Real Estate and COVID-19: Impacts on Values, Valuation Techniques, and Litigation

April 15, 2020

By Daniel Adomian, Orell C. Anderson, MAI, FRICS and Alexander R. Wohl 

The effects of COVID-19 on real estate are widespread, impacting nearly every aspect of the industry from rent and mortgage payments to loan processing and physical site inspections. At Strategic Property Analytics (SPA), we spoke to industry participants to develop an understanding of the emerging challenges. Based on our research, we believe that COVID-19 will have ramifications for short- and long-term valuations and will increase legal exposure for various players in the market.

Obstacles to marketing properties have delayed residential transactions. In Los Angeles, for example, overlapping state, county, and city orders issued on March 19th banned gatherings and non-essential business activities. The most stringent of these orders was the March 19th City of Los Angeles order, which did not list real estate as an essential business. That classification soon changed. An April 1st revision to the City of Los Angeles “Safer at Home” order listed real estate and leasing transactions as essential, though maintained that open houses and in-person showings were prohibited. This revision followed the March 28th release of a list of essential businesses by the U.S. Department of Homeland Security that included real estate. Since California Governor Newsom’s March 4th order incorporated this federal list, real estate was then included as an essential service in California. However, the California Association of Realtors advised licensees to refrain from holding open houses and reminded realtors that they must still observe their local guidelines which, as in the case of Los Angeles, often expressly prohibit in-person showings.

The patchwork of evolving orders and advisories from public agencies and recommendations from professional organizations, combined with the discretion and caution of real estate professionals themselves, has led to a climate of uncertainty in real estate markets across the country. For example, the legality of merely showing a residential property varies from place to place. Statewide guidelines published by the California Association of Realtors require that only a single agent and no more than two other individuals are to be in a dwelling at the same time. Los Angeles County’s own rules allow in-person viewing as long as local rules do not prohibit it. In-person showing remains illegal in the City of Los Angeles.

Los Angeles appears to be one of only a few municipalities to have taken such stringent measures. Neighboring cities and counties have various rules in place. For example, Culver City has adopted the same rules as the City of Los Angeles, while Santa Monica, Glendale, Santa Clarita, and Orange County refer to the State order. Long Beach restricts viewings to virtual-only, but allows that if virtual viewing is not feasible, then in-person viewing may occur with one agent and no more than two buyers. (A detailed list of the various regulations is updated by the CAR, available here.) The CAR requires that, before they visit a property, buyers must sign a form indicating that to the best of their knowledge they have no symptoms of COVID-19.  Furthermore, a seller’s express agreement to allow persons to enter a property must be obtained.

Delays and restrictions aside, some buyers rely on video apps to get a peek inside a property. It remains to be seen whether this will leave sellers defending against claims that negative conditions were not revealed until after a sale.

Just as important are the inspectors and appraisers, many of whom are either prohibited from or refuse to enter properties. This adds to the potential for third-party litigation. Some cities that previously required pre-sale inspections have now suspended these requirements or, in some cases, have set up rules that allow only an inspector, a realtor, and one buyer to be present. The Federal Housing Finance Administration instructed Fannie Mae and Freddie Mac to allow alternative methods of appraisal from March 23 to May 17, 2020. It is likely this timeline will be extended. Though unspecified, these alternative methods of appraisal may include drive-bys, desktop appraisals, or even appraisals guided by video call footage from a current owner. However well-intentioned, these “alternative” methods of appraisal and inspection leave room for errors, omissions, or worse.  At SPA, for example, we have heard of a building inspector from one Southern California municipality who would not enter a property and instead signed off on the permit based only on the property owner’s assurance that there was nothing wrong with the contractor’s work; he refused to take a virtual tour and left in less than two minutes. Indeed, for inspectors and appraisers who must choose between performing sub-standard work products and performing no work at all, the former choice creates the potential for significant liability. Meanwhile, the National Association of Realtors already notes that brokerages and realtors have begun adding addenda to escrow paperwork addressing concerns over lack of inspections and appraisals.

It is no surprise, therefore, that realtors report that sellers are pulling their listings. Between the health risks, legal risks, and financial risks, that decision might make sense for many sellers. Sale volume is down. However, listings and actual sale prices appear to be holding, at least in residential markets as rates are very favorable. For those whose jobs are unaffected by the virus or the economic shutdown, it is also a good time to apply for a refinance. For now, negative impacts appear to be counterbalanced by inexpensive money. Research shows additional evidence that investors seeking shelter from losses and risk in the stock market see real estate as a refuge. The net effect is price stability – or sometimes even price increases – in an environment of falling inventories and doubts about the economy.

Retail is another story altogether. Retailers were already fighting a losing battle against e-commerce even before COVID-19 hit. Its arrival has only hastened its fall. With the decline in retailers’ fortunes comes a decline in commercial real estate. This could have far-reaching impacts as tenants and developers scramble to survive or offload liability. Retail landlords may be forced to breach covenants with lenders as they deal with the economic fallout. We expect that bankruptcy proceedings will increase significantly. Furthermore, those proceedings may need to address whether the cause comes down to a force majeure event or more ordinary causes of insolvency.

Property owners forced to make repairs are also in a unique position. Despite construction and repairs being exempt from the stay-at-home orders, contractors who might otherwise take a job in some cases have been unwilling to take on new work that comes with additional red tape or the risk of fines for noncompliance with ever-changing requirements. In those situations, owners, insurers, and lenders risk properties sitting incomplete and running out of time on contract windows. This has the potential to turn existing damage to properties into prolonged or worsened conditions.

On the financing side, lenders are experiencing significant delays. These delays are caused by the large increase in refinance applications due to low interest rates and by the wave of forbearance requests for both residential and commercial loans. Previously lenders often offered 15- to 30-day rate locks to provide some stability for buyers. But in an environment where it takes up to 45 days to close a deal, lenders offer rate locks less frequently and sometimes charge points for the option. In the meantime, realtors report a rollercoaster of rates that their buyers must navigate, even if they are relatively lower than even a few months ago. From delays in showing properties to delays in obtaining financing, the risks and costs of transactions, refinances, forbearances, and repairs are significant. Then, of course, there is the heightened risk that mortgage forbearance and payment deferrals may cause some financial institutions to fold. If that happens, then we probably will see some form of unwinding of obligations as we saw during the Great Recession.

Finally, on the government side, we anticipate that agencies may run up against ethical issues in eminent domain. Should eminent domain proceedings be initiated while the macroeconomy is in a state of flux, the government agency risks the foreclosure being contested. This issue is compounded further by the restrictions on appraisers and inspectors visiting properties that are the target of acquisition as well as court closures and caseloads being pushed to undetermined trial dates.

At SPA, we expect that some of these detrimental conditions will correct quickly, once restrictions on activity are loosened. For example, site visits by appraisers, inspectors, realtors, and potential buyers likely will bounce back, albeit with stricter social distancing and health precautions. However, the potential liability from work conducted under the period of restrictions may end up being an ongoing issue. In addition, the primary and secondary effects in the retail market likely will linger for an extended period. We are still in the beginning phases of assessing the myriad issues caused by COVID-19 and the economic shutdown. The next steps will be to determine how best to repair the damage that has been done and then to address the ongoing conditions that surely will remain.

----------------

Strategic Property Analytics, Inc. is a real estate advisory services firm with a focus on litigation support, strategy, valuation and consulting. Founded in 2014 by Orell Anderson, SPA delivers timely and insightful forensic consultation and valuation services to clients in both the public and private sectors. Their focus is on real estate damage economics, which involves environmental contamination, construction and title defects, soil issues, natural disasters, etc.

Orell Anderson, MAI, FRICS is the president of Strategic Property Analytics, Inc.

Daniel Adomian is the founder of Pocket Project LLC, focusing on litigation support and real estate valuation. He is an affiliate of Strategic Property Analytics, Inc.

Alexander R. Wohl is a senior research analyst with Strategic Property Analytics, Inc.

--------------

References

[1] Safer at Home, City of Los Angeles, March 19, 2020 (Revised April 1, 2020)

[2] California Association of REALTORS?: Coronavirus (COVID-19) Updates. “Residential Real Estate Now Listed as an Essential Service in March 28, 2020 Federal List of Essential Critical Infrastructure Workers,” March 28, 2020. https://www.carcovidupdates.org/statement-from-car-3-28.

[3] California Association of REALTORS?: Coronavirus (COVID-19) Updates. “Guidelines for Real Estate Best Practices During COVID-19,” March 31, 2020. https://www.carcovidupdates.org/best-practices-guidelines.

[4] Khouri, Andrew. “How to Buy a House during the Coronavirus Pandemic.” Los Angeles Times, July 4, 2020. https://www.latimes.com/homeless-housing/story/2020-04-07/la-fi-home-buying-coronavirus.

[5] “Stay-At-Home Orders for Cities and Counties.” California Association of REALTORS?, April 12, 2020. https://www.car.org/-/media/CAR/Documents/Transaction%20Center/PDF/Risk%20Management/COVID19/OrdersMoratoria/Stay-At-Home%20Orders%20for%20Cities%20and%20Counties%20-%20Combined%204-12.

[6] Williams, Dima. “Fannie Mae And Freddie Mac Adopt ‘Alternative’ Home Appraisals Due To Coronavirus,” March 23, 2020. https://www.forbes.com/sites/dimawilliams/2020/03/23/fannie-mae-and-freddie-mac-adopt-alternative-home-appraisals-due-to-coronavirus/#1940e4cb4939.

[7] Federal Housing Finance Agency. “FHFA Directs Enterprises to Grant Flexibilities for Appraisal and Employment Verifications,” March 23, 2020. https://www.fhfa.gov//Media/PublicAffairs/Pages/FHFA-Directs-Enterprises-to-Grant-Flexibilities-for-Appraisal-and-Employment-Verifications.aspx.

[8] National Association of REALTORS?. “Transaction Guidance During COVID-19,” March 24, 2020. https://www.nar.realtor/transaction-guidance-during-covid-19