Subdivision Guarantee Options

When your company wants to perform subdivision or site improvement work, you’ll likely need to guarantee the work to meet legal statutes where the project is located. The guarantee helps ensure that the work is completed on time, and as agreed upon with the city, town, municipality, etc.

There are several different types of guarantees you can utilize, and there are distinct advantages and disadvantages between them.

Guarantee Options:
  • Subdivision / Site-Improvement Bonds
  • Irrevocable Letters of Credit (ILOC)
  • Certificates of Deposit (CD)
  • Other security options
  • Tripartite Agreement

Subdivision Bonds/Site Improvement Bonds

Surety bonds are the most effective option for the majority of developers, as they have advantages that the other guarantees do not provide, and eliminate all of the drawbacks that come along with the alternatives. Each of these is detailed below.

Bond Advantages
Review the key advantages and distinctions of using bonds to guarantee your work below:
As you can see, bonds offer many advantages, and lack certain disadvantages that you’ll find are associated with the guarantee alternatives shown further down in this article.
 
What Determines Whether a Developer Qualifies?
There are several underwriting criteria that sureties will use to determine whether a developer qualifies for bonding.
Industry Experience
When it comes to qualifying for bonds having experience both in the construction field and with similar sized projects the bond is needed for is crucial.
Financing Methods
Many developers don’t have sufficient assets available to fund projects, so they borrow money from a bank. The terms of the bank loan are very important, as they demonstrate the level of confidence the bank has in the developer/project, , the amount of “skin in the game”, etc. Getting this type of bond is impossible (except for very small bonds) without proving that you have the money available to pay for the work.
Financial Analysis
Financial strength is also important. Financial analysis is performed on the corporation as well as the personal wealth of the owners to determine how much surety credit they may qualify for.
Additional Bond Requirements
And that brings us to the last piece of the underwriting criteria. Who will the developer be paying for the work? The surety wants to see that the developer is using a well-known and well-capitalized contractor to complete such work. Our company always recommends that the developer request a performance and payment bond from the contractor to ensure completion of the job, since the developer also has to post their own bond to the township or whatever governing body is requiring bonds.
Project Type
The project classification also plays a role when it comes to whether a developer is qualified for bonding. Subdivision/site improvement bonds are needed for both commercial and residential projects. Some projects take much longer than others, as units are often required to be fully sold before the final work can be considered complete; this is especially true with subdivision projects which seem to be the most risky in that they are long term projects. In a subdivision, it can take two years minimum to sell all lots, build the homes and finally pave roads. Commercial projects, such as where the developer is building class-A offices to sell individually are similar in nature to residential projects, but usually much smaller in scope. For certain projects, the developer plans to build and own the structure for rental income once it’s complete. This project type is even more unique as the developer needs to demonstrate that a viable long term plan is in place to own, maintain and support the property since he will be acting as a landlord.
What's needed to apply
In order to apply for bonds, you will need:
  • A subdivision application

  • Business and personal financials

  • Proof of financing

  • Developer’s agreement with the obligee

  • Special bond forms (if any)

If you’re ready to partner with a subdivision bond specialist, please request a consultation.
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Not All Sureties Write Subdivision Bonds

Many sureties don’t handle subdivision bonds simply because they are non-cancellable guarantees and are often long term obligations. It’s important to understand that the bond is released once all work is 100% complete. Often times, the work can’t be fully complete until the developer sells 100% of the lots in the subdivision, 100% of the office space in the office complex being built, etc. Normally, these bonds are active for at least two years and, some even longer. Although sureties perform their due diligence when reviewing a developer’s financial strength, experience, character, etc., it’s hard for them to predict whether a developer will succeed or fail over the span of several years.

We’re Subdivision Bond Experts
Out of the top 100 sureties in the U.S., only about six of them will consider this class of bond. Our company is partnered with five of them and can handle subdivision bonds with ease. These bonds are a niche product and the markets our company represents have an intimate understanding of what the risk is, how to adequately underwrite and provide surety capacity to those that need surety credit. You can read more about why you should partner with us.
Irrevocable Letters of Credit (ILOC)

In order to secure an ILOC, the owner/developer typically ties up a portion of its line of credit for a fee or ties up their own cash reserves with their bank (which are restricted from use). ILOC’s renew every 12 months. If the bank elects not to renew the ILOC, the obligee would have the right to promptly draw down on the full amount of the ILOC. Such a drawdown of the ILOC will create a loan, which the bank could promptly call for immediate repayment.

It’s also important to understand that the governmental entity holding the ILOC has the right to draw on the ILOC any time they believe there is a breach of the developer’s obligations, in which case the developer would have little or no way of stopping. The ILOC is strictly a financial instrument and the bank provides no prequalification services to assure the owner/developer has the capacity or experience to perform the work.

Certificates of Deposit (CD)

Certificates of Deposit are effectively cash deposits that tie-up the owner/developer’s capital, which normally can be invested more productively. The CD is subject to liquidation by the demand of the obligee. For the obligee accepting the CD as security, it provides no prequalification benefits.

Other Security
(cash, money orders, certified checks, etc.)

This alternative has many of the same disadvantages as a CD. The public agency would also have to make a determination that the cash deposited was in fact “legitimate” and not subject to potential bankruptcy preference regulations.

Tripartite Agreement

Tripartite agreements often involve set-aside letters from a bank, special escrow accounts or fund controls. Tripartite agreements typically place disbursement of the projects funds under the direct control of the governmental agency, and are not utilized very often. The distribution of funds may be delayed by concerns about the value of completed work or the capability of the funds to complete the improvements and perform any required maintenance. Tripartite agreements are not performance guarantees, but control over a fund of monies that may not be satisfactory to pay for the work on the project. This type of guarantee places a substantial added administrative accountability on the public agency, which can lead to liabilities if the funds are not properly administered.

The overview of the guarantee options should demonstrate that bonds are the most advantageous. If you’re ready to partner with a subdivision bond specialist, please request a consultation.

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