REQUIRED READING: After Hurricane Sandy crashed through the Northeast in late October, the level of destruction created by the monster storm created deep shock across the country. While the humanitarian crisis created by the hurricane dominated the national news, the scope of property damage that resulted from the hurricane also spurred agitation – especially for many servicers dealing with real estate owned (REO) portfolios.
‘We've seen from the devastation that clients have now become more concerned about if they have the right coverage in place,’ says Steve Meyer, assistant vice president of high risk and hazard claims at Safeguard Properties, based in Valley View, Ohio. ‘They were wondering if they had flood coverage in place and if their standard policy also covered sewer backup. Most REO policies do not offer that kind of coverage.’
‘Banks are definitely giving this priority now,’ adds Les Kramsky, executive vice president and general counsel at The Silk Companies, a Plymouth Meeting, Pa.-based family of companies providing insurance, settlement and real estate services to both the residential and commercial markets. ‘They are going to have to make sure they have REO coverage, especially after seeing so many homes in New Jersey and Staten Island going into the water.’
However, John Alkire, executive vice president of Santa Ana, Calif.-based Carrington Mortgage Services, notes that despite the acute nature of Hurricane Sandy, seasonal experiences with severe inclement weather are nothing uncommon.
‘REO insurance is year-round,’ he says. ‘In the spring, there are tornados in the Midwest. In the summer, it is hurricane season in the Southeast. In the fall, you deal with winterization and freezing pipes.’
The waiting game
Of course, seasonal change is not just limited to meteorology. Economic and political shifts have made a profound impact on the housing market and, by extension, the attention given to REO insurance. John Vella, chief operating officer of Los Angeles-based Equator LLC, observes that the current environment of longer foreclosure timelines has helped place a higher importance on REO insurance.
‘From a property preservation and improvement standpoint, if a borrower sits in properties longer, he or she will probably do less repairs to the property,’ he explains. ‘Thus, there is more likelihood of deterioration in the quality of the real estate. And in certain states, it takes up to three years to foreclose. A borrower knows that for two to three years, they are not going to put income into the property.’
But once the homeowner is finally evicted and the property becomes REO, more problems occur – much to the chagrin of the REO insurance providers.
‘More and more, some of the carriers are looking to start to exclude some theft and vandalism from their coverage,’ says Meyer, noting that air conditioning units and copper wires and pipes have become favorites of housebreaking miscreants. ‘The insurance carriers are seeing properties sit longer and longer in REO status, and these properties are subject to the risk of being vandalized.’
‘As with any commodity that sees ebbs and flows in the volume, there will be a direct correlation in the demand for the corresponding product,’ says Benton Neese, president of the board of directors of REOMAC, a trade association for the mortgage default industry. ‘REO hazard insurance is no different. The decline in foreclosures results in a lower number of new foreclosures; however, that one factor does not totally determine the need for REO hazard insurance.
‘Because of the cost of the coverage, most investors are looking to REO hazard insurance coverage to cover a catastrophic loss,’ Neese adds. ‘A broken window or water pipe leak with minor damage would be paid for 'out of pocket' so to speak, but if there is a major fire or substantial storm damage, that is where REO hazard insurance would be most beneficial.’
Taking a closer look
Other changes impacting REO involve the growing demand by investors for greater portfolio transparency. Francis X. Riley III, partner with Princeton, N.J.-based Saul Ewing LLP, notes that some investors are including REO insurance as part of their demand.
‘I've see where investors want an insurance policy that allows a management company to make a claim should something go wrong with the property,’ he says. ‘When you have a pool of properties, investors may not know what they are.’
‘With so many banks owning property, there is a need to protect this investment,’ says Kramsky.
And while much of today's REO insurance is focused on the residential real estate market, servicers handling commercial real estate are also paying more attention to REO insurance.
‘In commercial buildings, there are a lot of empty spaces,’ says Adam Leitman Bailey, a New York-based real estate attorney and law professor at New York University. ‘A lot of buildings should have been foreclosed upon, but were not. It is called pretend and extend, and that market is not going to get better.’
‘I can see a need for REO insurance on commercial properties in some situations,’ says Neese. ‘For example, if an apartment complex becomes REO, there are various amenities that can be very costly to maintain. The same could be said for a shopping center or office complex. However, a large warehouse facility may not have the need for traditional REO hazard insurance or, at best, REO hazard insurance with an even larger deductible.’
Although no one can easily predict what future changes will reshape the industry, Bailey believes that servicers will not be canceling their REO insurance policies any time soon.
‘With the new Dodd-Frank Act rules, it may be harder to get a loan,’ he says. ‘People will not be able to sell for the same value as before the election. As a result, REOs could be coming back, and may even break records. Banks will be in for some wake-up calls.’