Will lenders be prepared for a possible downturn in the real estate market?

• Author: Diamond, Lawrence J.

We have certainly been enjoying a strong real estate market for the past several years. Many economists, however, believe that real estate markets run in 10-year cycles. Even though interest rates are at record low levels, and the Dow Jones Industrial Average recently surged to a record high, history suggests that we could be approaching the end of a good real estate cycle in the near future. Accordingly, prudent real estate lenders should start analyzing their existing real estate portfolios to prepare for a possible downturn in the market. This article discusses some simple steps that real estate lenders can take now to help avoid some of the problems that many lenders encountered when the real estate market collapsed in the early 1990s.

Ensure That You Have Complete Documentation

Lenders should make sure that they have a complete set of original loan documents, title documents, and similar instruments for all of their real estate transactions. While there is a strong likelihood that a lender will have a complete set of fully executed loan documents at closing, it is possible that a lender may misplace or fail to receive pertinent documents after closing. For example, loan documents may inadvertently get lost when a lender relocates to new office space, when two lenders merge with one another, or when one lender assigns its loan documents to another lender. Other times, a lender may allow a borrower or third party to execute a loan document post-closing (e.g., a subordination, nondisturbance, and attornment agreement), but ultimately may fail to receive that document from the borrower or third party. Moreover, title agents or title companies may fail to deliver the mortgagee's title insurance policy to the lender in a timely manner. Obviously, missing documents can be problematic if and when the lender seeks to enforce its rights and remedies in the event of a default by the borrower. Many workout lawyers discovered this in the early 1990s when they were asked to resolve troubled loan transactions, but did not have complete files to review. A missing note could be particularly harmful to a real estate lender since, as a general rule, the lender will be required to produce the original note in a foreclosure action or incur the expense over litigating lost note issues. If a lender discovers that a pertinent document is missing or was not properly executed, now is the time to consider having the borrower deliver or reexecute it. A lender should, however, be careful when asking a borrower to reexecute a promissory note since there could be adverse tax consequences in some states if the proper steps are not followed.

Perform Title Updates

It is not uncommon for a borrower, after the closing of a loan, to grant an interest in the mortgaged property to a third party or permit an encumbrance to be placed upon the...