In any real estate purchase, it is imperative to do your due diligence to ensure that you are making a sound investment and are aware of any potential issues with the property. You want to take some time to understand what you are acquiring and any potential issues before diving in headfirst. An asset may look good on the outside, but upon a deeper dive, it may have some undesirable characteristics that were not readily identifiable. That’s why you need a title search.
One of the key elements of due diligence when purchasing property is obtaining and analyzing the title report after a title search. A title report shows the legal standing of a property. The title report, or title search, runs through key elements of the property’s ownership and history such as the legal vesting, the legal property description, tax assessment, liens, municipal ordinances or violations, and recorded leases, among other things.
As you can see, the information generated in a title search is indispensable to assessing any purchase, but especially a commercial investment purchase.
Commercial title searches are more complicated than residential title searches because there are more documents involved to sort through. Typically, these documents are indexed by name at the County Recorder’s Office, rather than by address like they are for residential properties. Additionally, it is not uncommon for commercial properties to have multiple owners and/or inconsistencies in filing names. For these reasons, it is best to employ a title insurance company to run a dedicated title search for your property, rather than trying to gather the information from the County Recorder’s Office yourself.
Here are some common issues that come up on title reports:
Knowing exactly who owns the property you are buying is important. In commercial real estate, it’s common to have multiple entities own one property, for names of entities to be misspelled from document to document, or even for there to be uninsured deeds that might threaten your future ownership. The title report will show you the current owner(s) of the property so you can ensure the names on the title line up with the names on your purchase contract.
Additionally, the title report will show you any breaks in the chain of title. Say one entity deeded the property to another entity and then deeded the property to another entity and these deeds were uninsured and had discrepancies in the spelling of the names (unfortunately, not an uncommon situation). The title report will show you these breaks in the chain of title so that you can fix them through the escrow/title process before purchasing.
Purchasing title insurance is indispensable in this instance. If you purchase title insurance, the insurance company will be on the hook for any potential ownership issue in the future, so it is in their best interest to clear these things up during the escrow process, leaving you with clear title from day one of ownership.
The title report will show you any easements that are recorded on your property. An easement is a legal right to entry. Some common types of easements are public access roads and utility easements. It is important to understand what kind of entry these easements allow on your property and how those rights may impact the usage and value of your property.
Easements run with the property, meaning they are recorded against your property and are valid against every new owner. Thus, if there is an easement on the asset, you are buying the asset subject to that easement and won’t be able to remove it simply by virtue of you being a new owner of the asset.
The title report will show you any liens recorded against your property. A few common types of liens you will see on commercial title reports are finance liens and judgment liens. Finance liens are oftentimes very easy to take care of during the escrow process: the seller obtains a payoff demand and pays any remaining amount due on the finance loan before you obtain final title to the property.
However, sometimes you will find an old finance lien from a lending institution no longer in business that was paid off but not reconveyed, meaning the fact that it was paid off was never officially recorded by the County. In this instance, the seller might have to purchase a lien release bond from a bonding company to remove the old lien from the title report. A judgment lien is a lien against the property to collect a court judgment. To clear a judgment lien, the seller will need to pay off any amount owed in the court judgment to provide you with clear title.
The title report will show the full legal property description. The legal property description indicates not only the address but the boundaries of the property. Occasionally this will alert you to boundary errors or potential disputes in the contract or legal description that may become a problem for you down the line.
The title report shows currently assessed property taxes (but note that the title report will not show what your property taxes will be once they are reassessed by the tax assessor after purchase). It also shows any back taxes that are due on the property, as well as any franchise tax board or IRS tax liens against the current owners. IRS tax liens are particularly time-consuming and cumbersome to clear from title.
Title reports will show any leases that are recorded on the property, but be cautious — leases do not need to be recorded to be valid. Sometimes these leases are straightforward tenant leases. Other leases can be a bit more complicated, like a laundry lease where the laundry company is the lessee rather than the lessor. Understanding what leases run with your property and if/how you may remove them if desired is essential when purchasing commercial real estate.
The title report will show any code violations which will need to be cured and any fines that may have accrued from the code violations. It is wise to speak to the city or county regarding any code violations currently against the property as you will want to negotiate compliance with the seller as part of the purchase contract.
Additionally, the title report occasionally shows municipal ordinances recorded on the property that you must follow as the owner of the property, like a weed abatement ordinance (these are particularly common in fire-prone areas).
As you can see, it is incredibly risky to forgo a title report or title search in any real estate purchase, particularly in commercial real estate. Obtaining title insurance and working closely with your title officer to discuss and clear any problems unearthed by the title report is the smartest way to ensure that you receive clear title and unencumbered ownership.
About the Author:
Nic McGrue is a tenured professor of law and the founder of Polymath Legal PC. At Polymath Legal PC, Nic helps real estate investors lawfully raise capital allowing them to generate passive income while creating generational wealth.
Disclaimer:
The views and opinions expressed in this blog post are provided for informational purposes only and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.