Title insurance is one of the key pieces of any commercial real estate transaction. Without it, buyers and sellers would most likely find the risks of buying and selling property to be too high. Title insurance has been around in one form or another in the United States since 1874. The stronger your understanding of what title insurance is and its role in commercial real estate transactions, the better prepared you are for negotiating great deals and protecting your assets.
What is Title Insurance?
Title insurance is insurance that protects the buyer from any problems with the chain of title to a piece of real estate. Title insurance is used in both residential and commercial real estate transactions. Because the amounts of money are bigger, financial transactions are more intricate, and title is often more complicated, title insurance plays a vital role in the buying and selling of commercial real estate.
What Title Insurance Protects Against
Title is the right to ownership of a parcel of real estate. Deeds convey title between buyers and sellers. But, not all deeds convey full ownership of the property and real estate can be subject to liens or other encumbrances that limit the rights of ownership.
A buyer in a real estate transaction is buying insurance that the title to the property they are seeking to acquire is just as the seller promised it is. If a seller claimed to convey full and clean title to a buyer, but later a third party claimed that they actually had the rights to the property and not the seller, the title insurance will protect the buyer.
Every policy is slightly different, but typically the title insurance will cover the legal fees over the title fight and in the event that the third party prevails and is awarded the property the buyer paid for, reimbursement to the buyer.
The Role of the Title Search
Before a title insurance company will issue a policy, they will conduct a title search. This involves examining all of the recorded property transfers for the property in question. This research is called a title search.
The title search does not just trace ownership, but also looks at liens and other encumbrances, such as easements, that have been made against the property. During the title search every effort is made to ensure that the results of each lien and transfer are known.
At the end of the title search a preliminary title report is issued for the buyer and seller to examine before the title insurance policy is issued.
Different Types of Policies and Endorsements
Title insurance companies typically offer two different types of policies. There are loan policies and owner’s policies. Loan title insurance policies are designed to protect the investment of the bank or other lender should any problem with the title later surface. An owner’s title insurance policy is designed to protect the buyer or owner of the property from the future discovery of problems with the title to the property.
Title companies also offer a variety of endorsements for title insurance polices that protect against more than just title issues. These endorsements may cover things such as boundary mistakes, zoning conflicts, and environmental issues. The cost of the endorsements varies considerably depending on the risk factors and the value of the property.
Getting Title Insurance
There are numerous title insurance companies all over the country. Because title insurance agents also often act as the escrow agent in commercial real estate transactions, the buyer and seller must agree on which title company to use. The title insurance company is brought into the process early on, before closing. The title insurance process begins at the end of the due diligence phase and lasts through the completion of the sale.
The American Land Title Association (ATLA) governs the industry standards for the issuance of commercial real estate title insurance.
How is Title Insurance Used in Commercial Real Estate?
While title insurance in residential real estate is often seen as a mere formality, title insurance is an integral part of both the due diligence phase and the closing process in commercial real estate deals. Because the stakes are so high in commercial real estate, all of the parties from the buyer and the seller to the lender or lenders have a vested interest in making sure the title insurance issuance goes smoothly.
Who Pays for Title Insurance and Who Owns the Policy?
If a lender is involved in the transaction, the buyer will almost always pay for the loan title insurance policy. The cost of the policy is often rolled into the cost of the loan. If there are multiple lenders, each lender will require their own policy.
The buyers will also want an owner’s title insurance policy. Sometimes the seller will pay for this policy as part of the closing costs. However, as a practical matter, the buyer is the one ultimately baring the cost of the owner’s title insurance policy, as the seller will just add the cost into the purchase price.
The party who benefits from a title insurance policy will not necessarily be the same as the party who pays for the policy. While the buyer may be paying for the loan policies, if something goes wrong with the property, it will be the lenders that benefit from the policy, not the buyer.
The issue of who benefits from the policy is why buyers should have a separate owner’s policy. Even if the seller is paying for the policy, the buyer will benefit from the policy should there be any trouble with the title at a later date.
The Title Insurance Agent
While the title insurance agent is most irrelevant in residential real estate deals, they often play an integral part in commercial real estate deals. The title insurance agent will make sure the title search is conducted in a timely manner, communicate with the buyer and seller about the status of the title search, and the issuance of the preliminary report. Most of the time the title agent will also act as an escrow agent for little or no extra charge. He or she helps keep the closing process streamlined.
What Happens When Something Goes Wrong With the Title?
While most insurance products that you buy are to protect you against some future problem, title insurance protects you against something that may have already happened, but that you aren’t aware of yet.
If someone later comes forward to challenge your property rights or title to the property you will have to make a claim with the title insurance company. Depending on what your policy covers and what endorsements you purchased, the title insurance company will usually investigate the challenge and defend you against it.
Very early in the process a commercial real estate lawyer will be brought into help evaluate the claim and try bringing a swift end to any challenges. However, like all legal matters, disputes over title to a property can drag on for several years.
The Preliminary Title Report
One of the most important documents in the entire commercial real estate transaction is the preliminary title report. After the title search is completed, the title insurance company will issue a preliminary title report that explains its findings. This report will show any liens or other encumbrances currently made against the title to the property. It will also make a statement as to the title the seller has to the property. If any property rights have been previously sold, such as water or mineral rights, the title report will indicate when the transfers were made and to whom.
What Does the Report Mean to the Seller?
Once the preliminary report is issued the seller has a chance to review the report and challenge any of the findings. If there are any errors, the seller can demand that the errors be corrected and a new preliminary report issued.
If the report finds that the seller does not have the clear title that they thought they had, the seller can do their own investigation or go back to the title insurance policy they were issued when they purchased the property.
There is a small window of time for the seller to make any objections to the preliminary title report before it is made final.
What Does the Report Mean to the Buyer
The buyer needs to carefully review the report to ensure it substantiates the seller’s claims as to title and property rights. The policy will be based on the preliminary report. If there is anything the buyer is uncomfortable with, the preliminary report represents their last chance to pull out of the deal without severe financial consequences.
The buyer can also make objections to the report if there are inaccuracies.
Accepting the Preliminary Report
Once the objections of both sides have been dealt with, the parties will accept the report and it will be made final. The final report will become part of the title insurance policy that is issued to the lenders and the buyer.
After the report is accepted and the insurance issued, the rest of the transaction will quickly close. The title insurance agent, acting as escrow agent, will transfer the funds to the seller and the executed title documents to the buyer.
Title insurance makes commercial real estate transactions possible and keeps the closing process running smoothly. Without title insurance it would be impossible to get lenders to risk large amounts of capital on complicated transactions and buyers would be much more reluctant to buy from strangers. In this article we covered the role of title insurance in commercial real estate transactions, and along the way we outlined how it works, why it’s important, and what could go wrong.