Published on: July 20, 2009
Most condominium boards are struggling, to some extent, with delinquent common area fees, budget shortfalls, rising foreclosures and other collateral damage from the economic downturn. Many condominiums will also confront, if they haven’t already, another problem, painfully familiar to anyone who recalls the last crushing real estate downturn in the 1980s—arrested developments.
Some developers who began large-scale, multi-phased projects in happier times earlier in this decade have hit an economic wall. They successfully completed the initial phases, but are now unable to find financing or prospective buyers for the rest. So they have either moved on to more promising ventures or disappeared, leaving the communities they created with fewer units than anticipated, the land designated for the remaining buildings vacant, and the permits for the remaining phases approved but unused.
It is difficult for those living in a crisis to envision its end. But however dismal the current picture seems, real estate is still cyclical and this miserable cycle, too, will end. When it does, many condominium boards will have to decide what to do about their unfinished communities: Complete them as planned; remove and sell the vacant land; sell the development rights; plant corn and raise chickens, or some combination of those options.
These are complicated questions, requiring careful analysis and an informed decision-making process. One of the biggest mistakes many boards make is failing to recognize that the land and development rights the association owns are potentially valuable assets. In some cases, the development rights conferred by the permits the original developer obtained may be more valuable than the land itself. But after staring at open space and yellowing blueprints for years, boards sometimes assume a new developer is doing the community a favor by completing the project, failing to recognize the value of a project that has infrastructure improvements in place and permits in hand.
Boards can err in the other direction, too, by failing to consider other factors, such as market conditions and the quality and strength of the condominium community that will also affect the value of development rights. The opportunity to complete a stalled development will look considerably less enticing to developers if the project was ill-conceived to begin with, or is competing with higher quality developments in the area.
Boards contemplating the removal and sale of undeveloped land or development rights must be able to view the package they are offering through the eyes of prospective developers, understanding its strengths and weaknesses and making sure it is priced appropriately. This requires the advice of competent professionals – real estate brokers or appraisers – who know the market, understand condominiums, and can provide an independent, educated assessment of the development potential.
Boards must also consider the wishes of the community’s owners. In Massachusetts, at least 75 percent of the owners (and 51 percent of “qualified mortgagees”) must approve a plan to revive and grant expired development rights.
While a bird in hand, in the form of an interested developer, is always tempting, some boards may decide their development rights will be more valuable in the future when market conditions are even better, and they may be right. But boards adopting a “hold for later” strategy must consider the risk that market conditions may not improve as much or as quickly as they assume. They must also make sure they understand the terms of and any restrictions on the development rights they are planning to sell. A key question: Does the special permit the original developer obtained have an expiration date?
A recent case in which I was involved underscored the importance of that question and provided an answer that could be helpful to condominiums looking to complete the unfinished phases of stalled developments.
In this case (Lobissier Building Corp. vs. Planning Board of Bellingham), the original developer had obtained a permit in 1985 to construct 84 town house style units in four phases. The developer completed the first two phases – 21 units in the first and 20 in the second – but the project stalled at that point. Two decades later, the condominium association decided to revive the development rights and contracted with a new developer, who sought to modify the original permit to allow deviations from the project as proposed and originally permitted. The town rejected the request, ruling that the special permit authorizing the original development had lapsed because the first developer had not made “substantial use” of the permit for the two unfinished phases. The applicable state statute says that to preserve rights under a special permit, a developer must begin construction or make “substantial use” of the development rights within two years after the permit is granted or within “such shorter time period as established by local law.”
The Land Court sided with the town, ruling that the “substantial use” of the permit “must be directly related” to each phase. This contradicted common industry practice and the prevailing assumption, that beginning work on the development as a whole within the specified time limit was sufficient to preserve the special permit rights for future phases. Agreeing that the Land Court decision raised issues “of significant public interest,” the Supreme Judicial Court accepted the appeal on direct review.
The Land Court decision raised two key questions:
- Does the construction or “substantial use” requirement apply to the project as a whole or to each individual phase?
- Is there an implied “reasonable” time limit, as the Land Court had concluded, within which a phased development must be completed.
The SJC came down (in our view) on the right side of both questions. On the first question (preserving development rights in phased developments) the court ruled that the “substantial use” requirement for a special permit applies to the project overall, not to each phase. “Nothing in the statute indicates that each phase of the project is subject to its own lapse period,” the SJC said in a unanimous decision. “Once a special permit for a project, phased or otherwise, has been approved, all that the statute requires is that substantial use or construction commence within the applicable period, which may not exceed two years.” Given that the purpose of a phased development is “to build in stages, not to commence construction of each phase at the start of the overall project,” the court said, any other interpretation of the statute “would make no sense.”
No Implied Deadline
On the second question – whether a “reasonable” time limit, stated or not, should apply to phased developments — the Land Court had adopted a position similar to a long-ago U.S. Supreme Court definition of obscenity. Paraphrasing the Land Court’s view: “We don’t know how to define a reasonable time limit, but we know an unreasonable delay when we see one, and a 20 year lapse in a phased development simply isn’t reasonable. “
The SJC refused to accept that theory. The potential “warehousing” of development approvals is a legitimate concern, the court agreed – a concern the legislature has addressed by establishing a lapse period and a concern communities can further address by establishing a completion deadline for the project as a whole. But communities must set those deadlines up front, as a condition for granting the permit; they can’t impose the deadlines retroactively. In this case, the court said, “although the developer may have originally contemplated completing the project in four years, nothing in the special permit required it to do so.”
The SJC decision is important because it clarified the commonly accepted interpretation of the statute and confirmed existing practices. A contrary ruling would have created immense problems for condominium communities seeking to revive lapsed development rights. But while the decision counts as a victory for condominiums and developers, it is also a reminder to boards to make sure the development rights they are planning to sell aren’t encumbered by deadlines that, the court said clearly, communities have the authority to impose.
Careful analysis of the special permit and any restrictions on it is only part of the due diligence boards must undertake when considering the revival of a stalled development. Boards must exercise the same caution in selecting a new developer they would exercise in selecting a contractor for any major construction project; the developer’s reputation and track record are crucial. Like the contractor offering the lowest bid on a roofing project, the developer offering the highest price for your land or development rights isn’t necessarily the best choice. The $500,000 the developer paid your community up front won’t look like such a good deal if the buildings produced have $1 million worth of construction defects and trigger a five-year legal battle.
Review the Plans
The developer’s plans for completing a phased development also require close scrutiny both by engineers or other construction professionals (to monitor and ensure construction quality ) and by the association’s attorney, to make sure the plans comply with applicable zoning and other requirements and to make sure the community’s interests are protected. While the new developer may be able to use the original permit, the condominium association is not bound by the rights reserved by the original developer in the Master Deed. Boards can add new protections for the association — for example, creating new specifications for buildings in the remaining phases or requiring the developer to escrow funds to guarantee timely completion or as security against potential construction defects.
Of course, boards can go too far. Imposing too many costly requirements up front may reduce the value of the association’s development rights, limiting the amount for which they can be sold and/or increasing the risk that the only developers willing to complete the project are those who will cut costs, leaving the association with poorly constructed buildings and all the problems that go with them. This is why the advice of professionals – construction experts and attorneys – is so important.
What Could Go Wrong?
My files, and the files of most condominium attorneys, are filled with examples of all that can go wrong with revived developments. A common fault – developers don’t calculate the percentage ownership interests correctly when they add new units, or they aren’t as precise as they should be in describing the rights of new owners. How would you like to be on a board trying to sort out the dispute among the owners of five units that have been assigned the exclusive right to use the same parking space? Even less enviable is the position of the board that discovered its developer had added more units than the phasing right allowed, exceeding the threshold limits for the existing septic system and requiring the association to install a $1.8 million private waste treatment facility to comply with applicable regulations.
At least that association didn’t have to tear anything down. The developer building out another phased project constructed part of a new building within the setback to an abutter’s property – an illegal structure containing two town house units that may, in fact, have to be removed.
The owners in these associations and others where development projects have gone awry aren’t going to be happy — with the legal battles they will end up fighting and the bills they will have to pay, as the valuable development assets they thought would generate welcome revenue turn out to be costly liabilities creating a strain on association finances and headaches they don’t need. These pitfalls can be avoided, however, by careful planning and a well-thought-out approach. Boards have considerable control over the revival and granting of development rights; they should exercise that control to minimize the association’s exposure and maximize its returns.