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After surging for years, the U.S. real estate marketplace may have finally peaked. 

According to the most recent Emerging Trends in Real Estate® report published jointly by the Urban Land Institute (ULI) and PricewaterhouseCoopers, commercial realtors are entering a challenging environment earmarked by reduced construction demands and the prospect of an economic slowdown as forecasted by the Congressional Budget Office. 

However, as some opportunities decelerate, others are beginning to emerge. This includes repurposing retail spaces into affordable housing; the expansion of alternative energy sources programs; and the ongoing urban development of brownfields and other industrial sites.  

Regardless of type, each project’s benefits are also accompanied by their own set of risks. Common exposures often relate to unhappy clients and tenants, negligent or dissatisfied design and construction professionals, overly-aggressive government entities and other disgruntled third parties, businesses and investors. Under such circumstances, claims can range from the failure of HVAC units and other equipment to the negligent oversight of construction projects, civil conspiracy, zoning violations and just plain old construction defects and delays.  

As a result, many developers have turned to Real Estate Developer (RED) E&O policy forms to cover owners and developers for all manner of professional services in which they are personally or vicariously liable. This includes many standard services such as the management, coordination and supervision of design and construction, whether it’s performed in-house by developers or subcontracted to design professionals or contractors. It can also be written to cover the sale and management of both owned and non-owned property developments. Sophisticated buyers are even securing rectification, protective indemnity and expansive grants of pollution liability coverage both on a project specific or practice basis.  

For example, real estate developers who have in-house construction operations may gain significant value including rectification coverage as part of their professional liability coverage suite.  Rectification indemnifies the insured for costs incurred to remedy design errors created by subcontracted design professionals. So, in the event of a design defect discovered during construction, insureds can partner with their carrier to rectify the issue prior to the filing of liability claims against insureds.  In another example, developers with primary contractors’ pollution coverage can have an immediate seat at the table when pollution incidents arise on a jobsite, rather than “going along for the ride” and letting their subcontractor’s insurance assume the lead in the site’s remediation and any potential legal proceedings. For savvy real estate professionals who like to be in control of their projects, these coverage features provide peace of mind, while adding another layer of oversight.

Just like the RED E&O policy, RED Fund E&O is a primary coverage for the developer.  It covers exposures related to the financing and securitization of real estate projects and portfolios as well as the provision of asset management among these properties. Coverages can be contemplated for individual developments or the fund portfolios of multiple holdings. They can also be purchased by developers or real estate investment funds for their professional services or in conjunction with a Real Estate Developers E&O policy to provide a wider breadth of coverage. 

Here are several hypothetical scenarios that illustrate the professional risks assumed by many real estate developers and funds:

  • The developer and architect of a condominium project are sued by the owner for a design error. The architect not only disappears, but his or her insurance has lapsed. The suit against the developer continues due to its vicarious liability in hiring the architect.
  • A pedestrian is injured when a wall, which had passed inspection, collapses. The pedestrian files suit against all parties including the owner/developer, contractors and architect alleging design errors and omissions. The lead design team had all its plans approved by the owner/developer who had a licensed architect on staff. The design team’s A&E policy responded but fault was proportionately allocated to the owner/developer, who was not an additional insured on the A&E policy. 
  • A real estate investment firm sells a hotel operated by a national chain to an independent buyer. The firm fails to disclose that approximately $900,000 of the hotel’s annual revenue resulted from the redemption of the hotel chain’s rewards points – revenue that would not be available to the new owners, who sued for negligent misrepresentation. 
  • A developer of low-income properties contracts with a property manager who is negligent in administration oversight. This includes disregarding the eligibility qualifications for the property’s low-income tax credits. As a result, the IRS not only negates eligibility, but initiates a “recapture” for the previously awarded tax credits. Shareholders sue the developer for negligent oversight and the property’s lost value.  

In each of these scenarios, a RED E&O or RED Fund E&O policy may provide coverage the developer or fund would otherwise not have.  As always with insurance, the actual coverage available depends on the specific terms of the particular policy in question.

As for the coverage itself, insureds need to fully understand the potential exposures and risk tolerances when looking at Real Estate Developers E&O. That’s because many carriers have unique appetites for the categories they cover. For instance, while an insurer may have one position relative to healthcare facility developers, it can take an entirely different stance on energy projects due to its institutional knowledge of the industry. In addition, few carriers offer dedicated standalone policies, although some insurers are beginning to explore more robust options as developers increasingly look to transition from basic real estate E&O coverages.  

Furthermore, the policy can be purchased on either a practice or project-specific basis with pricing determined by factors pertaining to the type of development, construction values, ongoing real estate service fees and revenue sources such as tax credits. Typically, coverage is offered annually, although project policies can sometimes be offered on a multi-year basis, with extended reporting periods up to eight to 10 years. 

Limits of liability for these policies normally cap at $10 million on a primary basis and up to $50 million in total program capacity for most real estate development clients. Typical limits can be as little as $2 million for small, local real estate development operations with most purchasing around $5 million in limits. In the end, the final terms are most often based upon the size, scope and risk management philosophy of the customer.  

Now, the challenges. First, make sure the new RED E&O policy continues the coverage provided by the existing real estate E&O program. For example, if the current property manager E&O policy has a specific retroactive date of January 1, 2001, the new RED policy, which also covers property management services, should have the same service-specific retroactive date to ensure ongoing coverage. It’s also important to understand that the “what you get is what you pay for” philosophy is particularly applicable with this policy form. Since the RED E&O policy likely provides coverage well beyond current property management (PM) E&O terms, costs may increase materially for the broader expansion of coverage.  

Next, make sure provisions are written to include all the entities, no matter their role, that are involved in the development organization plan. Given the breadth of coverage and the complexity of most real estate organization charts, it is also imperative to provide complete underwriting information to ensure exposures are properly addressed as they occur.  

It can be extremely tough to ascertain the potential third-party financing and creditor exposures as well as E&O issues for anyone new to the real estate developers E&O segment. When in doubt, seek the advice of licensed, experienced professionals. Unfortunately, it’s too late to think ahead once the claims are filed. 

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