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Real Estate

Moving on Up to the East Side

By Benjamin E. Wilson

Like the late, great George and Louise Jefferson from the classic TV show “The Jeffersons,” Miami real estate developers and purchasers continue “moving on up to the East side” as several new luxury condominium projects along Miami’s coastline have recently been completed or launched construction or sales programs. Glancing through recent editions of Ocean Drive Magazine, Miami Magazine, and other local high-end publications, one will notice numerous advertisements and stories about new luxury condominium projects in Miami Beach, Coconut Grove, Brickell Avenue, Midtown, the Biscayne Boulevard/Design District corridor, and Bal Harbour.

One may wonder how construction of these luxury condominium projects and others will be financed in the midst of the current economic downturn and the decreased availability of condominium construction and acquisition financing. The answer for some Miami real estate developers has been to rely more heavily on the deposits of purchasers to fund construction of these condominium projects, and the formula has been successful for several projects.

During the condominium boom of the early and mid 2000s (a time when condominium construction financing was more readily available), most developers required purchasers to make a deposit equal to 20 percent of the unit purchase price, with half the deposit retained in an escrow account and the other half used by the developer for construction purposes. The developer financed the remainder of the condominium construction through one or more construction loans. The practice of using purchaser deposits to partially finance construction was, and remains, permitted under the Florida Condominium Act so long as the proper disclosures are in the developer’s purchase contract.

Now, some Miami developers are abandoning the notion of obtaining construction loans for their new projects and are requiring purchasers to make a series of deposits between the period of contract execution and closing, with all deposits above 10 percent of the unit purchase price being used by the developer to fund construction. In essence, by the time a purchaser in this scenario goes to closing, he or she may only owe the remaining 10-20 percent of the unpaid unit purchase price. That’s quite different from the development formula of recent years where the purchaser paid a deposit equal to 15-20 percent of the purchase price upon signing the contract (or even a 10 percent deposit at signing and another 5-10 percent deposit once construction commenced) and then paid the remaining balance at closing through a mortgage loan, cash, or a combination of both.

By using this new formula, the developer benefits by avoiding the costs of obtaining a construction loan for the project, as well as the pressures of satisfying construction deadlines to receive construction draws and to be in a position to make timely loan payments. This new formula also benefits the developer because it is conducive only to purchasers of substantial means who can purchase the unit without obtaining a mortgage loan and these purchasers are potentially less likely to default under a purchase contract due to the heavy equity investment required from them prior to closing. Even if a purchaser defaults, the developer’s collectable remedy has the potential to be much greater than before because it has the option of retaining the much larger deposit required from the purchaser, not merely the 15-20 percent deposit required in years past. However, if the project is subject to the Interstate Land Sales Full Disclosure Act (ILSA) because it contains more than 99 units and construction cannot be completed in two years, the developer’s liquidated damages for a purchaser default would be limited to retaining deposits equal to 15 percent of the purchase price.

This form of construction financing and development seems wonderful for developers; however, it is not an option for all. It is really limited to developers with substantial connections to high-net-worth international and domestic purchasers and an established reputation of timely delivering products featuring top-quality construction and amenities.

The international connections are essential for this method of construction financing because a substantial amount of Miami’s new construction continues to be purchased by international buyers. This development method appeals more to international buyers, who are accustomed to purchasing new construction in this manner, than to U.S. buyers. Further, international purchasers remain interested in investing in South Florida real estate for economic and perhaps political reasons.

The developer’s reputation is critical under this development strategy because purchasers are being asked to take a much bigger risk that the developer will complete the project within the time frame and in the manner promised. Purchasers will be more reluctant to take that risk if the developer is not well established, trustworthy and reliable. If the developer breaches the purchase contract after construction has commenced, chances are that the purchaser has little or no collectable remedies against the developer, other than a return of the 10 percent deposit required to be held in an escrow account. In situations like these, the developer will likely be a special purpose entity with few or no assets other than the project site and escrowed deposits, and the purchaser’s previously paid deposits (except for the 10 percent deposit in escrow) may have already been spent on construction costs.

This development formula worked well for a long-standing Miami real estate developer who used contacts in Latin America to quickly secure purchasers for its project along Biscayne Bay and completed closings for the project within a four-month period. This formula seems to also be successful for several other well-established Miami developers. Here’s hoping for continued luxury condominium ads in the upcoming issues of Ocean Drive Magazine, Miami Magazine, and other local publications.

Benjamin E. Wilson is an attorney in the Real Estate Department of Shutts & Bowen’s Miami office, where he concentrates his practice in the areas of real estate transactions, real estate development and finance, commercial leasing, condominiums, affordable housing, planned unit developments, mixed-use developments, and distressed property acquisitions, loan work-outs, and foreclosures.

South Florida Legal Guide 2012 Financial Edition

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