Saturday, March 10, 2007

Pay yourself in real estate closings

An article I had published recently in an ISBA publication:


I see a regular stream of attorney written articles, particularly in bar association publications, encouraging attorney involvement in residential real estate transactions. The frequently cited reason for legal counsel is some variation of the argument that the purchase or sale of real estate is often the largest financial transaction of peoples’ lives. It’s wise to have the legal counsel of a professional who works with real estate transactions regularly and knows the legal ramifications of the various contractual and mortgage-related documents. This is a great reason for attorney involvement in residential real estate transactions.

But there’s another particularly tangible reason for clients to use our services as part of a real estate transaction: money. That’s right, the good old U.S. greenback. When I represent a Buyer or Seller in a residential real estate transaction, not only do I aim to educate my client and provide diligent legal representation throughout a transaction, but I also innately challenge myself to pay my fees (in a sense) by finding "extra" dollars through aggressive, intelligent and thorough representation. Here’s my list of 10 factors whereby you can directly fatten your client’s checkbook during your next real estate transaction:

1. Analyze the personal property provisions of a contract with a fine tooth comb. First, recall these underlying legal basics as I recall them from Professor Wenona Y. Whitfield in first-year property class: fixtures are anything that would otherwise be a chattel or personal property that have, by reason of affixation, become permanently attached to the real property whereas personal property is not affixed or incorporated to the real property and remains a chattel. Why does it matter? It matters because a fixture is sold as part of the real estate identified in the contract (without further specification) whereas personal property is not. Personal property must be transferred separately, typically through a Bill of Sale. Most real estate contracts contain check-off lists where common items of personal property can be marked for inclusion in a transaction. Verify this check-list with your client. If there’s an unmarked refrigerator or outdoor play-set, you’ll have either a client without those items or a client forking over extra money at closing. Recently, I represented two Sellers who had an outdoor play-set in their backyard that had not been included in the contract’s personal property listing. My legal analysis was that this play-set was not a fixture and that the Sellers could do with it what they wanted. However, I also knew that the Buyers wanted it. So, I told my Sellers to go ahead and solicit the play-set to their neighbors and meanwhile I sent a letter to the Buyers attorney asking if the Buyers wanted to purchase the play-set. My goal was to create the assumption that this play-set was personal property and my Sellers could sell the item separately. The Buyers attorney should have been more diligent and investigated the play-set in question. Long story short, the Buyers ended up paying some $450 for the play-set to my Sellers at closing.

2. Request a home warranty. Generally, Illinois home warranties cover major systems such as heating and cooling systems, plumbing, electrical, and large appliances. Some may also cover roofs, private septic systems and wells too. These warranty contracts normally insure these systems regardless of the make and model or age. Home warranties allow for the repair or replacement, for a full year upon closing, and existing Illinois home’s covered systems that unexpectedly stop working due to normal wear and tear. It has been my experience that home warranties general cost approximately $300. A home warranty can be provided by a Seller within the contract or your Buyer should be advised of it post-closing. My personal, bad experience, when my wife and I purchased our first condominium we failed to get a home warranty and we ended up paying some $2,500 for a failed air conditioning unit within a year of the closing. I’ve learned from this mistake.

3. Home inspections. Most residential real estate contracts allow for a Buyer to obtain a property inspection by a licensed inspector within five to 10 days of the contract’s acceptance. Sometimes the contract inspection provisions cover the entire property and other times they’re limited to major components (it varies by the form contract). Every potential Buyer should conduct an inspection. It has been my experience that inspections cost approximately $300. Potential Buyers should obtain an inspection because major home repairs may impact their willingness to remain in the contract. Buyers should also obtain an inspection because problems are often found and a Seller is frequently willing to credit the Buyer specific sums of money for any repairs. This aspect of a real estate transaction also offers an opportunity to request that a Seller provide a home warranty to give the Buyer piece of mind regarding any issues raised by the inspection.

4. Association disclosure and review. The Illinois Condominium Property Act (765 ILCS 605/) provides for certain mandatory Seller disclosures for both condominium (section 22.1) and non-condominium (section 18.5(g)) associations. In every transaction where there is an association, a Buyer’s attorney must request these documents and make the transaction contingent on the Buyer’s approval of the disclosures. The disclosures allow a potential Buyer to analyze the financial health of the association and to know the various rules and restrictions involved with the association. The financial health of an association is directly related to a future owner’s potential assessment rate. The potential for a special assessment also looms. The review and approval of these disclosures is particularly critical in condominium associations where assessments are paid monthly. Horror stories of $20,000 and up per unit special assessments are more frequent than you might think and these unit owners can be financially paralyzed (or worse) when they hit.

5. Real estate tax reproration agreement. A real estate tax reproration agreement is a separate agreement between a Seller and Buyer of real estate whereby they agree that rather than (or sometimes in addition to) the Seller giving the Buyer a real estate tax credit for the current year’s taxes at closing, the parties agree that they will wait until the actual real estate tax bill(s) is issued by the county treasurer’s office the following year and then divide the tax liability consistent with the date of the closing. This is a particularly useful option when a property transfer coincides with the triennial (Cook County) or quadrennial (non-Cook Counties) reassessment years. The traditional 105% or 110% real estate tax credit is not adequate for a Buyer of property when a real estate tax reassessment will occur the following year. Ideally, Seller’s funds are held back to cover this tax liability. The condition of the real estate market often dictates how aggressively one can negotiate reproration agreements. Last year I aggressively sought reproration agreements when Chicago property was involved as Sellers were quite motivated by a soft real estate market. Also, 2006 was Chicago’s reassessment year and the General Assembly failed to extend the 7% property tax "cap." When available, this option provides perhaps the greatest opportunity to save your Buyer significant sums of money.

6. Pull the property tax bill and check exemptions. It is well-known that in most Illinois real estate contracts a Buyer receives a closing credit for general real estate taxes from a Seller prorated at between 100%-110% of the most recent full year’s tax bill. However, what I see mishandled far too often is the issue of real estate tax exemptions. There are five primary exemptions allowed by a county assessor’s office: homeowner, senior homestead, senior assessment freeze, home improvement, and senior citizen assessment freeze. Each of these exemptions allows for significant tax savings and also (for the sake of a potential Buyer) distorts the future real estate property tax level for a property. If the Seller of a property had multiple tax exemptions, a pure 110% prorated closing credit to the Buyer may not be adequate. Always analyze a property’s tax exemptions and request a closing credit that reasonably compensates your Buyer for her or his likely future tax liability.

7. Suggest a 1031 exchange. A 1031 exchange is a transaction which specifies that if an asset (usually some form of real estate such as land or a building) is sold and the proceeds of the sale are then reinvested in an asset of a similar kind (like kind asset), then no capital gain or loss is recognized, allowing the deferment of capital gains taxes that would otherwise have been due on the sale. This law is defined under section 1031 of the Internal Revenue Code, 26 U.S.C. § 1031. I am not a tax expert and I am not qualified to talk about all of the nuisances of a 1031 exchange. However, I do mention its availability because it does offer the possibility of significant tax savings for your client. These do not apply to the sale of one’s primary residence. My real estate practice involves mostly residential real estate (and therefore usually a person’s primary residence). But, I still don’t do a good enough job of considering the 1031 exchange option. I have found that with the real estate boom of recent years there are many somewhat small-time real estate investors who may own a small handful of properties where a 1031 exchange is an option. Further, as our population ages, I’m handling more and more transactions where children are buying real estate for a parent or parents, again making a 1031 exchange possible.

8. Request an appropriate earnest money contribution. As an attorney, both within real estate and all practice areas, an important mind-set must be cultivated to anticipate future "worst case" scenarios. In a residential real estate transaction one of the most likely "worst case" scenarios is a potential Buyer who strings a Seller along for weeks and sometimes months, breaches the contract and fails to close. What is the Seller’s remedy in this situation? Legally there are a number of possible causes of action including a complaint in equity for specific performance. Practically, in 99% of cases, the Seller’s remedy will be to keep the Buyer’s earnest money. As Seller’s counsel, make sure there’s enough earnest money to make your Seller whole in the event of a contract breach. Consider that at a minimum the Seller has likely continued paying her or his mortgage for an additional month or two and also the Seller may have taken the property off the market. I suggest $1,000 of earnest money for every $50,000 of purchase price, at a minimum.

9. Keep selling the property when a deal is contingent. I think that Sellers and their agents become too passive once a contract is pending, particularly if the contract is contingent on the Buyer’s sale of real estate. Again, question, what’s the worst-case scenario and how can I protect my client from it? The worst case scenarios are a Buyer who either breaches the contract, fails to qualify for financing, or fails to sell her or his real estate. These are common scenarios and Sellers must be ready for them. Keep marketing the property aggressively. Particularly in the case of a Buyer whose offer is contingent on her or his sale of real estate. Most contracts allow for a "kick-out" provision if another Buyer makes a higher offer. This provision allows a Seller to accept the higher offer if the first Buyer cannot match the new and higher offer.

10. Order a C.L.U.E. report from the Seller. C.L.U.E. (Comprehensive Loss Underwriting Exchange) is a database of consumer insurance claims that insurance companies can access when they are underwriting or rating an insurance policy. A C.L.U.E. report contains consumer claim information provided by the insurance companies. It includes policy information such as name, date of birth, and policy number, claim information such as date of loss, type of loss and amounts paid, and a description of the property covered. For homeowner coverage, the report includes the property address. C.L.U.E. reports are protected by the Fair Credit Reporting Act and can only be accessed by the owner or lender for the property. I don’t see these requested too often in residential real estate transactions, although if there are specific property concerns it is another tool in your arsenal of client protections. Further, your Buyer (and her or his lender) are going to need to purchase a homeowners insurance policy so the C.L.U.E. report will shed some light on a property’s insurability.

I hope that this list can help you bring more value to your real estate practice. Although all 10 of these items are rarely available in every transaction, many are. Further, a critical factor in any real estate transaction is the market environment in which you find yourself. Many of the items above would typically be requested pursuant to the attorney review provisions in a contract and would constitute a counteroffer. If the market’s hot and Buyers are lined up to buy a property, hard negotiating may not be practical. Remember, don’t just get your deals closed, represent you clients diligently and put more money in their pockets.

7 Comments:

At 10:56 PM, Blogger Eric Rojas said...

Peter, this stuff is great and I posted it on my site... I have been out of the blog loop for awhile. Had our fist kid two weeks ago!

 
At 11:33 AM, Blogger Peter said...

Thanks for the kind words Eric...congrats on the new kid! I actually tried to send you a hard copy of this article...but my mail got returned. Give me your addres if you had a moment.

 
At 8:37 AM, Blogger koenigstrey said...

I like this blog is fantastic, is absolutely acceptable written.

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At 7:17 AM, Blogger Adam Smith said...

Really a wonderful stuff, Great sharing....,.!!
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At 11:57 PM, Blogger touberproperties said...

Great piece of information, I really liked the way you highlighted some really important and significant points. Thanks so much, I appreciate your work.
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At 1:02 AM, Blogger dawnofanewhorizon said...

I found it quiet interesting ,Thank you for posting the great content…I was looking for something like this…, hopefully you will keep posting such blogs…
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At 12:52 AM, Blogger James Robinson said...

Very interesting about real estate closing.

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