Welcome to San Diego Blog | October 17, 2011

The Effects of Litigation on New Developments

Living in California doesn’t come without a certain amount of red tape.  Based on the population of the State of California, one could say the bennefits of weather and superb location make the buerocratic nonsense tolerable.  When it comes to new construction developments, the term litigation has become a part of everyday life.

California State Senate Bill 800 ( SB -800 ) has virtually left developers exposed on every new construction project for residential 1-4 housing units.  What does this mean to you?  If you buy a new home, or a home built in the last ten years, you will most likely have the pleasure of facing a construction defect lawsuit and or the litigation that comes along with it.

It also means you will be paying more for the next new home you buy because builders have to factor getting sued into the prices of the homes they sell.  We have seen major home builders like Barrat American homes recently go out of business because the costs of these heavy lawsuites and the depressed state of the real estate market.

San Diego Real Estate Litigation

Does litigation only take place on condo developments like those found in Downtown San Diego?

Not at all!  I own a number of single family homes as well as condos and have been through litigation on 4 of the communities.  You will be surprised to know that 2 of the communites are single family homes built Standard Pacific Homes and the other 2 projects are downtown San Diego condos in high-rise buildings.

Without turning this article into a novel, this is the gist of what you can expect with the filing of an SB-800 defect lawsuit:

First, a group or groups of attorneys will contact the individual homeowners or the Home Owner’s Association based on the time the building or housing subdivision was completed- they like to file in years 4-7 so they don’t get too close to the 10 year statute.  There will be contact regardless of whether or not there are any problems so it’s a fore sure event.

Next, once the homeowner’s association has hired a firm to represent them, they almost always do- the attorneys paint a beautiful picture, then the investigations start to compile a list that will be filed as part of the construction defect.

This entails all sorts of poking, proding, drilling, jackhammering and anything needed to investigate plumbing, electrical, AC/heat systems, roofing, flooring, concrete, window seals, and much much more.  This is intrusive, invasive and for homeowners and their tenants, it is an inconvenience.  Water or power will be turned off for extended periods of time and elevators or electric gates may be out of service while they are inspected.

Once the list has been compiled and filed correctly, then begins the litigation.  This is where the attorneys try to reach a settlement with the builder’s insurance company if they had insurance or with the builder themselves.  I’ve seen it both ways- check out the case studies below.

Litigation case study – Downtown San Diego Condo

In one of the properties I own, the HOA sued and was able to get a $10M award from the insurance wrap policy that was in place.  This HOA had to go to court and battle it out so the attorneys fees and costs involved in the inspections to make the defect list were heavy.  This particular HOA also had to get a credit line with interest to bear the costs.

  • Total settlement ____ $10,000,000
  • Attorneys Fees   ____  $3,500,000
  • Inspection Fees ____   $120,000
  • Interest on Credit ___ $27,000
  • Total after Costs ____  $6,353,000

This particular building faced a 2.5 year period where very little to no financing was available.  Many people could not even refinance their loans to take advantage of very low interest rates.  This made for angry home owners that couldn’t sell their properties or lower their payments.  The result, an abundance of foreclosures and short-sales and values dropped in some cases up to 50%.

Now, financing is available, but the building has not been able to rebound values to do the state of the real estate market.  It doesn’t help that the building is undergoing a 2 year construction period to fix defective bathrooms, balconies, roof-tops and more.  In other words, the property doesn’t show well because there are contractors in and out with materials and projects almost every day of the week.

Litigation example – Single Family Home

In this example, all of the steps I describe above ocurred and the “defect list” was compiled and filed.  The major difference in this case is that the developer, Standard Pacific Homes, did not have an insurance policy and neither did their subcontractors.  They were self insured so the process and settlement turned out to be a completely different scenario then the case above.  In this case, the attorneys representing the home owners decided to settle at a nominal rate because, “they had to pay any settlement or judgement from their own corporate funds.”

The attorneys stated that, “given the current financial problems that Standard Pacific and most of the large builders are encountering as a result of th collapse of the building industry, we are recommening a settlement which will result in $3600 to each homeowner after attorney’s fees.  What they don’t mention is that the attorneys charged 40% and for less than 1 years work for only approx 120 home owners, they are collecting $343,000.

The interesting part of this scenario is that the $3600 won’t cover the problems the home-owners face and they are releasing their ability to further pursue the problems.  I recently discussed this with an litigation attorney in San Diego and his take was that in this case, the homeowners would more likely have received more funds had they approached Standard Pacific Homes on their own.  He went on to state that in many cases, litigation is necessary, but that it is very costly and the attorneys representing the home-owners should have known upfront that the builder didn’t have insurance.

Why is financing so difficult when there is litigation if litigation happens all the time?

Almost all banks either sell their loans to Fannie Mae or Freddie Mac or they underwrite to Fannie or Freddie guidelines.  Fannie or Freddie will not lend on a property that is in litigation; they don’t have the time to read through the filed SB-800 to determine whether or not they want to take on the risk so they simply will not knowingly lend on these properties.   Can financing be obtained?  Yes, it’s not terribly difficult, but it takes a versatile and knowledgeable lender- we can get you set up with a great contact, just ask us.

Getting back to the general process of litigation, the next step is the settlement.  Once the judgement has been awarded or the case has settled, the HOA board needs to sit down and allocate funds and hire contractors for each of the repair projects.  Construction is not cheap at this point because counsel will make sure all parties hired have a substantial amount of insurance so they can be sued later if there is an issue with the work performed.

The last section is scheduling and completing construction.  This could take as little as 6 months and as much as two and a half years.  Keep in mind, these properties and communities don’t show well while under construction.  This makes good opportunities for buyers to buy low, but does not help sellers retain property values.  In condo buildings we generally see the need for common area hallways and elevators to be remodeled after construction due to the wear and tear of the contractors and their materials circulating through the buildings on a daily basis.

For single family homes, we often see the streets get weathered because of tractors, heavy equipment, cement trucks and a large number of workers and traffic.

Like so many things, litigation can be good or bad for homeowners.  It is important to make an informed decission and understand the positives and negatives before pursueing an SB-800 lawsuit.  These lawsuits are more often than not becoming the standard so expect to be involved if you buy new or newer construction in California.  Remember, it’s a win, win for the attornies so make sure to do due dilligence and negotiate well prior to signing an agreement for representation.

For specific questions, give us a call 619-309-8011 or shoot us a note Chad@DanneckerandAssociates.com

Written by: chad

Categories: Buyers, Real Estate Investment, San Diego Real Estate, Sellers

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