The Special Risk Index
Getting Real with the Risks
Offering plan disclosure is a topic of great interest in this blog. Specifically, there is a treasure trove of information about the development located in the “Special Risk” section at the front of the book. Those disclosures present the risk, but rarely quantify the significance of the information being disclosed. Some disclosures are required by the Attorney General’s office in every plan and some risks are unique to a particular situation. To help translate the information and quantify the level of concern, I am introducing my Special Risk Index. The Index will explain the real meaning behind the disclosure and rate the risk to the purchaser. The list will increase as time permits and as new risks come my way. Here we go…
The Performance Bond Disclosure
The Offering Plan for a new construction condominium contains a Special Risk disclosing that the Sponsor does not have a bond for the performance of the sponsor’s obligations. Should a purchaser be concerned?
It depends. I give this Special Risk a “5” on the Special Risk Index (10 being the most risky and 1 representing a risk of minimal concern).
Under Part 22 of the Regulations promulgated by the AG for offering plans that cover new construction, the sponsor is obligated to disclose whether there is a bond for performance of the sponsor’s “obligations”. Those obligations include the completion of construction and the sponsor’s other financial obligations as set forth in the plan. What exactly is a performance bond? When buildings are under development, it’s possible to insure that there will be funds available from a surety company if the sponsor runs out of money. This “insurance policy” is known in the trade as a “completion bond” or “performance bond”. The AG’s regulations require disclosure of whether the sponsor is obtaining such a bond to insure the sponsor’s performance under the plan. This requirement is somewhat comical, as I have never seen a sponsor obtain a performance bond, probably because of the significant cost. The disclosure in the plan usually reads along the following lines:
“No bond or other security has been furnished to secure the performance of the Sponsor’s obligations. Although at the time the Offering Plan is accepted for filing the Sponsor will be financially capable of performing Sponsor’s obligations, the subsequent ability of the Sponsor to perform it obligations will depend upon the Sponsor’s financial condition at the time”.
If for any reason, the sponsor runs out of money, it’s the purchaser’s problem, as the sponsor has no bond or other security for completion of the project. Although most projects do get completed, when a project does run into trouble during construction or after the sponsor has begun selling units, there is no regulatory requirement that the sponsor perform its financial obligations and the chips just fall all over the place. One has to wonder why a sponsor with no track record and no demonstrated financial ability can go ahead and start selling units to the public without securing the obligation to complete the project in some fashion. Disclosing that the sponsor might not be able to perform may educate the purchaser, but it does not protect the purchaser.
Residential Reality: Know Thy Sponsor
In the world we live in today, where purchasers rarely buy apartments in buildings that have not been completed, the significance of this risk has been minimized, but not eliminated. As the recession has demonstrated, developers can run into trouble when the real estate market softens as it did after Lehman’s demise. Purchasers are well advised to research the backgrounds and track records of the individuals involved in the offering as well as the current status of the project. Even if the building has been completed, financial problems can occur long after construction is over. As the expression goes, past performance is no indication of future performance, but it certainly says a lot about the folks you’re dealing with and the likelihood of their ability to perform their obligations under the plan.