Charles Perry
‘Big problem’
It’s a growing problem – literally. What once was a fear of asbestos in commercial real estate properties is now a fear of mold. And where the greatest concern over health and liability issues stemming from moldy commercial properties previously fell squarely on the shoulders of the contractor or insurer, such issues increasingly are becoming the problem of the mortgage lender.
In recent years, awareness of mold-related issues, and the number of resulting lawsuits, have increased across the country, causing serious concern for homeowners, businesses and insurance companies. Modern, nearly airtight, energy-efficient structures that keep heat – and moisture – locked in are often cited as partly responsible for the surge in mold cases.
According to industry experts, a growing number of high-profile insurance claims and facility closings are grabbing the spotlight and increasing public awareness of mold. And because the insurance industry, typically the party that takes on property risk, is now underwriting exclusions for mold, lenders are being forced to become aware of a new risk category. The financial infestation resulting from a moldy building can spread all the way back to the mortgage lender, with devastating consequences, according to one environmentalist and mortgage industry consultant.
“Lenders are working furiously to get a hold on mold. Before, mortgage lenders, when faced with environmental issues, never stepped up to the plate and addressed the concerns,” said Charles Perry, an official on the Mold Working Group at the Mortgage Bankers Association of American and principal of Environmental Assurance Group. “Lenders deserve to be in control of this issue because typically they have 80 percent of the money at risk. When mold infests a home or business, it can devastate the financial health of all connected parties: owners, developers, lenders, tenants and insurers. To a lender, mold carries property, or collateral, value concerns as well as liability concerns. The financial impact of mold could make the fallout from asbestos look like a day at the beach.”
According to Perry – a commercial real estate and institutional lender for almost 20 years before establishing the Environmental Assurance Group in Hartford, Conn. – if a borrower defaults because mold has damaged his or her property, the lender may not wish to simply recoup the mortgage by foreclosing and becoming the owner. The extent of the mold infestation may cause collateral impairment that could substantially affect the property’s market value, he said.
“In addition to the prospect of taking ownership of a property that will need expensive remediation, the lenders must classify the mortgage in question as ‘nonperforming,’ which can cause negative reactions from the Federal Deposit Insurance Corp. and rating agencies, among others,” said Perry. “Lenders ought to be educating themselves on data and science on mold. There is no evidence that mold is toxic and life-threatening, but it does make people very sick.”
One local mortgage lender said banks have to weigh the risks of commercial real property owners defaulting on loans because of mold concerns.
Richard Sullivan, vice president of Legacy Real Estate Finance at Legacy Banks in Pittsfield, said it is important for lenders to analyze the loan before signing on to a construction project.
“The concern is that a building that gets mold has the potential of the loan going into default because there is a huge expense for repair. Mold is usually in the wall structures and it is a very expensive [procedure] to get it all cleaned out so the risk factor [of the loan] has to be considered,” said Sullivan. “Property casualty insurance does not cover mold … you may have loss of rents because tenants have to move out of the building or incoming tenants have to postpone their move. Lenders really have to weigh that risk.”
According to Perry, the conditions under which mold occurs are the existence of spores, moisture in the air, a normal temperature range, and the presence of a food source like paper. Since normal temperatures, airborne spores and moisture are simply facts of everyday life, the only controllable variable is the food source – primarily paper-faced drywall.
‘All About Education’
Recently, construction companies have been promoting a new paperless wallboard that would deter mold growth and industry experts say lenders should inquire about this new construction material before offering a loan.
“Mold is in the wallboard and there are companies that are making paperless wallboards to augment the [minimization of] risk factors for this type of situation,” said Sullivan.
“It’s very different for lenders to [consider how to] protect themselves … the only way of protecting themselves at the immediate time is by requesting that developers and owners use specific types of construction materials and build a new building. It’s difficult to mandate that because lenders usually get involved after the building has already been started, but it’s essential, because there have been a lot of lawsuits by tenants who are in buildings affected by mold.”
Robert E. McDonnell, a partner at Boston-based law firm Bingham McCutchen, who concentrates in environmental, real estate and land-use matters, said lenders must use some due diligence before offering a loan to a commercial real estate property because of mold and asbestos liabilities.
McDonnell said banks are concerned that borrowers would not have sufficient resources and insurance coverage to meet the incurred liability of mold and asbestos contamination, and therefore the borrower would not make the loan payback.
“If you are a banker right now and you are lending to a developer or construction company, insurance on asbestos and mold is not available,” said McDonnell.
In one case, McDonnell said developers acquired an office park outside of Boston that had mold infestation, and claims from office workers concerning allegations of exposure to fungus and mold started accumulating.
“Classic cases are either cases in buildings where the owner has not maintained the building and there are water leaks, which ultimately create mold infestation,” McDonnell explained.
While states including California and Texas have specific legislation dealing with mold and asbestos, in Massachusetts there is no state statute that requires insurance companies or lenders to cover mold or pollution liability.
“Under the older policies, the general language has often been held to cover asbestos problems. As the asbestos litigation tidal wave got bigger, companies started making amendments to their policies so you couldn’t get [insurance] coverage,” said McDonnell. “Going forward, if you’re a lender or a borrower, to obtain coverage it’s either not available or much more expensive because this is a known problem now. Companies are struggling with how to deal with this … lenders want to do good due diligence and notice pollution issues. That’s an important step for a lender to take and most sophisticated lenders have a thorough approach to due diligence, and mold has made it on the list.”
Currently, bankers and lenders are reviewing their loan policies and adjusting bank policies to reflect specific liability concerns as they relate to mold infestation on commercial real estate properties.
“[Legacy Banks] hasn’t set anything in policy yet, but it’s certainly in planning phases. For a number of years, we’ve had environmental issues and our bank requires environmental insurance on all our loans, but that doesn’t cover mold issues,” said Sullivan. “It seems that every couple of years, there is an issue coming up and you have to start thinking about it and trying to put it into your policy and procedures to make sure that you don’t get blindsided. Hopefully, you don’t have a property out there that comes up with an issue and you are left with a serious default issue on that property. The bank has not experienced this scenario, but it is a concern [for us] down the road.”
According to Perry, “Mold is definitely the asbestos of the 21st century.”
“You can never potentially know that it [mold] is gone forever and health [issues] and property value issues are a liability. This is a big problem for multifamily housing lenders,” said Perry. “The property types of interest are all properties – financially to be using mold-resistant material is not a big deal. You’re talking about $100 difference in units, vs. a multimillion-dollar lawsuit. This is all about education. We ask for appraisals, environmental reports and property casualty coverage; we should ask for mold inspection.”
