New Construction: A Love Story
All that Glitters
It’s a familiar plot. As the real estate market picks up momentum, developers start building more and more condos. Buildings start sprouting up all over the city, with all kinds of features, architectural details and high-end appliances. The price per square foot sky rockets and the in-house steroidal sales staff is writing paper with no end in sight. Everyone wants in and folks go along with whatever crazy provisions are shoved in the Offering Plan. It all made sense…in 2007.
Welcome to Thunderdome
Like some futuristic Mel Gibson movie, we flash forward three years, and the residential real estate landscape is in shambles, and for some developers and condo purchasers, the dream has literally become a nightmare. Witness the recent ILSA cases, and the monumental and costly court decision involving the Rushmore last week. Although things seem to be settling down, as is evidenced by the housing numbers for the third quarter touted by the uber professionals, there are still ominous rumblings out there. Specifically, the many contract deposits that might have to be returned, if the ILSA appeals go the wrong way. As my friends at The Apple Peeled observed, some see positive signs, and some, not so much.
Retraining the Condo Buyer
So, now that we’re here students, we have what they call a teachable moment. It’s time for condo buyers to re-evaluate their checklists and priorities when it comes to making a decision about whether or not to buy a condo in a project that is less than five years old. What follows are five rules to consider before and after signing a condo contract in a new construction building:
Offering Plan as Get Out of Jail Free Card
First, let’s understand what the Offering Plan is all about. This document, filed with the New York Attorney General’s office, is the disclosure mechanism required in connection with any new condo development. The sponsor is obligated to disclose all material terms and conditions of the offering and all special features of the development, both positive and negative. If there is something unusual about the project, it will be disclosed in the Offering Plan, usually at the beginning of the document in the “Special Risks” section. As long as the sponsor accurately discloses those positives and negatives, the burden shifts to the buyer to understand those issues before signing the contract. In essence, it’s a classic case of buyer beware. So I’ll borrow from Bill Maher:
New Rule: Every buyer should read and fully understand the Special Risks section of the Offering Plan. No exceptions.
"Construction is a Complicated Process"
Every Offering Plan contains a line that reads something like the above caption. The sponsor will advise that construction can be full of surprises and difficulties. Basically, stuff happens. What the sponsor promises in the “Description of the Property” section (the technical exhibit to the Offering Plan that outlines the nuts and bolts of the construction), is not always what the final version of the building turns out to be when construction is completed. In all fairness, changes are often required for legitimate reasons, because the construction process, is in fact, incredibly complicated. Taking everything that's happened in the condo market into consideration, it’s rarely a good idea to buy an apartment before the construction has been substantially completed. Until the building has an operating history of three to five years, it's vitually impossible to know whether a construction defect will show up that may impact the apartment, the building or both. Unless the buyer has a high degree of confidence in the developer’s track record, as well as in the abilities of the construction professionals (such as the project architect and engineer, as well as the contractor), in the world we live in today, a buyer is better off waiting for that building to be completed, rather than betting on the sponsor to execute the construction exactly as promised. Nevertheless, since contracts for newly-constructed apartments will be signed every day irrespective of my suggestion, what can a buyer do to minimize the unknowns?
New Rule: Bring a Professional into the Due Diligence Process
In addition to a careful review of the offering documents, hiring your own architect or engineer (or both) to review the technical aspects of the construction should be very seriously considered. Here’s what should be done before the contract is signed:
--Measure the square footage of the apartment and compare the tally with the square footage represented in the Offering Plan.
--Compare the actual build-out of the building and the apartment to the technical description in the Offering Plan.
--Have an architectural and engineering inspection of the apartment and the building conducted, which should include a review and analysis of all mechanical systems (such as heating, cooling, plumbing and electrical service) as well as consideration of ventilation and other life-safety conditions that can possibly create environmental problems. New York City Building Department records should also be checked for serious violations. If possible, it is highly recommended that you attend the inspection when it takes place. And things do go wrong, even when the sponsor has the best of intentions.
As pointed out by Teri Rogers of Brick Underground, there are a number of new buildings that are “sick” because of poor ventilation conditions created by so called “green” construction. Nobody wants to live in a toxic environment.
The Punch List
The following applies to all real estate transactions:
New Rule: To the greatest extent possible, avoid any seller obligation that will not be fulfilled until after closing.
Unfortunately, that’s just not how condo sales work in New York. Somehow, the public, with the blessing of the Attorney General’s office, accepts the fact that the sponsor can compel the buyer to close, when any number of items in the unit are in need of repair or replacement. Conceptually, it makes no sense, but it is the reluctantly accepted norm. Think about it, the apartment does not have to be completed in all respects, and the sponsor does not have to specify the time frame in which the punch list items will be resolved or hold back an escrow to insure completion of the punch list. Considering the amount of money that is usually involved in a condo transaction, I simply don’t understand why the sponsor should not be obligated to deliver a completed product at the time of closing.
The Walk Through
Since the deck is stacked against the buyer, it is essential that the apartment be carefully inspected prior to closing. Accordingly, the punch list should be prepared with the assistance of an architect or other design professional, who will see things that the buyer might not recognize. Would you know if a door were not hung correctly? That’s the type of issue I’m talking about.
New Rule: Have the punch list prepared with the assistance of an architect or design professional.
Post Closing Issues
Exactly what the sponsor will be obligated to repair or replace after closing is set forth in most Offering Plans in a section entitled “Rights and Obligations of the Sponsor”. The list of exclusions from the sponsor’s repair obligations usually runs a full single-spaced page, and can be summed up in one word: comical. What most buyers don’t appreciate is that the sponsor excludes from its responsibility, anything that doesn’t relate to construction and installation. If there is a problem with materials, such as defective flooring, both sponsor and buyer have to look to the manufacturer for resolution of the problem. If the manufacturer does not remedy the problem, the buyer could be stuck with a defective condition and no remedy. If there’s a clear path to a solution when this situation arises, I haven’t heard about it.
Latent versus Patent
Most Offering Plans also make a distinction between a patent defect (that is, a defect which is immediately evident) and a latent defect (that is, a defect that comes to light after a period of time). Further, the Offering Plan will require notice of defects within a specified period of time (usually 6 months for patent defects and 12 months for latent defects). If notice is not given on time, the sponsor is off the hook and has no obligation to remedy the condition. Unfortunately, with new construction, sometimes latent defects do not arise for several years. Unless the problem is a building-wide defect, and condo management decides to pursue the sponsor for relief irrespective of the expiration of the notice period in the Offering Plan, the individual buyer who discovers a latent defect a little too late, will have a great deal of difficulty convincing the sponsor to do the right thing. Accordingly, when it comes to problems discovered after closing:
New Rule: Notify the sponsor immediately upon discovery of any condition that might constitute a defect.
Although the sponsor usually has a representative overseeing the completion of the punch list, if a serious issue comes up or if the sponsor’s representative is dragging his or her feet or is unresponsive, get your attorney involved in the process as soon as possible. Unfortunately, once a service professional loses interest, it never gets any better and it usually gets worse.
Residential Reality: With New Construction, Fall in Like, Don’t Fall in Love
Value, the condo's financial wherewithal and technical analysis, have equaled or surpassed location, architectural details and amenities, as the determining factors in whether to go ahead with a new construction purchase. To this end, to insure that you are investing your money wisely, spend a few more bucks and bring an architect or engineer (or both) into the decision making process. As we have learned from the housing crisis, it is immeasurably easier to buy an apartment than it may be to sell that apartment under market conditions existing when you need to move on. Keep that in mind as you contemplate the wine cooler.