Construction Defect Rules Are a Metaphor for California Housing

Exploring the quiet fight for the right to repair with SPURs Michael Lane

California Housing 7 : Where We Go From Here 9

Most of us who pay attention to California housing issues have developed a degree of fluency on the hot button issues. Whether or not you are a professional in this space, you probably are familiar with tenant’s rights, single-family zoning, or funding for affordable housing and homeless services, at least enough to know they are important issues.

But what about construction defect litigation? 

Until I started really digging into homeownership and development issues, I had no clue that something seemingly so mundane could be such a challenge to transforming California housing. (I certainly never would have put it on my top 10 list of important issues in state housing politics).

It also turns out that digging into the now two-decade old fight over construction defects can tell us a lot about the challenge of building more and better housing for Californians. As I will explore with SPUR State Policy Director Michael Lane - Where We Go From Here’s first official guest (stay tuned for many more)! - construction defect legislation tells us a lot about power in state politics, who carries and pays for risk, the struggle for homeownership opportunities, and why we need to pay attention to the building counter, not just the planning department.

The Right to Repair

In 2002, following two years of intense negotiations between the building industry and consumer lawyers, California passed SB800: The Right to Repair Act. The act, which was a response to an earlier State Supreme Court decision severely limiting liability, attempted to reach a compromise in long running struggles between builders and consumer attorneys over construction defect lawsuits. 

Attorneys, who are well organized, wanted to maintain their ability to sue over defects. Builders want to limit their liability and reduce their exposure to lawsuits, which in the case of condos and large subdivisions can become class-action suits when the HOA and many of its members get on board. 

For housers, most would recognize that construction defects are real, and that there needs to be a mechanism to a) incentivize builders to be extra careful, and b) some way to actually fix the repairs.

This is what the 2002 bill attempted to do. It maintained the liability, in many cases for up to 10 years - what is called the statute of repose. It also established a theoretical ‘right to repair’ - when a homeowner discovered a crack in the foundation, an incorrectly installed pipe, etc. the builder would have a chance to come in to fix the problem and avoid going to court.

A Fix that didn’t Fix

The problem is that it didn’t work. Lawsuits continue to be filed, and what was a problem in 2002 stayed a problem in 2012 and remains a problem in 2022. 

From the perspective of housers, there are a series of problems that come with the current system.

1. Cost of housing: The cost of insurance against construction defects lawsuits has added significant expense to an already expensive system. A 2013 study by Oakland-based planning consulting firm EPS found that construction defect insurance alone added $15k to the cost of condos in Metro Denver. Remember that with a 10 year statute of repose, builders have to carry that insurance long after the project is occupied, and that gets passed onto consumers.

2. Impact on small construction businesses: The high cost and terrifying liability deters all but the largest builders from getting into the business. Small subcontractors - plumbers, roofers, drywall installers, all the small businesses that make the construction industry work - are all liable, and a lawsuit over a single building can have 30 defendants. If you are Pulte Homes, one of the major developers of single-family home subdivisions (and much more), you can afford the insurance - in part because you own your own insurance company. You can protect yourself and your subcontractors, which means you can build homes and sell them. But imagine you are a small contractor trying to turn a vacant lot into a four-unit condominium? Imagine you are one of the many BIPOC and women-owned developers trying to break into the business? 

3. We’ve stopped building condos. Most of the new multifamily buildings built during this time in California are rentals. While condo defect laws aren’t the only thing leading developers to hold onto buildings or sell them to private equity - high rents certainly help - the easiest way to avoid a construction defect lawsuit if you are a developer is to hold onto the building. After all, you’re not going to sue yourself.

It’s even an issue for non-profit builders like Habitat for Humanity. Any builder that won’t own the building for a decade after they built it is potentially exposed.

What have been the proposed solutions? A conversation with Michael Lane

Two major ideas for fixing the problem are a warranty system, and a state-sponsored insurance program.

1. The warranty system would be based on what they have in New Jersey. This creates a mandatory warranty system by which both homeowners and builders are bound to getting buildings fixed, instead of going to court or the local building department.

2. A state-backdrop insurance program, where the state steps in as an insurer of last resort, much like we do with flood and earthquake insurance (and will likely have to do with fire). This approach was briefly tried this year and did not advance.

No matter what approach we take, the political headwinds are significant. To better understand the challenges, I spoke to Michael Lane, SPUR State Policy Director, veteran of Sacramento housing policy struggles, and former self-help housing builder in his native Visalia.

Michael, welcome to the California Housing version of Where We Go From Here. Thanks for your support of this Substack, and for all your work on California housing for years. You’ve been banging your head against this issue for a long time. Why is construction defect reform so hard to accomplish? I understand that consumer attorneys are powerful, but we have plenty of powerful actors in California housing. What makes this such a tough nut to crack?

Michael Lane: I’ve found the state of play on this issue is essentially a détente among builders and the plaintiffs’ bar that effectively locks in the dysfunctional status quo. The building industry is loath to reopen SB 800 for fear of ending up with something even worse. The consumer attorney lobbyists reject even modest reforms and modernization as undermining the rights and jeopardizing the health and safety of homeowners. Notwithstanding the builders’ so-called “right to repair,” it really doesn’t work like a warranty program; most claims end up in litigation and settlements with payouts and attorneys fees that, in turn, drive up insurance premiums. The result is that developers in the highest-cost coastal areas frequently flip projects to rentals which, of course, makes the existing for-sale inventory even more valuable.

As with other contentious issues in the housing space, we’ve basically just accepted that extremely high home prices - the median price now exceeding $800,000 - and the resulting declining homeownership rates - which have always been even lower for households of color - are simply too intractable to effectively tackle. Yet not all cost drivers are exogenous. Policy decisions and political battles have a direct impact on the availability of and expenses related to land, labor, materials and “soft costs,” like construction defect liability insurance.

The truth is we need both public subsidies and cost-containment measures. In this instance, an alternative approach would be for the state to create an insurance fund for affordable developers like Habitat for Humanity, and market-rate builders willing to include some percentage of below market-rate homes in their development and sell them to moderate- and lower-income households that would otherwise be priced out.

What do you think it will take to make real changes? What can convince other powerful actors in California housing - and beyond - to care about construction defects? Does it need to be part of a larger package of reforms?

ML: There is a growing interest in the Legislature in addressing the declining homeownership rates in the state and, in particular, the low ownership rates for households of color. Black homeownership in California is under 35% and, as CalHFA points out, is now lower than it was in the 1960s, when it was completely legal to discriminate against Black homebuyers.

While the emphasis on homeownership from some quarters may be from questionable motives that denigrate and seek to exclude renters and rental housing as less desirable to a community, there remains a broad and benevolent coalition across the ideological spectrum that sees homeownership as the key source of and support for intergenerational housing stability and wealth building that produces important socio-economic benefits to both households and neighborhoods without disdaining renters or shunting them off into second class status. The fact is we will always need both affordable rental and homeownership opportunities in all communities as we affirmatively further fair housing and meet an array of housing needs, incomes and lifestyles. With sufficient political will and adequate policies and investments, we can increase the ownership rate and avoid a repeat of the 2008 subprime mortgage debacle and waves of foreclosures.

During the statewide housing listening tour the Assembly Housing Working Group conducted last fall, construction defect litigation and insurance costs came up as a problem and barrier on multiple stops and the issue was also raised at a Little Hoover Commission hearing held last fall on affordable housing.

Assemblymember Sharon Quirk-Silva (D-Fullerton) has been valiantly pushing for a Legislative Task Force and California Master Plan on Homeownership and for HCD to include in its Statewide Housing Plan a plan to increase homeownership among people of color. This is also particularly timely given the work of the California Reparations Task Force and the urgent need to redress the redlining, segregation and lending discrimation that have directly led to such low homeownership rates and massive displacement of Black residents as housing affordability has continued to decline. In fact, the Black Leadership Council is proposing a $500 million one-time State General Fund budget expenditure to create a pilot San Francisco Bay Area Black Regional Housing Fund to support Black-led housing solutions and underserved neighborhoods throughout the region. We should all be backing this critical budget ask.

State Senator Robert Hertzbeg (D-Van Nuys) has also been focused on creating greater homeownership opportunities and is proposing a $25 billion statewide general obligation bond measure that would generate revenues to fund both downpayment and closing cost assistance for moderate and low-income homebuyers and finance infrastructure improvements needed to facilitate new home construction.

Given this interest in creating more affordable homeownership opportunities, reform of the construction defect liability regime should be included as part of a series of initiatives on this topic. Ideally the Governor and legislative leaders would convene and cajole key stakeholders to negotiate the most difficult deal points.

So we’ve talked about power, and homeownership. What else do you think that this issue teaches us about housing in California? Do we need to focus more on building regulations, and not just zoning? Should we all buff up our understanding of insurance and risk?

ML: Zoning is fundamental but then so are building codes, construction methods and financing; or to quote you, “everything in housing is hard.” The success of Factory OS and other modular and prefabricated approaches give cause for hope and Cross-Laminated Timber (CLT) is also very intriguing. Alternative modes of and materials for home construction must be part of the equation. We need to restructure it all: the way we zone, build, finance and insure homebuilding and homeownership. That is where targeted state interventions and public-private partnerships, like the insurance fund referenced above, can share risk, reduce friction and shape private sector behavior in ways that produce our desired public policy outcomes. Here are some additional actions we could take to increase our homeownership rates:

1. Provide financial incentives for modular factories to be based in California and create jobs here. The boom and bust real estate development cycles make these factories vulnerable. However, with consistent state funding for affordable housing, construction can continue through the downturns, keep the factories busy, workers employed and build the housing we need. In 2018, for example, San Francisco Mayor London Breed proposed committing $100 million to purchase affordable housing made using modular construction in San Francisco, in part, to “help ensure the financial viability of the modular factory,” but was met with opposition from the local building trades. Also, Assemblymember Tim Grayson (D-Concord) introduced AB 2492 this year, a bill that seeks to encourage the use of factory-built housing manufacturers based in California that pay prevailing wages and adhere to other labor standards by providing a density bonus for such developments. The labor provisions are modeled on the agreement that Factory OS has with the Northern California Carpenters Regional Council.

1. Make ongoing and targeted state investments that leverage and expand existing downpayment assistance and matching grant homeownership programs like the Federal Home Loan Bank’s WISH and IDEA and CalHFA’s mortgage and downpayment assistance programs that help get qualifying households into homeownership with a mortgage payment they can afford. This is another area of housing finance in which state/federal and public/private coordination and compatibility would create administrative efficiencies and additional resources would allow the programs to serve more households especially in the most expensive housing markets. In an environment of rising interest rates, these programs will be especially important.

1. Allocate significant state funding to HCD’s CalHome program - the main affordable homeownership production program used by Habitat for Humanity and other self-help/sweat equity community housing development organizations - as a consistent and ongoing budget priority. Dedicating just one-half of one percent of the State’s General Fund would allocate $1 billion per year to this highly successful program.

Thanks Michael. 

---

Things which need reading:

• The Little Hoover Commission, CA’s in-house think tank of a sort, released an interesting set of recommendations on CA’s housing crisis. Good to see them weigh in, and hopefully stay in. We need more sustained work on housing from Little Hoover and the LAO. Here is the OpEd version, and the report version.

• More Blackstone buying homes. This time student housing. Student housing is a better place for bigger investors than permanent housing, but this investor is a different story.

• There is some legitimately inspirational work + profound thinking coming from Sḵwx̱wú7mesh Úxwumixw | Squamish Nation housing actors in Vancouver. This video hosted by Sightline is interesting, especially parts featuring Chair Khelsilem.

• A brave and smart piece by Teo Armus in the Washington Post on Amazon’s housing initiative. When you are misquoted enough, getting quoted in a way that honors what you said, and respects your own vulnerability in the situation is appreciated.