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Regional Director of Surety, AXA XL

U.S. economic indicators suggest the recovery from the COVID-19 pandemic may be slowing in some areas, but residential housing and subdivision construction are still booming. As this growth continues, developers and contractors need to remain mindful of specific risks related to subdivision projects.

The pace of residential construction fell sharply in the second quarter of 2020, amid the pandemic lockdowns. But it quickly recovered and has been growing steadily since, according to data on housing starts compiled by the National Association of Home Builders. Since September 2020, the number of single-family housing starts rose by 6%, to almost 1.2 million in June 2021. Multifamily housing starts increased by 4.2% in the same period. At the same time, the prices of framing and lumber continue to fall. With mortgage rates still low and many home buyers seeking to move out of densely populated urban areas, demand for suburban and rural housing is high. In combination, these factors suggest new home and subdivision construction is likely to stay strong.

Homebuilder confidence, a measure of builder sentiment about current and near-term housing market conditions, not surprisingly, also remains high. In August 2021, the NAHB/Wells Fargo Housing Market Index dropped by five points, to 75. Anything above 80 reflects strong demand, with readings over 50 considered positive. The index has remained well over 50 since June 2020, after temporarily plummeting last March.

As long as the building boom goes on, subdivision developers are likely to enjoy profitable growth. But there are risks that could crash the party: an economic recession, the lack of skilled labor, or a surge in the price of building materials that might result from natural disasters or supply chain disruptions, to name a few. A higher interest rate environment could also increase the cost of capital for borrowers – especially home buyers, reducing demand for new homes. Developers and contractors can't control these things, so they have to manage the risks.

Subdivision projects can add considerable value to communities and residents, supporting jobs and local businesses, and introducing new amenities – as long as they're completed. If a contractor fails to complete the subdivision, those benefits can be lost. For this reason, some local governments require financial security before construction starts. One common form of security is a surety, or contract performance, bond. Known by various names, including subdivision bond, developer bond, site improvement bond, and plat bond, these specialized types of contract bonds provide funds if the project is not completed within a specified timeframe.

Subdivision projects can add considerable value to communities and residents, supporting jobs and local businesses, and introducing new amenities – as long as they're completed.

Different from other bonds

Unlike other forms of construction, which also may involve performance bonds, subdivisions typically include infrastructure including roads, sidewalks, sewer lines, storm drains and other utility connections. Subdivision bonds therefore play an important role in community development. There are some differences between subdivision bonds and other types of performance bonds used in construction projects, even though they all involve three parties: the principal (that is, the owner/developer/contractor), the surety (the insurance company or bonding company), and the obligee (the party requiring the bond).

A subdivision bond is a form of financial security required by the municipality or state where the work is being performed. Other forms of financial guarantees that a developer or contractor might offer include irrevocable letters of credit, certificates of deposit, or cash. A key advantage of a surety bond is it frees up credit and capital for the principal to use for other purposes. One of the major differences between subdivision bonds and other contract performance bonds, however, is the principal is obliged to pay for the cost of building the specified improvements. This is particularly significant to the community’s best interests and it ensures the public is not left holding the bill should the developer be unable to perform or pay for its obligations.

 

Importance of trusted partners

With so much riding on the successful and timely completion of subdivisions – for developers, contractors and communities – it's important to have a trusted surety partner. A good partner will have not only a high credit rating, but also significant experience in writing subdivision bonds. The underwriting of subdivision bonds requires special expertise with interpreting municipal codes, understanding the feasibility of the project and the ability of the principal to effectively finance and complete the underlying improvements. Despite the favorable industry underwriting results over time, not all markets have the appetite or expertise to effectively write this class of business.

AXA XL currently provides bonding support for many of the top 20 and established regional homebuilders. The ability to secure individual bonds up to $100 million and programs to $250 million are helpful on large and complex subdivisions.

AXA XL's Political Risk, Credit and Bond team offers a wide variety of commercial bonds, including subdivision bonds, with decades of underwriting experience, high financial strength ratings and a large risk appetite.

For more information on Political Risk, Credit and Bond solutions, please visit axaxl.com.

 

About the Author

Douglas Schmude is Regional Director of Surety for AXA XL. Before joining AXA XL, he held various executive positions in surety bonding at leading insurance brokerages. Schmude has more than 15 years' experience as a surety professional.

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