Buying commercial real estate is a substantial investment. If you discover that you don’t have a clear title after closing, it can cost thousands of dollars in legal and cleanup fees. No one wants that.
With a title insurance policy, you are protected by a form of indemnity insurance, which insures you against financial loss from defects in title to real property—as well as from invalidity or unenforceability of mortgage loans. This contract will reimburse you for your loss in the event someone asserts a claim against your property (as long as it is covered by the policy). Your title insurance company will defend you against a lawsuit attacking the title, or will reimburse you for the actual monetary loss incurred, up to the dollar amount of insurance provided by the policy.
For example, a seller claims to convey a full and clean title to a buyer. Yet after closing, a third party claims that they held all rights to the property. In this case, the title company will protect the buyer.
Most policies contain a number of specific exceptions (such as recorded liens) and general exceptions for issues the policy does not cover (such as defects known to the insured, or problems arising out of creditors’ rights or government documents not otherwise recorded). Most title policies insure the title against recorded and unrecorded claims, but are subject to exceptions. Because it is difficult—or even impossible—to ascertain all risks, coverage for unrecorded risks is extremely beneficial.
Every property is unique, so every policy is different. Cost is based on several factors, such as the characteristics of the property, the type of financing, and the entities involved in the transaction. Unlike other forms of insurance, title insurance is paid in a single lump sum premium at closing. Premiums are based on purchase price, loan amount and any additional coverage (called endorsements) that may be included.
Rates can vary from one company to the next, and it’s important to research the accepted market rates in your locality and state. If you would like to request a quote, give us a call.
Title insurance is issued only after a comprehensive title search, one that traces ownership, examines liens, and determines other recorded encumbrances. Yet even the most thorough and professional search can’t prove that absolutely no title hazards exist.
Not all threats to a clear title are reflected in public records. Claims by heirs, encroachments from neighboring property owners, the effects of local zoning ordinances, bankruptcy filings and potential claims of contractor non-payment can be difficult to discover during a title examination—even when done by an experienced professional title examiner.
A title is a right to ownership of a parcel of real estate. Unlike a title for an automobile or an RV, it isn’t determined by a single document. Rather, a real estate title is determined by an entire collection of documents that affect a property—including liens and encumbrances that can limit the rights of ownership. It’s not always easy to determine exactly who owns a commercial property, making it particularly important to insure against a defective title search.
Here are just a few of the most common hidden risks that can cause a loss of title or create an encumbrance on title:
- Errors or omissions in recorded legal documents
- Mistakes in examining title records
- Fraud or forgery
- Erroneous or inadequate legal descriptions
- False impersonation of the true owner of the property
- Forged deeds, releases or wills, instruments executed under invalid or expired power of attorney
- Misinterpretations of wills and deeds by persons of unsound mind
- Deeds by minors
- Deeds by persons supposedly single, but in fact married
- Liens for unpaid estate, inheritance, income, real estate or gift taxes
First, choose your title company. Your contract to purchase a property may designate a specific title company, or you may receive a recommendation from your attorney or real estate agent. You can shop ahead of time to learn more about commercial title products and the companies that provide them.
Once a contract is ratified, a copy should immediately be delivered to the chosen title company, which will initiate a title search to analyze the collection of public records that affect the property. This typically takes two weeks (or longer, depending on the complexity of the transaction).
The outcome of the title search is a commitment on behalf of the title company to issue a policy of title insurance to the buyer and lender subject to certain stated requirements and exceptions. The buyer should review the commitment and accompanying documents to make sure that the title it receives will be acceptable for its intended purposes, and address any issues in question. Once the buyer reviews the commitment documents carefully to make sure the title and conditions are satisfactory, the parties can then close the transaction. The title company will bind coverage as of the closing date, but will issue the title insurance policy approximately 30 to 45 days after closing.
Above all, you should expect clear and timely communication. Your title company will handle all of the moving parts of the transaction, managing contact between you and the attorneys, lenders and the buyers or sellers. It’s a complex process. You need to be able to trust your title company to support your needs efficiently and professionally.
Once the title commitment is available for review, it will be made available to all involved parties for due diligence. When all contractual and title requirements have been met, the transaction will close quickly.
In the days before closing, the settlement statement (which discloses the purchase price, loan amount and all fees) will be drafted, reviewed and finalized by all parties. When conditions are met, documents will promptly be made available for signing—in person, by email or by overnight delivery of documents. Keep in mind that some documents must be executed in front of a notary public.
After closing, the title insurance agent will act as a settlement (or escrow) agent—updating the title a final time, recording the deed and deed of trust at the local clerk of court office, and transferring the funds due to the seller. Any loans the seller owed on the property will also be paid off, as well as the various service providers.
When selling a commercial property held for investment, a 1031 exchange is one of the best tools for avoiding capital gains taxes. Under Section 1031 of the Internal Revenue Code, a taxpayer is able to defer capital gains taxes on the sale of real property as long as the proceeds are rolled into another like-kind investment property. There are other benchmarks that need to be met, but when done properly, a 1031 exchange can result in 100% capital gains tax deferral.
However, a seller must sign a contract that conveys his or her interest in the property being sold in exchange for interest in another commercial property. If you are considering a 1031 exchange, it is always important to have competent legal counsel involved due to complex IRS regulations.
If the commercial property is new construction, a title company can facilitate the process by providing title search updates as well as construction endorsements for the lender prior to each draw. With a construction loan, the lender will require mechanic’s lien coverage during the entire construction phase. The title company will give that coverage to the lender, with an important caveat: The title to the property must be updated prior to each disbursement. This ensures that the general contractor and subcontractors have been paid for labor and materials, and greatly reduces the likelihood of unpaid contractors and post-closing lien filings.
Typically, title insurance companies offer two different types of policies: Loan policies and owner’s policies. Loan title insurance policies are designed to protect the bank’s investment (or that of any other lender) if a problem with the title surfaces. An owner’s title insurance policy is designed to protect the buyer or owner of the property if future title problems are discovered. There are also leasehold title policies that protect the parties involved in a commercial lease.
Based on the type of property and transaction, title companies offer a variety of endorsements to lenders and owners. They serve as additional coverage, insuring issues such as matters of survey, zoning, access, environmental issues, and any future modifications to the original policy.
The cost of an endorsement varies based upon on the risk factors and the value of the property. In commercial financing, the lender may seek certain endorsements to the title policy covering a risk of concern, such as loss of priority, leasehold improvements, insolvency, and construction and mechanic’s lien coverages.
The American Land Title Association (ATLA) governs the industry standards for the issuance of commercial real estate title insurance. In the Commonwealth of Virginia, the Bureau of Insurance under the State Corporation Commission regulates the title insurance and settlement industries. National underwriters also audit title companies on a regular basis.
We use the following national title companies: Fidelity National Title, First American Title, Old Republic Title Company and Stewart Title.
An assignment of leases protects the commercial lender in case of borrower default. It assigns the debtor’s rights in leases on the property to the creditor, allowing the creditor to collect rent and providing a security interest in the rent stream. Rent is an important source of cash, and as such, can be used to pay off a loan if the debtor is unable to repay it. If a debtor defaults, the creditor can then step in as landlord—collecting rent and enforcing landlord’s rights—typically without a lengthy court battle.
The Uniform Commercial Code governs the financial interests of a creditor by giving the creditor a secure interest—and priority—in the personal property of a debtor, including fixtures. Like a mortgage lien, a security interest is a right in a debtor’s property that secures payment or performance of an obligation. In order for the rights of the secured party to become enforceable against third parties, however, the secured party must “perfect” the security interest. Perfection is typically achieved by filing a document called a “financing statement” with the city or county, as well as the state.
A financing statement itself does not create the lien or security interest, but when properly filed, only gives notice of the security interest created in the security agreement. Different perfection rules apply to fixtures, extracted collateral and timber to be cut. A security interest grants the holder a right to take action with respect to the personal property that is subject to the security interest when an event of default occurs, including the right to take possession of (and even sell) the collateral to apply the proceeds to the loan.
Typically called an SNDA, this type of agreement defines the relationship between the borrower, the lender and the property’s tenant in the event of a default or foreclosure. Subordination means that if the loan is in default, the lease may be terminated; however, the non-disturbance clause is an agreement by the creditor—or other purchaser at foreclosure—to avoid disturbing the tenant’s possession of the property. Attornment obligates the tenant to recognize the creditor or purchaser as the new landlord.
An estoppel certificate is a signed statement by a party certifying certain statements of fact as correct as of the date of its execution. In commercial financing, the creditor often requires estoppel certificates from existing tenants in a property to be mortgaged. It confirms the terms of a lease, and records whether the tenant claims any defaults by the landlord. An estoppel certificate keeps a tenant from later claiming pre-existing problems with the lease.
Creditors may require a guaranty of the loan by the debtor, which can include one or more members, investors, partners or shareholders of the debtor’s business organization. Depending on the creditor’s underwriting requirements, a guaranty may also be secured by additional collateral, such as a guarantor’s personal mortgage or security interest. This collateral is independent of the real estate that is the loan’s primary security. Guaranties are an added layer of protection for the lender, and provide another avenue for the creditor to pursue in the event of default by the debtor.
If a property has a due-on-sale clause, it means that the entirety of the outstanding debt (whether it is a note, mortgage or deed of trust) must be paid as soon as that property is sold. However, the creditor can waive this right. Typically, this provision is used to prevent a subsequent buyer from assuming the existing debtor’s financing at less than the current market value.
A property owner must decide whether the property will be held in an individual’s name or that of an entity. Most commercial partnerships involve entities such as corporations, general and limited partnerships, limited liability companies, and real estate investment trusts.
Choosing an entity is dependent on many complex factors, such as tax considerations, identities of the owners, who will operate the project, state law and more. This is a complicated decision, and it should be made with the help of competent tax and legal advisors.
When a tenant leases property, they typically focus on the lease and any guaranty that they may be asked to sign. They may also have the landlord’s lender execute a non-disturbance agreement to make sure that its leasehold interests are secure in the event the landlord defaults on its loan.
However, if the landlord does not have valid title to the property, the non-disturbance protection the tenant just received from the landlord’s lender will not be worth very much. Just like when a tenant purchases property, the interest in the underlying property could actually be held by an unrelated third-party. Leasehold policies protect the insured (in most cases the tenant) when the title to the property adversely affects the tenants’ rights. The policy is especially important when costly improvements are constructed within the leased premises. In fact, most lenders will require a leasehold policy when obtaining financing for improvements to the leased premises.