A typical commercial investment property may be 20+ years old. In many cases, this means that it has had several owners and it may have been subject to zoning changes, different mortgages, and multiple renovations. Given all of this activity, it can occasionally be a challenge to determine who actually holds title to a property. This is precisely why title insurance is one of the most critical components of a commercial real estate transaction.
What is Title Insurance?
Simply, title insurance is a specialized type of insurance policy that protects a buyer against issues regarding the chain of title for a real estate asset. It is needed to provide a buyer with comfort that the title to a property is clear of defects.
A property’s title is different from its deed. The title provides the right to ownership of a real estate asset, while the deed is the document that conveys a property’s title between a buyer and a seller. But, not all deeds convey a title that is free and clear of liens, easements, or other types of encumbrances that can affect a claim to ownership. This is why title insurance is needed.
Why Title Insurance is Important
To illustrate why title insurance is important, an example is helpful. Suppose a buyer purchases a commercial property for an investment. At first, everything is fine, but one year after purchase, another individual presents documentation that supports his or her own claim as the rightful owner of the property.
In such a situation, the buyer’s title insurance policy can fund the legal costs that are needed to fight the third-party claim and establish ownership. Should the third-party prevail—which is rare—the title insurance policy can also reimburse the purchase price.
Without title insurance, a buyer runs the risk of losing the property with no compensation if the other party is declared the legal owner. In addition, the buyer may have to spend tens of thousands of dollars in legal fees to defend his or her own ownership claim.
How Title Insurance Works
Prior to issuing an insurance policy, the title insurance company will perform a title search. This is a deep dive into public records and legal documentation—including liens and encumbrances—surrounding all title transfers of the property in question. If the property is very old and/or there have been many transfers over the years, this is no small task.
Once the title search is complete, the insurance company will issue a title report, which outlines all potential issues with the chain of ownership and legal claim to the property. For example, it could reveal that there is a lien that was placed on the property by a contractor many years ago after that vendor’s bill went unpaid. These types of title issues can be addressed prior to closing, or they can be listed as a title exception or title defect.
Once the buyer, lender, and seller are comfortable that the title can be conveyed free and clear of any issues, the transaction’s closing process can commence.
What Does a Title Insurance Policy Cover?
Each commercial title insurance policy is different, but they generally cover the following items:
- Title defects—including issues related to fraud, forgery, or unauthorized deeds
- Unrecorded liens for things like property taxes or past-due utility and contractor bills
- Issues related to encroachments—for example, a property’s boundary description could be different than the area that is used
- Incorrect legal descriptions
If the property owner encounters any of these issues, he or she could file a claim on the policy to fund the legal costs associated with resolving the issue.
What to Look For In a Title Insurance Provider
Like any insurance company, the key issue to consider when selecting a title insurance provider is the experience, local expertise, and financial capacity that this provider brings to the table.
Experience and a large number of transaction repetitions are needed to ensure the provider has a strong understanding of the commercial real estate purchase and sale process, as well as their role in it.
Local expertise is important because the rules and laws surrounding a property’s transfer of ownership can vary from one city/state to another. As such, it can be incredibly helpful to work with a provider who has local knowledge of these rules and laws.
Finally, and perhaps most importantly, the financial resources of the title insurance company must be sufficient to: first, stay in business; and second, pay out claims. In a worst-case scenario, a property owner/investor spends significant amounts of money on title insurance policy premiums only to have to file a claim and learn that the insurance provider went out of business or does not have the money to pay the claim. For this reason, investors should perform due diligence on their title insurance provider and consult with independent rating agencies.
Why Title Insurance Is Important in Private Real Estate Transactions
Private equity investors do not necessarily need to worry about every single aspect of a title insurance policy. Their primary concern should be that it exists, that the policy is issued by a reputable provider, and that the premium is paid in the transaction. Knowing these three things should provide sufficient comfort that the property is protected from any financial loss associated with competing title claims.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. We leverage our decades of expertise and our available liquidity to find world-class, multi-tenanted assets below intrinsic value. In doing so, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.
