SAN DIEGO-In today’s market, broken residential projects make attractive targets for real estate investors seeking to take advantage of low prices for distressed properties. However, these projects come with a hidden cost that might not surface for years: construction defect liability. Residential projects in California are notorious for being the target of construction defect claims. If a purchaser of a residential project does not consider and properly prepare for potential homeowners’ defect claims, any profits can quickly vanish.
Even after the enactment of SB800, California’s “right to repair” law, some potential homeowners’ defect claims do not expire for 10 years. Professional residential developers are very aware of these risks and plan accordingly from the inception of a project. However, often buyers of broken projects are real estate investors who plan to perform only a bit of cosmetic “refreshing” before selling units, or who intend to complete only minor construction on nearly completed units before selling them, and as a result may not consider the potential for later claims by homeowners.
Both the California Civil Code and case law place the purchaser of the project in the line of fire for defect liability. The purchaser of the project, as the seller of the individual units, is a target under California defect law and will be sued by the individual unit buyers in the event of defects.
If homeowners sue a seller who only acquired the project after construction and sold completed units, the seller of the units may attempt to turn to the original developer or contractors to resolve the defect claims. However, that may not be possible if purchase documents relieve any preceding owner of liability or the preceding owner has no remaining assets. In those instances, the investor who purchased the broken project looking only to sell completed units will be left to bear the burden of construction defect claims.
There are some measures an investor can take to protect itself against this liability. First, prior to purchasing a broken planned development/condominium project, check for construction defect insurance and whether it still may be effective to offer coverage. If the project is no longer covered, investigate whether you can get an insurance policy to cover your risks, including the construction prior to your involvement. Also, review the property's homeowners’ documents, including the CC&Rs and form of purchase agreement, to verify whether you would be tied to a particular claim resolution procedure and whether you can modify it to suit your needs. In addition to visually inspecting the property, it may be advisable to perform more thorough testing of certain construction components to confirm the quality of the construction. Lastly, it is imperative to disclose all material facts that you know about the condition of the project to your buyers.
Anyone considering the purchase of a broken project needs to be fully informed and should take steps to limit liability, including for construction defects, to the greatest extent possible.
The views expressed in this column are those of the author and not necessarily GlobeSt.com.
Lynn Borkenhagen is a partner of Allen Matkins, based in San Diego. She can be reached at [email protected]. Charles Pernicka is senior counsel based in Allen Matkins’ San Diego office and contributed to the column. He may be contacted at [email protected].
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