Two undeniable and interconnected facts: the U.S. housing market remains virtually stagnant and the number of lawsuits against real estate professionals is on the rise. Existing home sales have dropped steadily since 2005. There is a glut of product on the market, yet relatively few ready, willing and able buyers. During the same period, delinquency and foreclosure rates have grown at an alarming rate. Real estate professionals have been under considerable pressure to adapt to the conditions of this weak and sputtering market. Many have not fared so well, as there has been a noticeable increase in lawsuits filed against agents, brokers, inspectors and other real estate professionals.
A Deeply Troubled Housing Market
There is no concrete formula to calculate when the American housing “bubble” burst. What we do know is that the market was thriving in or around 2004 – 2007 then began to fizzle in the following years. New home inventory, whether completed or under construction, grew at a gradual rate between 1997 and 2003. Then, in or around January 2003, new home development skyrocketed. By 2005, Americans built more new homes than they had since the late ‘70’s. By most indicators, American real estate was booming in the summer months of 2005 and 2006.
Based on the vast number of new homes built at the turn of the century, it would be fair to assume that this development was catered to a growing number of eager would-be homeowners on the market for a new home. However, the supply far exceeded the demand. Every year beginning in 2005 through 2008 resulted in a significant drop in existing home sales compared to the prior year. In other words, Americans were not purchasing homes at the rate those homes were built. By way of example, Americans purchased approximately 100,000 less homes in June 2007 than they had in June 2006. During that same stretch, however, developers continued to build new homes at a staggering rate. As a result, the market could not support itself and soon collapsed.
Following the peak in 2007 – 2008, new home inventory dropped dramatically. That drop continued until today when new home inventory nationwide is significantly lower than that recorded in decades. As a result of that rapid decline, new homeowners found themselves living in property valued far less than the price they recently paid. Houses were rapidly losing value nationwide. By some accounts over 10 percent of mortgaged homes in 2008 – 2009 were “underwater”; or, the mortgaged amount exceeded the actual value of the property. Some suggest that the number of underwater homes continues to climb.
Sub-prime lending, of course, also played a significant role in the rise, and fall in the real estate market. Sub-prime financing, or high-interest loans, is catered toward high-risk borrowers. As the market reached its peak, sub-prime lending also increased. Only two percent of mortgages issued in 2000 were classified as sub-prime compared to nearly 30 percent in 2006. When the market was healthy, lenders were willing to take on more risk and perhaps were more creative with their lending agreements. Less documentation, reduced or zero down-payment, low initial interest rates that ballooned over time and other strategies were developed to get buyers in the door. The problem: aggressive lending programs invited Americans to purchase homes that they literally could not afford. What naturally followed was rampant delinquency and foreclosure.
During the good years, between 1995 and mid-2006, approximately 5 percent of all active loans were considered “delinquent” and about 1 percent was the subject of foreclosure proceedings. The delinquency started to slowly climb in ‘06 and ‘07 then took off in 2008 to a high of nearly 10 percent of all active loans as of year-end 2009. Foreclosures also increased to over 4 percent of all active loans. In 2008 and particularly 2009 – 2010, a higher percentage of delinquent properties resulted in foreclosure proceedings which, in turn, resulted in more short sales and REO properties. A disproportionate number of these foreclosures were the result of sub-prime financing. Of course, real estate professionals suffered as a result.
Increased Claims Against Real Estate Professionals
No doubt due, at least in part, to the distressed real estate market, claims against real estate professionals have risen over the past several years. Moreover, the types of claims against real estate professionals have changed due to the peculiarities of the recent rise and dramatic fall of the market. Agency issues, mortgage rescue scams, breach of fiduciary duty, fraud, negligence, breach of contract, and false representation issues are among the classes of claims on the rise against real estate professionals. Why the rise in claims? Here are several plausible explanations:
Dabbling: Due to the reduced work-load, the real estate professional may be more willing to take on work outside of his/her comfort zone in order to generate revenue, including property or construction management or providing credit counseling or quasi-legal advice as opposed to selling real estate.
Loan and Investment Fraud: Knowingly or unwittingly modifying transactional documents to mischaracterize the nature of a purchase to obtain more favorable loan terms. For example, denoting the purchase of a Bed and Breakfast as a “residential” property rather than an “income producing” property to generate better financing terms and, hence, close a deal.
Lay Offs: The termination of the most experienced (and most highly compensated) staff in order to reduce expenses while retaining a staff less able to meet the needs of their customers.
Misrepresentation: Even good faith reliance on a desperate seller’s disclosures, which turn out to be false, may result in a fraudulent or negligent misrepresentation claim against a real estate agent for allegedly ignoring red flags.
Referrals: A real estate professional may be subject to “negligent referral” liability by suggesting that her client retain the services of a particular vendor of some kind (e.g. inspector or title agency) of there are flubs on the job.
Unauthorized practice of law: A real estate professional walks a fine line between representation of her client, providing general advice and performing a legal function especially with respect to the financial end of a transaction. Should an agent provide advice outside of her scope of expertise, she may be subject to a claim of negligence, misrepresentation as well as the unauthorized practice of law.
Short sales and foreclosures: Perhaps more than any other cause, the most significant increase in real estate disputes of late is due to the foreclosure crisis. Short sales lead to difficulties regarding property condition disclosures. For example, since short sales can be a lengthy process, the condition of a property may change while the transaction is pending. Often, lenders and sales agents insist on listing short sales “as is” which may result in unreliable or non-existent disclosures and surprises following settlement. These surprises all too often lead to lawsuits. Moreover, these sales are overlayed with transactional complexity beyond the ken of less experienced real estate professionals, a hazard in and of itself. By way of example, short sales and foreclosures may force a real estate professional to address priorities amongst multiple liens or lending and listing problems as a result of the fact that prior owners are typically not involved in these transactions.
What Lies Ahead?
Signals of a recovery remain distant and weak. Fiscal policy at the macroeconomic level suggests continued pessimism and caution, as seen in sustained historic low borrowing rates, but these low rates continue to be foiled by far more rigorous underwriting standards. What one hears is: there’s plenty of money to borrow for people who don’t need it. So, those who earn a living off of the sale of real estate will find themselves under stress for the foreseeable future.