Condominium Escrow
Deposit Bonds

Advantages of the Escrow Deposit Bonds

For a fractional percentage of the full cash deposit, a credit worthy “principal” can pay a small premium to provide their Obligee with a deposit bond to cover the full obligation of the cash deposit. The deposit bond acts as an equivalent form of escrow payment in lieu of a full cash deposit. Employing this strategic leverage allows the principal to preserve liquidity.

Who Buys Escrow Deposit Bonds

Developers who sell and build residential condominiums will often attempt to pre-sell a percentage of a building prior to beginning construction. Each unit buyer (contract purchaser) will usually place a deposit with the developer’s escrow agent to be held in trust until it is applied at closing. Under defined circumstances in the contract, all or part of the deposit may be refundable prior to the closing.

Many states have established consumer protection laws or administrative directives to protect the interest of the contract purchaser so that the deposit is kept in trust. In several states a developer may have access to the funds in escrow if the developer provides a letter of credit or a condominium escrow deposit bond payable to either the contract purchaser, the escrow agent, and/or the state. In the event of a contractual default on the part of the developer, the purpose of the bond is to provide the funds to make the contract purchaser “whole” again.

Condominium Escrow Deposit Bonds (CEDB) can provide a developer with a low-interest source of working capital for their project. The bonds enable a developer to leverage the deposits which have been collected on pre-sold units before the construction has either commenced or been completed.

Once a developer (as principal) has acquired a condominium escrow deposit bond from a surety, they then deliver the bond to the appropriate Obligee (contract purchaser) to protect the interests of the Obligee (contract purchaser). A Condominium Escrow Deposit Bond enables the developer to use the escrow funds for the project’s construction costs as opposed to obtaining additional working capital from institutional investors. The savings to the developer is often quite substantial.

For instance, an annual bond premium will cost between 1% and 3% of the amount withdrawn from escrow. The cost of the bond premium will depend on the size, financial strength and experience of the developer. If the premium is 2% and the current cost to borrow construction funds is 6% the developer will save 4% on the amount borrowed. The deposit often represents 15% or more of the construction budget. A 200 Unit building with an average sales price of $500,000 per Unit may accumulate $10 million in escrow funds; with a 4% spread the developer will save as much as $400,000 or more per year in excess of the cost of the bond. The proceeds that the developer withdraws from the escrow may only be used for sitework and direct construction costs.

At this time, costs of construction funds are increasing and a prudent developer will wish to purchase this bond early on once the sales of units begin. A professional surety agent can likely negotiate with a surety carrier to begin bonding at a substantially lower bonding limit and collect this lower premium and increase the amount of the bond and collect more premium periodically as sales increase. This further reduces the developers carrying costs of the bond. Lexmos Inc. will work with the developer to develop a cost-effective plan. As the surety agent, Lexmos Inc. will collect a commission from the surety carrier for placing the bond and not charge any other points or placement fees to the developer as the bond is not a loan but an indemnity agreement protecting the rights of a purchaser to know that their deposit funds are secure.

Underwriting

Surety insurance companies are often regarded as easier to work with than a traditional bank. Both have a fairly conservative decision-making process, based on creditworthiness and the principals’ ability to perform their work and/or fulfill their financial obligations. Unlike many other types of insurance where there is a calculated chance of loss that is shared by a larger pool of similar risks, deposit bonds are only intended for principals who are able to perform and never create a loss to the insurance company.

Term

Escrow Deposit bonds usually remain active beginning from the start of when buyer deposits are made, and end with the completion of the project and delivery of all units.

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