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Posted: April 16, 2014

Real estate round up: Arrested development

Construction-liability law puts a freeze on condo construction

Margaret Jackson

During the Great Recession – which officially lasted from December 2007 to June 2009 – developers stopped building condos as financing dried up for both the projects and the buyers. Instead they focused on apartment buildings, which are easier to fund and attract those who can’t afford or choose not to buy a home.

Now that the recession has come to a close, you’d think developers would have reawakened to for-sale condos, but that’s not the case. Coming out of the economic slowdown, for-sale attached housing construction has trailed other housing segments, dropping from a high of 30 percent of total construction in 2006 to a low of 11 percent in 2012, according to a recent report prepared for the Denver Regional Council of Governments (DRCOG). Most of the for-sale attached projects are townhomes rather than condos. Over the same period, the portion of for-sale attached housing – condos – dropped from 50 percent in 2006 to 16 percent in 2012.

The report concludes that a number of factors kept the condo market down during the recession, but the major factor hindering its recovery is the state’s construction-defects litigation law that puts developers at risk of costly lawsuits if anything goes wrong.

Several groups, including the Metro Mayors Caucus, are pushing legislators to reform the law, making it easier to build condos without fear of impending lawsuits. Denver Mayor Michael Hancock in January called on state legislators to reform the law to simplify the process for building condos without legal action. Last year, a Senate committee killed a measure that would have allowed developers to fix any construction defects at transit-oriented projects before condo owners could file lawsuits against them.

“I’m watching with an interested eye the legislation that may be proposed this year to mitigate some of the construction-defects concerns,” said Marshall Burton, executive vice president of Opus Development Co. LLC, which is building a 10-story apartment building at 1490 Delgany in the Cherry Creek neighborhood. “If that is successful, I think you’ll see another round of condo construction. We think there’s opportunity.”

Opus built two condo projects – 1400 Wewatta and the Pinnacle at City Park South – before the recession. Neither project has been hit with a suit.

When The Nichols Partnership built Spire, a 500-unit condo project on 14th Street in downtown Denver, it took out a $3 million insurance policy to cover construction defect claims.

“I don’t know what that policy costs now, but it’s more,” said Bill Pruder, the firm’s chief financial officer. “The biggest problem with the law is people can just sue without letting the developer fix the problem. We’re not building any condos right now. I’m not going to say we’re never going to build condos again, but that’s slowing us down.”

Today, construction-defect insurance on apartment projects costs $1,030 per unit if the builder agrees not to convert the project into condos, said Tom Clark, chief executive of the Metro Denver Economic Development Corp. If the builder plans to convert the project, insurance skyrockets to $4,430 per unit.

“That immediately goes to the bottom line,” Clark said.

And that means that when developers do build condos, they’re expensive to insure against the potential cost of legal action. Western Development Group’s 250 Columbine project in Cherry Creek North, where prices range from $450,000 to $1 million, is one of the few condo projects under construction. Sales were so brisk when the 70-unit luxury project kicked off that the developer pulled three-quarters of the units off the market until this summer to keep an eye on market dynamics.

Industry experts say there was a point when the law was needed to protect homeowners and HOAs and ensure developers delivered good products.

“But now the pendulum has swung so far that it no longer makes economic sense for a developer to build a for-sale product because of the threat of liability,” said Jim Theye, owner and managing broker of Kentwood City Properties in Denver. “There’s a huge demand and there’s nothing being built. Denver is losing ground as a great city because of the impact, especially in the downtown area.”

The lack of condos is putting the region in a difficult position in terms of housing diversity, Clark said. One of the goals with FasTracks, the region’s voter-approved transit-expansion plan, was to deliver mixed-use, mixed-income communities along the rail lines.

“All we’re getting is apartments,” Clark said. “If you don’t have diverse housing, you don’t have a diverse community.”

Developer George Thorn, who built the Museum Residences condos at the Denver Art Museum, says he’s working on small affordable apartment projects at transit-oriented hubs.

“We’re not doing any big projects and wouldn’t consider doing another project like the art museum because of the construction-defect litigation issue,” Thorn said. “You’re almost certain to be sued.”

Because so few condo projects are in the works, prices are pushing higher, making it difficult for young professionals to enter home ownership. Most lenders require buyers to put down 20 percent of a home’s value when making a purchase. Last year the median price of a single-family home in metro Denver was $333,000, making the down-payment $66,000. Meanwhile, the median price of a condo was $190,000, making the down payment $38,000.

“That’s certainly much easier than almost double the price,” Clark said. “But the condos that are being built are $400,000. You can’t sell that to a new family or an elderly couple looking to downsize. The strategy is to buy a condo before the house, but that’s not happening because there’s no product out there to buy. If nobody’s building condos, where does the traditional wealth-building device in America, which is homeownership, go? It appears — nowhere. We’re freezing people out of the market.”

The Downtown Denver Partnership is particularly concerned that the shortage of condos could deter diversity downtown. Between now and the end of 2015, roughly 6,500 rental units will be under construction or planned for downtown and city-center neighborhoods, compared with 129 for-sale units during the same timeframe.

“We are only aware of townhomes being developed – no condos – between 2013 and 2015,” said Brian Phetteplace, the partnership’s senior manager of economic development. “The 2007 Downtown Area Plan has a goal of adding 18,000 new housing units by 2027. Since 2007, we have had 5,683 units completed, leaving 12,317 additional units to be built by 2017.”

Though it’s a challenge, some in the industry are working on contractual strategies to eliminate the risks associated with developing condo projects. Though he declined to name the project, architect Chris Shears of Shears Adkins Rockmore is one such person.

“One of the major loss-prevention strategies is to put together a very experienced team,” Shears said. “There needs to be peer review. We need to have construction observation services that allow us to watch carefully how the building is being constructed. We can draw a detail, but if it’s not constructed the way we’ve done it, we’re indirectly liable. There are also maintenance requirements and tracking warranties.

“We’re also interested in making sure the HOA and each buyer agrees to expedite binding arbitration and that it’s part of the covenants in the HOA association and bylaws,” Shears said. “If they purchase a residence, they cannot participate in a class-action suit until we have the opportunity to fix the problem.”

 

Biz-Bit

Colorado’s Construction Defect Litigation Issue:

The developer, general contractor, subcontractors and designers can all face liability for damage from construction defects.  

The owner of a property with a construction defect typically files the claim, though a tenant may also be able to recover damages in some cases.

A homeowners association also may bring construction defect claims on behalf of itself or two or more unit owners.

Under current law, the general contractor can be prevented from repairing the work if the HOA has hired an attorney and a defective notice is filed.

Margaret Jackson is an award-winning journalist who spent nearly 25 years in the newspaper industry, including seven years as a business reporter for The Denver Post covering residential and commercial real estate. She can be reached at myjackson7@gmail.com.

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