Supreme Court of California Makes Mortgage Due Diligence More Difficult

The Supreme Court of California ruled that borrowers have standing to challenge a foreclosure on the grounds that an assignment of the mortgage from the initial lender to the foreclosing lender was invalid. The ruling inTsvetana Yvanova vs. New Century Mortgage Corp., Case No. S218973, means that mortgage lenders must be extra diligent when acquiring loans to make sure the assignment procedure was fully and adequately documented.

In the case, the initial lender went bankrupt in 2007, and the mortgage was pooled into a mortgage-backed security in an assignment that was dated and recorded in December 2011. The plaintiff argued that the four-year delay in assigning the mortgage after the bankruptcy case "revealed a break in the chain of title," rendering the assignment invalid.

The foreclosing lender argued that, in accordance with established law in California, the borrower did not have standing to challenge the validity of the assignment, which was an agreement between the two lenders to which the borrower was not a party. The Supreme Court, in finding that the borrower did have standing, ruled that if the assignment was invalid, the foreclosure was wrongful. The court expressed the public policy that ruling in favor of the borrower would reduce the growing risk of foreclosure for borrowers by limiting the number of potential creditors trying to collect on the debt.

The practical implication to mortgage lenders is that their due diligence when acquiring loans will be more difficult. The suit also increases the possibility that borrowers will file lawsuits claiming that their foreclosures were wrongfully brought by creditors that lacked the appropriate power to collect on the debt.

U.S. Supreme Court Denies Review of San Jose Housing Law

The U.S. Supreme Court denied the review of San Jose's affordable housing law. Opponents of the law failed to convince the court to review the ordinance, which requires developers to set aside some of their units for low- or middle-income residents. The desire to overturn the ordinance is based on the belief that the law is an unconstitutional "taking" that penalizes property developers by denying them money they could otherwise collect on market-rate units and, in turn, drives up the price on all units other than the affordable units, making new home buyers bear an unreasonable burden.

The ordinance applies to residential developments that create 20 or more new dwelling units. The basic inclusionary requirement specifies that 15 percent of the proposed onsite for-sale units in the development shall be made available at an "affordable housing cost" to households earning no more than 120 percent of the area median income for Santa Clara County.

As an alternative to providing the required number of for-sale inclusionary units on the same site as the market-rate units, the ordinance allows a number of other compliance options, including paying an in-lieu fee. In exchange, the developer qualifies for a variety of economically beneficial incentives, including a density bonus, reduction in parking and set-back requirements, and financial subsidies and assistance from the city in the sale of the affordable units. The ordinance does not apply to rental housing.

UPREITs: The New 1031?

As an alternative to a 1031 like-kind exchange transaction, some real estate investors looking to dispose of their properties without incurring capital gains taxes are turning to the umbrella partnership real estate investment trust (UPREIT). When the UPREIT structure is used, the owner contributes property – usually subject to debt – to the umbrella partnership in exchange for limited-partnership units and a "put" option. This is usually a nontaxable transfer. The owners of limited-partnership units can exercise a put option and convert their units into REIT shares or cash at the REIT's option. This normally is a taxable event for the holder of units. Therefore, most unit holders do not exercise their puts.

Upon the death of a unit holder, the tax basis of his units is stepped up to market value. Therefore, the heirs can exercise the put without incurring income tax on the appreciation of the underlying assets. The principal advantage of exercising the put at death is to provide liquidity to the estate and to prevent income taxation of subsequent appreciation.