Real Estate Transactions Ward McDonald Fall 2012
Market Context for RE Transactions
Monday, May 07, 2012
Value in RE – In general, buying RE is about money & lifestyle, generally not for a public good.
Accounting vs. Economic Profit (not on exam)
Accounting Profit – Taking financial stmts and dealing with the profit after you've covered your costs.
Op Exp down to the bottom line, your profitability
Economic Profit – Measures the opp cost of the investment (i.e., how did you do in this investment as opposed to how you could have done in others)
· A lawyer tries to risk the risks by, if you represent the buyer, you want the seller to make reps and warranties.
· If on the seller's side, you want the buyer to minimize the # of contingencies (the ways they can get out of a deal).
Value, Utility and Comparative Analysis
· Value/Utility – What is this property worth to you? I.e., how will you use it?
· Wealth Opportunity – How will that affect your wealth accumulation?
· Credit Opportunity – How much can you borrow against this property? What's the leverage factor?
o Leverage can have a dramatic effect on your net return (more of a RE Fin concept)
Categories of Cost
· Transaction Costs
· Out-of-Pocket Costs – How much you'll have to spend out-of-pocket to fix things and get the property up to par.
· Opportunity Costs – Lost opportunity (how did you do in this investment as opposed to how you could have done in others?)
Rent-Seeking Behavior (don't get carried away with the terms since not so important)
· Zoning – Ward buys property that is zoned for residential but he believes he can get it rezoned for apts, or it's zoned for apts and he believes he can get it rezoned for commercial. This is a rent-seeking behavior. Ward is buying that land for the opp he believes he has to get the zoning changed.
· Public Assistance – Buying property b/c of some incentive you can get from the gov't to do the deal (so this does not refer to Sect. 8, etc.).
o Tax Increment Finance – Districts that are set up to provide incentives for people to develop
· Gives the impression this is something you shouldn't do but Ward had the following points to make:
· You represent the buyer in a commercial property and you want to lock up the property, you'd ideally like an option (but since that's not likely to happen), so you to contract and in the contract we have all kinds of contingencies — due diligence period (aka free-look period), inspection contingency, finance contingency, certain NOI reqs or certain debt coverage ratios, etc.
· Due diligence
o In commercial transactions there are due diligence periods (financial stmts, tenant profiles, physical structure, etc.)
· Temporal vs. Transactional (Ward doesn't give a shit about the distinction)
o Temporal – What's the accuracy of the information we're relying on
o Transactional – How do we take ownership? What r the transfer costs? What r the credit costs?
· What, if anything, can a lawyer do to reduce the risk?
o In Lucas, he buys two beachfront lots, waits 18mo and during that time one of the state agencies imposed a setback from the water's edge such that you couldn't build on either one. Lucas asks to be compensated for the condemnation and the state says, nope, we didn't condemn your lots, you still own them, you just can't build on them.
o The standard is all economic benefit; the S.Ct. said that b/c he had been deprived of all economic benefit, this counts as a taking such that you get paid under the 5th Amendment.
Should locked-in rents be considered a taking?
· San Fran and NY; people who are renting properties where so long as they live there the rent cannot go up (Ben Stiller movie)
· Ward referred to one instance where the lease could be assigned (he compared it to a perpetuity); he then questioned at what point this becomes a taking?
o S.Ct. is deciding on this now.
Commercial RE transactions (protocol is very similar across the U.S.)
· Seller, buyer, and lender are all represented by outside counsel
Residential RE transactions — What's involved in a residential RE transaction? Who is controlling it? What role should the atty play? To what extent should a lawyer be involved in a RE closing? Is the atty's role sufficiently important that it should be maintained?
· Ward has dedicated a significant part of his career to advocating the role of the atty in a residential RE transaction.
· CA, WA, OR, AZ, and some other states (mostly out west) shut out lawyers from residential RE transactions.
· Brokers take on a much bigger role, they handle much of the transaction including getting the title ins ordered, the transaction is closed with an escrow company (usually offices next door or with the title company), and the buyer/seller don't attend the closing (escrowed closing, so in this sense it's like a commercial closing but w/o attys).
· Closing costs are the highest in CA and some of the other states that don't have lawyers involved in residential RE transactions b/c per Ward there's no one there to keep them honest.
· Title insurance policy states so and so owned the property, now you own it but for the following (and they list a bunch of exceptions under Schedule B and one of them may be you don't own it, someone else does, and noone's going to explain that to you, or it has an easement that makes it such that you can't even use the property in the way you wanted to).
o Ward thinks it's unbelievable that no lawyers would be involved to explain these things to the clients and the reprecussions they may have.
o An argument that will be made to the buyer is that you don't need a lawyer b/c the lender will cover those things since they'll want to make sure they're in first lien priority.
· That's true up to a point b/c the lender will make sure they're in first position, but the lender won't advise you on how to own the property (TIC, by the entirety, etc.), or if there's an easement running thru the property, or the covenants (what can be built on the property?)
· No one has the FD or the legal expertise to explain these things.
· Ward wonders who is giving the buyers in IL who are not getting atty representation advice on how to take title, etc?
· NOTE: If a broker recommends how to take title to a property, this is considered unauthorized practice of law.
· Ward notes that if he's representing the seller at a closing and there's a buyer across the table that's not represented by counsel, there's an inclination to help them, but don't b/c you're crossing the line and really start to put yourself in a predicament if you start answering questions for them or trying to help.
· Bohn v. Cody
§ Approach the adversarial process with caution in this kind of situation. Just b/c the other side is not represented by counsel does not give you free reign to take full advantage. Ward sees this in the sale of residential RE where
· More often than not the closing will take place at the title company. The title company may be explaining the docs to the buyer and the buyer may be thinking the title company is looking out for them, but the title company is there as an agent of the lender and have no FD to the buyer.
· There's an increased pressure to lessen the role of lawyers, but that's starting to level off.
· Ward thinks it's a role that lawyers have done traditionally and he feels strongly they should continue to do. Ward says that examining Schedule A and B gives you the same info that examining the abstract would have shown, and then you as the buyer's atty you look at that and say “ok, in order to close this we need to pay off the 1st mortgage, 2nd mortgage, assessments, mechanics' lien, etc., and we need a deed and a release of the mortgage, all these things so that the buyer then gets title in the name of the buyer. So the commitment for title insurance is used by the atty as a work product to examine the title and make sure you get title passed just like you were in the old days with an abstract. And if you need a copy of the easement, covenants, etc., you just call the title company. So since it's the same process pretty much as it was in the abstract days, Ward argues it's a legal service that should be performed by lawyers.
· Ward thinks lawyers are necessary to explain how to take ownership, to explain easements, title issues, and other aspects of a contract, and no one has the FDs to that party except the lawyer. Brokers may say they do but they don't.
· Covenants and restrictions on the property should be explained to buyer, especially important in condos or subdivisions.
Parties in a residential transaction (commercial is not much different)
· Open – Comes up when the broker tells you they have someone that may want to buy your property and ask for a listing for a limited amt of time and just for that person; if they enter into a K during that period of time or soon after b/c of their visit when I showed them your property, you owe the commission.
o It's possible to have multiple open listings out at one time.
· Exclusive Agency – If property contracts for sale during the listing period or soon thereafter for any reason other than the owner selling it on his own; seller owes broker the commission, whether or not they were involved in the sale.
· Exclusive Right to Sell – Most common since it's the one that's req'd by the MLS.
o If that property sells for any reason during the listing agreement or due to a showing that occurred during the listing agreement or 6-12mo thereafter (depending on the agreement), the seller owes the broker a commission
· Seller is getting the benefit of all the advertising and exposure; and it's a team instead of an adversarial process b/wn seller and broker.
o There is a req that they provide minimal services (they must be “in the process of receiving offers”)
· If Ward sells property he can get a referral commission of 25% just for having a broker's license.
· Legal rule in IL is that you can act as both attorney and broker with full disclosures BUT the brokerage rule in IL says you may not! Do so once and lose your broker's license; cannot do both in the same transaction.
o Ward says to never take a dime as a broker for a transaction where you are acting as an attorney or you will lose your broker's license.
o Ward has asked himself about the referral commission. Can he represent a client as an attorney and still collect the 25% broker's commission?
· Ward won't take a referral commission for any transaction where he will serve as an atty for either party; better safe than sorry.
· However, if it's Ward's personal property, he doesn't have a problem with it.
Broker duties (goes beyond the book on this subject)
· The entire brokerage relationship is based on an agency relationship; the brokers and the agents are just agents of the parties they represent. If you are an agent, you owe a FD (highest standard under the law); these FDs include loyalty, disclosure and confidentiality.
Commissions are paid to the seller's managing broker who then redistributes the commission among the seller's broker, the buyer's broker, and the buyer's managing broker.
· This isn't a problem in residential transactions, however, it can be in commercial transactions b/c a broker has a right to file a lien for unpaid commissions on commercial properties. So it's important to disclose in a commercial contract who the brokers are and who gets what.
· The buyer-broker legislation simply creates a buyer-broker relationship where the FD of the agent runs to the buyer. This legislation was the solution to the problem of having an agent show a buyer a bunch of properties (where they are bonding and buyer may disclose some things to the agent) and when the buyer is ready to make an offer, the agent's FDs ran to the seller! Thank goodness that was fixed. So now even tho the seller indirectly pays the buyer's broker, the FD now runs to the buyer.
· Some creative lawyers created the concept of subagency, that the lawyer was really the subagent and the result is that today with the sale of homes, the seller is req'd to make disclosures.