Due Diligence at Foreclosure: What do lenders need to consider?

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.