Threat of Suits Curbs Condo Construction
To most observers, Southern California’s growing need for housing should create an ample market for new condominiums. Rising land costs are pushing single-family homes out of the reach of many would-be buyers at the same time that low mortgage rates make mortgages affordable.
At a similar point in the last real estate boom, many buyers opted for new condos. This time around, they don’t have that option. Construction defect lawsuits have all but halted condominium construction in Southern California, builders and other real estate experts say.
“Condominium builders today don’t just fear a lawsuit based on construction defects, they expect one,” said Dennis Ellman, a lawyer with Greenberg Glusker Fields Claman & Machtinger in Los Angeles. “This has had a chilling effect on developers’ willingness to build condominiums.”
Virtually everyone in the real estate industry cites construction-defect lawsuits as the primary reason condo construction is at a standstill while building is booming in nearly every other segment of the commercial and residential markets.
“If you build a condominium today, you can assume that you will be sued sometime in the next 10 years, whether the suit has validity or not,” said Geoffrey Stack, a managing director with Sares-Regis Group, one of the few companies that is building condominiums in Southern California.
Precise figures on the decline of condo construction are difficult to come by because condominiums are included with apartments as “multifamily permits” in figures tracked by the Construction Industry Research Board, said its research director, Ben Bartolotto.
But Bartolotto and others familiar with the trend say condominiums represent only a few of the approximately 4,000 multifamily permits being issued each year in both Los Angeles and Orange counties in recent years. They say condos represented a significantly higher percentage of the total in the 1970s and 1980s, when tens of thousands of multifamily permits were being issued each year in both counties.
According to Ellman, condo construction lawsuits proliferated when certain lawyers began filing suits on behalf of condominium homeowner associations, realizing they could reap significantly higher fees by lumping many condo owners into one lawsuit rather than filing suits one by one on behalf of individual owners of single-family homes.
“It’s hardly worth years of litigation for an attorney who is working on a contingency basis and is going to get a third of the $40,000 or $50,000 award on a single-family home. But in the case of condominium associations, claims can easily reach $5 million or $10 million,” Ellman said.
Some of the condo lawsuits continue to make news. In September, Crown Valley Parkway Homeowners Assn. announced a $9.4-million settlement with Hon Development Co. and the owner of J.M. Peters Inc., developers of the Niguel Summit condominium project. The 1994 lawsuit was filed after years of buckling and stress damage to the 41-unit complex.
While builders concede that many of the condo suits had merit, they maintain that lawyers and courts went overboard in awards. They say insurance rates rocketed as a result of the suits, further discouraging condo construction.
According to Juan Acosta, a lobbyist for the California Building Industry Assn., a recent survey of builders showed a typical insurance policy to protect against future lawsuits cost $300,000 and carried a $600,000 deductible, meaning a builder would have to absorb $900,000 in costs before insurance coverage would take effect.
Despite the risks, Stack said Sares-Regis has nearly completed construction of an already sold-out, 62-unit project called Summerside in Simi Valley and will begin construction within a month on a 125-unit project called Terracina in Rancho Santa Margarita. Prices in both projects range from about $140,000 to $190,000.
Ruling Gives Builders Hope
Why build condos when the risk of a lawsuit is so great?
“There is a strong demand and a dearth of product, and we believe we can make a reasonable profit,” Stack said. “We also believe we have done everything that we can do, with respect to being careful and correct in our construction, and that we’ve done everything we could to mitigate against a lawsuit. We’re hopeful that the legal climate will change, but we recognize that we are taking a risk.”
According to lawyer Ellman, builders are hoping for that change as a result of a decision earlier this year by the 4th District Court of Appeal in San Diego that is expected to limit the amount homeowners receive in settlements or jury awards.
The ruling says builders are liable for damages only if a home shows physical signs of decay. Previously, homeowners have collected jury awards and settlements after showing that their homes were not built according to plans, regardless of whether those changes resulted in defects.
Stack said soaring land prices prevent developers from building low-cost single-family homes in places such as Rancho Santa Margarita, yet those places have some of the strongest demand for low-cost homes.
“We can’t build single-family homes in that area for those prices [$140,000 to $190,000] because of the land costs,” Stack said. He said Sares-Regis is building about 12 to 15 condominiums per acre, compared with typical densities of four to eight per acre for single-family homes.
The shortage of low-priced housing makes California “one of the least affordable housing markets in the nation,” according to the Building Industry Assn., which estimates the state will build only about half of the 250,000 new housing units it needs this year.
One of the ironies of the condominium market, interviews with builders suggest, is that just as many luxury condominiums are under construction now as entry-level condos. It’s an odd state of affairs, considering that the demand for entry-level housing far exceeds the demand for luxury housing.
Crescent Heights of America Inc., a Miami-based developer, is well into construction of a 19-story, 224-unit luxury condominium project called Regatta Seaside Residences in Marina del Rey and plans to break ground within the next month on a 23-story, 93-unit project called the Remington on Wilshire Boulevard at Selby Avenue in Westwood.
Asking prices will range from about $400,000 to $1.2 million at the Regatta, while prices at the Remington will be “in the $1-million range,” said Bruce Menin, one of three founding partners at Crescent Heights, which Menin said has developed 25 high-rise condominium projects throughout the United States during the last 10 years.
Menin and partner Russell Galbut acknowledged that construction defect lawsuits have placed a damper on condo construction, but they believe developers can build condominiums successfully despite today’s litigious climate.
“We’re not afraid of condos,” Menin said. “We believe the projects can succeed if you do the work properly, work with the homeowners association and properly insure yourself.” Menin said Crescent Heights has targeted Los Angeles for new condos because the gap between supply and demand is wider here than in most major U.S. cities.
“Lack of new product is more of a problem in Southern California than in most other major cities. San Francisco, Chicago, Atlanta, Miami, and New York all have new product. The only city we know of that doesn’t have new product is Los Angeles,” Menin said.
Steve Heiferman, a director of luxury condominium sales for Coldwell Banker Jon Douglas, said one reason for the upswing in the upscale end of the condo market is that owners of multimillion-dollar homes can now command profitable prices for them--unlike the earlier years of this decade, when prices were depressed.
Heiferman said La Tour, a 21-story luxury condominium at Wilshire and Beverly Glen boulevards, illustrates the upswing.
Only 14 of La Tour’s 73 units were sold between 1991, when La Tour was built, and December 1997, Heiferman said. Of the remaining 59 units, 23 were rented, while 36 remained vacant.
Right Time, Right Price for Upscale Condos
But since January, 20 more units have been sold, and Heiferman is confident that the remaining 39 will be sold by the end of 1999 if sales continue at the current rate. Heiferman said the condos are selling faster now in part because of the economic upturn and in part because the building’s owner, a Dallas-based investment group called Oly La Tour, has reduced the prices. He said sales lagged under the previous owner, a unit of Japan’s Daiwa Corp., because asking prices far exceeded the market.
Ellman said the increased action in the luxury condo market is reflected in his practice.
“Between 1991 and 1996, I don’t think I represented any condominium buyers,” he said. “Up until then, projects that were originally built as condominiums were occupied as rental units because the market for sales was just not there.” In the last year or two, however, Ellman has represented half a dozen high-net-worth individuals who have bought condominiums at prices from $800,000 to $2.4 million in Wilshire Boulevard buildings.
While builders say demand for single-family homes will always exceed demand for condos in both luxury and entry-level markets, they say condominiums fill a specific demand that they’re not likely to be able to meet.
“With condominiums, you can present a product to a different segment of the marketplace than you can with single-family homes,” said Dennis Cavallari, a senior vice president at developer Lincoln Property Co.
