Spike in Foreclosures Signals Trouble Ahead

Residential and commercial foreclosures are on the rise, with home foreclosure filings up 13% in the first half of 2023 compared to the same period last year. This is the highest January-to-June foreclosure activity since 2019, outpacing the 165,530 filings that occurred in the first half of 2020, when COVID-19 was declared a pandemic, according to a report from Markets Insider. “Although overall foreclosure activity remains below historical norms, the notable surge in foreclosure starts indicates that we may continue to see a rise in foreclosure activity in the coming years,” ATTOM CEO Rob Barber said in the recent report.

The spike in foreclosures is partly due to the end of COVID-19-era financial aid, said Chris Ring of NACM’s Secured Transaction Services. In response to the coronavirus outbreak, the Federal Government imposed foreclosure moratoriums, a temporary halt in the initiation or continuation of foreclosure procedures, for as part of the CARES Act. “The banks were giving money to from the Federal Government to offset the losses that they had,” Ring explained.

A wave of foreclosures was one of the first signs of the Great Recession, and while the foreclosure rates today are still nowhere near the highs of 2008, it still signals economic stress.

All industries are impacted by foreclosures, but the construction industry is among the hardest hit—specifically suppliers that sell wood, concrete, steel and any other material that goes into home building. “We are primarily witnessing an increase in residential rather than commercial projects,” said DeAnna Leahy, CCE , NACM chair and corporate credit manager at Sunroc Corporation (Orem, UT), whose company has had several outstanding jobs for which they have not received payment. “While we've placed our mechanic’s liens, we've also received foreclosure notices. If a property goes into foreclosure sale, our liens may be invalidated and our sole recourse would be breach of contract claims against our customers, who might be financially incapable of payment.”

Soaring house prices coupled with rising interest rates have made it difficult for anyone to afford building or buying houses unless they are paying in cash. Many developers who previously engaged in housing projects based on the assumption that lots would sell quickly are now left with unsold lots. “Similarly, speculative construction of houses is no longer as successful as it used to be,” Leahy said. “With revenue from sales dwindling, these developers are struggling to meet their loan obligations, leading to defaults.”

Due to the increase in residential foreclosures, Leahy has become more cautious when dealing with developers involved in sub-divisions. “We now meticulously verify their funding sources and ensure they aren't solely dependent on lot sales to settle bills,” she said. “We only proceed with residential projects if a verifiable construction loan is in place. Moreover, we're exercising greater restraint in extending credit limits compared to our practices in the past, and we're quicker to put accounts on hold.”

Signs of a Distressed Customer

• Missed payments
• Payments slowing down
• Increased debt at or exceeding their credit limit
• Using multiple different suppliers
• Liens and legal action being taken by other suppliers
• Lack of communication
• Property abandonment
• Work on the project has ceased

As a form of protection against foreclosures, contractors, subcontractors and suppliers can file a mechanic’s lien against a property if they haven't been compensated for their work or materials. “However, if a bank has financed the construction project, the bank typically holds the primary position ahead of the liens,” Leahy said. “Occasionally, liens might precede the bank's involvement, but such cases are extremely rare. If the borrower defaults on payments to the bank, the bank can initiate a notice of default and opt to sell the property through a public auction. If the bank reclaims the property for the amount owed to them, it nullifies the mechanic’s lien.”

A residential or commercial foreclosure is much like a bankruptcy, the only difference is there are different types of creditors forcing the foreclosure. “In a bankruptcy, the bank has a direct contract, the mortgage, with the property owner,” said Dev Strischek , principal at Devon Risk Advisory Group, LLC (Atlanta, GA). “The bank monitors deposits and charges daily overdraft fees, which typically indicate cash flow problems. Creditors don’t have those advantages.”

In a foreclosure, creditors oftentimes don’t have a direct contract with the property owner, Strischek said. “It’s a higher bar to force that liquidation and force that Sheriff’s Sale, a public auction at which property that has been repossessed is sold by court order in order to compensate unpaid creditors, which means it’s a longer process of proof that you even have that right and force it through.”

Strischek advises that trade creditors pay close attention to credit reports and tax documents. “Payroll taxes are one of the first things that contractors stop payment on,” he said. “Creditors can also ask for proof that customers pay their taxes.”

For more information regarding NACM’s Secured Transaction Services, visit our website or contact STS representatives Chris Ring at [email protected] and Jocelyn Vanlandingham at [email protected]. You can also join our Construction Credit Thought Leaders Discussion group to connect and network with others in the industry.