Developers in Colorado are on track to pull more construction permits this year for multifamily homes than for single-family homes, something that hasn’t happened before. But condos are largely missing in that record surge and with them an opportunity to provide more affordable housing options for first-time buyers.
The state is on track for roughly 27,500 multifamily housing permits this year versus 25,700 permits for single-family, according to the 2023 Colorado Business Economic Outlook from the University of Colorado Boulder. Historically, multifamily has represented 30% of all housing construction and since 2012 it has run closer to 40%. This year, it will represent 52% of all permits pulled.
That surge in denser development would seem like a good time to add more condos, which cost much less than single-family homes, to the market. But the Outlook estimates that since 2010, the state has added one condo for every 19 apartments built. It attributes that lopsided distribution to concerns about construction defects litigation, higher insurance costs for condos and easier-to-obtain financing for apartments.
“There is such a pent-up demand for condos, but building more affordable condos doesn’t really doesn’t pencil out for the builders,” said Bethel Sand, a real estate agent with LIV Sotheby’s International Realty, who runs the website Denver Condomania.
Unraveling the why behind the lack of condo construction, which is almost identical to apartment construction, isn’t easy. Economic considerations are at play both locally and nationally. As more potential buyers get priced out of the purchase market, it makes sense to build more apartments for them.
Because of higher mortgage rates, a household at the median income in Denver could afford a home that cost $487,111 in 2021. In November, what the typical household could afford dropped to $350,037 because of higher monthly payments, according to a study from Point2Homes.com.
In Denver, only 13% of homes listed were affordable to someone earning the median household income, while in Aurora that ratio is an even lower 8%, according to the Point2 study. The median price for a single-family home that sold in metro Denver in November was $622,490 and for condos it was $405,000, according to the Denver Metro Association of Realtors.
People who might want to buy are stuck renting, and more people who could afford to buy are choosing to rent. The demand is there for more apartments, so developers are bringing more to market. But they also realize that the demand is also there for condos.
“We absolutely need more condos,” said Tim Walsh, CEO and founder of Confluence Companies in Golden. “It is an entry point and an exit money for most homeowners. If we built more condos, we could sell more condos.”
Confluence quickly sold out its 124-condo building in downtown Castle Rock called Encore, mostly to older adults looking to downsize rather than the millennial professionals it had expected to dominate. But its other projects nearby have been apartments, and those remain its primary focus across metro Denver.
When interest rates were very low, multifamily rentals provided a way to earn a higher yield, making them attractive to investors. Walsh acknowledges the cash flow as one motivation for building apartments and holding onto them. And the tax benefits are better as well. Selling a condo triggers a short-term capital gain, which comes with a much higher tax rate. But hold an apartment building for more than a year and its sale will be taxed as a long-term capital gain.
And there is the question of construction defects and the six-year window owners have in Colorado to request repairs to problems with the original construction, an issue that has plagued the state for decades. Walsh said owning a building allows Confluence to better handle issues that do pop up after construction. It can go directly to its general contractor to resolve an issue rather than fight it out with multiple owners.
“We are the owner and we can go in and fix it,” he said.
It comes down to insurance
A big difference between building apartments versus condos is the premiums that insurers charge to cover a project and pay out any claims that come up after construction is done. Developers often cite the added costs and the fear of litigation as tipping the scales in favor of apartments.
A developer in Colorado can expect insurance costs to total roughly 1% of overall costs on an apartment project, said Clayton Sharkey, director of construction practice at IMA, an insurance brokerage in Denver. But a similar project insured with for-sale condos faces insurance costs closer to 3.5% to 4% of the project value, assuming an insurer can be found.
“It is not a very healthy insurance marketplace for condos in Colorado,” Sharkey said. He knows of a half dozen insurers who will take on an apartment building in metro Denver, but only two that will even consider condos, and only wood-framed ones, which are smaller and with fewer stories.
He attributes that to Colorado’s reputation for elevated levels of construction defects litigation. Despite two decades to address the issues contributing to those higher premiums, both legislatively and through the courts, insurers still do not appear to be comfortable.
In theory, higher insurance premium costs can be written off as a cost of doing business and passed on, not unlike what builders did after lumber prices doubled or how higher labor costs get wrapped into the final price tag. Much of the condo construction that has happened since 2010 in Colorado has focused on luxury developments, which come at a higher price and carry a thicker profit margin.
Even so, developers say going through construction defect litigation is a headache they would prefer to avoid, especially if the market is offering them a lower-cost and less stressful alternative in apartments.
“You are trying to make the consumer happy and you are trying to make profits and you are trying to do the right thing, but we have this very litigious environment,” said Peter Kudla, CEO of Metropolitan Homes in Englewood, which has had a front-row seat to litigation.
In 2017, Metropolitan Homes won a key decision from the Colorado Supreme Court against Village Inverness Residential Condo Association to submit defect claims to arbitration rather than through the courts, where costs can be higher. More developers now require arbitration and a higher share of votes approving an action from owners rather than just the HOA board of directors, an issue that also was addressed in a 2017 bill.
Kudla and Walsh said construction practices today are much better than they were 30 years ago, especially when it comes to controlling water penetration into a structure. More eyes are on the process, more quality-control measures are now in place and most builders try to follow the best construction practices possible.
Yet insurance premiums remain elevated and condos aren’t getting built at the level needed. Affordability concerns raised mortgage rates in the 6% range are also making developers proposing condos skittish, causing them to switch to apartments.
The Golden Triangle neighborhood along Broadway is one of the most active areas for new construction in Denver after the River North Arts District and it highlights how lopsided things have become in multifamily construction. Five projects underway and five more proposed are all apartment buildings, according to the website DenverInfill.
The development score is 2,977 apartments underway or planned. Condos – zero.
A contrarian perspective
Denver resident Jonathan Harris bought into The Points, a mix of condos and affordable housing units in Five Points, in 2004, and got more than he bargained for. A poor design in the courtyard caused water to drain into the units, resulting in a mold problem. Owners tried to work with the builder, but the fixes, he said, were inadequate and stretched out.
It felt like the builder was trying to run out the clock on the statute of limitations for making repairs, which in Colorado is typically six years, and owners felt backed into a corner, he said.
“I didn’t want to get into defects litigation. It is not any fun at all. It is a horrible experience and I would not wish it on anyone,” he said. “We trust that they will build things right the first time.”
The payments from the case weren’t enough to completely resolve the problem, and the association had to drain its reserves, he said. Association fees are much higher than they were before. And now more problems are popping up as the building ages, additional evidence that things weren’t done right in the first place.
Although the construction industry likes to paint a picture of overly zealous lawyers encouraging frivolous claims, construction defects litigation is driven by owners who face severe economic harm and are trying to find a fix after reaching out directly to builders for resolution, said Mari Perczak, an attorney and shareholder at the law firm of Burg Simpson.
“The playing field has become more difficult and it hasn’t increased the incentive of builders and developers to build it right in the first place. They can continue to make more money if they do things more quickly and without supervision. There isn’t enough of a downside,” said Perczak, who has represented numerous associations and homeowners over the years in construction defect cases in Colorado and other states.
Colorado has loosened its construction defect rules to the point that developers and insurers no longer have the incentive to resolve claims as early and quickly as possible, she said. Dragging things out and offering only minimal solutions does not come with a penalty and unpaid damages don’t carry interest, a prod that helps disputes get resolved more quickly in other states.
She provides the example of a window that shows water damage around the frame because of a lack of adequate flashing. A builder may offer to fix the flashing on that one window and consider it a done deal. But if the window installer did a bad job on that one window, the odds are high that they didn’t provide enough flashing on the rest of the windows, where the damage may be more hidden.
If a builder refuses to go beyond a minimal fix, owners are forced to hire consultants and experts to prove their case. Those working on the construction side also say they would like to handle problems earlier and more directly, and they are also critical of how costs run up once claims are made. But the problem comes down to what is an adequate resolution.
Sharkey said he knows of a 24-unit project that cost $8 million to fix, but $6 million for experts brought in to determine what needed to be fixed. A process where disputes are resolved before costs pile on needs to be found in Colorado, he said.
Because disputes now mostly go through arbitration rather than the courts, where records are public, it is hard to know what kind of settlements are being reached and how much insurers are paying out, Perczak said. Attempts to do a study on claim costs have been defeated in the past and the state’s construction defects situation is becoming more opaque rather than more transparent.
Bringing third-party inspectors into the process, which more insurers now require, is a plus when it comes to quality control. But Perczak said those inspectors need to have the power to stop construction to address problems if they feel that is necessary, something that Colorado doesn’t provide.
