As the old saying goes, necessity is the mother of invention. And old it is. Perhaps the earliest expression of this sentiment came some 2,400 years ago from Aesop’s fable The Crow and the Pitcher.
From the invention of the wheel to facilitate travel or the steam engine to facilitate travel even better, there are many such examples throughout history of necessity egging on an invention to meet that need. One particularly good example relates to finance and accounting.
Throughout much of human history, traveling was fraught with peril, pirates, thieves, storms, other natural disasters, etc., which made commerce (not to mention vacations) rather difficult, to say the least. Then, in 13th-century Florence, double-entry accounting and bills of exchange were introduced. This allowed exchanges to be done on a ledger without the risk of a bulky bag of silver coins tempting some would-be bandit prowling about some medieval road in the middle of nowhere.
More recently, finance has seen more invention with things like collateralized debt obligations, which were created to better diversify portfolios of mortgage-backed securities—OK, scratch that last one. Sometimes—perhaps particularly in the world of finance—invention can be the mother of disaster.
When it comes to title insurance, however, it was the other way around: Disaster was the mother of invention.
Why Title Insurance Is Important
As any real estate investor worth their salt knows, buying a property without going through a title company or attorney (depending on the state) is a no-no, and paying for title insurance to guarantee there are no other liens or encumbrances on a property is an absolute must. Buying a property without going through title or with just a quitclaim deed in an arms-length transaction is basically just begging to be scammed. (That said, there are some instances, like buying foreclosure auction properties, where title insurance is not available. In such cases, you should still do a thorough title search and be extra careful.)
A title insurance company insures that the title is clear and marketable. If there are any liens or encumbrances the title company missed, they will pay the cost to remedy. Thus, the title insurance business works like any other insurance company, and the small cost to buy title insurance for every transaction ensures buyers the property they are getting is free and clear while simultaneously making it easier for sellers to sell their properties as potential buyers don’t have to worry if there are any looming mechanic’s liens or old mortgages out there waiting for the most inopportune time to surface.
The Great Chicago Fire of 1871
But what would real estate investing be if title insurance simply didn’t exist? Well, for one, it would be a lot riskier. And this was the case throughout the first 100 years of American history— and just about all human history—up until the Great Chicago Fire of 1871.
At least in terms of the amount of real estate destroyed, that fire was the most devastating in American history. The fire killed approximately 300 people and left more than 100,000 residents homeless.
According to Wikipedia:
“Eventually, the city determined that the fire destroyed an area about 4 miles long and averaging three-quarters [of a] mile wide, encompassing an area of more than 2,000 acres. Destroyed were more than 73 miles of roads, 120 miles of sidewalk, 2,000 lampposts, 17,500 buildings, and $222 million in property, which was about a third of the city’s valuation in 1871.”
Supposedly, Mrs. O’Leary’s cow knocked over a lantern in her barn, which started the whole conflagration (or perhaps it was some kids playing cards with a lantern that got knocked over during the game.) The truth is buried in the sands of time.
Either way, the cause of the fire was not the reason it was so devastating. Chicago had been rapidly growing, and cheap housing was being thrown up at the same time the city was becoming more and more dense. In addition, most of the city’s buildings were made of wood and had balloon framing, which is vulnerable to fires.
Most buildings also had tar or shingle roofs that were quite flammable. Even many of the roads and sidewalks were made of wood. And the city’s fire department was grossly understaffed. One spark—wherever it came from—mixed with hot, dry conditions was bound to set off a catastrophic fire.
The Origins of Title Insurance
As with most financial inventions, title insurance evolved over time. The first traces of it began in 1847, as the West Ridge Historical Society notes, when “an obscure young law clerk, Edward A. Rucker, devised a system of keeping track of every recorded instrument and legal proceeding affecting real estate titles. This saved attorneys the laborious task of searching official records in connection with transfers of real property. It was a valuable service that was welcomed.”
Several others joined Rucker in this endeavor that helped attorneys search through records before the Great Fire made this service absolutely essential because one of the 17,500 structures that went up in flames was the county courthouse, where all the abstracts were held.
Fortunately, three of these nascent title companies had “snatched their records from the inferno.” Shortly thereafter, the records were compiled in a safe place and turned over to a newly organized firm named Handy, Simmons, Smith and Stocker.
In 1872, the Illinois Legislature passed the Burnt Records Act, which made it so “the existing abstract records of the three companies were made admissible as evidence in all courts of record.”
But what was to be done about the records that were irretrievably lost? And what was to ensure potential property buyers that the property they were buying didn’t have multiple liens—which couldn’t be found unless you count the ash heap where the courthouse used to be as “found?” These liens still might exist, though, and be held by a long-forgotten uncle somewhere off in Nantucket to return with a lien in hand to demand restitution at the most inopportune time.
It took some time (and technically, they were beaten to the punch by a small outfit in Philadelphia named the Real Estate Title Insurance Company of Philadelphia in 1876), but in 1887, under the General Trust Company Act, which “granted qualified corporations the right to act as executor, administrator, guardian, and trustee, and as fiduciary in other capacities,” the company that would become Chicago Title and Trust Co. began issuing what we now call title insurance.
Yes, it should be no surprise that one of the largest title companies in the world was born in Chicago. (Chicago Title was bought by Fidelity National in 2000.)
Title insurance was a game changer for rebuilding Chicago in the late 19th century. According to the Rogers Park/West Ridge Historical Society’s HistoryWiki:
“To Chicago, [title insurance] brought a new element of stability in property ownership. Now, since titles were insured, Chicagoans needed no longer fear that the ghost of a former owner would rise out of the past to threaten the ownership of their homes or businesses. Loans were more available to property buyers and home builders, and Chicago’s growth was given a new impetus.”
Indeed, title insurance was so important in giving the citizens of a ruined Chicago the confidence and impetus to rebuild that the city of Chicago and the State of Illinois declared Aug. 16, 2022, to be Chicago Title and Trust Day. Says an article in The Title Report:
“The day was established in recognition of Chicago Title’s role in rebuilding the city after the Great Chicago Fire of 1871. During the fire, the official property ownership records of the city were destroyed. Chicago Title managed to preserve its records, which became the foundation of rebuilding the city.”
While the Great Fire made title insurance essential in Chicago, it was quickly realized that such a service was useful to any property buyer anywhere. Indeed, it’s been pointed out that some of the major problems in developing countries that inhibit economic growth are insecure property rights and unclear or extralegal property arrangements. Without title insurance, there was always ambiguity regarding property ownership, which inhibited economic growth (and could also cause complete ruin to a good number of individuals).
Thus, title insurance spread across the country. First American Title traces its roots to 1889, Stewart Title was founded in 1893, Old Republic Title in 1907, and Fidelity National Title began issuing title insurance in 1920. Soon enough, title insurance became standard in all property transactions.
So if you’re ever tempted to skip on paying for title insurance, just remember that 300 people had to die in a fire that destroyed almost a third of one of America’s most prestigious cities for this exceptional financial device to exist and prevent homebuyers and real estate investors alike from making a very costly mistake.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.