Monday, March 19, 2012

The Foreclosure Crisis in DC

Have you wondered why the inventory of so-called shells and investment properties seems to have dropped in DC? Are you finding it difficult to acquire a property for the purposes of creating a condominium? The reason is due, in part, to a standoff between title insurance companies and DC government over foreclosure laws. The standoff has created an artificial increase in property values because the supply of shells and houses that could be renovated and put into the stream of commerce is so low.

In 2011, there were only 10 or so residential foreclosures. Unless there are changes to the law, the number in 2012 will remain the same. It might even be worse. The reason for the low number is that DC modified its foreclosure law at the end of 2010 to include a mediation process on all residential foreclosures. Maryland has also added a mediation component to its residential foreclosure process. The problem with DC’s process is that, unlike Maryland’s, the mediation certificate issued at the end of the process does not have the force of law equal to an estoppel certificate and, therefore, no title insurer will issue a title insurance policy on a foreclosure sale. The title insurance industry has been trying to persuade the District of Columbia to amend the law, but to no avail. This standoff between the title insurance underwriters and the District of Columbia has caused a de facto moratorium on foreclosures and, thus, foreclosure sales.

To make matters worse, DC passed an amendment to the law last fall that requires any property that has any residential units (up to 4) to go through the mediation process. It does not matter if a unit is owner occupied or not. This also includes mixed use properties.

This amendment means that a commercial building owned by a limited liability company in Georgetown that has a shoe store on the first two floors and a tenant-occupied residence on the third floor—and has a commercial loan on the property—can only be foreclosed by going through the mediation process Thus, you cannot foreclose on the commercial loan because no title insurer will provide title insurance when you complete the foreclosure.

A more glaring scenario would be a corporation buying a dwelling for the purpose of doing a condominium conversion in DC. Because the loan would be for investment purposes, it would be made by a commercial lender with a commercial promissory note. If the corporation defaults on the loan, the lender cannot foreclose—even though it is a commercial loan taken out by a corporation—because the property is residential, and no one will insure the trustee’s deed out of foreclosure.

Amazingly, lenders continue to make loans on residential properties in DC despite the lenders’ lack of recourse on loan defaults. It is entirely likely, however, that lenders will become increasingly aware of this issue, and then DC’s foreclosure law will have a chilling effect on new loans for residential properties.

In conclusion, DC’s foreclosure law is having a huge impact. Very few foreclosures are taking place, and the DC housing market is suffering as a result. Even in the case of some commercial loans, DC’s new law has had a chilling effect on foreclosures, and might soon have a chilling effect on new loans for residential properties.