The increased frequency of foreclosures in today’s market is a reality that many lenders have to face head on.  In addition to the headache of dealing with a failed loan, having to deal with the property itself and becoming an owner of that property can prove an even bigger headache.  Which is why performing thorough due diligence is so critical.  In fact, often the due diligence a lender does at the pre-foreclosure stage is above and beyond what was done during the origination of the loan. Here are a few reasons why:

Environmental Issues

Even though often a Phase 1 Environmental Site Assessment was completed at the time of the loan origination or re-finance, conditions on the property (or surrounding properties) could have changed since that time.  In particular, properties that store or use hazardous materials on site that did not have any significant issues in the past could have very costly issues when it comes time to foreclose.  A gas station may have had a release causing soil or groundwater contamination.  Or, at an industrial facility, the lender will want to know how many hazardous materials are on-site and determine how to properly dispose of them.  In the hundreds of Phase 1 ESAs on pre-foreclosure properties Partner has done on behalf of lender clients, it is not uncommon for the property to be in bad housekeeping condition, or worse, the owner has purposefully created an issue by dumping hazardous materials on site. 

Other conditions such as regulatory compliance issues, operation permits, underground storage tanks that need to be removed, on-going remediation, wetlands on the property, asbestos and mold are also conditions that could exist at a property that could make foreclosing a non-viable option.  Thorough pre-foreclosure environmental due diligence such as a Phase 1 ESA, testing of the building materials, compliance review or perhaps even Phase 2 soil or groundwater testing, can help identify and assess whether any of these factor in. 

Property Condition Issues

Another issue lenders face is taking back a property that has been damaged, either by the owner or because it has sat vacant so long that it has been vandalized.  Often the appraisal will alert the lender to such issues; however, in order to get more information on what immediate repairs and maintenance items will be needed on a property, lenders are hiring qualified engineering firms to produce a Property Condition Report.

Of utmost concern during a pre-foreclosure Property Condition Assessments are life and safety issues.  Once the lender becomes the owner, something as simple as a trip hazard becomes their liability.  A Property Condition Report can help identify such issues.

Unfinished Construction

One of the more unique situations lenders face is having to foreclose on a project when a developer has run out of funds to complete it.  Sometimes these projects are 50%, 75%, 90% complete.  Deciding what costs are associated with taking over on a project mid way through is a challenge in itself.  The lender is essentially stepping into a developer’s shoes.  One tool they are using are Cost to Complete Reports to determine not only what it will cost to finish the project to the original specs but often times they are also asking for costs to demolish the half built project.  This especially comes into play when a project has been sitting so long that there are damages to the property such as mold growth from exposure to moisture, vandalism, etc.

Erosion Control

Another potential issue on unfinished construction sites is erosion control, especially on sites where only grading has occurred.  Storm water runoff can be a significant issue that can lead to civil and sometimes criminal liability. Understanding what is required and having Storm Water Pollution Prevention Plans (SWPPPs) and Best Management Practices (BMPs) in place is essential.  Often it is best to contact local regulators who are overseeing the project to understand what is involved before considering foreclosure.

This is not an exhaustive list of what physical due diligence should be done at foreclosure, and each site is different.  Discussing these potential concerns up front with your consultant can help you take the right course of action.