Is 25 Broad Street just the tip of the iceberg? That project, a 346-unit condo, had its funding frozen after investment bank Lehman Brothers declared bankruptcy. As The Real Deal first reported, subcontractors have filed $2.8 million in liens on the stalled conversion being developed by Swig Equities.
Now, some real estate insiders are surmising that the apparently growing number of construction jobs delayed in New York City may present mounting problems for contractors seeking payment.
Even before Lehman’s highly visible flameout, subcontractors were already struggling at some sites, primarily from having taken on too many jobs, which was delaying some projects and eating into some subcontractors’ profits, said Barry LePatner, a partner at Barry B. LePatner & Associates, which specializes in corporate construction counsel.
Now, with financing for development projects on the fritz, construction sites are closing and contractors may not be paid on time as a result.
“We have smaller projects in Brooklyn, Queens, and the Bronx where smaller developers who were counting on a small project throwing off some nice money are not finishing the jobs,” LePatner said.
“You’ll see those projects all dotting the city. You can see construction walls that they put around projects now where there’s no work going on, and it’s all over the city.”
Lines of recourse
While the problem may become more widespread going forward, Ronald Berger, the executive director of the Subcontractors Trade Association, said he has not yet received any reports of subcontractors not being paid on job sites in New York City.
If developers do stop paying construction workers, “they have lien laws which allow them to put a lien on the job, and attach personal property and corporate property, and that’s what they do,” said Berger.
However, getting liens paid can take precious time that small construction companies that survive from paycheck to paycheck don’t have.
The Sheffield57 condo conversion, in which Kent Swig is a partner, is facing $2.77 million in mechanic’s liens filed by four contractors since July.
The pace of major renovations has fallen off sharply at the building. Sheffield57 made it onto the watch list issued in August by Standard & Poor’s, which expressed worries regarding Swig Equities’ ability to refinance the project. Swig did not return calls for this article.
Like Swig, some developers who may have thought they’d secured financing are learning otherwise, said Steven Spinola, the president of the Real Estate Board of New York.
“It’s happened to some others,” he said, though he knew of no other instances where contractors were not being paid.
“And the longer we have this uncertain market, and the longer we have this unavailability of credit, the greater the chances are that we’ll have more projects like this.”
Typically, contractors on a job will submit a monthly requisition detailing the charges for labor and materials, which goes to the construction manager and the developer, who submit it to the banker, who then advances the money for payment.
“If your lender was Lehman Brothers, they’re in bankruptcy, so there’s nobody there — knock, knock — to pay you your monthly requisition,” LePatner said. “As a result, very quickly the contractors shut down the job, because they cannot afford to stay on a job where they’re not going to get paid. They file mechanic’s liens, and they start lawsuits.”
In addition to shaky financing, LePatner said that he believes that residential developers, and even some commercial developers, in the current real estate market have missed the boat.
“Buildings that are finishing up now, and in the next few months, are not likely to find buyers who can afford mortgages, because lenders are not giving the money,” he said. “And those projects are going to be finding themselves short of cash. They don’t pay the [subcontractors]. They don’t pay the construction managers. And that causes a ripple effect that goes out and out.”
Historical patterns
In past recessions, developers and/or borrowers often suspended work on development projects while they attempted to secure continuation financing, a process that can take as long as a year or two, LePatner said.
Spinola said that he would hope that developers would choose to suspend work on the project before contractors were left unpaid.
“My guess is owners would stop the job voluntarily, rather than have contractors in effect go without being paid, at least in terms of my membership, which uses predominantly union contractors,” he said.
But LePatner said that the unions don’t typically consider it their job to ensure that construction workers are paid.
“That’s the obligation of the construction company,” LePatner said, referring to getting workers paid. “The union is not contractually bound to chase after a developer who’s not paying his contractors.”
The Building Trades Employers Association, which represents union contractors, did not return numerous calls for comment.
LePatner argued that cash-flow troubles in construction start a snowball effect.
“As cash flow [on a job] stops, many subcontractors will go out of business or trigger bankruptcy proceedings, which by law brings all lawsuits affecting the bankrupt subsidiaries under the auspices of federal bankruptcy courts,” he said.
“Now, because they didn’t get paid on this job, they don’t have enough money to pay their workers on their four other jobs, so they start defaulting on some of these other projects, causing a ripple effect on jobs even though they might be going forward,” he said. “Before you know it, there is a market meltdown.”
Vulnerable mom-and-pops
According to LePatner’s book, “Broken Buildings, Busted Budgets: How to Fix America’s Trillion-Dollar Construction Industry,” as of 2007 nationwide, there were 883,000 construction-related companies employing 9.6 million workers, and 92 percent of those workers were at firms employing 19 people or less.
LePatner said he expected the total number of construction-related companies to shrink substantially this year. And the New York Building Congress recently released a report predicting that the construction industry in the city will lose 28,000 jobs by 2010.
In the booming economy of the past seven years, if contractors did go out of business for any of various reasons, even simply a late payment, they could typically find more work. Now the lucky contractors will finish off five jobs and replace them with two, LePatner said.
Every year, even in the good times, tens of thousands of contractors go out of business, he said. “And they go back into business — they just form up a new company and see if they can get another job. But in this economy, they will go out of business for years now and not come back, because there’s no work to sustain them.”
While LePatner said the situation will remain dire until credit loosens, Spinola said that REBNY has been “talking to people in Washington about the fact that we need to somehow get credit available again.”
Until that happens, New York City may see more jobs put on hold, he said.
“Obviously, developers, if they have it, can decide to put some equity into the project, but in this market, we potentially will have projects that will in effect be stopped,” Spinola said.
Another incentive for developers to avoid having construction workers walk off the job unpaid is that if the job does ultimately obtain financing and continue, most construction companies prefer not to come in and finish off another contractor’s job site, LePatner said.
“It’s very difficult and costly to an owner to replace a contractor,” he said. “Contractors do not like to come onto a project and clean up somebody’s mess, and when they do it’s usually at substantial additional cost … and there’s always a delay of several months to find the contractor, get the insurance and bring him aboard.”
Maintaining the good will of job contractors can be worth a lot to a developer, Spinola agreed.
“You try to work things out with the contractors,” he said. “That’s what people try to do in order to maintain their relationships with contractors. Eventually we will get beyond this, and they’re going to want to bring back the contractors who they like and have a good relationship with.”