Two changes to to Colorado’s construction defect law have raised questions about whether condo construction and conversion will cause a glut in condo inventory —- the a/k/a “condo shadow inventory.” Some brokers might be saying, “Oh no, we’re going to have a bunch of properties hitting the market and prices will fall.” Other brokers might by saying, “Thank goodness, finally we will get some needed additional inventory in the first-time home buyer market.”
Regardless of whether you’re fearing additional condo inventory, or looking forward to it, all that “shadow” inventory will remain in the dark. The changes in Colorado’s construction defect law are not going to cause rampant condo construction and conversion, especially at the lower price points. Here’s why:
Proponents of construction defect law reform have argued that the high cost of defect litigation has curtailed developers, and insurance companies, from investing in condo construction projects. There is probably considerable truth to this position, as anytime you raise the cost of development you’re going to reduce the amount of overall development at some level. However, neither House Bill 1279, or the recent opinion of the Colorado Supreme Court in Vallagio at Inverness Residential Condominium Association v. Metro Homes, Inc, shield developers from costly liability for construction defect.
House Bill 1279 doesn’t shield developers from construction defect claims, nor does it cap damages for liability. House Bill 1279 essentially sets forth a procedure whereby the members of a homeowners association must be notified of a potential defect claim and the majority of members must vote to approve pursuit of the claim against the developer. While HB-1279 sets forth some additional procedural hurdles for a lawsuit, it’s unlikely to curtail the lawsuits.
The Villagio opinion doesn’t do a lot to reduce liability either. In Villagio, the Colorado Supreme Court upheld a mandatory arbitration provision in favor of the developer that required the lawsuit to proceed to arbitration rather than court. So, in certain cases, where the condominium declarations require arbitration absent developer consent, the construction defect claim would have to be litigated through arbitration rather than courts. This isn’t a clear cost savings. Arbitration can be just as expensive and time consuming as a court proceeding.
Setting the legal changes aside, condo construction and/or conversion for the first time home buyer market isn’t going to happen any time soon because it’s not profitable for developers in the current market. Currently, multi-unit apartment buildings in the Denver area are bringing much more profit to developers than if the developers sold individual condo units. When they decide to build condos, developers are choosing high end product, not low income units.
In 2016 (prior to HB-1279 and Villagio case) we saw an uptick in condo new home starts from 2014 and 2015. See charts below from Common Sense Policy Roundtable – Restrictions on the Supply of Affordable, Entry-Level Housing in Colorado, March 1, 2017. However, the number of starts for units above $1 Million were nearly triple that of units in the $200-299k price range. It costs a lot to build in this market, regardless of the costs associated with construction defect liability. Consequently, developers are building luxury condos at high price points.
Are we going to see entry-level condo construction or conversion? Yes, but not anytime soon, and it’s more likely to be prompted by market conditions rather than the recent changes to the construction defect laws. Conversions and construction of lower end condos will take place when it becomes more profitable for developers. Based on the money pouring into apartment complexes it will likely take a few years before we see any significant increase in inventory.
Remember the doom and gloom bank-owned shadow inventory that had everyone spooked between 2010 and 2014? That never happened either. Just saying…