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David Hellmuth quoted in Finance & Commerce on condo laws

07.23.15

Condo conundrum in downtown Minneapolis

Realtor Cindy Froid says she can’t find enough condominiums in downtown Minneapolis to sell to prospective buyers banging on her door.

Froid, who co-represented the buyer in the high-profile $4.3 million purchase of a condo in the Carlyle tower, finds she often has the purchase agreement for a condo signed before she finishes the listing agreement for that unit’s seller.

“It’s almost like we’re waiting for people to either move out of Minneapolis or literally die,” said Froid, principal of the Cynthia Froid Group, a part of Keller Williams Realty.

It’s a stunning shift from the downtown condo bust of a few years ago.

Between 2004 and 2009, developers built 4,581 condos, according to Maxfield Research. The peak year for downtown condo construction was 2007, when 1,409 units were built just ahead of the Great Recession. But the peak sales year was 2005, when buyers closed on 1,269 units. Still, 707 more units were built in 2008 and 2009 as the economy struggled. The six-year boom left empty condos and some lenders holding the bag.

Then last year, nearly 900 condos sold for an average of $265 per square foot — a big jump from $209 in 2010, according to Maxfield Research.

Despite the demand Froid and others are seeing now, just one condo building is under construction in downtown Minneapolis.

So what’s holding back developers?

Although some developers are still recovering from the condo bust, multiple sources interviewed for this story say that building condos today exposes developers, contractors and even architects to potential lawsuits. At the same time, some lenders are still squeamish and require high presales, and insurers are hesitant because of the risk of construction defect lawsuits.

But at least one Minneapolis City Council member hopes to create a permanent fix and bring more owner-occupied units downtown. And a state legislator is looking at proposing a change in state statute.

State law allows a condo owner or condo association to sue project partners for “major construction defects” for up to 10 years after the unit or building was completed. In 2010, the law was amended to add commercial contractors to the list of liable partners.

While lawyers representing condo owners and associations say the claims are based on legitimate complaints, critics say lawyers may have found an easy way to make a buck.

Warranties are about to expire for many condos built just before the bust.

“That’s the primary reason why there aren’t more condos being developed, and by a wide factor,” said Brad Schafer, a principal of Minneapolis-based Schafer Richardson, which developed several condo buildings during the boom. “The market would love more condos.”

It doesn’t seem to matter that some condo prices may be sky-high, with some buyers presenting “make-me-move” offers to reluctant sellers. That’s what happened when Crave restaurant co-owner Keyvan Talebi agreed to sell his condo in the Carlyle for a record $1,200 per square foot, said Froid.

At the same time, the apartment construction boom continues, with some new downtown buildings fetching $300,000 to $425,000 per unit from investors looking for long-term yields.

Add it all up, and many experienced developers say the condo segment of the residential market just isn’t as attractive as apartments.

Legitimate claims or easy legal fees?

Shamrock Development’s 17-story, 112-unit Portland Tower is the only condo building under construction in downtown Minneapolis. The building is at 740 Portland Ave. (Staff photo: Bill Klotz)

Only one condo project — Coon Rapids-based Shamrock Development‘s 17-story, 112-unit Portland Tower — is under construction in downtown Minneapolis today. Shamrock is also planning about 400 more condos on the former Cenveo plant site at 121 12th Ave. S.

But even Shamrock principal Jim Stanton, a well-known risk-taker, said the threat of a lawsuit is significant.

“You have to consider it,” he said. “There are lawyers who just specialize” in suing condo builders.

Not everyone agrees that’s the case.

David Hellmuth, founding partner of Edina-based Hellmuth & Johnson who frequently represents condo owners and associations, said his clients’ complaints are legitimate and most often are backed by an engineering report.

Most of the defect claims relate to water intrusion, he said. Other common claims are concrete or blacktop failure and window defects.

Most of his claims are confidential and settled out of court, so he declined to name any specific cases.

“Ten years [length of warranty] is a long period of time but at the same time, any owner who buys residential real estate — that’s probably the largest investment they make in their life,” he said.

Hellmuth said he always pushes for agreements outside of a courtroom before pursuing litigation even though it may mean less business for him.

“We’re not trying to create claims that don’t exist,” he said.

Suits against condo builders are certainly nothing new, but they seem to be happening more often, said Tom Bray, a shareholder at Briggs & Morgan and member of a committee of the Minnesota State Bar Association that deals with condo laws.

Several reasons may be behind the trend, he said, including a high number of condo buildings reaching the right age for a suit, potential changes in the insurance market that make it tougher to protect against the suits and the growing number of attorneys with a specialization in construction defect cases.

All could make attorneys “more proactive” in advising ownership associations about potential claims, he said.

Stanton said his company has been sued multiple times during his career. When developing condo projects, he said, it’s a good idea to set aside extra money for that possibility.

“In our mind, you probably set aside a certain percentage to go back and fix things we might not be required to do by code or statute,” he said. “You just do it.”

Only two of Schafer’s condo buildings made it past the 10-year mark without a suit in his 30 years as a developer, he said. A few more are still inside that window of exposure.

“If you build a condo, you’re going to get sued,” he said. “… It’s a target-rich environment for the legal community.”

Susan Fauver, general counsel for Minneapolis-based Sherman Associates, which also developed condos during the boom, said in an email that developers must consider the risk before proceeding with condos. State law contains “broad warranties in favor of condominium buyers” that can lead to issues “difficult to project” for developers, she said.

Reluctant contractors

Some construction companies and related businesses are staying away altogether. Schafer said he has worked with contractors who will demand a developer sign documentation that makes all warranties null and void if the proposed apartment building is converted into condos in its first 10 years — the statute of limitations for a structural defect suit.

Stanton and Fauver each mentioned they knew of either contractors or financing entities that steer clear of condo projects.

“Lawyers have recognized both the ready availability of plaintiffs in an organized group, the consumer orientation of the statute, and the ambiguities in the statute, creating a litigious climate,” Fauver said in the email. ”This threat of litigation has caused many contractors and architects to elect not to work on condominium projects and has caused many lenders to stop or restrict financing these projects.”

Contractors consider condo construction a “legal minefield,” and many are leery of taking on the projects when there’s other work available, said Dave Semerad, chief executive officer of the Associated General Contractors of Minnesota.

“Anyone that’s in this market is concerned about it, and if they’re not concerned about it, they’re not paying attention,” Semerad said. When contractors have a choice, he added, they’ll take on projects with a higher return on investment and lower risk, meaning condo projects may fall by the wayside.

Bray, of Briggs & Morgan, has observed the same reaction.

“The fact that contractors are that concerned about it, that they’re asking this from people they’re trying to get work from, tells me that they’re concerned about that liability,” he said.

Bray adds he often hears other attorneys speak of a “sense of inevitability” that their developer or contractor clients would get sued.

But Hellmuth, who represents condo owners and associations, says he disagrees with the view that it’s “inevitable” a condo builderwill face a lawsuit.

“I think there’s a perception on the builder side of it that they’re going to have a claim, but I don’t think that’s the reality,” he said. “A small percentage of them” face suits, he said, “but they’re big problems.”

Leery lenders

Financing a condo development is inherently more complicated than financing an apartment building, with dozens or hundreds of individual condo sales required before project completion.

That complexity, combined with the recent losses from the condo bust and the legal atmosphere, is holding back potential lenders who normally would consider new condo projects based on the demand.

“There are a lot of lenders out there that got burned before,” said Herb Tousley, director of the Shenehon Center for Real Estate at the University of St. Thomas. “They’re gun-shy.”

The lawsuits also can scare off insurance companies, who may decline to back a condo project, or only do so for a higher premium, said Stanton of Shamrock.

What can be done?

The concerns in the development community resound with Minneapolis City Council member Jacob Frey, whose ward includes the Central Business District, Downtown East, the Mill District, and the Northeast and North Loop neighborhoods. Frey receives frequent calls from condo seekers who want to move into the ward.

“Demand is sky-high,” he said. “People want to live in downtown condos, but so few opportunities exist.”

Frey, an attorney, plans to push for legislation, perhaps as soon as next year. Although the plan isn’t fully developed, Frey’s ideas include specifying more thoroughly what can be defined as “structural defects” under state law.

“This is a big, big deal,” he said. “We just want a diversity of housing, everything from low-cost rentals to high-cost rentals to owner-occupied. Right now we just don’t have owner-occupied.

“What’s that going to do to the downtown experience in 20 years from now if everything’s rental?”

Stanton, the only active condo developer in downtown, is on board.

“While I’d be inviting competition, I’d say it would be most welcome,” he said of Frey’s idea. “It’s something that needs to be done.”

Sherman Associates is also “very supportive” of statutory changes that would encourage more condo development, Fauver said. She offered multiple ideas for change, including a new construction warranty law that applies only to condos and more legal distinction between new construction and rehabilitation of existing buildings.

“Condo developers, contractors and architects are all too exposed by the current laws,” she said.

Hellmuth thinks the laws are “pretty fair as written.” While he said there is “some ambiguity” in what qualifies as a major enough defect, he believes case law has defined it well enough that “everybody has a good understanding of what that standard is.”

Frey is working with state Sen. Kari DziedzicDFL-Minneapolis, and has discussed the topic with Rep. Raymond Dehn, also a Democrat, whose district includes downtown.

Dziedzic said she hears frequently from constituents who hope for more owner-occupied developments. She has worked since last fall to find the best solution for condo developers and homeowners alike, and hopes to propose something next year.

“It’s not an easy fix,” she said. “It’s not something we’re going to do overnight.”

Dehn says he’s “absolutely open” to the idea of changing the law, but hasn’t spoken to specific developers or spent much time on the issue. Still, he has seen the legal battles and knows developers feel exposed.

“It’s a sector of the legal profession, something that’s gotten abused, quite frankly,” he said. “That’s why there’s a lot of reticence by developers to do for-sale units.”

Dziedzic and Frey said they hope to keep plenty of consumer protection under the law. Bray said he hopes his committee and the State Bar Association can help in crafting new laws.

Under consideration

Shamrock remains the only developer willing to take on the risk and build new condos downtown today so far, with the Portland Tower under construction and the Cenveo site project yet to come.

The Portland Tower condos will be priced between $300,000 and $600,000, but Stanton declined to reveal pricing for the Cenveo units.

The project will start “once we get [further] along with Portland” construction, he said.

His recent downtown condo projects, the 164-unit Stonebridge Lofts and 282-unit Bridgewater Lofts, have both either sold out or surpassed expectations.

Minneapolis-based Ryan Cos. US Inc. is considering condos for the air rights it controls on a city-owned site kitty-corner from the new Minnesota Vikings stadium. But Tony Barranco,vice president of development, isn’t committing to for-sale units. The structure would be built next to and above a parking ramp designed to serve the stadium.

“We’re still running numbers on both” apartments and condos, he said.

Bloomington-based United Properties has also said it’s considering condos on the Nicollet Hotel Block in downtown Minneapolis but has yet to commit. The developer expects to announce project partners by the end of summer.

The only other possible downtown or nearby condo project announced so far is Alatus LLC’s potential 35-story, 325-unit residential tower on the Washburn-McReavy Funeral Chapel site just across the Mississippi River from downtown. Alatus has said it may pursue either condos or apartments on the site it recentlypurchased, but hasn’t officially applied for the project yet.

Fauver said either the law needs to change or condo pricing would have to “increase dramatically” for Sherman to develop condos today.

Barranco agreed that a larger profit margin would help some developers overcome the potential legal issues attached to condos.

As for Froid, she hopes developers will bring new condos to the area.

The market is clearly coming back, she and other Realtors say.

In 2010, just 514 condos were sold and average sales prices had plummeted to $209per square foot from $244 in 2005.

Last year, 877 condos of all ages sold in or near downtown for an average of $265 per square foot, according to Maxfield, up more than 60 percent since 2010. After the bust, no condos were built between 2010 and 2013.

“There is so much money out there right now, and so many buyers who just want to spend it but have no place to put it,” Froid said.

As a result, they become “accidental renters” downtown and look for other places to invest.

“Then they’re buying a big house in other cities and renting in Minneapolis,” Froid said. “That’s not what we want.”

While Froid supports Stanton’s ongoing condo projects, she said more luxury units are needed for the market and architectural variety.

“It would sell in a week,” she said of a potential high-end condo tower. “To me, it’s a no-brainer. I wish I had the capital to put a shovel in the ground.”

*Originally published in Finance & Commerce