There are many risks to buying a new construction home in NYC besides being expected to pay transfer taxes and attorney fees on behalf of the sponsor. We’ll talk about risks unique to buying new development units from sponsor control of the board, allowed variances in square footage to being forced to close on a TCO.
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Table of Contents:
Additional Closing Costs When Buying New Construction
Sponsors typically expect the buyer to pick up a substantial portion of the sponsor’s closing costs in a new development purchase. This typically includes the seller’s NY State and NYC transfer taxes as well as the sponsor’s attorney fees.
Extra Fees on Sponsor Deals
While sponsor attorney fees averaged $3,000 until recently, you now see sponsor attorney fees ranging up to $5,000. Transfer taxes are even more expensive and range up to 1.825% of the consideration.
Note we say consideration vs sale price. That’s because consideration includes the sale price plus anything you give up in value. In this case, that includes the transfer taxes you are paying on behalf of the seller. Interestingly enough, New York does a gross up when calculating the total consideration to tax on.
Furthermore, you may have to pay upfront for the superintendent’s apartment if the building will have a live-in super. If the building decides to get a mortgage to purchase the super’s apartment from the sponsor, then instead of an upfront closing cost you may simply have additional common charges. Either way, this is an additional front loaded cost to buying new construction as you don’t really get it back when you sell.
Sponsor Control of the Board
When will the sponsor relinquish control of the building’s board of directors? What conditions need to be fulfilled for the developer to give up control? This special risk to buying a new construction home in NYC is disclosed in the Special Risks section of the original condo or co-op offering plan.
Most offering plans will stipulate that the sponsor relinquishes control of the board after 90% of the units are sold, or within 5 years of the first closing. This is the norm in the industry as of 2018, and it means that buyers of new housing developments will at a minimum be able to take control of their building within 5 years.
However, it’s important to carefully peruse this section of the offering plan because some sponsors may try to sneak in additional language that lengthens their hold on the building. Some condo offering plans will stipulate that the sponsor will control the board as long as the sponsor owns at least one unit in the building.
We’ve seen this happen when a developer kept a unit for himself to live in. Or a sponsor could simply keep one unit as a sponsor unit to rent out indefinitely, and as a result be able to control the building forever.
Sponsor control of your building post-closing can cause conflicts of interest. If the sponsor still has a substantial amount of unsold inventory or is simply renting out the unsold sponsor units, then the sponsor will likely veto any miscellaneous spending that the other owner residents want. Not only will minimizing spending increase the sponsor’s net rental yield, it’ll make the remaining inventory easier to sell because common charges will appear lower.
Understated Common Charges and Taxes
A key risk to buying a new construction home in NYC is that advertised monthly running costs (i.e. co op maintenance or condo common charges plus taxes) will typically be lower than reality. There are a couple of reasons for this.
The first is that the NY State Attorney General’s Office which oversees all new construction offerings allows a 25% variance on what total monthly charges are vs what is disclosed in the offering plan. As a result, some sponsors will undoubtedly play around with the proposed co-op or condo budget to understate the common charges as much as possible. Perhaps they’ll assume the building won’t need to pay anything for a super and the residents will take out the garbage themselves!
Second, it’s important to understand that the NYC real estate taxes disclosed in the offering plan are typically only for the first year. The first year real estate tax figure is actually an average of the taxes on the in construction and finished values. Since the taxable value of a finished building is higher, your real estate taxes will be higher than listed in the offering plan.
Variance in Square Footage
A special risk to buying new construction in NYC is that the square footage of the apartment you thought you were buying can vary or even change from what was advertised. Offering plans will typically disclose the possibility of a plus or minus 5% difference in square footage upon completion. Sometimes the wiggle room disclosed can even be 10%!
Be Wary of Square Footage
Keep in mind that new developments are already very liberal in how they calculate square footage. Instead of using interior or usable square footage, new developments sometimes use the space occupied by walls and even common areas such as elevator banks or hallways.
Furthermore, there is a small risk that your unit’s layout will be different during the final walk through vs what you saw at the initial viewing.
Because of the allowed variance, we’ve seen instances where the developer literally took about 20 square feet of closet space away from a master bedroom’s walk-in closet. When the buyer attended the final walk through inspection, there was a wall put up that took away half of his bedroom’s closet space! In this rare instance because the developer was a big player in the space with a lot of brand equity, they actually ended up writing a check to the buyer for a little over $20,000.
Delays or Cancellation by Sponsor
The sponsor can cancel the sale at any time before filing an effective amendment. An effective amendment can be filed when at least 15% of the units are in contract. Once this is done, the project is declared effective and there is no turning back for the sponsor.
However, sponsors will wait until the last possible moment to file an effective amendment, typically right before the first closing takes place. Sponsors will obviously do this to protect themselves in the case of a market downturn. Sponsors want to retain the right of cancelling your deal, even if you have a fully executed contract, if the market crashes.
This way, a sponsor will have the option of sitting on their inventory or operating the new development as a rental building if the market crashes. Keep in mind that the chances of a sponsor cancelling a sale are very slim, and some real estate attorneys claim that they’ve never seen it on a deal.
In terms of delays, it’s important to understand that new developments can take months or even years longer than expected to complete. The only protect consumers ordinarily have is that the sponsor must have had at least one closing with a legitimate Temporary Certificate of Occupancy issued by the last day of the budget year.
For example, if you are in contract on a new construction condo that is scheduled for completion on July 1st of 2019, then the first budget year may run from July 1st of 2019 to June 30th of 2020. If the sponsor has not had a closing with a legitimate Temporary Certificate of Occupancy by June 30th of 2020, then everyone has the right to rescind their contracts.
You should also keep in mind that new development purchase contracts do not allow buyers to sue the sponsor if the deal doesn’t go through. Typically the only recourse a buyer has is to get their contract deposit back.
The Sponsor Can Force You to Close
A quirk of the new construction home buying process is that the sponsor can force you to close on a whim as long as they have a Temporary Certificate of Occupancy. You typically won’t have a courtesy 30 days notice or “on or about” closing date language as you’d see in a normal re-sale.1 If you don’t or can’t close, you risk being in default as the purchaser and can be subject to paying both the common charges and taxes as well as a penalty.
This penalty can be quite stiff, and some lawyers have told us that it can be as high as 5% of the purchase price. If you still don’t close within 30 days, we’ve heard lawyers tell us that sponsors can cancel your deal, keep your deposit and move on.
A good new construction real estate attorney will attempt to negotiate more time for you to close. A good attorney might be able to negotiate one right to adjourn for 10 to 15 days. This means that you won’t pay any carrying costs or penalties during this adjournment.
1The language in normal re-sale purchase contracts are generally much looser. On or about and on or before mean the same thing according to lawyers we’ve spoken to.
The Sponsor May Not Have Funds to Complete Construction
The NY Attorney General’s office does not check whether a developer actually has enough funds to complete a project. All that is required in the new development offering plan is a disclosure that the sponsor has not put up a bond and is not claiming to have enough funds to complete construction.
Remember that when the AG’s office accepts an offering plan, it only means that they’ve checked the offering plan to make sure that there is an accurate description of the project and that proper disclosures have been made.
Not Being Able to Rent or Sell Post Close
Most new development offering plans will have a prohibition against owners advertising a unit for sale or rent for a year after close. Please note that this only applies to new owners and not the sponsor.
As a result, investors may have to reconsider their rate of return assumptions if they are not allowed to rent their units out immediately. Even buyers who plan to move in will have to consider contingency plans if their circumstances change and they can no longer use the property as a personal residence.
Remember that new construction projects can take many months and even years to complete. As a result, a buyer may have a new job in a different city by the time closing happens!
Building Amenities May Not Be Finished
Sponsors have one year from the first closing to finish the building’s amenities. Sponsors are technically in default of the offering plan if they don’t finish the amenities in time.
A special risk to buying a new construction home in NYC is that there’s not too much you can do about it in reality even if the sponsor doesn’t quite finish on time. Your real estate lawyer can threaten to sue in order to try to get some concessions, but it won’t be worthwhile typically to litigate. Furthermore, your real estate lawyer typically won’t be the one to litigate even if you really pushed for it, why would they want to harm relations with someone they might do business with again?
Your Views or Windows May Disappear
One of the risks to buying a new home in NYC is that your view may disappear in the future because of neighboring construction. This can be an acute problem if you paid up for a higher floor with an unobstructed view only to have a high rise be built in a few years that completes blocks out your view and any natural light you had.
You can mitigate this risk by buying apartments with windows that face public parks, the water or any other areas that have a lower risk of being developed. If the apartment is located in a historical district or any other neighborhood that has mostly low rises, you may be able to mitigate this risk simply by having windows that face the street, or ideally a corner unit facing two streets.
Another risk to buying a new construction home in NYC are lot line windows. You should carefully peruse the offering plan to see if any of the apartment’s windows are lot line windows. A lot line window means the neighboring lot has the right to develop their lot and build to and above your window.
A window is typically considered a lot line window if the neighboring lot can build within 30 feet of your window. Often times lot line windows will become entirely covered, flush against the wall of the newly built development next door. Not only may lot line windows lose their view, the window has to be bricked up at the owner’s expense!
Has the Sponsor Developed Property Before?
A major risk to buying new construction in NYC is that the sponsor is inexperienced or that this is their first deal. There are lots of hurdles and inevitable delays to developing a property in NYC, so you’d ideally like to see that the sponsor has done it before.
You can find out more about who’s behind the project in the Identities of Parties section of the offering plan. This section will talk about the building’s architect, the sponsor’s lawyers, the proposed managing agent as well as the sponsor. The main point of this section is to get a sense of whether the sponsor is hiring high quality people and whether the sponsor has done a deal before.
If you’re interested in learning more about the architect, you’ll find a very interesting section of the offering plan written by the architect. This ten to thirty page section talks about all aspects of the project, starting from the lot, then the building and then the units themselves. The architect will even list specific model numbers of appliances in the units.1
1If there are any changes to the appliances actually used vs what is in the offering plan, they need to be as good as the ones listed.
Will the Sponsor Finish the Punch List?
Another risk to buying a new construction condo or co op is that there is no official timeline for the sponsor to have to finish the punch list. The sponsor only has to make commercially reasonable efforts to fix the punch list.
With that said, the punch list is actually a legal document as it’s referenced in the offering plan. Therefore, you can technically sue and complain about the punch list. With that said, the bigger developers with reputations to protect generally do a good job on completing the punch list of items to fix to the buyer’s satisfaction.
Is the Building Habitable and Safe?
Remember how a sponsor can force an in-contract buyer to close as long as a Temporary Certificate of Occupancy has been produced? Unfortunately, the only criteria for receiving a Temporary Certificate of Occupancy are that the building and unit must be habitable and safe. This obviously leaves much up to interpretation.
For example, can you adjourn a closing if the floors need to be completed or re-done? Yes because if the floors need to be worked on, it’s hard to argue that you can live there and that it is habitable.
What if the stove and other appliances don’t work yet? Yes, you can make an argument that it is not habitable because you cannot cook.
Risks to Buying a Model Unit
Model units are the apartments which are fully finished and staged which sponsors show to prospective buyers. Model units often times come with a slight discount because they’ve been used and walked through by many people.
However, a special risk to buying a model unit in a new development is determining what condition it will be delivered in. We’ve seen cases where the purchase contract included “touch-up language” in regards to the condition of the model unit to be delivered. However, this can be vague. Does touch up mean the sponsor will do anything? Does it mean the sponsor will sand the floors and paint the walls?
Opting out of Diplomatic Status
Sponsors really think of everything when it comes to offering plans and the purchase contracts they use. You’ll notice in every new construction purchase contract a clause that forces the buyer to opt out of diplomatic status (i.e. diplomatic immunity) or any other special status they have.
This is important for the sponsor because diplomats can’t be sued in the country they are serving in. By opting out and agreed to be treated like everyone else, sponsors can go after diplomats if something goes wrong.
Rights and Responsibilities of Sponsor and Owners
This section of the offering plan is useful on shedding light on any special restrictions in the building. For example, are there any limitations on the maximum amount of financing a buyer can use to purchase in the building?
Take a look at this section and the rest of the offering plan to see if a flip tax is discussed. Many new construction condos these days allow for the imposition of a flip tax, even though that is rarely seen in condos and is mainly a feature of co op apartments.
Disclosure: Hauseit and its affiliates do not provide tax, legal, financial or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, financial or accounting advice. You should consult your own tax, legal, financial and accounting advisors before engaging in any transaction. The services marketed on Hauseit.com are provided by licensed real estate brokers and other third party professional service providers. Hauseit LLC is not a licensed real estate broker nor a member of any multiple listing service (MLS).