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Real estate downturn increases professional liability risks

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A flagging U.S. housing market could spur errors and omissions claims against real estate industry professionals as reality catches up with a heightened demand that drove many deals, insurance observers say.

Some real estate-related professionals could generate E&O claims as they move into new business areas to try to make up for lost revenue but lack the expertise to properly service a new set of clients. Others could face claims as it becomes more difficult to fulfill promises made when the real estate market sizzled with sales activity, experts say.

In an Oct. 11 report, the Washington-based National Assn. of Realtors said it expects existing home sales to drop 8.9% this year to 6.45 million. Despite the downturn, 2006 is on track to be the third-strongest following record sales in 2004 and 2005.

The NAR also projected that new home sales would fall 17.3% nationwide with housing starts down 10.9% to 1.84 million for 2006.

That follows a late September statement by the Washington-based National Assn. of Home Builders that said the housing market is fairing "a bit rougher than the soft landing" that housing analysts had expected.

The NAHB noted that housing prices rose to a record level during the recent real estate boom, but prices have since been dropping under their own weight. The association forecast an 11.5% decline in housing starts this year followed by another 11.7% drop in 2007.

Also in September, the U.S. Department of Housing and Urban Development said that inventories of new and existing houses reached record levels.

Developers, design professionals, property appraisers, realtors and real estate attorneys all face increased risk in a down cycle, insurance industry observers say.

Developers and sponsors that raise money for condominium and mixed-use projects that combine retail and urban living units, for instance, now face sales that have slowed precipitously, notes Alexandra S. Glickman, area vice chairman for Arthur J. Gallagher Risk Management Services in Glendale, Calif.

Consequently, investment returns from condominium and mix-used projects are in retreat. So developers and sponsors that made promises about certain returns for investing in such projects could now see lawsuits from investors when they can't deliver, Ms. Glickman said.

"There is so much money chasing so few deals that really make economic sense now," Ms. Glickman said. "If the yields don't come in that were projected, then there might be much greater pressure...to really go after the sponsors in terms of misrepresentation."

Bruce Eisler, senior vp in New York for Liberty International Underwriters, said claims related to the slowing real estate market have not yet materialized, nor has his professional liability book of business changed since the downturn began. But with the potential for further slowing, Mr. Eisler said he knows that he must now be extra vigilant as a professional lines underwriter that claims are likely to follow.

"That is something we are paying close attention to," Mr. Eisler said.

Past economic down cycles had a "profound impact" on certain professional liability claims activity, Mr. Eisler said. One of his concerns is that professionals attempting to make up for lagging business will move into new areas where they lack expertise.

"In the past if you look at claims against design professionals, often times the claims arise from when a design firm begins to take on work outside of their area of specialization," Mr. Eisler said. "That is what I am looking at."

Architects that until recently faced a backlog of designing high-end homes or condominiums, for example, may attempt to design office buildings or strip malls.

Attorneys that have specialized in handling real estate closings could now turn to handling wills, estates or other work where they lack experience.

"Odds are they will," he said.

Shutdown not all bad

For some real estate professionals, however, an economic slowdown could reduce their risks, said Judy Lowe, executive vp for Realty Executive Southern Arizona in Tucson.

A slowing of business would mean real estate professionals would have more time to make sure their business is conducted properly, said Ms. Lowe, who described current conditions as moving into a "more normal market."

Also, real estate agents who are new to the business, having jumped in when the market was hot and hoping to make quick and easy money, are likely to flee during tougher times, Ms. Lowe said. Newcomers are more likely to spur claims than seasoned professionals, she said.

When the housing market was hot, it also was rife with stories of buyers hurrying to beat escalating prices or competition by making hasty purchases without the usual inspections or careful deliberation.

That could mean that homeowners dissatisfied with deals they eagerly agreed to when the housing market was hot, "could be looking for someone to blame other than themselves for them being in the situation they are in," Ms. Lowe said. They, too, could become a source of claims, she said.

Similarly, when the real estate market was booming, developers and their partners were much more likely to see a project completion with everyone profiting, LIU's Mr. Eisler said. A developer might have even absorbed the cost of a problem caused by, for example, a design professional.

However, with the market slowing and profits thinning, developers faced with those situations are less likely to be so magnanimous and the filing of a claim is more likely, Mr. Eisler said.