Conversion hazards Featured

8:00pm EDT August 29, 2006
Converting apartments to condominiums has become a popular phase throughout California in recent years. According to market reports, developers as well as investors are jumping into this market because of the growing need for affordable housing in the state.

But there are some risks associated with such projects. There are numerous laws and regulations surrounding the issue, and the vital need for investors and developers to be sure they have sufficient risk transfer.

Smart Business spoke to Rob Ranallo of DLD Insurance Brokers Inc. about this growing trend and how businesses can avoid the hazards that could follow.

How has the need for insurance covering condominium conversions changed over the past 10 years?
It seems to have increased or at least resurged greatly. Clients are seeing more opportunities linked with, hopefully, a better rate of return on their investments by buying apartment projects and then rehabbing them into condominiums for sale in today’s tougher marketplace, where there continues to be a high demand for affordable housing in Southern California.

But there is a very limited insurance marketplace, and carriers are closely underwriting the exposures due to heavy litigation in the past on condominium development. California laws have changed recently, making carrier underwriting standards a bit less tough. Carriers mandate brokers to send complete applications that include the claim history for owner/developer and general contractor if an outside general contractor is used, as well as a detailed forensic physical property inspection report and budgets on each location to be remodeled.

What are the major liabilities and risks facing developers of condominium conversion projects?
Courts have yet to determine the full extent of liability a developer would face on condominium conversions, so conservative clients and their counsel are very cautious and treat the projects like new construction. This translates in the purchasing of multi-year wrap-up/Owner Controlled Insurance Programs for liability insurance that include the owner, general contractor, most subcontractors and a 10-year products-completed operations extension to protect them from the 10-year property damage statute in California.

It is important that policies are purchased without any prior work exclusions. Also, some limited coverage for the architects and engineers is added when possible as their policies — like most subcontractors’ — will exclude work done on condominiums or apartments.

Wrap-up policies take more effort on behalf of the broker as well as the developer, as there is more administration of the subcontractors as well as contract amendments that must be made with counsel’s insight.

How fast is this business growing?
We are quoting quite a few risks, but only about 10 percent of them have come to fruition. The cost of these programs can be expensive, so the acquisition cost of the existing project versus insurance costs must be closely reviewed.

What liability statutes are in place?
Various statutes are in place dictating the period of time in which an owner, developer or contractor is liable for bodily injury and property damage to third parties. State statues appear to apply to new construction, but again there are a lot of unknowns as to whether the original work will be brought into a claim. The gray area is whether the statute will apply if the renovation does not involve structural changes: Is it a facelift or does it qualify as new construction?

How can developers protect their assets?
Consult with counsel in respect to setting up an LLC as well as how the statute may apply in respect to the scope of remodeling they are considering.

Consider strict contract indemnity wording with sellers as well as arbitration clauses with potential homebuyers.

Consider self-insuring to a certain level that they are comfortable with, to keep insurance costs down.

Buy appropriate limits, since condominium projects have the potential to generate large construction defect settlements, at least in the past or in a depressed economy.

Excellent customer service and warranty call follow-up after the unit is sold can go a long way with buyers as well to deter potential claims.

Are there any other concerns businesses should be aware of?
Make sure the property/fire/builders risk insurance coverage is placed correctly. This involves obtaining coverage for the entire project term, usually beyond one year; being sure coverage is there for existing structures as well as work to be done; and making sure coverage stays in place until the actual unit sells versus when the remodeling work has been completed. This last issue is especially important in this slowing economy when standing inventory may increase considerably.

ROBERT RANALLO is an assistant vice president at DLD Insurance Brokers Inc., responsible for marketing and risk management services to Southern California-based clients involved in residential construction and property management. Reach him at (949) 221-1788 or rranallo@dldins.com.