CPE finance editor Keat Foong talked with leading title insurance executives about what they are witnessing on the investment scene today. The first part of this Q&A appeared in the October 2012 issue of the magazine. In the following discussion, they talk about warier clients and complex issues related to troubled properties.
Roundtable participants include:
Sally French Tyler, Executive Vice President & Divisional President, First American Title Insurance Co., National Commercial Services
Phil Seaver, President, Seaver Title Agency
David A. Barris, Vice President & Corporate Counsel, Seaver Title Agency
Bruce Hawley, Senior Vice President & Senior Underwriting Counsel, Multinational Title Services Group Manager, Stewart Title Guaranty Co. – National Title Services
Brian Tormey, Executive Vice President, TitleVest Agency Inc.
CPE: Did the Great Recession give rise to unexpected issues or complications in the title search industry?
Hawley: All title companies have seen an increase in claims caused by the Great Recession. For example, there has been an increase in defalcation claims by agents, and claims because of theft and fraud, mechanics liens and tax liens.
Another issue we face in times of recession is with county and local governments falling behind on indexing title records and reduced hours of operation. Some counties are broke and in bankruptcy, which causes layoffs in the county clerks’ offices. As a result, it can take a long time to get search work done in these counties where offices might be closed two to three days a week due to budget cuts. During times like these, the local governments have to make tough decisions about where to spend their limited resources. Land records are low priority when it comes to decisions like whether to buy a snowplow or school books. So consequently some counties may be six to seven weeks—or more—behind in indexing the land records, which impacts the time it takes to certify a title.
Seaver: From a practical viewpoint, one of our biggest issues has been to make sure we receive payment for the search work we’ve performed in expectation of issuance of a policy for the sale/purchase. A large proportion of transactions during the recession did not close, primarily because for a period of time, commercial property was very difficult to finance, which caused the deal to fall through.
Due in large part to difficulty in obtaining financing in today’s market, the dynamic of who constitutes the parties to both sale and mortgage transactions has changed. The falloff in the availability of financing has resulted in investor groups tending to utilize pooled funds to purchase commercial properties with cash instead of through financing; a resurgence in land contracts.
And the refinancing of old/open mortgages, while recently increasing in frequency, has largely succumbed to modification of the structure of open financing, leading to issuance of endorsements to modify prior loan policies instead of issuance of new loan policies to insure new mortgages. In addition, as a result of the recession, lenders that are vested with title to distressed properties by either foreclosure or deed in lieu oftentimes appear as sellers.
Tyler: As a result of the Great Recession, there have been some industry changes. For example, the industry no longer underwrites creditors’ rights. During the last several years, we have also witnessed a number of construction projects that have failed, resulting in an increase in mechanic’s lien claims. This has resulted in stricter mechanic’s lien underwriting throughout the title insurance industry. Other matters also affect our industry, including the fact that many developments have been placed on hold, and deals with increased complexity take longer to close. Also, in today’s market there are less sizeable, single-site trophy asset deals and many more portfolio deals.
Tormey: In addition to the tremendous drop-off in transactions levels that accompanied the freeze of the credit markets and the banks’ willingness to make real estate-related loans, with the dissipation of market value, the debt-to-equity level of many properties rose so broadly that defaults, foreclosures or distressed situations had to be addressed more frequently for new transactions going forward. As a result, we saw a higher incidence of lenders being forced to make title claims under the policies they had previously obtained from a prior title company. Moreover, with the decline in transaction volumes has come a much higher level of competition among title companies to acquire new business. Understandably, many title companies have not been able to weather the storm. TitleVest has not only been able to survive the past few years but we’ve actually grown threefold since the financial crisis began in 2008.
CPE: What have been the greatest sources of commercial property clients for you in today’s business environment?
Seaver: In today’s commercial real estate world, many of the purchasers are investor groups as opposed to mortgage-financed transactions. These groups oftentimes seek the advice and counsel of real estate attorneys and commercial real estate brokers. A significant portion of the sellers are lending institutions that have either foreclosed on or taken deeds in lieu of foreclosure, or investors that have purchased a distressed property, turned it around, leased it out, and are now selling. Collectively, these professional parties contact us to handle the title insurance portion of the transaction.
Tormey: We are seeing everything from semi-novice individual capital investors at the lower end of the market to the standard professional owners and operators, along with joint venture/equity partners ranging in origin from private individuals to large funds. While the levels have yet to return to where they were prior to the economic downturn, we have also been seeing an increase in portfolio refinances by borrowers securing debt from institutional lenders. We are proud to say that, for TitleVest, word-of-mouth referrals are still our greatest source of new clients.
Hawley: A trend we’re seeing coming out of the global economic recession is an increase in foreign investment in U.S .commercial real estate. I lead Stewart’s multinational title services group, and we get a lot of inbound investment clients due to our company’s global presence in countries across the world. There are a lot of high-net-worth individuals looking to invest in U.S. commercial real estate right now, particularly from Germany, China, Canada and Mexico. When you look across the world, the commercial real estate market in the U.S. is pretty stable compared to other countries. Our land record and court systems are intact.
Within the United States, most of our transactions involve the sale of office buildings, followed by retail—mainly strip centers and big boxes—followed by hotels and multi-family. In my role as a senior underwriting counsel, I am also seeing a good bit of transactional activity across Stewart operations on energy, mixed-use and industrial projects.
We are not seeing as much multisite portfolio work right now as we are single-site transactions. That shift is largely due to the lack of activity in the commercial mortgage-backed security (CMBS) markets. … Until about five years ago, almost all of our orders for commercial real estate transactions came from the parties’ outside attorneys. Since then, however, we have seen more orders come from the inside counsels at our customers who do a high volume of commercial real estate transactions–particularly life insurance companies, real estate investments trusts (REITs), pension funds and energy companies.
Tyler: The array of commercial property investors in today’s business environment is broad. It includes the typical composite of public, private, corporate, educational and government entities, as well as institutional players, equity funds and crossborder players. We are also witnessing an increase in deals by high-net-worth individuals, family offices, endowment funds, hedge funds, sovereign funds, global funds and foreign pension funds allocating assets to the U.S. These clients are doing debt-to-equity swaps, refinances, entity-level transactions, partial-interest transactions, mezzanine financing deals and traditional sales. To make matters more complex, many of our clients are doing joint venture deals on both the buy side and sell side.
The economic environment is certainly a driver in determining the types of clients we are seeing, as well as the markets in which they are investing. They deploy strategies and financial leverage in a spectrum of core, value-add and opportunistic areas, including all the typical asset classes and sub-categories. As the economy improves, more investors may become active once again in multifamily ground-up development opportunities.
CPE: What do you find your commercial property clients to be most interested in, and concerned, about today?
Hawley: The biggest concern our commercial property clients have today is ensuring that they receive accurate and complete title insurance commitments before they sign the purchase and sale agreement. During the boom years, from 2004 to early 2007, when deals closed very quickly, it was the practice to order the title commitment after the contract was signed and make the deal contingent on clear title. Buyers are much more cautious today. They want to check the status of the title before they sign the agreement and put down a deposit.
Another trend we’re seeing come out of the “go-go” years has been a shift in interest from buying property to just buying the notes and taking an assignment of the mortgages that secured those notes. Ultimately, if the notes perform, the note buyers make money. If they don’t, they’ll foreclose the mortgages on the properties and get them at a reduced price. That’s the so-called “loan to own” concept. Commercial investors who are buying mortgage notes, as opposed to the real estate, want to make sure that the mortgages were recorded properly and that there are no taxes or other liens that take priority over the mortgages. From a title perspective, we’re not necessarily seeing new title insurance policies for note transactions but endorsements to existing loan policies that show that the mortgages were properly assigned to the note buyers.
Tyler: Commercial property clients are … definitely interested in land-use and zoning issues. We have seen an increase in energy-related, structured finance and infrastructure deals. In fact, First American has a dedicated energy group established specifically to underwrite these complex deals. There has also been, in certain parts of the country, concern regarding mineral rights and water rights. Attention has also increased on subsurface mineral and gas mining exploration. These issues could affect a lender’s collateral if one property has mineral rights and the adjoining property does not. For areas affected by mineral rights, the search may need to go back to the 1800s, which is deeper than the traditional period for most title searches. During the last several years, we have also seen an increase in energy deals, which brings into play other factors, such as zoning and easement rights. Due to the complexity of many of these transactions, the time required to complete title searches has also increased.