Much has been said about the ever diminishing supply of condominium inventory and the reluctance of banks to lend to construct new condominium projects since the market collapse. As previously discussed, several determined developers, including The Related Group, NewGard Development Group, and Terra Group, are relying upon buyer deposits of 70-80% of a unit’s purchase price to finance the next wave of state-of-the-art projects.

Buyer Deposits vs. Traditional Financing

Using buyer deposits instead of restrictive and relatively expensive traditional construction financing has obvious appeal to developers. The risk of the project failing or the money running out is largely borne by the buyer. Unlike traditional financing, unit purchasers do not expect repayment with interest and lack the leverage (and sometimes the sophistication) necessary to extract typical protections from developers such as guaranties backed by the assets of the parent company or the developer individually. Moreover, except for the initial 10% deposit that is escrowed in accordance with Florida law, unit purchasers have no mortgage lien or other security interest to protect their investment should the developer fail to deliver the unit on time and as promised. Unlike a single construction lender with a large amount of money at stake, individual purchasers, many of whom are foreigners, may have difficulty mustering the clout or justifying the expense of proceeding against a developer and, as a result, may be left with little effective recourse in the event of a project failure.

Buyer Beware

Should the money run out before the project is completed, a buyer is left to hope that the parent company or other equity holders choose to inject additional capital and honor the agreement of the now-penniless project entity to preserve its reputation. Although, for example, Related Group’s condominium division president Carlos Rosso tells The Miami Herald that “Related stands behind every project”, purchasers are contracting with a newly-formed project level entity, and the parent company is typically under no legal obligation to step in. At bottom, a buyer is wagering that the developer will be willing and able to stand behind its project if the time comes and can mitigate this risk by choosing a seasoned, experienced, well-known developer.

Absent new capital, a unit purchaser’s position in a developer bankruptcy is a weak one. Without any collateral beyond the initial 10% deposit, a buyer is left with a priority unsecured claim for $2,600 and a general unsecured claim for the balance of the buyer’s deposit. These claims are likely junior to the mechanics’ lien claims of the contractor and sub-contractors and to any other secured indebtedness that the developer may have incurred. Developers will be forced to restructure, find new sources of additional capital, or sell the unfinished building at a steep discount leaving creditors to battle over the proceeds. At the end of the day, if the project does not succeed, the unit purchaser may be left holding nothing but an empty promise from a shell entity. Caveat emptor.