Will CO’s New Construction Defects Law Revive its Stagnant Condo Market?

Kim Slowey | Construction Dive | May 23, 2017

Colorado, like many urban areas across the country, is experiencing a building boom. The influx of new residents has largely been attributed to the state’s physical beauty, culture of recreation and burgeoning tech industry — a magnet for young workers and families. In fact, in its latest survey, Mayflower Moving Company found that, behind Chicago and Dallas, more millennials are heading to Denver than anywhere else in the country.

Others have cited the legalization of cannabis for the recent boom, as industrial areas in Denver undergo a pot-fueled gentrification, bringing in new grow businesses, marijuana retail stores and a marijuana tourism industry, along with the requisite workers.

So, what better way to foster and promote the resulting demand for affordable housing than by making construction of condominiums, which are typically an entry-level vehicle to homeownership, a winning proposition for contractors and insurance companies?

Unfortunately, that wasn’t the case until very recently.

In the 1990s and early 2000s, there was an uptick in defect lawsuits, particularly in the condominium market, according to Jonathan Pray, shareholder at Brownstein Hyatt Farber Schreck in Denver. An offshoot of that wave of litigation was a rise in the cost of insurance policies. As a result, insurance premiums went up, and developers left.

In 2005, the year that more restrictive construction defects provisions were legally enacted to protect homeowners was enacted, condominiums made up 20% of the housing market. Now, they represent only 2% to 3%.

“The original [defects] statute was intended to create a vehicle for plaintiffs’ defect actions to go forward,” Pray said. “There weren’t meaningful protections for developers or contractors. It was a pro-homeowner framework.”

However, a change to that environment was firmly planted earlier this month when the Colorado Legislature landed a blow against that lawsuit-inspiring legislation and passed a bill requiring that a majority of condominium owners approve builder defect lawsuits, not just a majority of the HOA board. It also mandates that homeowners be informed about the drawbacks and benefits that could come from filing a lawsuit.

But will the new law be enough to breathe life back into Colorado’s condominium market?

The current condo construction environment

Lane Schwarzberg, national client manager at Partner Engineering and Science in Denver, said, “Since the late 1970s, the construction defect law has grown into its own industry, generally focused on condominium projects at a large expense to contractors and [the] insurance carriers that underwrite commercial general liability policies.”

Because of the “litigious nature” of those laws, he said, condo construction carries a significant risk of liability, and that has all but halted condo development.

In fact, Denver officials have said the risk of litigation for condo construction defects adds $15,000 per unit to construction costs.

“Insurance got more and more expensive until it wasn’t viable for developers to build condos any longer. It was too expensive, or they couldn’t get it at all.”

Peter Knowles

Executive president at Rider Levett Bucknall

Peter Knowles, executive president at Rider Levett Bucknall, a global AEC cost consultancy firm, said the defect laws made it easy for homeowners’ associations, sometimes consisting of only three members, to make legal decisions regarding construction claims a simple prospect.

“They really didn’t need to jump through many hoops to bring those lawsuits,” he said. Because the lawsuits were coming so fast, contractors and developers had to take out pricey insurance policies to cover claims.

“The argument,” Knowles said, “is that insurance got more and more expensive until it wasn’t viable for developers to build condos any longer. It was too expensive, or they couldn’t get it at all.”

Builders and developers were not the only ones harmed by the unrestrained ability for homeowners’ associations to bring lawsuits against builders. Pray said some homeowners, who might not even have realized that their HOA filed a suit, encountered difficulties in selling or refinancing their units while in the middle of litigation.

Architects and designers, he said, can be sued as well.

“It definitely happens,” said architect Nathan Sciarra, associate principal at KTGY Architecture + Planning, “but more often than not, the developer is brought in and then they bring in the contractor and design team. We all get dragged in somehow.”

Sciarra said apartment projects have been filling in the condo gap. Total new residential units in Denver are in line with past years, but rentals make up 75% of those figures rather than the traditional 25%, he said.

What’s next under the new measure

The majority of experts agree that the change passed by state lawmakers could potentially stimulate new condo work, but they say it’s going to take time for insurance companies to feel comfortable lowering the dollar amount of policies and to see the condo market in Colorado as less risky.

In addition, there were additional measures left on the table that could have sped up condo development but that the legislature found too contentious.

Those include a binding arbitration agreement, allowing judges in defect lawsuits to set percentage of liability for subcontractors at the beginning of the legal process, letting condo owners work directly with construction companies in resolving conflicts, and an effort to redefine what constitutes a defect.

Nevertheless, Pray said the turnaround could take a few years. “My hope is that the bill will get developers back in the market,” he said. “Getting development back in the market will create better loss histories, and that will bring rates down.”

If there isn’t a sea change in the next year or two, maybe there would be an appetite to revisit some of the other measures. This is a great first step.”

Jonathan Pray

Shareholder at Brownstein Hyatt Farber Schreck

Schwarzberg said, “Denver is one of the busiest markets in the country for [our company]. We’re seeing that with a strong population growth and continued shortage of housing, the multifamily market here is especially hot. Municipalities want to increase the stock of condominiums in their cities for young professionals and empty-nesters.”

He added, “While the direct impact of the new law remains to be seen, I expect that reducing an obvious creator of liability risk will [eventually] encourage more risk-averse developers to enter the condo market here at such a competitive time.”

Even with such a modest change to the law, according to Sciarra, opponents of the new regulation say the only ones who will benefit are developers and that the change will promote shoddy construction.

But don’t look to Colorado lawmakers to revisit the issue of defects anytime soon.

“I think that the appetite in the legislature for running another construction defects bill will be fairly low after this,” Pray said. “The next year will be telling to see how many projects get back in the pipeline. If there isn’t a sea change in the next year or two, maybe there would be an appetite to revisit some of the other measures. This is a great first step.”

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