Karen Scott

 
                                         
                                                               Chinese Drywall: Why Investors Must Do Their Homework First by Karen Scott
Investors interested in purchasing homes on short sale or through foreclosure pools are eyeing residences with Chinese drywall as a source of additional opportunity for renovation and resale or “flipping” as commonly known.  These houses have suffered from severe devaluation beyond standard market appraisals due to negative publicity and the corrosive impact of the drywall itself.  As a result, these houses can be purchased at substantially below current market values.  Investors who are not closely following current litigation and resulting remediation requirements could end up with expensive renovation costs beyond what is typically required for a home remodel. 

Reports of homes with “odd odours”, corroded air conditioning coils and copper oxide “soot “ on electrical, mechanical and plumbing components started to surface as early as 2006.  Media coverage on the problem started in 2009 with extensive stories on houses made unliveable due to odour, humidity and mechanical failure.  To date, Chinese drywall has been found in 38 states across the US with over 3,000 home owners reporting in to the Consumer Product Safety Commission.  It is believed that more houses are affected than have reported and it has been found in homes built as early as 2001.

Homeowners trying to figure out what to do with these homes and how to maintain value in the midst of the current housing recession are frustrated with the lack of interest in assisting them by lenders, governmental authorities, builders and contractors, insurers and the Chinese government.  As a result, many property owners who have been financially challenged to make their monthly payments have chosen to simply walk away, leaving the problem in the hands of their lender.

If you are an investor, lender or a general contractor looking to take back or purchase and renovate these homes, there is information you need to know.

First, many of these houses and properties have been registered through attorneys as part of the Multi District Litigation (MDL) proceedings filed under the United States District Court, Eastern District of Louisiana against some of the manufacturers of Chinese drywall.  If you are foreclosing on a house with Chinese drywall consult with your counsel to see if you can register the house for any potential claims under specific manufacturer’s suits going forward.  Also find out if the homeowner has previously filed and see if you can negotiate to participate in any settlement with them as this might help to reduce the obligation for the note on the house and defray repair costs.

While there is no industry accepted remediation protocol as of yet,  there is a “defacto” one based on the ruling of the Multi District Court managed by Judge Fallon under Case No. 09-6687 relating to Germano, et al. v. Taishan Gypsum Co., Ltd. et al. 

As part of the court proceedings, repair work in seven subject houses in Virginia were used as the basis for repairing costs to houses impacted with corrosive drywall.  The total amount of the judgment against Taishan for the seven houses is $2,609,129.99 with the average cost for repairing the subject homes coming in at $86 per square foot. 

This could be a tremendous shock  to to an investor who has purchased a house thinking that they would be able to remediate or refurbish it for around $25 to $35 a square foot which was a number commonly assumed reasonable for remodeling prior to the issuance of the court system’s remediation recommendations. 
 Based on the Court’s findings, a good remediation protocol needs to address the following:

1. The removal and replacement of all drywall in the home.

2. The removal and replacement of all electrical wiring; the court evidentially decided that it is not feasible to clean wiring to render them free of risk of future failure.

3. The removal and replacement of all copper pipes in the home.

4. The removal and replacement of the entire HVAC system including duct work.  Outside air handlers should be considered on a case by case basis according to the ruling as the compressors might have been damaged due to the conditions within the house and the coils or because it will not be compatible with the new air handler systems being required.

5. The removal and replacement of all insulation in the home

6. The Court also stated that most appliances need to be replaced, particularly refrigerators. 

7. The replacement of electronics such as home stereo systems and fire and security systems and anything with a circuit board.

8. Replacement of carpeting as well as hardwood floors (due to humidity damage) and vinyl flooring.  Tile flooring should be replaced unless it can be properly protected during remediation.

9. Removal and replacement of cabinets, countertops, trim, crown molding and baseboards.

10.  Removal and replacement of all bathroom fixtures.

11.  After removal of all drywall, property must be cleaned with a HEPA vacuum, wet-wiped or power-washed and then allowed to air out for 15-30 days.

12.  The property must be certified by an independent engineering company to certify that the remediated home is safe.

 

Some investors and their contractors might simply elect not to do the complete remediate protocol.  However, failure to do so will result in reduced market value as fully remediated houses come on the market, even if the partially remediated house does not off gas again in the future.  The same will hold true if an investor chooses to use one of the cleaning, gassing or molecular control processes currently being promoted, even if the science behind what is causing the off gassing eventually proves that form of remediation as safe and acceptable.
Finally, if you are a contractor or a private investor planning to purchase cheap, remodel and flip, it is important you make sure you get the correct permits from your local municipality or you could end up having to pay unexpected holding costs. 

Florida Statue 489 requires anyone performing construction work to be properly licensed through the State and the local municipality.  Homeowners are exempted from this statute as long as they are pulling permits to perform any work on a single-family home for their own occupancy.  Any owner-builder cannot sell or lease their property for one year after completion.   If the owner offers the property for sale or lease within one year after completion, it will be assumed that the owner is operating as a licensed contractor and will be charged accordingly. Full disclosure will be required if the house had Chinese or corrosive drywall and remediation and repair during the due diligence for a future sale.

It would appear to the average person that the replacement cost is almost as much as initial construction.  However, remediation is extremely labor intensive.  The court based its decision on recommendations from builders already involved in remediation who told the court that it is simply cheaper and more efficient to remove items and replace with new versus take out, clean and replace.  So if we are an investor or buyer interested in purchasing houses with Chinese drywall, should we go ahead and take the risk of purchasing these homes with an eye towards re-selling them? 

Some of these homes are in beautiful, high end complexes and neighborhoods where the return on investment might make them valuable to long-term investors who plan to rent them and wait for the eventual return of the market versus fixing them up and selling them immediately with less return.

-Karen Scott, SCMD, CDP, LEED Green Associate  is Principal of  Asset Advisors and Managers, Inc.

 

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