Toolkit for Purchasing From a Sponsor
New York's Love Affair with the Condo
Although 75% of the available ownership housing stock are co-ops, as I pointed out earlier in the year in "The Condo Kicks In", flexibility of ownership, privacy, and relaxed financial guidelines have made condos the asset of choice, particularly for foreign buyers. Condo sales now equal and sometime exceed co-op sales, at least in Manhattan. Since developers produce new construction condo units like rabbits produce offspring, with all the unsold condo units out there (which those in the trade like to call "shadow inventory"), there are great deals to be made when purchasing a newly constructed apartment.
You Get What You Pay For
But sometimes a discounted price can be a symptom of problems with the development or with the financial wherewithal of the sponsor. It is essential, therefore, that you do your due diligence before going forward with a new construction purchase. Here's a checklist for issues to be reviewed when considering a purchase in a new development.
The Offering Plan as Road Map
New construction sales are regulated by the New York State Attorney General's Office. The sponsor's disclosure document is long, complicated and not easy to understand. Most purchasers do not actually review the Offering Plan, but rely on their attorneys to explain the relevant issues disclosed in the Plan. Nevertheless, there is one section, at a minimum, that a purchaser should review.
The Good, the Bad and the Ugly
At the beginning of each Offering Plan, there is a section entitled "Special Risks," in which the sponsor discloses all of the material aspects of the Plan and possible risks to ownership. These disclosures are discussed in greater detail within the body of the Offering Plan, but the Special Risks section will disclose the most important issues that the purchaser should consider. It is essential that the purchaser review these disclosures and understand how this information might affect ownership of an apartment and the future of the development. Make a list of questions as you go through the disclosures and make time to discuss those features that you don't understand with your attorney. In my view, it's the best way of finding out exactly what you're getting yourself into when you go ahead with your purchase.
"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 description of the development attached as an exhibit), 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 virtually 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?
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. An architectural and engineering inspection of the apartment and the building will speak volumes about the quality of the construction and the likelihood of problems in the foreseeable future. An architect can also confirm the square footage reflected in the Offering Plan as well as the construction details described in the Offering Plan. If possible, attend the inspection when it takes place.
Think About Owner Occupancy
No issue has created bigger problems for developers than low owner occupancy--that is, the number of units sold compared to the number of units in the development. When less than 50 percent of the apartments in a new development have been sold, obtaining a loan can be challenging, and in some cases, impossible. Low owner-occupancy also places a financial burden on the developer to carry the unsold units as well as the construction financing that lingers until a majority of the units have been sold. Even sponsors with great track records can run into a financial problem in the current economic climate we are living in. Use the Internet to find out as much about the project as you can. When a sponsor goes south and the lender takes over, day-to-day life in the condo can be impacted and resale can be difficult.
Residential Reality: Kick the Tires
Although the condo market in New York seems to be dragging along the bottom at the moment, there are signs of life and things will improve by Christmas... 2011. Take advantage of the opportunities that are out there at the moment, but finish your due diligence, it's good for you.
For more: See the post on brickunderground, where Teri Rogers and I discuss what is actually meant by the language of Special Risks.