May 28, 2024

Joint ventures between title firms and real estate companies are under the microscope

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AI-generated image of two lawyers scrutinizing title insurance joint venture agreements
AI-generated image of two lawyers scrutinizing title insurance joint venture agreements. Image was created using MidJourney.

In 1983 Jim Campbell launched what is believed to be the first joint venture experiment between a real estate brokerage and a title and settlement firm.

It was the genesis of a several things, Campbell said, but primarily that real estate brokers and lenders in Pennsylvania were looking for a more effective way to control the process of buying and selling homes. Things went wrong more often when using unfamiliar title and escrow companies, Campbell and his business partners reasoned. Why not create one entity to ensure a smoother process?

Campbell is now something of a JV guru, having completed over 80 joint ventures with real estate or lending firms. In fact, it’s all his Pennsylvania-based company Title Alliance does.

Mike LaRosa, the chief operation officer of Florida Agency Network, also follows the JV playbook.

“I know the one-stop-shop thing is cliché, but if you do it right, that can be a major benefit not only to the Realtor and the title company as ancillary income, but to the consumer who it is benefiting from efficiencies and better pricing through economies of scale,” LaRosa said.

But the joint venture model may soon be on the way out.

In February 2023, law firm McGuireWoods released a white paper claiming that the joint venture business model between title insurance firms and real estate brokerages “drives up costs, stifles competition” and violates the 1974 Real Estate Settlement Procedures Act (RESPA) and the 2010 Consumer Financial Protection Act (CFPA). 

The paper’s authors, which include Jeff Ehrlich, the former deputy enforcement director at the Consumer Financial Protection Bureau (CFPB), urged the CFPB and state regulators to look into title and real estate joint ventures for potential RESPA, CFPA, and state regulation violations.

“To qualify for the safe harbor, an affiliated-business arrangement must meet three statutory conditions,” the authors argue. “First, certain disclosures must be made to the consumers who are being referred. Second, consumers must not be required to use any particular settlement-services provider. And third, the only thing of value that the referring party may receive is a return on an ownership interest. The JVs do not qualify for the safe harbor because they fail to satisfy (at least) this third condition.”

According to the paper, when a joint venture is set up the real estate agents or brokerage involved “contribute nominal or even no capital in exchange for their ownership interests in the JV,” and the title company “makes almost no investment, either, leaving the JV grossly undercapitalized for the amount of settlement services that it purports to provide.”

The authors also claim that the profit dividends received by the title company and the real estate brokerage are “wildly disproportionate” to their respective investments.

Frances Riley, an attorney who focuses on RESPA issues at Saul Ewing LLP, says that while these claims may be true of a handful of title joint ventures, but it’s not the norm.

“They are asking how an investor only invested $2,000, but is getting a $5,000 dividend last quarter, and you could say the same thing about the early investors in Microsoft or Facebook who bought shares for $100 that are now worth thousands of dollars,” Riley said. “I think it is being pushed by competitors who don’t like the business model of going out and getting investors who are your referral sources.”

Riley added: “They’ve made these allegations about how it is terrible and they are not compliant. What the investigators are finding — not in every case, but in a majority of the cases — is that the investment is proper and they are paying fair market value for the investment.”

Regulators are bearing down

The stakes are high for title insurance firms that have joint ventures operating in the gray areas of the law.

“The environment we are in right now is probably the most enforcement heavy that I’ve seen in probably 20 years, certainly on the state side,” Marx Sterbcow, a RESPA attorney at Sterbcow Law Group, said in an interview with HousingWire. “There are companies that really do things by the book — they are uber compliant. They don’t want to have any misconceptions that their company is doing, and they want everything to be straight and narrow. But then you have a competitor in the marketplace that is doing everything completely illegal.”

Besides RESPA, the McGuireWoods paper also claims the JVs violate the CFPA, which prohibits abusive acts and practices between “covered persons” and “service providers.”

“A joint-venture partner is a ‘related person,’ and thus deemed to be a ‘covered person,’ when they ‘materially participate in the conduct of the affairs” of a covered person,” the paper reads. “Here, the real-estate agents are ‘related persons’ because they materially participate, by referring their customers to the JV for title services, in the affairs of the JV, which is itself a ‘covered person’ because it offers real- estate-settlement services. Accordingly, the real-estate agents could be deemed to be ‘covered persons,’ subject to the CFPA.”

Ehrlich said that in some states the potential violations don’t end there.

“Many states have their own laws that prohibit kickbacks for referrals, like RESPA does. Most of those state laws, like RESPA, make an exception for lawful joint ventures. But a handful of jurisdictions ban kickbacks without exception,” Ehrlich said. “Section 31-5031.15 of the D.C. Code, for example, makes it illegal for any person to ‘give or receive, directly or indirectly, any consideration for the referral of title insurance business or escrow or other service provided by a title insurer.’ And it makes no exception for JVs—even those that would be okay under RESPA. This provision basically outlaws all title-company JVs in D.C.”

Ehrlich attributes the increased scrutiny of joint ventures to a proliferation of JVs over the past few years and the rising home affordability challenges

“Prices are up; rates are up; and closing costs are up. Sham JVs distort competition and cause consumers to pay more for settlement services,” Ehrlich wrote in an email. “So, to the extent that the CFPB or a state attorney general wants to address this housing problem, one place to start would be dealing with sham JVs.”

While Sterbcow acknowledges that housing affordability is a challenge for many, he sees some additional factors at play. Sterbcow believes the lull in CFPB RESPA enforcement action between 2017 and 2023 gave real estate and title professionals the impression that RESPA was no longer a priority. That, combined with the housing market slowdown, created a perfect storm for some questionable business practices to arise, piquing the interest of regulators.

“What happens, is when the market state is declining and revenues start decreasing, you start seeing people becoming very panicked and they start putting together all sorts of crazy, cockamamie schemes to facilitate business coming in and that delegitimizes and impacts the market in which those companies are operating in,” Sterbcow said.

Arizona in particular has been scrutinizing joint ventures between title insurers and real estate brokerages.

“We are looking at how those are structured and that they are bona fide joint ventures and also that they are not just sham organizations created to give kickbacks to agents,” James Knupp, the deputy director of the Arizona Department of Real Estate, said. “We want to ensure that our agents, as well as title companies, are operating within the statutory confines of what they are able to do, and it all comes back to consumer protection and affordable housing.”

Knupp said they are also looking into the neutrality of the escrow agent and the disclosures real estate agents are making to their clients about the nature of their relationship with the title joint venture.

To conduct the investigation, Knupp’s department is teaming up with the Arizona Department of Insurance and Financial Institutions (DIFI).

“We want consumers to be fully aware of the choices they are making — buying a house may be the biggest transaction that a consumer makes in their entire life — and we don’t want these joint ventures working together to diminish that choice for consumers,” said James McGuffin, a spokesperson for Arizona DIFI.

It’s not known how many joint ventures between real estate brokerages and title insurance companies exist across the United States. No single authority tracks such entities, experts told HousingWire.

According to Riley, local regulators in Pennsylvania, Maryland and Washington, D.C., have also begun looking into title JVs. (None of the local regulators returned requests for an interview.)

Despite Ehrlich’s assertions and the suspicions of state regulators, industry professionals maintain that joint ventures are consumer friendly.

“Having these joint ventures or affiliated businesses creates more of a closed loop,” Aaron Davis, the CEO of Florida Agency Network, said. “Any time a buyer exits the loop there is an opportunity for poor service. If I am a buyer and I go to a real estate office that has a joint venture title company, the businesses are tied together and the brokerage has more of an ability to better control the overall experience for the buyer.”

LaRosa added: “When you create that closed loop environment, you have a better ability to integrate systems and allow the transaction to flow much more naturally and it is less clunky from order entry to close.”

Gretchen Pearson, the broker-owner of Berkshire Hathaway HomeServices Drysdale Properties, is part of an affiliated business agreement with Orange Coast Title, which also has similar deals with two of her largest brokerage competitors in the area.

“The main core of why you would set up a JV is to create a better experience for the consumer,” Pearson said. “It is awful when something does come up on title and you are trying to complete the transaction with the buyer and it is taking forever, but if the title company is your business partner, they might be willing to issue the title policy early while still undergoing curative action so your buyer can close.”

In addition to increased interest from state regulators, the CFPB issuing its first RESPA enforcement action in six years earlier this year, making it clear to the real estate industry that RESPA is coming more into focus. But, for LaRosa, at least for the moment, this isn’t too much of a concern.

“I welcome the scrutiny,” LaRosa said. “I think anybody who operates the way that we do welcomes it because we are not out there looking to tattletale on anybody, but there are bad actors and I’ve been waiting for more enforcement. I don’t think they are necessarily looking to bust people. I think they are looking to provide some guidance and make sure that there is a level playing field.”

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