I. In Arizona, Parties Considering Investing in Real Estate Development Projects Have to Make Investments Without Full Knowledge about One of the Key Issues — Who Has a Priority Interest in the Property if the Project Fails.
Construction development projects generally involve multiple parties who “invest” some set of resources into the construction in an effort to obtain a return. Most projects include at least three types of “investors” who all invest differently in a particular project: (1) developers and their agents; (2) a commercial lender who invests capital to finance the purchase of the property and/or the construction; and (3) contractors and material suppliers who invest labor, machinery, fixtures, materials and tools for direct compensation. And, as with any investment, the more certainty those involved in a project can have of the potential risks and rewards at the outset of the project, the better decisions they will make going forward.
Before the 2008 economic downturn, many of these decisions were easy because the appraised equity in most real estate developments in Arizona exceeded the estimated costs for the project, so nearly everyone ended up getting paid for their investment. Obviously, that is no longer the case. As real estate values declined, multiple projects were substantially underfunded and underwater, making it impossible to complete the project. Those left standing, whether a subsequent buyer of property, a lender who funded a purchase after construction, or a contractor who made improvements, were all left seeking to recover whatever they could. Since, in most cases, the “investors” had contractual relationships with the developer, who was often a singlepurpose LLC or company with no assets other than the project in question, the only asset of any value was the property itself. Unfortunately, the property often did not have enough value to pay everyone back, so the question of who gets paid first often controls who gets paid for their “investment,” period.
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