Damages Arising from Defects in Real Estate Construction Projects by Stan Stephenson

by 26 Jul 2011
Analyzing Claims in Business Interruption Cases   Defects that were introduced during construction can lead to classic legal disputes between owners and contractors where considerable sums of money are involved.    It all begins when the defects are first discovered.  This becomes the starting point for the analysis of when economic damages begin; who is impacted and how much, and how long they last.  For those involved in any litigation, this is where the calculation of economic damages starts.   Consider defects to the roofing of a large apartment complex. Once construction defects in a project are discovered, their impacts become more pronounced, and a cascade of damages may flow that first may involve the loss of income from paying tenants, and then cause added costs as management seeks to remediate the problems the defects are causing.   In another case, poorly installed windows in a nearly 200 house development located on the San Francisco Bay led to a claim of lost home values against the builder. However, statistical analysis by using property tax records showed no loss in house values once size, exact location, and other house characteristics were considered.     “Real estate construction cases can be very complex. Lawyers for both sides may have to engage and rely on the testimony of a host of experts. The expert list for each side may include contractors, designers, architects, plumbers, electricians, mold specialists, soil engineers, and financial experts. An experienced financial expert typically draws on the other experts’ work and provides a summary opinion regarding repair costs, lost rents (or value), and other damages.”   A recent case involving a 280 unit condo complex in Northern California can illustrate this point. The project was completed in mid-2000 and occupancy grew over the following year. During winter rains in early 2001, water-intrusion defects first appeared in external stairwells and minor repairs were made by the builder.   During the next two years, as the scope of the defects to the stairwells and external landings became more and more apparent, many tenants complained or moved out, and the rate of new leases fell in spite of a rent concession program that was already in place to increase lease rates during the winter months; traditionally slow rent periods.   Property management did not begin to capture extra repair costs incurred until 2003 and a full assessment of the defects was not known until 2004. In early 2005, a systematic, building by building repair and reconstruction program began that continued until June 2006. During this time, vacancy rates rose as existing tenants moved out and the rate of new leases slowed.    Tenants who stayed were granted special concessions during the time their building was under renovation.  Two “swing units” were set aside during this reconstruction period for day use so that adversely impacted tenants could use those units. In this case, no tenants were relocated off the property because no repairs were inside units.     The property owners gave special gift certificates at nearby restaurants to some tenants inconvenienced by noise or limited access to their units or parking. Cars that were scratched or damaged by construction trucks or dust were detailed.   After the reconstruction period ended in June 2006 rent losses continued because it took many months and special efforts to bring occupancy back to the level it would have been “but- for” the disruption caused by the construction defects.   The economic damage began once the defect interrupted the enjoyment and use of the property.  Damages expanded in many ways during the remediation period, and they continued well after the construction defects had been repaired. There were lingering economic damages for many months due to both excess vacancies and reduced lease rates.  Some leases made with concessions during reconstruction could not be raised to normal rates until the following year when the lease contracts expired.    The case illustrates the types of damages that need to be identified, investigated and documented.  This case was relatively simple.  In general, ‘but-for’ profits were compared and contrasted with actual profits and further consideration given the costs of gifts, swing space, extra marketing, and related special factors. Damages assessment also made adjustments for local economic conditions, normal vacancies, and seasonality. These cases can become very complex especially if relocation of numerous residential tenants or commercial business operations is involved.   These real estate defect cases are best handled by those who have had experience with large complex cases involving commercial properties or housing developments. This is one area in which the financial expert may need to take on something like an “operations research role” and build on the technical/construction plans and various repair schedules before developing associated economic damages estimates.   Communication and timing issues usually requires people to come together often.  This involves scheduling of the real property owners, the residential and commercial property tenants, the various repair and reconstruction contractors, their attorneys, and the experts they engage to prepare for the case. Often a ‘special master’ provides this coordination.   Coordination and information-sharing thus becomes very important to successful outcomes. Clear, ongoing lines of communication are absolutely critical.    Simplifying data, so the jury can understand, can make a huge difference at trial. For example, testimony in front of a jury in a complex case using an easel, magnetic white boards, and small strips of information, to “tell a story” piece by piece is better than using multiple TV screens with detailed spreadsheets which the jury can not read.     Stan Stephenson is managing principal of Tampa-based Litigation Economics LLC (www.LitigationEconomics.com) a national firm that works with lawyers to put a proper value on business losses. Stephenson, previously taught economics at Penn State University and the University of Hartford, and has been involved in at least 350 cases over the last eight years, representing either plaintiffs or defendants.


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