Condo Defect Liability | January 23, 2023

How Condominium Defect Liability (CDL) Legislation Can Drive Underproduction

Written by Anjali Kolachalam, Research and Policy Manager, Up for Growth

Reading time: 10 minutes

Condo Defects

As reported in Up for Growth’s 2022 Housing Underproduction Report, virtually every state in the U.S. is experiencing some level of housing underproduction, leading to unaffordability, inequitable access to opportunity, and obstacles to making progress on climate goals. Traditionally less costly to buy, condominiums have been an important resource in addressing equitable access to affordable and environmentally responsible housing. However, the way some states legislate condominium defect liability (CDL) is driving housing underproduction in their cities, particularly of affordable homes. While protecting home buyers and tenants is essential, current policies are not well calibrated to both protect condo owners and ensure strong market conditions. In the highly litigious environments of some states, the risk of building condominiums is just too high, not only for builders and developers, but also for contractors, subcontractors, insurers, and funders. Those projects that do break ground are typically luxury units priced beyond new homebuyers’ means. Given the importance of condos as part of a healthy housing type mix, it’s an issue that needs addressing.

Why Condos Are an Important Part of a Healthy Housing Type Mix

Since the mid-1960s, condominiums have served as an entryway into real estate ownership for first-time and lower/middle-income homebuyers who might not otherwise be able to afford to buy a home. Empty nesters look to condos as a great way to downsize while remaining homeowners. When they are able to move into housing that makes more sense for their changing household size, their old single-family home opens up for another family, helping curb upward price pressures on the single-family home market. According to Zillow’s Home Values Index, as of November 30, 2022 in Portland, Oregon, the median value of condos was $370,119 with a median value of $585,728 for single-family homes, a difference of 36 percent. In Seattle the gap is even wider, with single-family homes costing 47 percent more than condos.

Many condos are built in urban cores, areas of high opportunity with easy access to transit, close proximity to jobs, and well established infrastructure and community amenities. Building affordable housing in these walkable neighborhoods makes progress toward climate goals through fewer vehicle miles traveled, avoids new carbon-intensive infrastructure, preserves greenspaces, and builds on the economic dynamism of urban cores. There is high demand for housing in these areas, but the absence of affordable condos on the market forces many potential homeowners to leave the city.

Without enough affordable housing on the market, individuals and families are kept from wealth building homeownership. This is particularly felt in communities of color. Black Americans are less than half as likely to have access to money from the sale of an existing home or help from family to afford a down payment than white Americans, and they tend to be more cost-burdened across the board, paying more than 30% of their income for housing. According to Sightline, condo owners in Seattle have tended to be more racially diverse than other types of owned homes. “Whereas 84 percent of all householders living in owner-occupied homes in 2015 reported ‘white’ as their sole race, some 79 percent of owner householders in condos did so. Four percent of owner-occupied condos housed people who reported being two or more races, as opposed to just 1 percent of all householders in owner-occupied homes.” While condos are only one form of affordable housing, they are an important part of a housing mix that creates equitable opportunities for homeownership that can begin to address the racial wealth gap.

Some Condo Defect Liability Laws Make Building Too Costly

CDL laws regulate the process of handling condominium construction defects and consequent disputes. Created to protect buyers of condominiums from developers who might use inadequate materials or construction methods, they create an implied warranty of the construction. Many of the laws, however well intended, have led to a glut of litigation, Homeowner Associations (HOAs) often suing for defects the builders would not have been liable for in other building types such as single-family dwellings. Issues with these CDL laws include: unclear defect standards, excluded or disincentivized arbitration and/or right to repair, non-binding arbitration decisions, uncapped attorneys fees and court costs, incentivisation of monetary damages over actual repair, and the financial risk to HOA board members of personal liability for not fulfilling their duty of care if they do not sue builders within the liability timeframe.

With these policies in place, ones that make the likelihood of lawsuits inordinately high, very few insurers are willing to take the risk on condo development. When building a condo project, developers take an owner-controlled insurance policy, known as an “OCIP” or “wrap” policy, to protect them against potential liability from construction defects. This is different from apartments and single-family residences, where contractors and subcontractors take their own insurance policies and pass those costs on to the developer in their pricing. Recent reporting in the Denver Post shared that according to Clayton Sharkey, director of construction practice at IMA, an insurance brokerage in Denver, “A developer in Colorado can expect insurance costs to total roughly 1% of overall costs on an apartment project . . . But a similar project insured with for-sale condos faces insurance costs closer to 3.5% to 4% of the project value, assuming an insurer can be found.”

Insurance policies that are secured have very high deductibles, as high as $800,000, and that is money that must be accounted for in the budget, making it nearly impossible for condo projects to be financially feasible. Funders don’t want the risk either, so finding financial backers for projects can be difficult if not impossible. Condos that are built tend to be luxury units where the purchase price can offset the high cost of insurance and legal liability. But more often, developers in states with disincentivizing CDL laws focus their efforts on apartment buildings, which have lower liability and, therefore, greater financial feasibility. Thus, while multifamily units are being built and therefore helping alleviate the housing supply shortage, they are not contributing to the opportunities for home ownership that many Americans are looking for to begin building wealth for themselves and their families.

The higher financial risk of building condominiums extends to actual material and construction costs as well. Because builders can be sued many years after a building is complete, giving ample time for wear and tear and other typical depreciation to take place, their choice of materials and methods reflects that high risk. For example, timber framing might be replaced with concrete, a less sustainable building material, and higher levels of fit and finish like bigger spaces, wider hallways, and more windows are needed to attract buyers for what will be luxury units. Onerous CDL laws, in effect, drive the developers who do stay in the condo game to overbuild in order to mitigate risk, increasing the overall carbon impact of the development.

Reforming Condo Defect Liability Laws

Various states with disincentivizing CDL laws have made efforts to understand their impacts on the building of affordable housing and to mitigate some of the more onerous liability issues for developers. The changes to policy are as different state to state as the original statues, but as the impacts of these policies become more clear and the housing affordability crisis more acute nationwide, some potential actions to improve the situation have become clear.

First, there need to be stable standards. All buildings experience wear and tear and become less efficient or in need of repairs over time thanks to weather and use. When developing apartments, buildings are built to standard and then inspected at the time of sale for compliance. When developing condominiums, on the other hand, inspection, effectively, can happen any time over the extended warranty period, putting builders at risk of issues arising not from a failure to build to code, but by the natural breakdown of all built environments. They are being held to the same standards as a just-built building years after the project is complete and the risk inherent in that is extremely disincentivizing. The length of condo defect liability should be reviewed with a keen eye, and shortened where appropriate, which, when coupled with other changes to CDL policies, should encourage more condo development.

Second, builders need to have the opportunity to cure defects that do arise from a failure to meet standards. In states with disincentivizing CDL policies, defects trigger lawsuits rather than communication and agreement between builders and homeowners/HOAs on making needed repairs. Instead of immediately involving attorneys, who may have financial incentives to pursue expensive damages, builders should be able to directly work on and fix the problems raised by the current homeowners. This “right to cure” would save developers money in the long run since the litigation initiated by HOAs is often more costly than the repairs themselves. It would protect tenants by ensuring that any repairs needed to their homes are performed in a timely manner, not part of a lengthy process in the courts, and would support builders who are working in good faith to build safe homes.

Immediately turning to litigation, rather than first granting an opportunity to cure, makes building condos an unattractive investment and property management prospect, particularly compared to apartment buildings. Given the value of having a large stock of condos along a wide range of affordability measures—luxury, market rate, below market rate—states with particularly strict CDL laws should consider creating a robust and well protected right to cure.

While none of these solutions alone will solve the problem of CDL laws disincentivizing condo development, changing the incentive structure around the building of these important multi-family homes can help reduce the fear builders quite reasonably have around this type of production.

Closing

There are many elements of disincentivizing CDL laws that stymie the building of condominiums: the HOA board member’s personal financial risk if they do not fulfill their duties of care, unclear standards, the opacity of the arbitration, and monetary damages, all of which are exacerbated by lengthy liability timelines. The effects of policies that chill condo development are seen in a lack of desired housing options for young people and young families, particularly in city centers. Strengthening urban city centers—rich in job opportunities, infrastructure, and cultural institutions—requires creating communities where people are able to live and build wealth. Condo ownership is an important piece of that puzzle and in many states, development of condos is stifled by policies that don’t reflect market realities and which fail to focus on the truly important aspect of strong CDL policy: protecting condo and homeowners. Policies geared toward building and maintaining stronger and safer homes, like the right to cure, could offer more incentives for developers to build more condos while also ensuring safe homes for residents.

 CDL reform is a necessary part of addressing chronic housing underproduction, housing affordability, equitable access to affordable housing, and climate change. It’s a bedrock problem, but it will take some time for financiers, insurers, and builders to get back into the condo business. Even though the impact on the market may take several years to be seen, these are not fixes that can be put on the back burner. All the progress we have made and will continue to make—inclusionary zoning, equitable access to financing, fair fees and taxation, using data to drive policy—will have less impact if developers can’t reasonably take the risk to build affordable housing. We need to make it safer for them to go back into what one developer described as “shark infested waters” so they can get back to doing what many of them want to do: build high quality affordable condominium homes.