SS262: What are Surety Bonds?

SS262: What are Surety Bonds?

A surety bond is a financial agreement that guarantees a business or individual will complete specific obligations. In this episode, Charles discusses surety bonds and the different types used within the context of real estate.

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Talking Points:

  • Surety bonds within the realm of real estate are a type of three-party financial agreement that provides a guarantee that one party fulfills a specific obligation. The bond serves as protection against financial losses arising from breach of contract, permitting and compliance issues, misconduct, or failure to fulfill specific duties. 
  • There are Three Parties in a Surety Bond:
    • 1. Principal: The party who is required to fulfill the specific obligation and obtain the bond. This is commonly a real estate developer, a real estate broker, or a property manager.
    • 2. Obligee: The party who is requiring the bond. This could be a government agency, a licensing board, the owner of a project, a property owner, or a client.
    • 3. Surety: The company, usually an insurance or bonding company, that financially guarantees the principal’s performance and fulfillment of the specific obligation. In other words, if the principal fails to perform, the surety steps in to cover financial losses up to the bond’s limit while seeking reimbursement from the principal.
  • Common Uses of Surety Bonds in Real Estate
    • Licenses and Permitting Bonds. Where real estate professionals are licensed by a state agency, it guarantees that the professional will comply with all laws, regulations, and rules.
    • Performance and Payout Bonds. Where a real estate contractor or developer guarantees a property owner that they will complete a project according to specific contract terms. It also guarantees that any subcontractors and suppliers will be paid.
    • Subdivision Bonds. Where a real estate developer guarantees to a government municipality that they will complete all required public improvements, like sidewalks, utilities, roads, etc., in a subdivision.
    • Property Management Bonds. Where a property manager guarantees to a property owner that they will fulfill their obligations and handle funds responsibly.
    • Lease Guarantee Bonds. Where a tenant, possibly a commercial tenant, guarantees a property owner they will fulfill their financial obligations as an alternative to a large, upfront security deposit.
  • Why are Surety Bonds Important?
    • It is common for states to require certain real estate professionals to secure surety bonds as part of their licensing process to ensure that the licensees follow state laws and industry standards.
    • Surety bonds protect the client or government agency from losses if the principal defaults.
    • Surety bonds offer financial security and reassurance to their clients that the principal will act responsibly. 
    • Surety bonds differ from insurance since, with insurance, the insurance company pays on your behalf via a claim. With surety bonds, they serve as a guarantee that your obligations are fulfilled. If the principal is unable to fulfill their stated contractual obligations, the bonding company will pay out and then seek to recover its funds from the principal. If a payout occurs, the bond essentially becomes a loan, where the principal must repay the surety company. Insurance policies are more general in nature; surety bonds are for specific guarantees or projects.
  • In closing, the surety bond provides financial protection and assurance to clients and government agencies that the principal will honor their contractual obligations and fulfill their specific duties.

Transcript:

Charles:
Imagine a developer walks away from a half finished project and yet the client doesn’t lose a dollar. How is this possible through a surety bond? Most people think surety bonds are just another form of insurance, but that’s not true. They’re actually a financial guarantee that keeps everyone accountable. Welcome to Strategy Saturday. I’m Charles Carillo, and they were breaking down what surety bonds are, how they work, and why they matter in the world of real estate. So let’s get started. Surety bonds within the realm of real estate are a type of three party financial agreement that provides a guarantee that one party fulfills a specific obligation. Now, the bond serves as protection against financial losses arising from a breach of contract permitting in compliance issues, misconduct or failure to fill specific duties. There are three parties in a surety bond. Number one is the principal. Now, this is the party who is required to fulfill the specific obligation and obtain the bond.

Charles:
This is commonly a real estate developer or a real estate broker or a property manager. Number two is the oji, and this is the party who is requiring the bond. So this could be a government agency, a licensing board, the owner of a project, a property owner, or a client. Number three is surety, and this is the company, usually an insurance or bonding company that financially guarantees the principal’s performance and fulfillment of a specific obligation. In other words, if the principal fails to perform the surety steps in to cover financial losses up to the bonds limit while seeking reimbursement from the principal. Common uses of surety bonds in real estate, number one would be licensing and permitting bonds. And this is where real estate professionals are licensed by a state agency, and it guarantees that the professional will comply with all laws, regulations and rules, performance and payout bonds.

Charles:
So where a real estate contractor or developer guarantees a property owner that they’ll complete a project according to a specific contract terms. It also guarantees that any subcontractors and suppliers will be paid subdivision bonds where a real estate developer guarantees to a government municipality that they will complete all required public improvements. This is like sidewalks, utilities, roads, et cetera in a subdivision. Next are property management bonds where a property manager guarantees to a property owner that they will fulfill their obligations and handle funds responsibly. Lease guarantee bonds, where a tenant, possibly a commercial tenant, guarantees a property owner that they will fulfill their financial obligations as an alternative to a large upfront security deposit. So why are surety bonds important? It’s common for states to require certain real estate professionals to secure surety bonds as part of their licensing process to ensure that the licenses follow state laws and industry standards.

Charles:
So surety bonds protect the client or government agency from losses. If the principle defaults surety bonds offer a financial security and they reassure their clients that the principal will act responsibly. Now, surety bonds differ from insurance. Since with insurance, the insurance company pays on your behalf via claim. With surety bonds, they serve as a guarantee that your obligations are fulfilled. Now, if the principal is unable to fulfill their stated contractual obligations, the bonding company will pay out and then seek to recover its funds from the principal. Now, if a payout occurs, the bond essentially becomes a loan where the principal must now repay the surety. Company. Insurance policies are more general in nature and surety bond are more specific guarantees or projects. So in closing, the surety bond provides financial protection and assurance to clients, government agencies, and the principal that they will honor their contractual obligations and fulfill their special duties.

Charles:
Thank you so much for watching. Please remember, for rate review, subscribe, submit comments and potential show topics at globalinvestorspodcast.com. If you’re interested in actively investing in real estate, please check out our courses and mentoring programs at syndicationsuperstars.com. That is syndicationsuperstars.com. Look forward to two more episodes next week. See you then.

 

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