This article is written for novice condominium developers. That usually means the condo project has a small number of units; typically, two to four units. I will, therefore, address some of the issues faced by a novice developer of a small unit condo regime.
Required Due Diligence
It has become fairly common to find new two-unit condominium projects in older, centrally located, neighborhoods. Often the developer intends to re-furbish and condo a duplex or fourplex, but just as often the project, especially if it is a two-unit condo, will be constructed on the former site of a single-family residence.
Before the purchase of property for condo development, especially a single-family residential lot, a buyer must be certain no restrictive covenants prohibit the intended use of the property. The developer must also determine that zoning will permit construction of the condo project. Zoning can be checked by contacting the municipality in which your project is located.
When purchasing property, the title commitment will list all restrictive covenants and the title company will provide copies of those restrictive covenants. If you already own the property, check the title policy you received when you purchased. Proceeding without checking the restrictive covenants would be risky and even foolish.
When you have copies of the restrictive covenants they must be reviewed to make certain the condo project is permitted. If you are not sure you can review and understand the documents, retain legal counsel to help. If, for instance, the restrictions permit only a single-family residence on the lot you intend to purchase, your project may be still-born. Amending restrictive covenants is possible, but it is difficult and expensive and the outcome is problematic.
What Is a Condominium?
There are major differences between owning a single-family home constructed in a platted lot and owning one unit of a multi-unit condominium project. A condominium unit, although it is purchased and sold as real estate, does not include ownership of any real estate. A condominium is typically a structure constructed on land owned by a non-profit owners’ association owned by the condominium owners in the condo project.
In most condominium regimes, there are three types of ownership interests: the actual condo unit, limited common elements, and general common elements, often called “common areas”.
The condominium unit (the actual unit) is owned by an individual but the land under the unit is owned by the owners’ association. A limited common element, such as a patio or parking space, is owned by the owners’ association but dedicated to the exclusive use of an individual owner. A general common element is owned by the owners’ association and can be used by all of condo unit owners.
What Is Required to Create a Condominium?
To create and sell condominium units in Texas you must have these documents:
- A condo declaration creating the condos;
- The documents required to create a non-profit corporation to serve as the owners’ association; and
- The condo information statement.
Condominiums are created by filing a legal document known as a condominium declaration which vests ownership of the land in a condominium owners association and creates the three types of ownership interests listed above.
Creation of a non-profit corporation to serve as the owners’ association is required by Texas law before a condo unit can be sold.
Condo developers are also required to prepare and give a condominium information statement to prospective owners. This document contains budget information and basic information about the condo regime.
Two-unit condos also have unique management issues. There are only two owners in a two-unit condo. If the two owners disagree, how will the dispute be resolved? How will the two owners decide on the required third board member for the owners’ association?
Some declarations will attempt to deal with disputes by requiring mediation or arbitration of disputes. Some will create a process where the third board member has a one-year term and is chosen one year by one owner and the next year by the other owner. Often a more robust method of resolving disputes in two-unit condos is required.
Condominium Insurance Issues
Insuring a condo during construction is usually not complicated. A standard builder’s risk policy should be sufficient. However, for a buyer, insuring a condominium, especially a two-unit condo, can be tricky. The owner of an individual condo unit must make certain that the insurance policy is coordinated with her actual ownership interest. In most larger condominium projects, the owners’ association will own the roof, foundation and exterior walls of the condominium. The unit owner will only own the interior of the unit.
However, in many small condominium projects, a unit owner may own the exterior walls of his unit and the roof and foundation. Many insurance agents will quote what is commonly referred to as an HO6 policy which insures from the “studs in”. If the unit owner owns the exterior walls and roof, for instance, this policy may leave the owner underinsured. Since the unit owner owns the exterior walls and roof, the owners’ association master policy will likely not insure those items either.
As a developer, we believe you should advise your buyers to find a knowledgeable insurance agent and point out what the buyer owns and what the buyer needs to insure. The buyer needs to make sure the portions of the unit which she owns, which could include the roof and exterior walls, are insured, that she has liability insurance to cover injury to persons inside the unit and that the contents of the unit, such as furniture, personal items, and equipment, are also insured.
Texas Property Code §82.111 requires the owners’ association, no later than the date the first unit is sold, to insure the common elements against all risks of physical loss in an amount equal to at least 80% of the replacement value of the property and have commercial general liability insurance in place. As the developer, you will be responsible for making sure the required insurance is in force when the first unit is sold.
The owners’ association is a non-profit corporation organized under the Texas Business Organizations Code. Unit owners are members of the association. The association is governed by a board which may be referred to as a board of directors or as a board of members. The board is required to have at least three members. The board members are elected by the unit owners.
Construction Lender Negotiations
If you intend to borrow money to build condos, you must negotiate partial release of lien provisions with your construction lender.
I’ll use a hypothetical to illustrate the issue. Suppose you are constructing two condo units and you intend to borrow $500,000 for construction. It is unlikely that you will close the sale of both units on the same day. A partial release provision in the mortgage will obligate the lender to release a unit from its mortgage upon payment of less than the entire amount owed.
For instance, if you have a partial release provision requiring the lender to release a unit upon payment of $300,000, if you sell a unit for $350,000, you have sufficient funds to obtain a release of the lender’s lien on that unit and close the sale. Without a partial release provision, the lender could require payment of the entire $500,000 loan and you would be unable to close the sale of a unit for $350,000.