Condominium Escrow Deposit Bonds

Advantages of the Escrow Deposit Bonds

For a fractional percentage of the full cash deposit, a creditworthy “principal” can pay a small premium to provide their Obligee with a deposit bond that covers the full obligation of the cash deposit. The deposit bond serves as an equivalent to an escrow payment, replacing the need for a full cash deposit. This strategic leverage allows the principal to preserve liquidity while meeting their financial requirements.

Who Buys Escrow Deposit Bonds?

Developers who build and sell residential condominiums often aim to pre-sell a percentage of the units before construction begins. Each buyer typically places a deposit with the developer’s escrow agent, which is held in trust until applied at closing. Under certain conditions in the contract, all or part of the deposit may be refundable before the closing date.

To protect the interests of contract purchasers, many states have consumer protection laws or directives ensuring the deposit is kept in trust. In some states, developers can access the funds in escrow if they provide a letter of credit or a condominium escrow deposit bond payable to the contract purchaser, escrow agent, or state. If the developer defaults on the contract, the bond ensures that the contract purchaser is compensated.

Condominium Escrow Deposit Bonds (CEDBs) offer developers a low-interest source of working capital. These bonds allow developers to leverage the deposits collected on pre-sold units before construction begins or is completed. Once a developer acquires a CEDB from a surety, they provide the bond to the appropriate Obligee (the contract purchaser) to protect their interests. This enables the developer to use the escrow funds for construction costs rather than obtaining additional capital from institutional investors, resulting in significant savings.

For example, the bond premium typically ranges from 1% to 3% of the escrow funds withdrawn. The premium cost depends on the developer’s size, financial strength, and experience. If the premium is 2% and borrowing costs are 6%, the developer can save 4% on the borrowed amount. Considering a $10 million escrow fund for a 200-unit building with an average sales price of $500,000 per unit, the developer could save as much as $400,000 per year, aside from the bond premium costs. The escrow funds may only be used for site work and construction costs.

Given the rising costs of construction funds, developers should consider purchasing the bond early once unit sales begin. A professional surety agent can help negotiate a lower bonding limit initially, allowing the developer to pay a lower premium and gradually increase the bond amount as sales increase, thus reducing carrying costs. GG Insurance Agency Inc. works with developers to create cost-effective plans, acting as the surety agent to secure the bond without additional fees or charges to the developer, as the bond is not a loan but an indemnity agreement protecting the purchaser’s deposit.

Underwriting

Surety insurance companies are often considered easier to work with than traditional banks. While both follow a conservative decision-making process based on creditworthiness and the principal’s ability to perform their work and meet financial obligations, deposit bonds are distinct. Unlike other types of insurance, where the risk is spread across a large pool of similar risks, deposit bonds are specifically designed for principals who are capable of performing their obligations and are unlikely to create a loss for the insurance company.

Term

Escrow Deposit bonds typically remain active from the time buyer deposits are made until the completion of the project and the delivery of all units.

? Underwriting

Surety insurance companies are often considered easier to work with than traditional banks. While both follow a conservative decision-making process based on creditworthiness and the principal's ability to perform their work and meet financial obligations, deposit bonds are distinct. Unlike other types of insurance, where the risk is spread across a large pool of similar risks, deposit bonds are specifically designed for principals who are capable of performing their obligations and are unlikely to create a loss for the insurance company.