Under the Arizona Department of Real Estate’s application of federal and state law, condominium developers are required to deliver a finished condominium unit to an end-purchaser within two years of signing the purchase agreement (Two-Year Delivery Requirement). Otherwise, developers could face significant liabilities, namely, exposure to a potential breach of contract, right of purchase and sale revocation, and refund to the purchaser.
Although initially framed as a consumer protection, the two-year deadline does little to protect condominium purchasers and, instead, creates a material obstacle to getting desirable developments, such as affordable housing or high-rise towers, “off the ground” in Arizona. Unless the Arizona State Legislature changes the state’s subdivision laws to be consistent with federal law, Arizona will be at a significant competitive disadvantage to a large majority of states in which condominium developers are given more flexibility to competently complete projects.
Federal Law: The Interstate Land Sales Full Disclosure Act
For context, Congress adopted the Interstate Land Sales Full Disclosure Act (adopted by Congress in 1968 and codified in 15 U.S.C. §1701 et al) .more than 50 years ago to push back against subdivider/developer fraud and to protect end-purchasers of lots, parcels, or units within large subdivisions.
Among other requirements, the ILSFDA requires developers of certain types of subdivisions to provide property disclosures to purchasers via a detailed “property report” prior to signing a purchase contract, and it further requires developers to continually register with and update the Consumer Financial Protection Bureau with information about the subdivision and sales offerings.
Developers who fail to comply with certain provisions of the ILSFDA are exposed to potential liabilities. In addition to facing civil and criminal penalties, as well as other remedies, developers are subject to what many consider a far worse fate: Purchasers can unilaterally revoke a purchase contract for a period of up to two years and seek a full refund.
Congress Unanimously Amended the ILSFDA to Exempt Condominium Developers
Not all subdivisions are subject to the ILSFDA. One important exemption is known as the “Improved Lot Exemption.” Developers used this exemption for nearly 50 years to exempt out of the ILSFDA where either the lot was already improved or, alternatively, where construction could be commenced and finished within two years. This then excused condominium developers from the ILSFDA requirements if they could deliver the condominium unit within two years of signing the purchase agreement.
Condominium developers operated under this exemption until Congress unanimously voted to exempt condominium developers altogether from the ILSFDA reporting and disclosure requirements. The bipartisan amendment (H.R. 2600) was adopted by Congress in September 2014 and signed into law in October 2014. by then-President Obama, and it became effective in 2015.
Substantially Equivalent State Law and the Arizona Subdivided Land Laws
The ILSFDA permits the CFPB director to exempt developers from the ILSFDA requirements in states that have otherwise adopted acceptable and substantially equivalent public reporting and disclosure laws. Initially, four states, including Arizona, were certified as having acceptable “substantially equivalent” subdivision laws.
Arizona’s Subdivision Laws
Arizona’s “substantially equivalent” land sales program (collectively, “Arizona Subdivided Land Laws”) was certified in 1982. The Arizona Subdivided Land Laws require a subdivider of qualifying lots or parcels to provide notice to the ADRE Commissioner of its intent to subdivide land, prepare a public report, and provide the same to purchasers prior to signing a purchase agreement. The ADRE Commissioner must examine and approve a public report authorizing the sale, unless there are grounds for denial.
If a developer violates these requirements, the purchaser may unilaterally revoke the sale but, instead of a two-year rescission period like under the ILSFDA, Arizona imposes a longer three-year period from the date of contract. Developers may also be subject to court action and civil penalties, among other remedies.
‘Substantially Equivalent’ but with a Significant Difference
In Arizona, “subdivided lands” — improved or unimproved land divided into six or more lots or parcels — are generally subject to the Arizona Subdivided Land Laws. “Improved lots or parcels” are lots or parcels either containing an existing building or for which the developer is obligated to construct such building within two years of the contract date. This aligns with the ILSFDA “Improved Lot Exemption” noted above.
This statutory definition of “improved lots or parcels” is the only completion-related time frame applicable to condominium units in Arizona. All condominium units sold to a purchaser are considered improved lots or parcels because they are either already constructed and therefore improved or they are being sold with the intent of constructing and delivering a finished building. As such, they are subject to the Two-Year Delivery Requirement.
And, unlike the ILSFDA by way of the 2015 amendment, there is no statutory exemption for condominiums in Arizona, and the Arizona State Legislature did not make a corresponding amendment as Congress did more than eight years ago.
ADRE’s Application of the Two-Year Delivery Requirement
Despite the passage of the 2015 ILSFDA amendment, the ADRE continues to operate under a dated subdivision regime with respect to exempting condominiums from the Arizona Subdivided Land Laws or the Two-Year Delivery Requirement. In practice, the sale of a to-be-built residential structure or building is not allowed by the ADRE if it will take more than two years from the time of purchase to complete and deliver.
The Negative Impacts of Arizona’s Two-Year Delivery Requirement
The Two-Year Delivery Requirement is problematic on many levels. It not only impacts developers as the entity that must construct and deliver a completed building on time “or else,” but it also affects the end-purchaser and communities. While smaller, low-rise condominium projects may be constructed within two years, larger, high-rise projects can easily span a two- to four-year construction period. If the project involves below-grade parking or historic preservation, a two-year construction period is simply not possible. For bigger projects such as these, sales cannot begin until a developer is well into construction.
Below is a nonexclusive list of the negative impacts of Arizona’s Two-Year Delivery Requirement:
- Limited, delayed, or staggered presales and purchase agreements: Developers may be forced to limit, delay, or stagger presales or enforceable purchase agreements so that delivery of a condominium unit can be accomplished within two years. Such delay or staggering conflicts with the desires of all parties involved:
- Developers. Developers need to ensure cash flow and marketability of a project and confirm that there are purchasers who are ready, willing and able to take possession of finished units. The inability to adequately “lock in” a project from the outset impairs a developer’s ability to obtain sufficient financing, or even undertake certain projects that would otherwise be desirable if purchasers could be contracted with from the start.
- Purchasers. Purchasers want assurances that the developer will complete the agreed-upon unit. Allowing for sufficient presales, deposits and signed purchase agreements decreases such risk. Additionally, having sufficient financing in place may aid a developer in overcoming financial setbacks, budgetary discrepancies or unforeseen costs or delays.
- Lenders. A key component of the due diligence performed by lenders on the front end of the loan is the availability of executed purchase agreements, which evidence marketability. This due diligence affects the type, quantity and quality of financing available to a developer, and the lack thereof could crater projects from the beginning or unintentionally pre-select the developer for less desirable financing (the expense of which is eventually passed on to the purchaser). This can also impact the possibility of constructing condominium developments for low-income households, as financing terms can be cost prohibitive.
- Communities. Communities and governmental entities desire well-financed, high-quality developers and condominium regimes that are not likely to fail, either partway through construction or after delivery of finished units. Financial instability caused by the inability to conduct meaningful presales can make it difficult to attract desirable builders and developments. This may result in hindering community goals like increasing home availability and housing ownership, including availability of affordable housing; generating consistent tax revenue and attracting adjacent businesses; and renovating or rehabilitating blighted or mischaracterized areas and buildings.
- Lack of favorable financing: The Two-Year Delivery Requirement can impact the attractiveness of potential projects in Arizona to both developers and financial entities, particularly where alternative opportunities may be available in similar or nearby markets subject to the ILSFDA (with the beneficial condominium exemption) or a state-adopted regime with more favorable or nonexistent condominium delivery deadlines. Financing terms, or even the availability of financing, is paramount to whether these projects are undertaken, especially for low-income housing projects (which require favorable financing to keep costs lower) and for large-scale projects, high-rise developments, or rehabilitations to existing structures, all of which require more time to develop.
- Impaired construction: Developers may rush construction — potentially compromising the safety and desirability of the condominium unit — to avoid penalties for extending past an extremely tight deadline. Further, developers may need to redesign buildings to accomplish timely delivery, impacting the overall effectiveness, appearance and lifespan of condominium buildings.
Moreover, a developer who breaches the Two-Year Delivery Requirement is exposed to significant financial risk — perhaps enough to implode the project completely. Purchasers, lenders and communities may be left with the expense and task of finding a replacement developer to finish construction with significant risk. One of these risks may be purchasers with “triggered” rescission rights.
The Arizona State Legislature Should Exempt Condominium Projects
Arizona is at a substantial competitive disadvantage to the majority of other states that follow the ILSFDA. The Two-Year Delivery Requirement is not consistent with the ILSFDA (the basis for the creation of the Arizona Subdivided Land Laws) and it makes Arizona unattractive for many desirable condominium developments that are, by their nature, impossible to complete within two years or unattractive if sufficient financing cannot be obtained. Arizona’s Two-Year Delivery Requirement may drive developers to states that provide more leeway for a developer to complete a project in a safe, sound and desirable manner — not under the constant pressure of an arbitrary deadline.
It was clear throughout the United States — hence the unanimous, bipartisan passage of the ILSFDA amendment in 2015 — that a two-year deadline for completion and sale of condominium units does little to protect purchasers. Instead, it serves as a roadblock to desirable development.
For the common good of developers, purchasers and communities in Arizona, the Arizona Subdivided Land Laws need to be amended, as federal law was in 2015, to exempt all condominium projects from the Two-Year Delivery Requirement.
Jill Casson Owen, partner at Snell & Wilmer, focuses her practice on real estate and business transactions, advising public and private entities.
Benjamin Hawkins, associate at Snell & Wilmer, focuses his practice on real estate, commercial finance and general business transactions.
Emily Thomason is an associate at Snell & Wilmer and member of the firm’s real estate practice group.
Did You Know
Arizona developers are subject to Arizona Revised Statutes (“A.R.S.”) Title 32, Chapter 20 and the ADRE’s corresponding regulations in the Arizona Administrative Code (Title 4, Chapter 28). Article 4 of Title 32, Chapter 20 (codified in A.R.S. §§32-2101 through 32-2185.09) provides Arizona’s substantially equivalent statutory regime.
