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Understanding a developer’s construction escrow requirements makes for a smoother deal

by Chicago Agent

Construction escrow insight.
Have you ever had a new construction or rehab deal held up because of title company construction escrow issues? When working with real estate developers, it can help to better understand what the title company’s role is in the construction process and in clearing the property for sale.
The title insurance company provides insurance to the buyer and the buyer’s lender that they are not taking the property subject to liens or title claims which jeopardize the buyer’s ownership interests.
Perhaps the simplest, and most common examples are prior mortgages and pre-closing taxes. The buyer and lender typically expect all prior mortgages and taxes to have been paid off, satisfied and/or released before the buyer will take title. Failure to clear these title exceptions would result in title interests adverse to the buyer.
When a developer builds real estate, the title company, buyer and lender must also be wary of possible mechanics lien claims. These are specific claims for non-payment filed by contractors, subcontractors and suppliers against property owners. In Illinois, these claims are strictly controlled by the Illinois Mechanics Lien Act and provide a powerful mechanism through which these contractors and suppliers can enforce their rights to payment for services and materials provided as part of the development and construction process.
Perhaps the greatest area of risk exposure to title companies lies in the area of mechanics liens. For this reason, title companies must carefully review the developers’ records with regard to payment for all services and materials provided in the construction of real estate before they can allow a sale of a new construction or rehabbed property to go through. This is done through highly detailed owner’s and contractor’s statements and affidavits, together with statements and receipts from the subcontractors and suppliers.
Experienced developers learn to work hand-in-hand with the construction escrow department at their selected title company. When properly employed, funds for construction are placed in escrow with the title company and the construction escrow department oversees the disbursement of the payouts as work is completed on a project.
Closing delays may arise when a developer does not use a title company in this manner. If, at the time of closing, the title company is not satisfied with the developer’s payment and cost records, then the developer is generally faced with having to place funds with the construction escrow department to ensure the availability of funds sufficient to satisfy the potential costs on the project for which the title company sees risk of claim.
Generally, the title company will require the amount of the escrow to be between 150% and 200% of the costs in question. If the developer does not have sufficient funds to set aside in this manner, or if the developer does not want to establish that escrow, the closing will be delayed until the developer can prove, to the satisfaction of the title company underwriters, that the contractors or suppliers in question have been fully paid.
For over 25 years, the team at Erwin Law has been helping both new construction and rehab real estate deals run simpler, smoother and, ultimately, more successfully. Call Jim Erwin at (773) 525-0153 to learn more about how we can help you. For more information, visit http://erwinlawfirm.com.

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