Convincing Jurisdictions to Use Subdivision Bonds

By Kathy Hoffman posted 11-05-2018 03:07 PM

  

As of November 5, 2018, the population of the United States was more than 328 million, based on projections from the U.S. Census Bureau. And there’s no sign that growth will stop anytime soon. After all, when factoring in the various components of population change—births, deaths, and migrations—there’s a net gain of one person every 14 seconds in our country.

As the U.S. population booms, housing supply must keep pace. Faced with increased development, some local governments are requiring subdivision bonds to guarantee contractors meet their performance obligations.

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“Subdivision bonds generally guarantee public or private work improvements to a city or a municipality,” said Jason Valle, AFSB, AIS, Regional Manager in the Pacific Northwest for International Fidelity Insurance Company, a member of IAT Insurance Group. “Let's say you want to create a subdivision for single-family residential, commercial or multifamily. Within your permit, you are guaranteeing to the city or municipality that you're going to do certain things, whether it's extending stormwater sewers or putting in public streets, sidewalks, and trees.”

While subdivision bonds have long been recognized as viable securities, their use depends upon local jurisdictions. “Review the statutes that govern building permits,” Valle (pictured here) said. “If you go into a jurisdiction where they say they only take irrevocable letters of credit or cashier's checks, you should look at the statutes of the state, municipality, or city that govern building permits and see if they say anything to the contrary to what the city or municipality is telling you.”

If a statute dictates other forms of security are allowed, it’s time to start a conversation about surety bonding. Valle said the surety bond pays off to complete an unfinished project. But if a substantial portion of the work is completed, a surety bond would not necessarily pay the full bond amount. This flexibility represents a financial advantage for a developer.

“What we do is two-fold,” Valle said. “We convince the developer that using a surety bond is to their advantage because an irrevocable letter of credit or cash is convertible at the obligee or holder’s whim. If they say something's wrong, they can just convert it and there's no claims process — whereas with a surety bond, if you're 80 percent complete with the guaranteed improvements and the city says they need the project completed, we would pay the additional 20 percent as opposed to letting the city convert the entire security.”

Subdivision bonds also benefit the city since bonding regulation occurs at the state level. “We'll generally give the city several options: A) Upon written notification of default from the city, the principal will have 15 days to remedy or confirm that they will remedy the default,” Valle said. “Or, B) If the principal doesn't respond, the surety will respond in the principal's place to remedy the default — or if no one responds, the city can look for liquidation of the surety bond to remedy the default on their own.”

Valle said some jurisdictions are simply unaware that subdivision bonds are an option. “Some places, like the rural Midwest, are just now emerging as potential residential areas,” he said. “So states, counties, or municipalities that haven’t had a lot of development may not have encountered this.”

The housing crash of 2007 also halted the use of subdivision bonds. “The market tightened so much that not a lot of surety companies were willing to write the bond, and it fell off their radar as a viable mechanism for risk aversion,” Valle said. “Today, we need to make sure we're promoting this as a viable option through up-and-down cycles, because housing will always be built.”

For the bond producer, it's essential to unearth all potential opportunities. “I'm not afraid of doing some research, and if we're getting pushback, the best way to counteract it is through facts,” Valle said.

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