Mitigating Risk at Home and Abroad
Property investors' love affair with Central and Eastern Europe (CEE) is set to continue for the foreseeable future, despite the fact that the return on investment was significantly higher a couple of years ago. Although prices are steadily rising in countries like Poland and Hungary, the less developed countries in the region, including Romania and Bulgaria, remain exceedingly attractive to investors not least because there is still so much that is not there.
Commercially, there is an increased demand for malls, office and other retail space; while residentially the CEE region continues to be a hub for investors who are drawn to the prospect of buying an ocean-front house, city centre apartment, or ski slope cabin for a comparatively reasonable price. Although title insurance currently predominantly focuses on commercial transactions, it is expected that residential business will increase significantly over the next couple of years in the CEE region.
Before 2004, the value of mortgage loans in Turkey was extremely low, but reached US$25 billion in November 2007 and is set to rise to US$100 billion by 2015. Market conditions are therefore looking extremely promising for residential investors.
Approximately 300,000 British households now own a foreign property, and the number has trebled over the past decade, according to Grant Thornton. It is important, therefore, that these purchasers understand that the buying process is not only often very different abroad, but that it varies from country to country.
For example, while the well-established 145 year old UK land registry system is organised and consistent, the CEE region gives rise to a myriad of discrepancies. In Transylvania, north-western Romania, registration traces its roots to the Austro-Hungarian Empire. It registers the interests of parties, including mortgages, by an 'address land registry system'. This is virtually the same as in Hungary; but in Lithuania, registration is not compulsory for the sale of a property; meaning that, in turn, title could be transferred between two parties without any third-party learning about it.
In Bulgaria, in addition to the fact that land registry records can be incomplete due to inadequately maintained records, restitution claims also pose problems for investors. There have been cases where flaws in a public tender resulted in ownership risks for the next investor, but Bulgarian law provides for only limited compensation should the court rule that the public tender was flawed.
Restitution is a huge issue in many CEE countries, where property was taken from the original rightful owners by previous Communist governments. Often, there is not always evidence available that the land was returned to the rightful owner, or that all of the required steps were followed if it was. There is also the danger that there may be pending restitution claims against the land which are not identified during the due diligence process. Title insurance, available from firms such as First Title, is designed to provide financial assistance in the event of ownership wrangles. It may also help the investor to secure a mortgage, as lenders may be reluctant to lend if they think there may be ownership problems.
Other countries where title problems are relatively common include Spain, France and Greece.
This, like the land registry issues, creates a risk that is insurable. Any purchase - whether it is commercial or residential - requires due diligence into the history of the property, but it is absolutely imperative that this process is carried out with a fine-tooth comb in the CEE region. Title insurance can cover both the known and unknown risks and pricing depends on the underlying risk.
As well as ownership wrangles and land registry issues, fraud and forgery is an ever-present threat when it comes to buying a second home abroad - and one which can be mitigated by the employment of title insurance. Yet fraud and forgery is certainly not limited to the CEE region - it is also a huge issue for purchasers of properties in the UK.
No matter how diligent lenders or solicitors are, fraud and forgeries appear to be an ever-present fact of life. In today's climate of constantly evolving technology, it is still difficult to understand how these exceptionally developed systems still fail to combat fraud and forgery.
However, on closer inspection, technology itself combined with the customer's understandable desire to obtain a mortgage as quickly and as efficiently as possible, could be contributing to making it easier for fraud to be committed today than say 50 years ago.
Obtaining a mortgage has moved-on from the days where holding a deposit account with the building society was a requirement and being an acquaintance of the manager was often the deciding factor in a lending decision. Quite rightly, the market has evolved so that it is now arguably the most competitive in the world and in order to meet customers' demands it is not even imperative to meet the lender or solicitor at all.
Bearing this in mind, it is hardly surprising that identity theft, and related frauds, are the fastest growing crimes in the UK. In 2002, according to Cabinet Office figures, fraud cost UK taxpayers £1.3billion. Interestingly, no further data has been officially released since - a move by the government, which cynics might justifiably denounce as a PR exercise or cover-up.
Yet, despite the FSA, Law Society and CML Handbook all promoting compliance and careful regulation in the mortgage industry, the lending arena is still a perfect breeding ground for fraudulent activity. Obtaining a mortgage nowadays is far more complex than simply getting through the fact-find stage. Lenders and solicitors consistently work together to demand certified copies of passports, utility bills, payslips and voters' roll checks. But, the lack of consolidation between all of these components, only serves to enhance the likelihood of fraud.
Earlier this year, Home Office minister Joan Ryan, claimed that 16,500 fraudulent passport applications were received between October 2005 and September 2006 - 50 per cent of which remain undetected to this day. By the Home Office's own admission, "the level of undetected fraud is about 0.5 per cent of passport applications".
Moreover, the current online going-rate for three months worth of remarkably genuine-looking payslips is a mere £35; the real upside being that dishonest consumers can feel safe in the knowledge that client confidentiality is guaranteed, to the extent that client data is only held on the vendor's computer system for 24-hours.
Ever since, the advent of the home computer lender has had to deal with fake utility bills, to the extent that it is difficult to place any confidence in them as a form of identity.
With property prices continuing their meteoric rise, the mortgage labyrinth remains extremely lucrative for canny fraudsters, as crime continues to pose a real threat to lenders.
While it is of paramount importance for lenders to really get to know their clients, this will not always protect them from falling foul of fraud. After all, what does a lender do when a perfectly amiable client turns out to have been masquerading as somebody else, subsequently making off with significant amounts of cash?
The simple answer is that, in most cases, the lender looks to recover the loss from its solicitor which is often easier said than done. In most cases, the solicitor is as innocent a victim as the lender. If the authorities, with all of their checks, can let 10,000 fake passports slip through their fingers annually, it would be somewhat churlish to expect a solicitor to spot a counterfeit passport, or any other form of fake identification for that matter.
Moreover, even if the solicitor has been negligent, it could take the lender years to pursue the claim, tying up the lender's capital in additional legal costs all the while. To make matters worse, even if the lender was to win the case, it will rarely - if ever - make a full recovery; after all, the lender will only recover interest at the 'cost of funds' rate. And all this after it has had to battle tooth and nail to prove that it was the negligence, rather than the fall in property prices or its own lending decision, which caused its loss.
In order to avoid such expensive and time-consuming legal battles, lenders are increasingly turning to title insurers to cover the risk that fraud and forgery presents to them and complement the service provided by their solicitors. In this way, if the lender incurs a loss at the hands of fraud and forgery, the claim will be paid within weeks or months. Indeed enlightened solicitors are also using title insurance to achieve better, faster and cheaper completions for their lender clients.
Title insurance also provides no fault protection, which means that there will be no arguments over the lender's underwriting decision. This means that whether the forgery or fraud caused all of the lender's losses becomes incidental.
Whatever attempts are made by the FSA and industry bodies, such as the Law Society and the CML, to enforce regulation in the mortgage market, fraud and forgery still continues to flourish. In fact, it is becoming increasingly difficult to prevent in a market that is continuously evolving to become more flexible and competitive than ever before. This coupled with the fact that more and more people are becoming eligible for mortgages, has led to ripe pickings for fraudsters - the consequences of which can be devastating for lenders and solicitors alike. Yet, title insurance can mitigate this risk, in turn saving lenders and solicitors precious time and money.
All in all, buying a property can be a risky business. As a result, it is absolutely imperative for the investor to understand the risks posed, whether it is restitution in Bulgaria, land registry in Romania, or fraud in the UK.
In the UK, a one-off premium buys a title insurance policy which gives an owner perpetual cover against the known title defect, and/ or protects a lender until the loan is repaid. Should an onerous encumbrance contained in the title deeds be enforced, the title insurer's standard policy provides cover for the legal costs, which could include the cost of an out of court settlement, as well as compensating loss in the value of the land.
In short, title insurance protects owners from unexpected third party challenges, based on defects in title which may affect an owner's ability to use or develop the property. The cover provided by title insurance enables land to be developed, mortgaged and used, notwithstanding a range of title defects.
Although, historically, title insurance has been predominantly used for commercial projects, it is becoming increasingly popular for residential transactions, as it offers the peace of mind which investors need when they venture into unfamiliar environments. With between 1.5m and 2m British households expected to own a second home abroad by 2025, and with more exotic locations increasing in popularity, title insurance business is expected to experience a surge over the next couple of years.