Greenbaum Rowe Smith & Davis Newsletter

Weathering the Current Real Estate Market: Developers in Existing Residential Communities

By Christine F. Li, Esq.



In today’s market, efforts to predict the timing of full build-outs and the path of a developer to reach it have become difficult, if not impossible. Economic reality requires foresight to advance the developer’s goals of a sold-out community and to discharge the developer’s legal and financial commitments to the homeowners and to any association governing the community. In reaching these goals, developers face unique issues:


  • How does a slow market impact the developer’s transition of control of the governing association’s board to homeowners?

  • How can professionals serve to protect the developer’s pending transition?

  • What can a developer do if the community’s existing documents do not accommodate the changed needs of a developer in light of market conditions?

  • What should a developer know before temporarily leasing unsold units?

  • What disclosure regulations apply to a developer that acquires a partially completed community?


Transition of Control to Homeowners


The delay in the turnover of control of a community from the developer to homeowners is a natural consequence of lagging sales. Even with brisk sales, the surrender to the homeowners of the responsibility for the management and financial operations of a community is a serious concern of both developers and homeowners. The developer wants to complete construction and terminate its potential liability for claims of defective construction or improper fiscal and property management. The slow pace of unit sales legally impedes the developer’s ability to do so.



Closings Dictate Turnover.

Under New Jersey law, a developer must gradually surrender control of the community association’s governing board when threshold numbers of housing units have been conveyed. Once the requisite number of homeowners have been elected to the board, the association will then have the power to evaluate the condition of the development and the association operations, and release the developer from further liability. If there are insufficient closings to entitle homeowners to assume control of the board for a protracted period of time, an otherwise properly constructed, managed and financially operated community may become compromised due to the passage of time or improper management. What steps should the developer consider taking?

How is the Developer Doing?


Risk Assessment and Management.

Developers can act to protect themselves from allegations of construction defects and improper management and accounting practices. Even during the early stages of a development, a developer should consider retaining experts to inspect completed improvements and audit the accounts of the association. The developer may not be able to compel the homeowners on the board to formally accept the reports or conclusions of these experts since the developer still controls a majority of the positions on the board and, therefore, the decision-making power of the board. Nonetheless, the existence of such professional reports will provide a permanent record of existing conditions, even though the experts might be considered partial to the developer in the evaluation of the developer’s construction or fiscal management of the project.



Findings as a Shield.

The reports of engineers, accountants, and other professionals retained to assess the quality of the construction and the operation of the community will give the developer and subcontractors the opportunity to correct any problems they may identify. If no deficiencies are identified, such a finding will support the conclusion that improper maintenance or repairs caused any problems subsequently detected by the association. In the same vein, early financial audits will serve to document the activity of the governing board while controlled by the developer, and help to evidence the point in time that improper expenditures or questionable accounting practices may have been introduced into the association’s operations or records. Presumably, if the association subsequently challenges the accuracy of any reported findings of the developer’s experts, the expert will stand ready to defend the contents of the report and the developer.

When the Best Laid Plans Go Wrong


Legal Audit of Documents.

Economic conditions may put the feasibility of the original development scheme in doubt. For example, there may no longer be market demand for the dwellings and common amenities of the size or model type originally contemplated by the developer. The market may not support the number of homes that had originally been approved for development or the common amenities of the nature originally contemplated. Or, the developer may have committed itself to complete the phasing and build-out of a community within a specified period of time that is no longer achievable. Part of the scrutiny given to the project should therefore include a legal analysis of the community’s documents to determine if they mesh with current reality.



Homeowner Consent.

Homeowners should have the same interest as the developer with respect to the modification of the original governing documents, such as the master deed or declaration and the by-laws of the association, in order to ensure the future success of a community. However, to amend the documents lawfully, the developer may have to obtain the consent of a majority of homeowners. The developer faces the sometimes difficult task of educating the existing homeowners about the proposed changes and convincing them of the enhanced value the proposed changes will bring in the long run to their individual homes and the community. Amendments may also effectuate changes not only in construction plans and completion deadlines, but also in the number or type of homes, and in the phasing of construction.



When to Amend.

It may be challenging to obtain the consent of owners to proposed amendments to the governing documents. However, it is important to remember that if only a few homes have been conveyed to owners, it will be relatively easy for a developer to get the necessary percentage vote of that small number of homeowners. The task gets more daunting when that same percentage vote must be obtained from a larger number of owners who may purchase after the market has recovered.

To Lease or not to Lease?


Leasing as a Last Resort.

Some developers consider “temporarily” leasing some of the unsold dwelling units in a completed multi-unit building. Developers contemplating the lease of some or all of the unsold units should be wary of the legal protections granted to tenants under the statute governing the removal of tenants in New Jersey, at N.J.S.A. 2A:18- 61.1, et seq., commonly (and aptly) referred to as the “Anti-Eviction Statute.”



Beware the Tenant Protections.

Under certain circumstances, the Anti-Eviction Statute will afford tenants the right to remain in leased premises a minimum of three to eight years before the developer may commence legal proceedings for removal. This may be true regardless of the term of the rental (e.g. month-tomonth, one-year term) stated in the lease. Senior citizens, disabled persons, and tenants of properties situated in Hudson County may enjoy even greater protections. The unwary developer may find itself burdened with newly constructed or converted housing units occupied with tenants for many years after the for-sale market has recovered.



Arming the Developer/Landlord.

If a developer decides to lease some of the dwellings within a completed structure, there are certain protections available under the Anti-Eviction Statute that a developer should implement before commencing the very first lease. Careful drafting of leases and related documents, and understanding the significant implications of the timing of the creation of the condominium and the initial rental of the dwelling units may afford a developer the right to remove a tenant after giving the tenant a sixty (60) day notice, provided that the prospective purchaser wishes to personally occupy the unit.

Distressed Communities: Picking Up The Pieces


Forewarned is Forearmed.

The downturn in the market brings with it opportunities for those who have the financial means and foresight (and, perhaps, fortitude) to acquire interests in existing communities. The interests available within condominium developments cover the spectrum from unimproved land to “paper units” to completed units. The project may have been subjected to a bankruptcy filing or acquired by a lender in a foreclosure. With the potential for these projects to become successful ventures for the acquiring party comes the need for a diligent assessment of the project in the context of the financial commitment which the developer is willing and able to make to the development.



DCA Regulation.

 Most developers are aware of the need to scrutinize the land use and environmental approvals which have been issued for a project already under construction. From a disclosure standpoint, the acquisition of a partially completed community raises the threshold question of whether the project is subject to the Planned Real Estate Development Full Disclosure Act (“PREDFDA”) and the extent to which the community may (or may not) be in compliance with PREDFDA at the time the unsold interests are acquired. An acquiring party may be required by the New Jersey Department of Community Affairs (“DCA”) to discharge certain responsibilities under PREDFDA that the original developer failed to perform. These requirements include surrendering control of positions on the governing board to owners; performing annual audits of the Association’s accounts; filing annual reports with the DCA; updating and adopting operating budgets; maintaining fidelity bond and insurance coverage; and filing an Application for Registration and Public Offering Statement to bring the development into compliance with PREDFDA.



Developing a Game Plan.

Aside from complying with the requirements the DCA may impose on a developer acquiring the interests in an existing community, there are decisions to be made regarding the completion and marketing of the balance of the community. The issues to be addressed will involve completion of the dwellings and the common and recreational facilities; the extension of expiring (or expired) deadlines; the performance of Unit and PREDFDA warranties for existing improvements; and an assessment of the original developer’s financial obligations to the association, including funding any deficit in the association’s reserve or operating budget accounts. The DCA may also be concerned about any default of the original developer under agreements of sale, the termination of the agreements, and the return of contract deposits issues which have been addressed in cases such as Coastal Group v. Planned Real Estate Development Section, Dept. of Community Affairs, 267 N.J. Super. 49, 630A. 2d 814 (N.J.Super.A.D. 1993).

Conclusion


Not too long ago, no one could have predicted the current condition of the residential real estate market. Knowing how to respond to today’s problems and anticipating those that are likely to arise can provide some interim relief and put the developer in the best position to move forward with the development in the future.



Christine F. Li is a partner in the Real Estate Department and Planned Real Estate Practice Group. She is admitted to practice in New Jersey.