete; are roof terminations fully and properly installed; have the exterior of doors and windows been fully covered & caulked; are corridors & stairwells fully finished; are basement areas cleaned out; are the garages complete?

Building conditions and repair costs will in part become a liability factor for a unit owner. How much any such building repairs will cost is always a big question. To some extent that depends on the component and to some extent it depends on how soon repairs are performed.

In the end, what these means for a new Association is that the Association / unit owners will be looking at completing non-finished items in the short term at their expense rather than the Developer having done what he had advertised or implied at his expense. One could view this as basic capitalism or one could view it a bit more skeptically as someone gaining more profit at the expense of others.

At times myself and other inspectors I know provide consulting services to new Condo Associations that have ended up having to deal with these types of incompletion issues. One could say it isn’t fair for new unit owners to have these types of issues. While that is true, life isn’t fair. More importantly this is about protecting the home buying public, getting developers to do what they said they would do and maintaining housing stability.

WHAT’S THE SOLUTION TO THE PROBLEM?

This would be a case of the Legislature stepping in to protect the Condo buying public from a problem, that sometimes doesn’t occur, sometimes occurs in manageable ways, and other times occurs in very severe ways that affect the financial stability of owners and neighborhood stability along with taking an emotional toll on new owners. One cannot say in any certain way how unfinished Condo building common elements will effect an Association and its individual members. Every building, its conditions and the related finances vary too much. Nonetheless in the moderate to severe cases the impact tends to be great. This legislation would go a long way to reducing or even eliminating such problems. By having a compliance regiment in place Condo buyers could purchase real property with greater confidence and less adverse risk.

Often Condo buyers are buying a Condo because it is what they can afford under their current financial position. To a great degree however it is also busy buyers who don’t have the time or inclination to buy a home and deal with all the maintenance and up keep issues a traditional free standing home has. Buying a Condo eliminates a lot of the home maintenance concerns 1st time, busy or younger buyers often have. Unfortunately some new construction Condo buyers end up putting out a lot of time and money dealing with unfinished Condo building common element issues that they never thought would occur. Someone has to deal with resolving building common element issues in order to maintain the building and related property values. Sometimes building issues are simple enough but often they are complicated construction issues that require assistance.

In larger buildings, a management company can do the homework to figure out how to resolve building problems. Owners essentially just have to approve work and write checks often beyond normal monthly assessments. While that process may sound easy, writing checks that you didn’t count on can be very problematic for young 1st time buyers. Other owners may have the financial resources to write those checks but the loss of savings can still have a negative impact on family stability.

Typical newer small 3-6 unit Condo buildings are usually self managed which tends to make dealing with building issues more complicated and drawn out in the beginning stages. Unit owners generally don’t have construction experience and therefore aren’t sure even where to start or what to do. There are problems in the building but how important are they, who do we call, what will it cost, where will the money come from? If the Association gets good advice from the beginning, getting the right type of work done to remediate building issues can go well. Unfortunately that is often not the case. If they get poor advice, an Association can end up learning costly lessons along the way that unit owners may not be able to well afford. Whichever way it goes there are costs involved that new owners should never have had to deal with at all.

HOW WOULD THE LEGISLATION PROTECT HOMEBUYERS?

This proposal is in no way intended to take money out of the pockets of Developers, impose restrictions on construction, or cause an undue burden on new Condominium construction. The sole intent of this proposal is to establish a compliance regiment to ensure that Developers of new construction Condo projects actually do what they advertise they plan on doing and complete developments fully. Actual “additional” costs to Developers should be minimal unless adopted legislation ends up with a hodge podge of superfluous requirements. There are however two probable costs for Developers if this legislation were to pass.

HOW WOULD THE HOLDBACK WORK?

During the purchase / closing of a Condo unit within the building or development, the title company conducting the closing would deduct 10% of the sale proceeds from that unit and deposit those funds into an escrow account owned by the Developer or holding legal entity. Holdbacks from all sales of units within the building / development would be deposited into that same escrow account. The escrow account would pay going rate interest on the deposited funds or as allowable by law.

– The Developer could request full or partial payout of the escrow account once he has turned over control of the property to the newly formed Association. Asking for payout of the escrow funds would initiate the various procedure and documentation requirements as set forth under the Legislation. Once all requirements have been met all escrow amounts would be fully paid out by the Title company to the developer.
– There are also a few feasible variations on this theme…
– To start, a percentage of the initial unit sales would not be required to have a hold back with funds deposited into the escrow account. There are a couple reasons for this. Developers often need all of the initial sales money to pay down material or other project costs, pay contractors or begin to pay loans back to the applicable lending institution as is common. Developers tend to collect their profits during the latter sales. Because of this, not having a hold back as part of initial sales would help maintain financial stability for the project. A workable percentage could be figured out. On a typical 6-8 unit Condo building the first 2-3 unit sales could be exempt.
– Another option could be that a Developer could petition for partial escrow payout if they could show substantial completion and/or extenuating circumstances that prohibit work from being completed as it otherwise would be. Extenuating circumstances would include ongoing weather delays, strikes effecting material deliveries, or agreed upon plan revisions that result in delays.
– Obviously a 10% holdback sounds a bit high. Depending on the development this amount could be realistic or very out of proportion. A sliding scale or lower percentage rate could also be feasible.

WHAT ARE THE COSTS INVOLVED?

The first cost to Developer would be for additional documentation. This should not be overly burdensome for a Developer. The typical paperwork would likely be done by the project manager, contractors or office staff. Granted there would be additional paid hours involved. For the most part this shouldn’t be about “new” paperwork for a Developer, rather a case of good documentation rather than sloppy paperwork and of putting information together in a useable format. Reporting paper work that would be required as part of this legislation could include affidavits from contractors that all work within their trade has been completed; a standardized checklist noting status of typical building common elements; and an affidavit from the project owner stating that there are no unfinished areas in the building. Project owners already collect a lot of this information, albeit in sloppy form, in order to verify whether or not they should be writing their contractor a check or not. Under this legislation the project owner would need to provide the information in a format, as in standardized forms, so that others, i.e. an Association or their representative, could reasonably verify conditions.

The second cost related to this legislation is potentially a much higher cost depending on the Developer. For a good Developer who finishes his/her buildings anyway there would likely be minimal additional cost. Those costs would probably be more about minor to moderate improvements to installed components or smaller incompletion items that got missed as is common. For the Developer who tends to leave a lot of unfinished loose ends at a building on his way off the property costs could definitely add up. This proposal focuses on those types of projects. It should be noted that if completing component X would cost the developer $1000, it would likely cost a new Association more just due to the nature of the business.

The primary out of pocket expense related to this legislation would be to the new Condo Association and/or new unit owners. These costs would likely be for payment to a licensed inspector for a review of the property along with a report on conditions and incompletion concerns. There would also likely be some attorney fees to the new Association. Costs would obviously vary based on the size and type of building. Based on inspection experience with these types of issues a general cost would probably be in the range of +/- $100-$125 per Condo unit. A typical Chicago style 8 unit Condo building could run +/- $1000 for inspection and reporting. Depending on conditions and how things go there may or may not be additional inspection costs. Attorney fees would also vary but shouldn’t be unmanageable unless there is a lot of fighting.

Initial inspection costs could be funded by the new Association as a line item paid by each unit owner as part of their purchase or from the 10% holdback. Adding any additional line item into the purchase of a new home probably won’t be popular to some. However, given the low expense and high return it should be a small price to pay for piece of mind that a building is complete.

Please feel free to leave commentary on this proposal. As stated the intent of this proposal, a large part of the overall inspection process, is to protect the home buying public from what they don’t know.

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