As the economy slowly improves, developers are finding opportunities with distressed assets. Many of these distressed assets are construction projects that were funded prior to the recession, ran out of money and have been sitting unfinished for the last few years. These incomplete projects can be attractive values, as the receivers are eager to offload them to a financially viable developer or construction company. However, these projects carry many risks, some of which can be addressed through risk management and environmental insurance.
The environmental risks associated with taking on an incomplete project are mostly related to how the structure was managed during the project’s downtime. Incomplete structures are exposed to the elements in a manner for which they were not designed. This type of exposure can lead to a number of problems, including general degradation of building materials, water intrusion and mold.
The degree to which a project is affected by these issues depends not only on how well the building was managed when it was dormant, but also on how complete the project was when it lost funding. Obviously a building made watertight before the project stalled tends to fare better than one left exposed to the elements for a few years.
How to Manage the Exposure
Start by hiring qualified inspectors to enter the structure and get a sense for how weather exposure impacted the project, as well as how well the first developer and its contractors handled the project before it ran out of money. To the fullest extent possible, identify any existing construction defects and how the project was impacted by being abandoned.
For projects exposed to the elements for long periods of time, it is crucial to locate and understand the nature of any water intrusion issues, including how far into the building they extend, what materials have been impacted, and the sources and origins of the water intrusion. Although it is possible to remove the water and mold, both will come back if the source remains.
The risks associated with distressed assets largely can be mitigated through a quality inspection and by following the inspector’s recommendations, but the long-term exposure to risk remains. With condominiums or apartments, there likely will be numerous third parties inhabiting the space once the project is completed. The long-term risk for mold to recur despite best practices is still higher than average for these types of distressed assets. This is where environmental insurance can be a very effective long-term risk management tool. Coverage can be structured so it protects not only the developer and contractor, but also those lending on the project.
Because lenders are more risk averse today and have tightened their underwriting guidelines, obtaining project funding can be a tough sell for a developer. In most cases, the lender can be added to the policy (or could have its own separate policy) to mitigate the risk and allow the loan to be approved.
Environmental insurance recently was used to restart work at a project in California that was roughly 70 percent complete when the developer ran out of funding. Because work ended abruptly, there was significant water intrusion and mold throughout the structure. The new developer hired an expert to assist with the construction defects, water intrusion and mold evaluation. The expert provided the insurance company with sufficient data and evidence of how mold and other pollution conditions could be remediated so an environmentally focused owner-controlled insurance program could be placed.
The policy covered the developer, contractors and lender for mold or other pollution resulting from construction, as well as from work performed by the prior developer and contractors. The policy was written for a term of three years to allow completion of the remediation and development, and was followed by a completed operations period of 10 years to satisfy the California statute of repose.