Preliminary title reports and Title insurance. A breakdown of what’s involved

Preliminary title reports, Commercial & Residential Real Estate: Title Insurance, Entity Selection, and Financing Guide

What Is Title Insurance and Why It Matters

Title insurance is a crucial protection for real estate owners and lenders against potential property loss or damage from title defects. These defects can include ownership disputes, improper recording, fraud, liens, easements, and encroachments that might affect your property’s value or use.

Companies like US Title Records conduct thorough title research, while insurers such as First American Title Insurance Company issue the actual policies. Before issuing coverage, title companies perform comprehensive searches of public records to identify any potential claims or liens (Preliminary title report).

Important: Title insurance only covers defects existing when the policy was issued, not new issues that develop after closing.

Types of Title Insurance Policies

Several policy options exist to meet different needs:

• Owner’s policy: Protects your ownership interest
• Lender’s policy: Safeguards the lender’s security interest
• Ground lease policy: Covers leasehold interests

Policies come in standard or extended coverage. Extended coverage requires property inspection and survey, costs more, but provides more comprehensive protection.

Enhanced Protection Through Title Endorsements

Title endorsements (riders) provide additional coverage beyond standard policies for specific risks:

• CLTA 100 (CC&Rs/Encroachments)
• CLTA 116 (Improvement)
• ALTA 9/CLTA 100.2 (Enhanced CC&Rs coverage)
• CLTA 103.7 (Access)
• CLTA 116.4 (Contiguity)
• CLTA 103.5 (Water Rights)
• Patent Endorsement
• ALTA 8.1/CLTA 110.9 (Environmental Protection Lien)

Closing Cost Practices in Real Estate Transactions

Typical industry practices allocate closing costs as follows:

• Seller pays for buyer’s standard title insurance
• Buyer covers extended coverage and endorsements
• Buyer pays for their lender’s loan title policy
• Seller and buyer split escrow costs
• Buyer pays for deed recording
• Seller covers release of encumbrances

Choosing the Right Entity for Your Real Estate Investment

Selecting the optimal entity structure is essential for commercial real estate success. Consider these key factors:

• Organization and maintenance requirements
• Ownership and management structure
• Owner liability exposure
• Tax implications

General Partnership Benefits and Limitations

General partnerships form automatically when two or more people engage in profit-seeking activities together.

Advantages:

• No formal organization or filing requirements
• No annual reports or fees
• Flexible management structure

Considerations:

• Each partner has unlimited personal liability
• Partners share managerial control (modifiable by agreement)
• Pass-through taxation with profits/losses flowing to partners
• Partnership tax laws allow flexible economic arrangements

Limited Partnership Structure

Limited partnerships require more formality but offer liability protection for limited partners.

Key characteristics:

• Requires certificate filing with state authorities
• Minimal annual reporting in many jurisdictions
• Must have at least one limited partner and one general partner
• General partners maintain full management authority with unlimited liability
• Limited partners enjoy restricted management rights but limited liability
• Pass-through taxation like general partnerships

Limited Liability Company (LLC) Advantages

LLCs have become the preferred entity choice for many real estate investors due to their flexibility.

Benefits:

• Requires Articles of Organization filing
• Can have single or multiple owners with different membership classes
• Management vested in members or designated managers
• Members and managers generally protected from LLC obligations
• Multi-member LLCs taxed like partnerships by default
• Single-member LLCs disregarded for federal tax purposes
• Can elect corporate taxation if beneficial

Corporation Considerations for Real Estate

Corporations involve more formalities but may offer advantages in certain situations.

Requirements:

• Articles of Incorporation filing
• Adoption of bylaws and organizational minutes
• Annual reports and board meetings
• Shareholders generally protected from corporate obligations

Tax implications:

• C Corporations face potential double taxation
• S Corporations function as pass-through entities
• S Corporations must allocate profits/losses based on ownership percentage

Commercial Real Estate Financing Structures Explained

Understanding the “capital stack” is essential when structuring commercial real estate financing. This relationship between equity, debt, and mezzanine financing determines risk allocation and potential returns.

The Capital Stack Hierarchy

As you move up the capital stack, both risk and potential return increase:

1. Secured debt (lowest position):
   • Senior to all other interests
   • First to be repaid
   • Lowest return (interest rate)
   • Most secure position
2. Mezzanine financing (middle position):
   • Hybrid between equity and debt
   • Senior to equity but subordinate to secured debt
   • Returns often include fixed annual payback plus participation
   • Moderate risk and return
3. Equity (top position):
   • Highest risk position
   • Paid last after all other obligations
   • Typically requires largest returns
   • Participates in investment success
   • No fixed payout term

Commercial Loan Types for Different Needs

Different project stages require specialized financing solutions:

Acquisition & Development (A&D) Loans

• Finance site acquisition, preparation, engineering, and preliminary work
• High risk profile
• Lower loan-to-value ratios
• Often require significant credit enhancement

Construction Loans

• Fund vertical/underground construction and renovations
• Short-term (1-3 years)
• Funded through progress draws with disbursement controls
• Include interest reserves
• Require interim inspections and retainage
• Often involve personal/completion guarantees

Permanent Loans

• Finance property acquisition, construction loan take-outs, and refinancings
• Longer terms (5-10 years)
• Amortization (sometimes with interest-only periods)
• LTV and DSCR covenants
• Competitive rates
• Permitted transfer provisions
• Limited or no guarantees

Bridge Financing (“Hard Money” Loans)

• Serve various purposes including impaired collateral situations
• Feature rapid underwriting
• Very short maturities
• Expansive guarantor obligations
• Upfront points/fees
• Higher interest rates

Understanding Commercial Loan Underwriting

Lenders focus on the “Three C’s” when evaluating commercial loans:

• Collateral: Existing or potential value
• Cash flow: Existing or future income potential
• Credit: Borrower/guarantor asset base and income

Essential underwriting metrics:

• Net Operating Income (NOI): Property’s operating income after expenses
• Debt Service Coverage Ratio (DSCR): NOI divided by anticipated debt service
• Capitalization Rate (CAP Rate): Expected market rate of return on property’s NOI
• CAP Rate Value: NOI divided by the applicable CAP Rate
• Loan-to-Value Ratio (LTV): Property’s appraised value divided by proposed loan amount

Today’s Commercial Lending Landscape

The commercial real estate market features diverse lending sources:

• Insurance companies: Increasing market presence, competitive rates, tighter underwriting, longer terms
• CMBS lenders: Typically 10-year fixed rates with initial interest-only periods
• Agency lenders (Fannie/Freddie): Multi-family focused, “mission-driven” toward affordable/workforce housing
• Banks: Relationship-driven, higher rates, tighter underwriting, heavy use of personal guarantees
• Private/hard money lenders: Higher rates, looser underwriting, relationship-driven

Securities Law Implications for Real Estate Investments

When structuring investments involving multiple parties, securities laws may apply. The “economic realities” test from SEC v. W.J. Howey determines whether an investment constitutes a security by asking: “whether someone will invest in a common enterprise with an expectation that profit will be earned substantially through the efforts of someone else.”

Federal regulations include exemptions under Section 4(a)(2)/Rule 506/Regulation D, typically requiring:

• Limited solicitation
• Accredited investors
• Thorough disclosure

Many states have additional securities laws that must be considered when structuring real estate investments.