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Real Estate Exam Glossary

Accretion/Accession

Accession is the extension of an owner's land through either annexation or accretion.  Annexation occurs when a tenant annexes a fixture to a building and thus increases the value of the property. 

Accretion

Accretion occurs when a riparian owner (the owner of a property next to a moving river or stream) or littoral owner (next to a body of water. . .such as a lake, pond, or ocean), acquires title to additional land by the gradual build up or accumulation of land deposited on the owners property by the shifting of the river or lake's action .

An owner may acquire property by accretion. Accretion is defined as an addition to land

that results from a gradual build-up by natural causes.  The party who would benefit from this action would be the landowner.

The soil deposited to form the new land is called alluvium.  Alluvium is the land that

accumulates due to the splash-up action of water. 

Avulsion

When a stream suddenly tears land away from its bank, this is called avulsion.

Water

            When a parcel of land is adjacent to a stream or river, it may have riparian water rights.

Riparian Water Rights

 Riparian water rights include a river, stream, or watercourse, and allows the property owner to use the water for any reasonable use.

Appropriation

            When a property owner is not adjacent to a river, stream, or watercourse, he will obtain his water through appropriation.   This is accomplished by applying to the State Division of Water Resources.

Percolation

            Percolation occurs when surface water is absorbed back into the soil.  Hydraulic engineers perform a percolation test to determine the ability of the ground to absorb and drain water.  This is especially important when trying to determine whether a site is suitable for a septic tank.

            Percolating waters are underground water that are not confined to a channel or bed. Waters that seeps from the ground from an unknown source are called artesian waters.

 

Adjustable Rate Loan

An adjustable or variable rate loan is a loan that adjusts to some predetermined index (Federal Home Loan Bank Board District Cost of Funds Index, Cost of Savings Index, Treasury Securities, London Inter-bank Offered Rate/LIBOR, etc.) that changes over the life of the loan. 

Lenders look favorably upon this type of loan because it places the market risk of rising interest rates on the buyer and not the lender.  Lenders usually offer attractively lower initial interest rates than fixed rate loans to entice borrowers to accept this type of loan the the market risk that accompanies it. Adjustable/variable rate loans generally assure a good refinance market in the future.

            Therefore, a loan with an interest rate that changes with money market rates is called a variable rate or adjustable rate loan.  In other words, a real estate loan providing interest rate increases or decreases depending upon money market conditions, is called a variable interest rate loan.

            Conversely, fixed rate loan interest does NOT change over the life of the loan.

 

Adverse Possession

The courts generally require substantial proof that the following five conditions are met before allowing adverse possession:

  1. Open and notorious;
  2. Uninterrupted use for 5 years or more;
  3. Claim of right;
  4. Hostile to the owner's intent;
  5. Taxes paid by the adverse possessor.

Remember:   OUCH + Taxes = Adverse Possession.

            For a title insurance company to issue a policy of title insurance, they will require the adverse possessor to perfect his title through a quiet title action (a court action to remove a cloud on the title

 

Agency

An agency relationship is created when one person (the principal) gives another person (the agent) the right to act on his behalf.  These acts are generally limited to a special agency of a broker listing a property for sale.  In this instance, the agent is employed to find a ready, willing, and able buyer to purchase the property; and can neither sell the property for the principal or bind him to any contract for the sale of the property.

An agency relationship gives rise to a fiduciary duty of utmost care, honest, integrity, and loyalty of the agent to the principal.  This is a higher standard of care the agent must exercise when acting for his principal.

Establish An Agency Relationship

            The best way to establish an agency relationship is by written contract or agreement.  An agency relationship can be established by written agreement, oral agreement, or implied statement of law.  An agent "volunteering" is not one of the three ways to establish an agency relationship.

            Competent parties, a fiduciary relationship, and legality are also required to create an agency relationship.  However, consideration (bargained for exchange) is NOT needed to create an agency relationship.

Ostensible Authority

            An agency relationship can result from the conduct and actions of the parties, even though there is no express agency agreement between the broker and principal(s).  In other words, ostensible authority occurs when Seller Able lets Buyer Baker assume that broker Charlie is his agent.

Gratuitous Agent       

An agent who acts as an agent for a principal and is not paid for his services is called a gratuitous agent.  For example, an agent who sets up a financing package and doesn't charge a fee or commission is called a gratuitous agent.

Terminate Agency Relationship

            A broker representing a buyer may NOT terminate an agreement if it is not yet completed.

Fiduciary

An agency relationship gives rise to a fiduciary duty of utmost care, honest, integrity, and loyalty of the agent to the principal.  Fiduciary obligations include truth, confidentiality, and competence.  Most importantly, a fiduciary duty involves trust.

            The position of trust assumed by the broker as an agent for a principal is described most accurately as fiduciary.  For example, in a real estate sales transaction you are the agent of the buyer and not of the seller.  You owe a fiduciary duty to the buyer.

Violate Fiduciary Duties

            If the seller's agent informs a buyer that the seller will take less than the list price, he has violated her fiduciary duties to the seller.

            Also, if an agent reveals to a buyer that the seller will take much less money for a property, this is unethical and a violation of the agent's fiduciary responsibility to the seller.

            A selling agent is the exclusive agent of the buyer only. He cannot reveal anything negative regarding the buyer to the seller.

Broker Owes Buyer

            If the broker is the agent of the seller, he owes the buyer the duty of honest and fair dealing.  This is the disclosure of all material facts regarding the property.  A material fact is a fact that will affect the value of the property and must be disclosed to the buyer.

            The broker who represented only the seller in a transaction has a fiduciary responsibility to the seller.  When dealing with a third party the broker must disclose all material facts regarding the property.

            A real estate broker acting as an agent for his principal could not file an action in a court of law.  Attorney's file law suits, not real estate brokers.

Dual Agency

            Dual agency occurs when a broker represents both the buyer and seller in a real estate transaction.  The broker has fiduciary duties to both the seller and the buyer and must act with extreme care.  Loyalty and confidentiality can be easily compromised for each party.

            If an agent does NOT disclose dual agency to both parties, he may be disciplined (by the Real Estate Commissioner), he may not receive his commission, and it may be grounds for either party to rescind the contract.

            Mr. Brown hired a broker to find a warehouse for lease and agreed to pay a commission for the service. Several days later, Mr. Green tells the broker he has a warehouse lease and agrees to pay a commission if he finds a tenant. The broker writes the lease that is signed by both parties. Mr. Brown knows that the broker was representing Mr. Green, but Green did not know that the broker was representing Mr. Brown. In this case NEITHER is liable to pay a commission.

A dual agency is legal if buyer and seller consent to it. The buyer and seller must consent to dual agency.

Accidental Dual Agency

            When a real estate agent acts as an agent for both the buyer and seller in a transaction, but does not specifically reveal this fact because he is unaware that both consider him their agent, he is involved in accidental dual agency.

Material Facts

            A material fact is a fact that affects the desirability and value of a property and, if the buyer knew about it, she probably would not purchase the property.  An example of a material fact is a leaky roof or extensive plumbing repairs. 

For example, the owner of a single-family residence lists the property for sale with a real estate broker.  The roof to the property leaks.  The owner informed the broker about this problem.  The broker did not tell the buyer, in this case the buyer could recover damages from both the seller and the broker, and then the seller could recover damages from the broker. 

Earnest Money Deposits

            In a listing agreement, the seller generally authorizes the broker to accept earnest money deposits on his behalf. If there is no deposit with the offer, the broker must inform the seller.  The agent is also required to do as his principal instructs him to do.  However, he must inform the seller of the any checks held by the broker because this is a material fact.

Not Authorized To Accept Deposit

            If Able, the owner of Blackacre, lists the property for sale with Broker Baker and Able fails to authorize the agent to accept the deposit on his behalf,  Buyer Charlie makes an offer on Blackacre and gives Broker Baker a check for $5,000 as a deposit.  Under these circumstances, Broker Baker can accept the deposit as the agent of Buyer Charlie and place the monies in the broker's trust fund.

            For example, a property is not listed for sale.  A person who wants the property executes an offer to purchase it through a real estate agent.  In doing so, he gives the broker a $5,000 check as a deposit.  The broker can accept the check as the exclusive agent of the buyer.

Buyer Withdraws Offer          

            Buyer Baker made an offer and gave the seller’s broker Charlie a $500 check as a deposit.  Before the offer was presented to seller David, buyer Baker withdrew the offer.  The broker should return the check immediately.

Secret Profit

            A broker cannot receive secret profits.  It is a violation of the Real Estate Law, violation of the laws of agency, subject the broker and salesperson to disciplinary action by the Real Estate Commissioner, and subject both to a civil suit by the seller or buyer.

Agent Acting In Excess Of His Authority

            The seller is NOT liable for the broker's actions if the broker acts in excess of his authority.

Vicarious Liability

            If a salesperson does something unethical, the salesperson and broker are liable.  Anything the salesperson does that is unethical or illegal in the course of their job as a real estate agent also implicates the broker. 

Agency Disclosure

            In January 1988 Agency Disclosure became a new California law.           As soon as practical, an agent must disclose who is representing whom in a real estate transaction.  This includes who is representing the seller, buyer, and if dual agency exists.  This disclosure must be in writing.

            For example, if Able is the agent of the buyer, he should disclose this relationship to other persons involved in a sales transaction as soon as possible.

 

Alienation Clause/Due-On-Sale Clause

An alienation or due-on-sale clause in a trust deed provides that the principal amount of the loan plus accrued interest is due in the event of the sale of the property.  If the owner conveys the property, it allows the lender to call the entire loan balance due and payable immediately.  The term "alienate" means to convey the title.

Assumption

A formal assumption of a loan by a buyer assigns all rights, obligations, and responsibilities of the seller over to the buyer.  The buyer steps into the seller’s shoes regarding loan payments to the lender.  The seller is completely relieved of all responsibilities for repayment of the loan.  

Subject To

When a borrower assumes an existing loan “subject to” that loan, the lender does not approve the assumption and the seller continues to remain primarily liable for repayment of the loan for five years after the subject to assumption date.   Therefore, if a buyer takes a property subject to the existing loan, "subject to" most nearly means the buyer will not be personally liable for the loan and the seller remains liable for five years.

            For example, if Able buys Blackacre from Baker, taking title to the property subject to the existing loan, the person primarily responsible for the repayment of the loan would be Baker.  

 

Alquist-Priolo Special Studies Earthquake Zones Act

            The Alquist-Priolo Special Earthquake Studies Zone Act requires all owners of properties located within ¼ mile of an earthquake fault zone to disclose this fact to prospective purchasers.

            Under the Alquist-Priolo Special Studies Earthquake Zones Act, a subdivider would be required to disclose earthquake fault lines to potential purchasers.

            The Alquist-Priolo Special Studies Zones Act is designed to regulate the development of property in the vicinity of hazardous earthquake faults.

A broker is listing a home that lies on an earthquake fault.  The owner of the home tells the broker not to disclose this fact to the buyer.  The broker should refuse to take the listing.         

Please note: A SUBDIVIDER is required, under the Alquist-Priolo Special Studies Earthquake Zones Act, to submit a report on earthquake fault lines to the Real Estate Commissioner's office.

 

Amortization

            Amortization is the liquidation of a financial obligation on an installment plan or basis.  In other words, a loan that is completely repaid by a series of regular equal installment payment of principal and interest is called a fully amortized loan.  An amortized loan will have less interest cost over time than a straight note.

Amortization Tables

            Amortization tables or charts are used to determine the amount of each payment that goes toward interest and the amount toward principal reduction.

            With each payment the interest portion of the payment decreases and the principal portion increases. However, these changes are non-linear and favor the lender early in the amortization period and the borrower late in the period.  In other words, when a loan is fully amortized by equal monthly payments of principal and interest, the amount applied to principal increases while the interest payment decreases.

            When reading an amortization table or chart, the amount shown as the payment, based on a given loan amount, rate of interest, and loan term indicates both principal and interest.

            Many financial calculators, such as the HP12C calculator, have the amortization tables programmed into the calculator.

Fully Amortized Loan

            When a loan is completely repaid by a series of regular equal installment payments of principal and interest, this is called a fully amortized loan.

Down Payment vs. Loan Term

            If a buyer has a small down payment and a long loan term, more interest is paid than if he had a large down payment or a shorter loan term.

Partial Amortization (with Balloon Payment)

            A partially amortized loan is a loan that is paid off in a very similar fashion to a fully amortized loan, except the loan becomes due and payable sometime before the end of the amortization schedule (usually 5-7 years from the loan origination date).  This lump sum payment is called a balloon payment and is the entire balance due.  Therefore, a partially amortized loan has a balloon payment.

            Residential lenders will many times give a borrower a lower than market interest rate to induce them to accept a partially amortized loan with a balloon payment.  The balloon payment allows the lender to obtain his loan funds back within a reasonable length of time and re-loan the funds at market interest rates.  Therefore, the borrower is bearing the market risk associated with a rise in interest rates.

            Commercial loans are many times amortized over 20-25 years; however, virtually all of these loans have a balloon payment in 10 years or less from origination.

Negative Amortization

            A negative amortization loan requires monthly payments that are not sufficient to cover the monthly interest that is due.  The borrower pays such a small payment that it does not cover the principal nor part of the interest due to the lender.  The principal balance of the loan actually increases over the life of a negative amortization loan.  Negative amortization loans are used when a real estate market is appreciating and a commercial investor would like to obtain as much cash flow from a property as possible--while stabilizing rents, rehabilitating, and selling the property at a substantial profit.

 

Anticipation/Principle of Anticipation

The capitalization approach is based on the appraisal principal of anticipation.  An investor would be willing to pay $1,000,000 cash in anticipation of an income of $80,000 per year over the holding period.

 

Appraisal Reports

Most single-family residential appraisers utilize the Uniform Residential Appraisal Report (URAR) to provide appraisal reports to lenders and buyers.  In commercial transactions, an appraiser may use a narrative type report which is the most complete report and may comprise several pages of pertinent information related to the subject property's value.

            An appraiser measures the outside of a house and garage when making an appraisal. The appraiser generally uses a long tape measure and obtains exact measurements of the outside of the house and garage.  He then uses these actual measurements to determine the square footage of useable area (house itself) and the garage area.

            An appraisal is good on the date of the property inspection report.  After this date, there may be changes in the surrounding area (economic obsolescence) or to the structures on the property (fire, earthquake, or vandalism) that will cause a different value estimate than on the date of the property inspection report.  For these reasons, an appraisal report is required to be dated, must describe the subject property, and can be oral or written.  

 

Assemblage/Plottage Increment

            The act of placing two or more properties under one ownership with the resulting value of the parcel being greater than the total purchase price of the parcels is called assemblage.  The primary purpose of combining lots is to create assemblage in anticipation of plottage increment.

            Plottage increment is the actual increase in value that occurs when properties are assembled together.  When two properties are combined to make one property that is more valuable than the sum of the two properties separately, this is called plottage.

 

Assignment

            An assignment is the transfer of rights, interests, or title of a person's real property (assignor) to another person (assignee).  Typical assignments occur with mortgages and leases.  

However, a personal service contract cannot be assigned. In an assignment the assignee (person receiving the rights, interest or title) becomes primarily liable for obligations occurring from the assignment.

If Able holds a two year written lease with an option to purchase at a stated price and Able assigns the lease to Baker, Baker would now hold the option.  Options can be assigned.

 

Backfill

Backfill refers to the soil placed next to the foundation as a replacement for the soil removed during construction.  It is soil used to fill in trenches and around excavations. 

 

 

Bearing Wall

            A bearing wall is considered real property because it is part of a house.  The walls that hold the house up are called bearing walls. Bearing walls usually remain intact during remodeling, can be at any angle to a door (archway), and usually are made of stronger structural members (2x6 boards instead of 2x4's).

 

Broker Delegates Document Review To Salesperson

            It is quite common for large real estate brokerage operations to delegate to a salesperson (sales manager within an office) the review of documents completed by  other salespersons in the office.  The broker can delegate these reviews to a salesperson who has at least two years full-time experience as  a real estate salesperson within the past five years.

Who can sign for a broker?  A licensed salesperson with at least two years full-time experience who has a written agreement delegating responsibility.

 

Broker Dies

            When a real estate broker dies, a daughter (who has a broker’s license) must re-list all of her father’s listings in her own name.

 

Broker Relies on Information Furnished by the Seller

            If a broker relies on information furnished by the seller, and makes a misrepresentation while relying on this information, the broker is entitled to a full commission. A broker may include a "hold harmless" clause in the listing agreement to protect the agent from liability resulting from misinformation given by the seller concerning the property.

            If a broker makes a misrepresentation while relying on information furnished by the seller, the broker is entitled to a  full commission.

For example, the broker made a material misrepresentation about the seller's property to a prospective buyer. He was acting in good faith from representations made by the seller, therefore, he is entitled to a full commission and indemnification by the seller.

 

Broker/Salesperson Agreement

            A written broker-salesperson agreement is required between all real estate brokers and salespersons in California.  The  broker must keep a copy of these agreements for three years after termination.

            California brokers must have an employment contract with each of the licensed employees in their office.  This contract must be in writing.

            After termination of employment, a real estate broker must retain the written agreement he has with each salesperson in his office for three years.

            A written agreement between the broker and salesperson is required by the Real Estate Commissioner's Regulations.

            A salesperson is regarded as an employee of the broker.

A salesperson is legally an employee of the broker, however, he is an independent contractor for tax purposes.

 

Broker Retains Records

            A broker must retain copies of all of his records for three years.

 

Building Permit

            A building permit allows a developer to construct a building or improvement on the property.  If a developer would like to construct a residence, he would secure a building permit from the local building department.  The local building department is where an application for a building permit is made by the developer.

 

Business Opportunity

A business opportunity is defined as the sale or lease of a business, the sale of a business and its goodwill, and the lease of a business and its goodwill.

 

Cal-Vet Loan

In recognition of veterans’ sacrifice and service, the California legislature enacted the Veterans Farm and Home Purchase Program (Cal-Vet) in 1921.  This act provided low-cost, low-interest financing for eligible veterans who purchase a home, farm, or mobilehome as a primary residence.

Cal-Vet utilizes general obligation bonds to finance home purchases made by qualified veterans. Cal-Vet purchases a designated home for a veteran and then sets up a real property sales contract (land contract) for repayment of the loan.  Cal-Vet is the vendor and the veteran is the vendee.  Cal-Vet loans have the lowest closing costs.

            Cal-Vet always has an adjustable interest rate and may use a variable amortization period.  Therefore, Cal-Vet loans may experience interest rates that increase or decrease during the term of the loan.

            Cal-Vet purchases the home that is designated by the veteran and then uses a real property sales contract as a security device.  The seller of the home executes a grant deed in favor of the California Department of Veteran's Affairs (Cal-Vet).  Cal-Vet uses funds collected through issuing bonds to purchase these homes. 

A real property sales contract is a purchase contract and security device between Cal-Vet and the veteran.  Therefore, title to a Cal-Vet home is in the name of the Department of Veteran's Affairs (Cal-Vet) until it is paid off in full, then it will be transferred into the name of the veteran.

 

Capital Gains

When an investor purchases a real estate investment property and then resells it sometime in the future, he may have capital gains or capital losses.

A capital gain occurs when the property increases in price and the investor makes a profit on the sale of the property.  A capital loss occurs when the investor loses money on the sale.

For federal income tax purposes the change in market value identified in the sale of the property could be identified as a capital loss or gain in disposing of a capital asset.

Capital Gains Example

Investor Sharp purchased an apartment building in 1990 for $1,000,000.  He held the property until 1999 and then sold it for $1,500,000.  His profit on the sale is $500,000.  Therefore, $500,000 is his capital gain on the property. (This does not take into account permanent improvements and/or accrued depreciation that will be discussed later in the chapter.)

Capital Loss Example

Investor Able purchased an apartment building in 1990 for $2,000,000 and sold it in 1999 for $1,500,000.  His loss on the sale would be $500,000.  Therefore, $500,000 is his capital loss on the property. 

The Formula

Unadjusted Cost Basis (what the investor paid for the property) + permanent improvements (pool, etc) – accrued depreciation (27.5 years straight line method for all residential properties accrued over the number of years the property is held by the owner; 39 years straight line depreciation for all other commercial properties such as office buildings, shopping centers, etc.) = Adjusted Cost Basis (used to calculate capital gains and losses.

 Unadjusted Cost Basis

For federal income tax purposes, the unadjusted cost basis of a property would include the original sale price or original cost. 

 PLUS (+) Permanent Improvements

For federal income tax purposes, capital expenditures for improvements of an income property are added to the cost basis of the property.  Capital expenditures may include a new roof, concrete patio, or swimming pool.

When an owner adds a swimming pool to an apartment property, it will increase his basis in the property.  Permanent improvements are added to the unadjusted costs basis and then depreciated.

Acquisition costs, brokers commissions, and an addition of a concrete patio would be added to the basis of a property for income tax purposes.  However, mortgage principal payments may NOT be added to the basis of an income property for income tax purposes.

Minus (-) Accrued Depreciation

Depreciation for income tax purposes is very different than depreciation for appraisal purposes.  Depreciation for income tax purposes is a paperwork loss allowed by the Internal Revenue Service.

To calculate the depreciation on an income property, the building portion only (land is NOT depreciated) is divided into a predetermined number of useful years on a straight-line basis. 

For example: the property value is $200,000.  The land value is $100,000, therefore the building value is $100,000.  The building portion  ($100,000) is divided into 27.5 years to obtain the amount the property depreciates each year.  Therefore,       

$100,000

            27.5 years                    = $3,636.36

The property depreciates $3,636.36 each year.  When the investor sells the property and capital gains are calculated, the accrued depreciation is the total amount of depreciation taken over the holding period (between purchase and sale).  For example:

 

Unadjusted cost basis               $250,000

+          improvements               $50,000(swimming pool)

-           accrued depreciation     $25,454.55

(7 years x $3,636.36)

=          Adjusted cost basis       $274,545.45

 

Only the improved portion of the property can be depreciated.  This is usually the building.  Land cannot be depreciated, only the building portion.                          

            For federal income tax purposes, an estimated life of 27.5 years is used for the capital improvements made to residential income property after 1986.  All residential properties (single family, duplexes, and up to huge apartment buildings use a 27.5 year straight line depreciation schedule.  All other commercial properties use a 39 year straight line depreciation schedule.

 Equals (=) Adjusted Cost Basis

The adjusted cost basis is the cost used in calculating capital gains and losses for a property.

Therefore,

Sale Price (today)

           adjusted cost basis (purchase price + permanent improvements – accrued depreciation)

=          Capital gain/loss

            Basis For Depreciation

Basis for depreciation is defined as the property value minus land value equals the improved portion of the property (property value - land value = improved portion).  The improved portion is the only part that can be depreciated for federal income tax purposes.

            For example,    if Able purchased an income property for $200,000, obtained a loan for $190,000, the land was valued at $40,000, and the salvage value of the building was $10,000, Able could use $160,000 as his basis for depreciation.     Answer:  Purchase price of income property - land value = improved portion (can be depreciated).  Therefore, Able's basis for depreciation will be $200,000 - $40,000 = $160,000.  The loan amount and salvage value are useless information and are not relevant to the question.

            Another example, Mr. Smith paid $100,000 cash for the purchase of vacant land.  Later he paid $500,000 to construct an income property building on the property.  He secured a $400,000 loan on the property and paid the rest in cash.  The basis upon which he can take an income tax deduction for depreciation will be $500,000. Answer:  $500,000 is the improved portion of the property and can be depreciated.  Land cannot be depreciated.  Loan and salvage value are not pertinent to the question.

Capital Gains Calculated
            When a capital asset (such as real estate) increases in value, upon sale the owner must pay a capital gains tax when the property is sold.
            For example, a developer purchased four lots in 1981.  In 1991 he sold them for $10,000 each.  His tax basis for each lot was $2,000.  For federal income tax purposes, the capital gain recognized in this sale would be $32,000.  Answer:  $10,000 x 4 parcels = $40,000 sales price for all four lots. $2,000 (basis for each lot) x 4 lots = $8,000 basis at the time of sale.  $40,000 (sales price) - $8,000 (basis) = $32,000 capital gain recognized in the sale.
Capital Losses

            Under the provisions of the federal income tax rules and regulations, a taxpayer may deduct a loss on the sale of residential real property when the property was acquired as an investment which was rented or leased to others.

            The owner of an unimproved parcel of real estate which is held by the taxpayer for investment purposes, would be permitted to deduct a loss suffered in the sale of the property.  It should be noted that a person cannot take a capital loss on the sale of a home that was used as his personal residence.

Operational Loss

            An investor may take an annual loss if her income property loses money during the year.

For example, if an apartment building receives $100,000 in revenue during the year and incurs operational costs of $120,000, it would show an operational loss of $20,000.  This passive loss is deductible against other passive income the investor may receive from other sources and a limited amount of active income derived elsewhere.

            If Able owns an apartment building and sustained a $3,000 operational loss for the tax year, for income tax purposes he may deduct the full amount from his ordinary income.  Prepayment penalties, mortgage interest, and property taxes are all deductible for income tax purposes.

 

Community Property

Community property is property held by husband and wife.  Property acquired by a husband or wife during marriage is considered community property, and is therefore owned by both parties.  A husband's salary is considered community property. Exceptions to community property include property that is willed to one spouse or property taken in severalty by one of the spouses is not considered community property.

Equal Interest

            The husband and wife must have equal interests if real property is held as community property.  Vesting will be:  Husband and Wife, as Community Property.

Unenforceable

            Both husband and wife need to sign for a contract to be enforceable.  An agreement to sell property held as community property that is signed by only one spouse is unenforceable until the other spouse takes action (up to one year) to set aside the sale and rescind the contract. 

            To transfer property deeded to Anna Able, a married woman would require husband and wife's signatures. 

            If a married couple acquired a deed in only one spouses name, this would be considered community property.  Property acquired during marriage is considered community property and owned by both spouses.        Cloud On The Title

            How a spouse takes title to real property can create a cloud on the title.  For example, Mrs. Smith locates a property while her husband Mr. Smith is out of town.  So she doesn't lose the property, she places an offer on it in Mrs. Smith's name only.  She cannot sign for Mr. Smith.

            Another example, Anna Able recorded title to her existing property as "a single woman."  Later, she married Bob Baker and changed the name on the deed to read, "Anna Baker, a married woman."  This would create a cloud on the title.  When conveying the property in the future there will be a question as to who really owns the property--Anna Able or Anna Baker?  Clouds on title are usually cleared up with a quiet title action.

No Right of Survivorship/Can Will Property

            Real property held in community property does NOT have a right of survivorship. The husband can will his 1/2 of the property and the wife can will her 1/2 of the property to each of their designated heirs (devisees).  For this reason, holding title in community property is a common way for a husband and wife to provide for children from a previous marriage.  They are able to will portions of their 1/2 of the property to these children without being concerned with right of survivorship issued inherent with joint tenancy. 

            For example, a husband dies and in his will specifies that his wife shall receive his half of the community property.  His wife can sell all of the property.  She would hold the property in severalty and would own all of the property.

Commission Earned

            In community property, either husband or wife can employ a broker and either party can change their minds; however, if an offer was produced (by the broker) meeting the terms of the listing agreement, the broker has a valid contract and a commission is owed.

 

Comparison/Market Data Approach

            The sales comparison approach or market data approach/method of appraising real properties in California utilizes the principle of substitution to appraise real property.  An appraiser uses sales comparables to value a subject property.  Sales comparables are similar properties that have recently sold near the subject property.

            The closer the sales comparables are to the subject property in relation to size, amenities, and other characteristics, the more suited they are to be used to value the subject property.

            The sales comparison/market data approach is most often used with single-family homes and unimproved land.  

            The market data approach or method of real property appraisal is most often used to determine office building rents and apartment rents.

Principle of Substitution

            The comparison or market data approach is based upon the principle of substitution.  An appraiser  substitutes the entire subject property for similar properties that have sold in the area.  An appraiser looks for sales comparables that are close geographically to the subject property and as recent as possible.

            Since an appraiser uses the entire property when utilizing the market data approach, it is most readily adaptable for use by real estate licensees.

            An appraiser uses the market data approach when he concentrates only upon the cost to the buyer of acquiring a comparable substitute parcel.

When The Sales Comparison/Market Data Approach is Used

            The sales comparison/market data approach is used for the sale of single-family homes and vacant/unimproved land. It is also used to determine office and apartment building rents.

Sale of Single-Family Homes

            To determine the value of a single-family residence, an appraiser would primarily use the comparison approach.  Therefore, appraisals of single-family dwellings are usually based upon the sale prices of comparable properties.

            For example, when an appraiser is appraising a twelve year old home, the greatest consideration should be given to the current prices for other homes in the same neighborhood (sales comparables).

Sale of Vacant/Unimproved Land

            The comparison approach is the most common for valuing vacant land.

            Since the land does not produce income, the income/capitalization approach cannot be used.  Since it did not cost anything to build the land, the cost approach cannot be used.  For these reasons, the comparison approach is used to compare other parcels of vacant property that have sold recently and within  close geographical proximity to the subject property.

Office Rents

            Realistic rents for an office space can be determined through the comparison approach.

            An analysis of the rents being obtained by surrounding properties is a good way to compare rents and determine market rents for the subject property.  In this manner, a prospective purchaser can determine if there is any upside to the rents (if can raise the rents).

Apartment Rents

            An owner of an apartment building can rely upon the comparison approach to help determine what rents to charge for the units in his complex.

            An analysis of the rents being charged by surrounding apartment properties is a good indication of the rental amount that can be charged for the subject property.

Market Data Approach Limited By

            Effectiveness of the market data approach is limited by rapidly changing economics.  If there is a large and rapid increase in population that increases demand for homes, then fairly recent sales comparables, that sold only a short time ago, will be useless.  Conversely, if a major employer moves out of the area, resulting in a loss of jobs; demand for homes may decrease and recent sales comparables could be equally useless.

Adjustments

            An appraiser must make adjustments between the subject property and the properties used as sales comparables.

            For example, a sales comparable has a swimming pool and the subject property does not have one.  The appraiser must reduce the sales comparable by the amount of the swimming pool in order to compare it (principle of substitution) to the subject property.

            In using the market data approach to value a property, an appraiser increases or decreases the sales prices of comparable properties because any two properties are rarely similar or alike.

            The most important and difficult step is the adjustment of data to reflect differences between the subject property and comparable properties.

            An appraiser adjusts for features making a comparable property better than the subject property by subtracting the value of the better feature or amenity from the sale price of the comparable property.

Swimming Pool Adjustment

            In using the market data/comparison approach to value a single-family residence, a sales comparable has a swimming pool and the property being valued does not have one.  Under these circumstances, an appraiser would subtract the value of the swimming pool from the sales price of the comparable property.

Least Reliable

            The original cost or original sale price of a property would be the least useful in establishing the value of a property using the market data approach.  In other words, what the property sold for when purchased has no bearing on what the property is worth in today's market.

            For example, the seller purchased the property in 1991 for $140,000.  Based on sales comparables the property is valued at only $120,000 in today's market.  Does the original $140,000 sale price have any bearing?  The answer is no.

            The sales comparison or market data approach would also be least reliable in an inactive market.  This is because there would not be enough recent sales comparables to adequately determine the value of a subject property.

 

Commission After Term of the Listing/Broker Protection Clause/Safety Clause/Protection Period Clause

            To protect a real estate broker from one of his buyers (who he showed the property to during the listing period) coming in after the expiration of the listing agreement and purchasing the property without paying him a commission, real estate brokers routinely place broker protection clauses (also called safety clauses and protection period clauses) in listing agreements.

            A broker protection clause states that if a buyer, who was shown the property by the real estate broker, purchases the property within (for example) 180 days after the expiration of the listing agreement, then the broker will be paid a commission on the sale of the property.

            Therefore, a real estate broker only has a right to earn a commission when the property sells during the listing period except when a broker's protection clause is included in the listing agreement.

 

Commissions in Probate

            Commissions in probate are set by the courts. The real estate commission for a property that is in probate is set by court order.

 

Company Dollar/Office Operating Cash

            A broker’s company dollar is the amount of money he has after paying commissions to other brokers (cooperative arrangements through the MLS) and agents in his office (agent commission split).

 

Condominium

            A condominium is a form of ownership where the condominium owner owns the airspace of her unit  separately and the common areas in common with all the other condominium owners.  A condominium has fee title to airspace.  Common areas include clubhouses, pools, and sidewalks.

            For example, an undivided interest in common areas and a separate interest in a living area or a working area in an industrial, residential, or commercial building or office building is best known as a condominium.

            The type of common ownership subdivision in which a person has a deed to his own unit and an undivided interest in the land and common areas is known as a condominium.

Disclosures Required Upon Sale (Resale)

            A buyer of a condominium, other than the original buyer from the subdivider, must be given a copy of the articles and bylaws of the association, deed restrictions (CC&R's), and a copy of the most current financial statement. A condominium’s CC&R’s are physically located at the county recorder's office in the declaration of restrictions.

Condo Conversion is Subdivision

            When a developer converts five apartments to a form of common ownership, this results in the separate ownership of the individual units and shared ownership of the common areas.  This is a subdivision.

Condo Conversion--Notice To Tenants

            The minimum time required for an owner to give notice to the tenants in an apartment building (when that building is being converted by the owner to a condominium form of ownership) is 180 days.

 

Construction Loan/Interim Loan/Obligatory Advances

            Construction loan and interim loan are synonymous.  They have the same meaning.  An interim loan is an agreement between a lender and builder where the lender agrees to advance certain sums to the builder during construction.

            When a lender advances part of the construction funds immediately and will release more as each home is completed, this is called a loan for obligatory advances.  The lender is not comfortable giving the builder all the construction funds ahead of time because too many things could happen to the money before it is spent on construction (i.e. a wild weekend in Tahoe).

Period To File A Lien

            If a contractor obtained a construction loan and the loan funds were to be released in a series of progress payments, most lenders disburse the last payment when the period to file a lien has expired.

            A sub contractor has 30 days to file a lien;  a general contractor has 60 days to file. 

 

Contracts

A contract is an agreement to do or not to do something.  It is a legally enforceable agreement between competent parties who have agreed to perform certain acts for consideration or refrain from performing certain acts.

Express Contract

            An express contract is a contract where the parties put their intentions and the terms of the agreement in words.

Implied Contract

            An implied contract is a contract where the agreement between the parties is shown by acts or conduct, rather than words.

Enforceable Contract

            A purchaser may make a contract contingent upon obtaining satisfactory leases (inspection of an existing lease and approving it). This would be considered an enforceable contract. However, if a purchaser attempts to make an offer subject to obtaining a satisfactory lease, this is called an illusory contract and is not a contract.

Bilateral Contract

            A bilateral contract is a promise for a promise. The promise of one party is given in exchange for the promise of the other party.  For example, when a seller promises to pay the agent a commission when the home is sold and the agent promises to use diligence in marketing the property, this is called a bilateral contract.  A listing agreement is usually considered a bilateral contract.

            A bilateral executory contract is one where the seller agrees to pay the licensee a commission if the licensee agrees to use diligence in finding a buyer.  Executory is present tense and denotes a contract in the process of being completed.

Unilateral Contract

            A unilateral contract is a promise for an act.  A promise is given by one party to induce an act by the other party.  For example, A promises to pay B $10 if she will walk across Brooklyn Bridge.  B walks across Brooklyn Bridge, therefore, A owes B $10.  B performs her requirements under the contract with an act rather than a promise.  An example of a unilateral contract is an open listing.

Executory Contract

            An executory contract is a contract that is in the process of being performed and has not yet been completed.

Executed Contract

            An executed contract is a contact that has already been completed.  If a contract has been executed, both parties have performed completely their obligations as provided by the contract.

Elements Of A Valid Contract

            There are four essential elements of any valid contract (all contracts):

·        Competent Parties/Capacity To Contract

·        Mutual Consent

·        Lawful Objective

·        Sufficient Consideration

Real estate contracts have a fifth element:

·        in writing.

 Not all contracts are required to be in writing, however, real estate contracts are require to be in writing (except leases of one year or less are not required to be in writing).

It should also be noted that all contracts (real estate or not) that are not to be performed within one year must also be in writing.

Competent Parties/Capacity To Contract

            If a person is declared mentally incompetent, a contract between buyer and seller is void (has no effect and never was a contract).  If this occurs, a conservator is appointed for the person by the court.

            If a person is formally committed to a metal institution, all of their subsequent contracts (entered into after being committed) will be void by statute.

Minors

            A minor can receive title to real property by gift or inheritance without court approval. However, a minor cannot convey real property without court approval.

            For example, a single young man enters into a contract to sell real property he owns.  After escrow had closed and the deed was recorded, the title company determines that the young man was under 18 years of age.  In this circumstance, the transaction was void.

            However, a divorced person under 18 years of age has the capacity to contract and is not considered a minor.

Aliens

            Non-resident aliens who are not citizens of the United States of America have the capacity to contract.   Minors, convicts, children, and incompetents are all restricted from contracting.

Mutual Consent

            If the buyer and seller agree to the same thing, then there is mutual consent.  A real estate licensee uses a purchase agreement, which is an offer to purchase real estate, to  start the process of offer and acceptance.

            For example, the buyer (offeror) makes an offer to the seller (offeree).  The buyer/offeror may revoke the offer anytime up until the seller's acceptance of the offer has been communicated back to the buyer.  The seller/offer may do one of three things:  accept the offer, reject the offer, or make a counter offer.  If a counter offer is made, then the seller now becomes the offeror and the buyer becomes the offeree (they switch positions). When the counter offer is communicated to the buyer/offeree then it terminates the original offer and the seller may not go back and accept the original offer made by the buyer.

            A deposit receipt and offer to purchase a property becomes enforceable when the buyer is notified of the seller accepting the offer.

Offer Without Deposit

            If an offer comes in without a deposit, the agent can accept it but must advise the seller that there is no deposit.

Seller Changes Terms of Offer

If a buyer makes an offer to a seller and the seller changes the terms of the offer, this is a rejection of the offer.

Offeror Dies

            If an offer is made, acceptance is NOT communicated back to the offeror, and then the offer dies, a contract is NOT formed.

            If Able sells property to Baker and each party performed fully, and then Able dies.  There is a valid contract.  Since each party had performed their portions of the contract, a contract was formed and was valid.

Spouse Sells Separate Property

            When a spouse sells separate property on his own, the contract is valid.  Separate property may be property he owned before marriage or acquired through inheritance.

Offer Terminated

            An offer may be terminated by a counter offer by the offeree, death or insanity of the offeror, or by the offeree failing to accept the offer within the prescribed period by the offeror.

Word Problem

Seller Able listed a property with Broker Baker for $86,000.  Buyer Charlie submitted an offer of $80,000 that would expire in four days.  The next day Seller Able made a counter of offer of $83,000.  When Buyer Charlie did not respond to this counteroffer within the four day period (time to respond to the original offer made by Buyer Charlie), Seller Able accepted the original offer of $80,000 from Buyer Charlie and instructed Broker Baker to deliver the property to Buyer Charlie.  Buyer Charlie informed Broker Baker that he had changed his mind and did not want the property.   Seller Able insisted that they had a deal. In this case there is a void contract.  When Seller Able made the counter offer he terminated the original offer made by Buyer Baker.   Therefore, Seller Able did not have the power to accept the original offer and the contract is void (no legal effect whatsoever).

Offer Becomes Enforceable

            A deposit receipt and offer to purchase a property becomes enforceable when the buyer is notified of the seller accepting the offer.

Auctions

            When real estate is sold using an auction the auctioneer is the seller.  The bidders are the buyers.

Auctions can be with or without reserve. An auction with reserve allows the auctioneer (seller) to remove the property from the auction at anytime up until the gavel is dropped and a sale is consummated. An auction without reserve does NOT allow the auctioneer to remove the property from the auction.  As long as a bid is over the minimum bid set for the property, the auctioneer must sell the property to the successful bidder.  For example, Tom Crown is in Europe bidding on some paintings when he hears about an auction for a wonderful chateau in the Napa Wine Country of California. He thinks this may be a nice place to store some of his art work and decides to fly to California to bid on the luxury property.  He asks the auction house if the auction is, “with or without reserve.”  The auction house informs him that it is without reserve and the minimum bid is $1,000,000.  He exclaims, “jolly, wonderful!” and flies to California in his private jet.  He knows that as long as he bids at least $1,000,000, the auctioneer will be required to sell the property to him.  When the auction starts, with a smug look Tom bids $1,000,000 for the property. A striking young lady, who bears an uncanny resemblance to Rene Russo, bids $1,500,000 million.  Tom decides to invest his money in art and not real estate and lets her have the property for her bid price.  Tom is not too upset, not only does he get a date with the young lady, but he also realizes that he did not waste a trip to an auction where the property is pulled off the market just prior to the auction. An auction with reserve would allow the property to be pulled out of the auction anytime up to the sale of the property.  In this case, Tom didn’t obtain the chateau, however, since he was outbid he doesn’t feel too bad because his trip wasn’t wasted by a non-existent auction (or a non-existent lady, either).

Without Reserve

            In an auction without reserve, the auctioneer is required to accept bids.  An auctioneer is not required to accept a bid on a foreclosure sale unless the auction is without reserve. For example, an auctioneer sets a minimum bid to begin an auction.  Someone offers to buy at 10% more than the opening bid.  The auctioneer must accept this bid in an auction without reserve.

 

Lawful Objective/Illegal Consideration

            A contract based on an illegal consideration is void.

Sufficient Consideration

            Consideration is required for a valid contract.  Consideration is not required to be money.  Money is only one form of consideration.  Anything of value can be used as consideration (bargained for exchange).

            Consideration can be services rendered, a promise to perform an act, and an exchange of money.  To be binding, every real estate contract must have consideration. 

In Writing (Statute Of Frauds)

      The Statute of Frauds is an old concept that came from England (where it was abandoned a few years ago).  However, it is still in effect in California.  The Statute of Frauds states that all real estate contracts must be in writing, including agreements that are not to be performed within one year of their making. 

Since a lease of less than one year will be performed within one year of its making, it does not fall under the statute and is not required to be in writing.  All other real estate contracts are required to be in writing.

      Real estate contracts are written instruments and fall under the statute of frauds.  The statute of frauds was designed to prevent fraudulent proof of a fictitious oral agreement.

Unenforceable Contract

            An unenforceable contract is a contract that is valid, however, for some reason cannot be proved or sued upon.  An example is when a contract cannot be enforced because of the passage of time within the statue of limitations.  Another example of an unenforceable contract is an oral contract to purchase real estate.  However, an oral agreement may be enforced if the purchaser has gone into possession, paid part of the purchase price, and made improvements to the property.

Voidable Contract

            A voidable contract is a contract that appears valid and enforceable but is subject to rescission by one of the parties who acted under a disability. In other words, one of the parties is able to void the contract or not at their sole discretion. 

An example of a voidable contract is one that is signed under duress.  The person who was held under duress while signing a contract can void the contract (rescission) or enforce it at their sole discretion.

            A voidable contract is good until it is rescinded.  To rescind is to terminate.  Prior to close of escrow a contract can be rescinded. However, after close of escrow the aggrieved party must file a lawsuit in court.

For example, Baker accepted an offer from Able to purchase Blackacre.  During the negotiations Able inquired and was assured that the property was connected to the sewer.  After the contract was accepted and before escrow closed, Able learned that the property was not connected to the sewer, but that a new septic tank had been installed on the parcel.  Able could rescind the contact because escrow had not closed.  If escrow had closed, he would have had to file lawsuit in court.

A contract for the sale of community property signed by the husband only is voidable.  It is voidable at the discretion of the wife.  Both husband and wife must sign the contract for the sale of community property.

Duress

            A contract signed under duress is voidable, until rescinded.  Although a contract signed under duress is voidable, it is valid until rescinded by the party who signed the contract under duress.

Void Contract

            A void contract has no legally binding effect.  It is unenforceable from the very beginning and is not a contract at all. Examples of void contracts include:

 

Contribution/Principle of Contribution

When a property owner adds a swimming pool to an apartment building, and the pool increases the value of the property MORE than the cost of the swimming pool, this is called contribution.

            For example, an apartment building near the subject property charges $50 per month more rent because they have a swimming pool and the subject property does not. The subject property adds a swimming pool at a cost of $30,000.  the increase in rents would equate to an increase in property value of $50,000. Therefore, the swimming pool has contributed a $20,000 increase in value to the property. 

            (However, please note:  the addition of a swimming pool to a single-family home usually will cause only an increase in value of approximately 1/2 of the cost of the pool and would not be an example of contribution.)

Conventional Loan

            A conventional loan is a loan that is either a private loan or not government sponsored. Conventional loans are many times made by such entities are commercial banks and savings banks. 

            Conventional lenders are usually comfortable making up to 80% loan-to-value (LTV) loans. 

            Since an 80% LTV loan is not insured or guaranteed by the government, a conventional lender is usually not comfortable making a loan higher than this amount.  For this reason, private mortgage insurance is commonly used to protect a conventional lender who is making loans above 80% LTV.

 

Corporate License

            A corporation may engage in the real estate brokerage business if the officer acting for the corporation is licensed as broker-officer of that corporation.

 

Cost Approach

There are three methods used to determine the cost of a property:  Quantity Survey, Unit-Cost-In-Place, and Square Foot/Cubic Foot Method.

Quantity Survey Method

            The quantity survey method takes into account every board, every nail, and virtually every item that goes into the construction of the property and totals them up to determine the total cost to build the property.  This is the most accurate method of determining the cost to build a replacement property.

The cost approach determines the cost to build improvements (buildings) on the property.  The land value must be added to this total to arrive at the appraised value of the property.  The land value is generally determined by using the comparison approach.

Unit-Cost-In-Place Method

            The unit-cost-in-place method considers each entire wall as a component part and totals up each component to reach a cost to build a replacement property.

Square Foot/Cubic Foot Method

            The square foot or cubic foot method considers the cost to build a similar property on a  square foot basis for residential and most commercial construction; and cubic foot method for warehouses. 

For example, an appraiser selects an estimated cost per square foot to build an apartment building and multiplies it by the total number of square feet in the apartment building to arrive at an estimated cost to build a replacement property.

            Please note, however, a warehouse (M1 zoning) is rented by the square foot and appraised by the cubic foot.

            When utilizing the cost approach, an appraiser must consider whether to use the replacement cost or reproduction cost of the building.

Replacement Cost

            Replacement cost considers the cost to replace the property with a comparable structure using today's materials and building methods.  It is the most common method to estimate the cost of a structure.  Since today's materials may be lighter, stronger, and possibly cheaper to produce that those manufactured when the property was constructed many years ago, replacement cost my be a more indicative method that will determine the cost to reconstruct a subject property.  In other words, replacement cost is the present cost to replace the building with another building having the same utility.

 Reproduction Cost

            Reproduction cost considers the cost to reproduce the property with an exact replica of the subject property.  This is the most expensive and is therefore, not used as frequently as replacement cost to estimate the cost to replace an existing structure on a property.  Reproduction cost will produce the highest value estimate in appraising real property.

 
Cost Approach Applies To

            The cost approach applies to special use/special service buildings (a library or fire house) and new construction (new homes).

Special Use/Special Service Buildings

            The cost approach is mostly used to determine the value of special use or service buildings such as a library or firehouse.

            The comparison/market data approach is not applicable when appraising special purpose buildings because there are generally not many sales of libraries or firehouses that can be used to compare to the subject property.

            The income approach is not applicable because the subject property does not produce income.

            Therefore, the cost approach is the only method suitable for appraising special use or special service buildings, such as libraries or firehouses.

New Construction

            The cost approach is best applied to new construction, such as new residences.  Residences that have recently been built can be valued using the cost approach.

Depreciation

            Depreciation is loss of value for any reason or from any cause.  Depreciation is described through physical deterioration, functional obsolescence, and economic obsolescence.

            Depreciation can be the wearing out of a property, a decrease in a property's value due to an increase in property taxes, or buildings placed on a parcel in such a manner to cause the value of the property to decrease.

Physical Deterioration

            Physical deterioration occurs when a property actually wears out (wear and tear).  Good maintenance will affect a property's useful life and slow physical deterioration.  When heating units and fixtures wear out this is an example of physical deterioration.   

Economic Life vs. Physical Life

            Economic life is the number of years a property can actually be used and/or provide income. In contrast, the physical life of a property is the number of years the property is actually standing, even though it may not be used in the later years.  For these reasons, the economic life is generally shorter than the physical life of a property.

            In the evaluation of the economic life of a building, an appraiser considers what the purpose for which the property is to be used, the repair and maintenance policies of the owner, and condition and age of the building.

            The estimated period of time over which a property will yield a return on the investment above the economic rent attributable to the land itself is called the economic life.

            In fact, the economic life of a building or improvement is the period of time from the completion of the building to its inability to produce income.

            Therefore, when estimating loss of value from depreciation, an appraiser would look at the property's economic life to determine if it will develop sufficient income.

Effective Age vs. Actual Age

            The actual age of a property is its age from the time it was built until present.  The effective age is the actual condition of the property. Due to differing maintenance schedules the effective age could be more or less than the actual age.

            For example, if an owner has performed consistent and good maintenance for the property and a property looks like it is 6 years old, when in fact it is really 19 years old, its effective age is 6 years old.  Its actual age is 19 years old.  Therefore, if a house is 19 years old, and looks like it is 6 years old, the appraiser would most likely use the effective age of the improvements (6 years old)to appraise the property.

            On a similar note, a 15 year old building has been well-maintained and an appraiser gives it an age of 7 years, this would be known as the effective age of the building.

            Obsolescence occurs when a property suffers a loss in value.  It is a major cause of loss of value in real property.  The loss can be attributable to internal factors (functional obsolescence) or external factors (economic obsolescence).  Wear and tear would NOT be considered obsolescence, it is considered physical deterioration.

 

Functional Obsolescence

            Functional obsolescence is the loss of value a property receives from factors INTERNAL to the property.  Anything that is within the property lines and causes a loss of value would be considered functional obsolescence.

            A home with 3 bedrooms and only 1 bathroom would be considered to have functional obsolescence.  Especially when all the other homes around it have 3 bedrooms and 2 bathrooms.  The loss in value due to having only 1 bathroom would be due to functional obsolescence.

            Functional obsolescence would also occur in an outdated kitchen.  Since an outdated kitchen is internal to the property (inside the property lines) it is considered functional obsolescence.  It would also occur in an outdated heating system.

            A building that is an improper improvement on its site would be considered incurable functional obsolescence.

            If there is a substantial difference in value between two properties that were built concurrently (at the same time) on adjoining lots of equally valuable land, with construction and maintenance costs the same, this would be caused by functional obsolescence within one of the property. 

            Buyers tastes change faster than properties wear out.  This would be considered functional obsolescence.

            Economic Obsolescence 

            Economic, social, external, and environmental obsolescence are all terms used to represent economic obsolescence on the State Exam.  We will use economic obsolescence to denote all of the above names.

            Economic obsolescence is a loss of value due to external factors (outside) the subject property.  When an airport is placed very near to a single-family home, this external factor may cause a loss of value to the subject property because of excessive jet engine noise.

            Because the loss of value is external to the property, it is the hardest form of depreciation to correct and the most difficult type to overcome.  External factors are generally not under a property owner's control, and therefore extremely difficult to correct.

            Examples of economic obsolescence include:

If a person builds a $250,000 home in a neighborhood of $75,000 to $85,000 homes and he is only able to sell the property for well below $250,000, this is called economic obsolescence.

 

Debt-Income Ratio

            Debt-Income ratio is defined as:  Monthly Loan Payment (Principal + Interest + Taxes + Insurance + Homeowner Association Dues + PMI + other recurring costs) divided by gross monthly income.

            Lenders also consider revolving debt such as credit cards, car loans, etc. is added to the monthly loan payment and divided by the borrower's gross monthly income. These two ratios are used by investors on wall street to ascertain default risk inherent in a borrower and loan type.

            Therefore, lenders are referring to a loan qualifying tool when they mention "debt-to-income ratio."

 

Deed Of Trust/Trust Deed

A deed of trust is an instrument placing the real property being purchased or refinanced as collateral for the loan.  A promissory note is evidence of the debt and uses the trust deed to collateralize the loan. A trust deed is security for the note and is executed when signed by the trustor.      

Deeds of trust are the principal security devices used in California.  Many States use mortgages as their primary security device; however, deeds of trust have many distinct advantages over mortgages and will be discussed at length in the following pages.

            There are three parties to a deed of trust:  trustor, trustee, and beneficiary.

Trustor

            A trustor is the borrower who signs the note and deed of trust for the amount of the loan.   Memory hint:  who is trusting everyone in the deal?  Yes, the borrower. 

Trustee

            The trustee is a third party who holds legal title to the property securing the loan and has power of sale in the event of foreclosure.  The trustor and beneficiary rely upon the trustee to hold the legal title to the property.

Beneficiary

            The beneficiary is the lender.  An owner who gives a trust deed as security for repayment of a debt has borrowed money from the beneficiary. Memory hint:  who will benefit the most financially from the deal?  Most likely, the lender. 

After-Acquired Title   

When the owner of a property adds a barn or other structures to a property and then defaults on the loan, the lender that forecloses on the property will receive the additional improvements (barn and other structures) in the foreclosure.  In other words, the owner loses the money spent on the improvements and the lender receives after-acquired title to the property.

After-acquired title is conveyed in any trust deed for the benefit of the beneficiary. It conveys personal property later affixed to the real property so as to become real property, improvements built on the land after title is acquired, and additional land acquired afterward by the trustor.

Since the property itself is being used as security for a loan, trust deed beneficiaries would insist that they give approval for restriction agreements, boundary line adjustment agreements, and consolidation agreements.

Beneficiary Statement

            When a loan is being paid off, a beneficiary statement is issued by the lender to the borrower. It identifies the current status of the loan.  In other words, a beneficiary statement shows the loan balance.  This is usually requested by an escrow officer who will pay the existing loan off at close of escrow.

            A beneficiary statement is a statement sent by the beneficiary (lender) to an escrow informing the escrow officer of the exact amount that must be paid out of the seller's proceeds to pay off the existing loan.  Lenders usually charge a fee of $50-$75 to provide this statement.  The escrow officer receives the beneficiary statement and then pays the existing lender the amount stated in it. 

The lender then authorizes the trustee to reconvey the legal title back to the trustor. The trustor may then sell the property or refinance it and place another trust deed on the property through a different lender.

Foreclosure of a Deed of Trust

             A deed of trust can be foreclosed either through a trustee's sale (non-judicial foreclosure) or through the courts (judicial foreclosure).  An acceleration clause in the deed of trust allows the lender to accelerate the loan amount due and payable upon foreclosure.

Acceleration Clause

            An acceleration clause in a trust deed makes the loan due and payable upon the happening of a certain event.  If a buyer defaults in making payments on a loan, the lender's action probably would result in acceleration.  In other words, if a buyer defaults on a loan, an acceleration clause would enable the lender to cause the promissory note to become all due and payable.  Therefore, an acceleration clause allows the lender to declare the unpaid balance of the note due and payable upon default.

Power of Sale

The trustor gives the trustee power of sale to sell the property if he defaults on the loan payments.   Therefore, the power of sale authorizes the sale of the property.   Default results in a trustee’s sale.

Notice of Default       

A notice of default is recorded by the trustee when the trustor defaults on loan payments made to the beneficiary.  When this occurs, the trustee (through the power of sale) moves forward with foreclosure proceedings.  The first thing the trustee does is record a notice of default.  The trustee must then wait 3 months and then publish a notice of the trustee’s sale for three weeks prior to the sale.  Therefore, the trustee’s sale can take place 3 months + 21 days after the recording the notice of default (or about 4 months).

Request For Notice of Default

A request for notice of default alerts a holder of a 2nd trust deed that the trustor has defaulted on the 1st trust deed.  If this occurs, then the holder of the 2nd trust deed can move forwawrd, pay off the 1st trust deed, and take over the property.  She is attempting to preserve the collateral position of her 2nd trust deed.

Right of Reinstatement

The trustor has up to five days before the trustee’s sale to pay up the back interest due (as well as other fees and costs) on the loan.  This is called a reinstatement, and is used to reinstate a loan.  If the trustor does not reinstate prior to 5 days before the trustee's sale, then the trustee will move forward and sell the property to the highest qualified bidder.

Deficiency Judgment

Foreclosure by trustee’s sale does not have a deficiency judgment.  In other words, if the property does not bring enough money to the lender from the foreclosure to pay off the loan, the lender cannot go after the trustor for his losses. 

However, the lender can foreclose a trust deed through the courts (as a mortgage) and obtain a deficiency judgment in this manner.

Right of Redemption

If a deficiency judgment occurs (foreclosed through the courts), then the trustor has a one year right of redemption.  He can pay up all back interest, fees, and costs and redeem the property anytime up to one year after the judicial foreclosure. 

This places a lender in a poor position to dispose of the asset, since he must wait until the one year redemption period is over before he can transfer clear title to the property.

Deed In Lieu Of Foreclosure

When a trustor informs the lender that he does not have to go through the foreclosure process because the trustor will deed the property over to him, this is called a deed in lieu of foreclosure. 

The one pitfall a lender faces with a deed in lieu of foreclosure is that the lender who accepts a deed in lieu of foreclosure also accepts any existing 2nd, 3rd, or 4th trust deeds, etc. (junior loans or liens) that may exist on the property.

For this reason it is in the lender’s best interest to make sure there are no additional loans existing on the property prior to accepting a deed in lieu of foreclosure.

Deed of Reconveyance

A deed of reconveyance transfers the legal title held by the trustee back to the trustor.  This occurs when the loan is paid off.

Blanket Trust Deed

A blanket trust deed “blankets” several parcels under one trust deed.  It is commonly used in subdivisions.  As a parcel is sold, it is released from the blanket trust deed with a partial release clause.

Release Clause

A release clause or partial release clause allows the developer to sell lots within a subdivision and remove them from an existing blanket trust deed covering all of the lots in the subdivision.  When a developer sells one of these lots, the escrow officer will use a partial release clause to remove the lot from the encumbrance, hence a buyer can purchase the lot free of the blanket trust deed.  The buyer can then place a loan on the property that is in first position (1st trust deed).

Trustee's Sale Example (Non-Judicial Foreclosure)

            About two months after the trustor stops paying the beneficiary required loan payments, the beneficiary instructs the trustee to start foreclosure proceedings. 

            The trustee first records a notice of default in the county where the property is located.  Secondly, he waits three months from the notice of default recording date before publishing a notice of sale (trustee's sale) in a newspaper of general circulation.  The notice is published once each week for three weeks, the then the property is sold to the highest bidder at a trustee's sale.

            For example, on January 1st the trustor loses his job and does not pay the January payment (January's payment is for December because interest is paid in arrears). On February 1st the trustor misses his February payment also.  Near the end of February, the beneficiary realizes that the trustor is not paying his scheduled interest payments  and instructs the trustee to foreclose the property.  The power of sale given by the trustor to the trustee allows the trustee to foreclose.

An acceleration clause in the deed of trust allows the lender to call the entire loan balance due in the event of a default.

            On March 1st the trustee records a notice of default at the county recorder's office in the county where the property is located.

            The trustee waits three months (March, April, and May) and then on June 1st advertises the upcoming trustee's sale that will occur on June 30th at 12 noon in a newspaper of general circulation.  He advertises the trustee's sale once each week for three weeks and must expedite the foreclosure process. 

            The trustor has up to five days before the trustee's sale to reinstate the loan.  He may reinstate by paying all the back interest plus costs incurred by the lender and trustee.  He will then continue paying the scheduled loan payments as before. 

            If the trustee's sale does take place and there is no reinstatement by the trustor, one of two things will occur:  (1)  if the value of the property is greater than the loans and costs incurred, then the property will most likely be sold to an investor who will purchase the property with a cashier check (or more than one cashier's check if there is competitive bidding).  The investor will receive a trustee's deed and there is no right of redemption by the trustor.  When the property is sold, the former trustor is gone and has not rights to the property whatsoever.

            Or (2) if the value of the property is not sufficient to cover the loans and costs incurred, then the property will most likely go to the lender.  The lender will bid the amount of his loans and costs and there will not be any investors who will bid against him for an upside down property and pay more than the property is worth.  The lender wins the bid and places the property is his REO portfolio (Real Estate Owned).  He then utilizes the services of a real estate agent to list the property and sell it at market value.  He must write off the loss on his balance sheet and is not happy about the situation.  Foreclosed properties are many times advertised as "Repos."  However, they are being sold at market value and a transfer disclosure statement is not required with foreclosed properties.  A trustee's sale does not allow a deficiency judgment. Therefore, if the lender chooses to foreclose non-judicially through a trustee's sale, he cannot go after the trustor for losses sustained through the foreclosure.

            Money is disbursed with taxes and assessments being paid first and mechanic's liens second. Any money left over is paid to the lender and then to the borrower.

Judicial Foreclosure

            If a beneficiary elects to foreclose a trust deed through the courts (judicially, as if it were a mortgage), then he may be able to obtain a deficiency judgment for the money lost in the foreclosure.  However, the trustor will receive a one year right of redemption where he can live in the property and attempt to redeem it.  The beneficiary cannot transfer clear title to the property during the redemption period.

 

Death Disclosure

If someone dies in a property, this fact must be disclosed for three years.

 

Desk Cost

To arrive at a broker’s desk cost, divide the total operating expenses of the firm, including salaries, rent, insurance, etc. by the number of salespersons in the office.

 

Diminishing Returns/Law of Diminishing Returns

The law of diminishing returns states there is a point that is reached where increased investment will not substantially increase the net income of the property.

 

Discounting

            When a lender sells a loan for less than the unpaid balance this is called discounting a note.

            If Able sells a $15,000 note secured by a second deed of trust to an Investor Baker for $7,500, this is called discounting.  The promissory note may be due in 2 years, however, Able is willing to accept $7,500 now, for payment of the note.  Investor Baker pays $7,500 now and receives a note valued at $15,000 in two years.

            Therefore, a lender on a second trust deed who sells his interest in a note for less than the unpaid balance has discounted the note.

 

District Attorney

            The district attorney would prosecute a non-licensee who performs acts required by a real estate license.

            In the event a non-licensee performs an act for which a license is required, the party that would prosecute the non-licensee is the district attorney in the county where the activity occurred.

            Jones, who does not have a real estate license, is the owner and president of an investment firm.  He advertises and sells properties for his clients.  Since these transactions involve real estate, the district attorney will prosecute him for violating the real estate law.

 

Documentary Transfer Tax

            Each county in California can collect a tax on the transfer of real property.  The county collects a Documentary Transfer Tax of $.55 for every $500 of new money coming into the transaction. 

For example, Seller sells the property for $200,000.  An existing $100,000 loan is assumed by the buyer.  The buyer obtains a $50,000 2nd trust deed from an outside lender and pays $50,000 cash.  The documentary transfer tax is calculated:

$100,000 ($50,000 2nd trust deed + $50,000 cash = new money) x $.55 per $500 = $110  Documentary Transfer Tax paid to the county where the property is located.

 

EER

            Energy Efficiency Ratio (EER) is rating of energy efficiency for an air conditioning unit.  The higher the EER, the better the energy efficiency.

 

Eminent Domain

Eminent domain is the power of the State to take private lands for the public benefit; however, the State must compensate the real property owner for the involuntary conversion of the property.

Generally the taking of private land by governmental bodies for public use is governed by due process of law and is accomplished through eminent domain.

Eminent domain is not a private right.   It is a public right.

Buyers owning a property could not enjoy eminent domain (most people don't enjoy it).

Zoning NOT Included In Eminent Domain

The exercise of zoning authority is not included in the definition of eminent domain.  Remember, zoning is under police power, not eminent domain. 

            Involuntary Conversion

A city or county may take a piece of property for public use through a condemnation action.  This action is called an involuntary conversion.

            A city or county may take a piece of property for public use through a condemnation action.  When this occurs, the former owner is paid for the property and this is called an involuntary conversion.

 Inverse Condemnation

            Inverse condemnation occurs when an owner sues to recover damages caused by the State.

 

Encumbrance

An encumbrance is anything that affects or limits (the fee simple) title to real property.  It is also any right or interest in land possessed by a stranger to the title which affects the value of the owner's estate, but does not prevent the owner from enjoying and transferring title (fee estate title).

            There are two types of encumbrancesmoney encumbrances (liens) and non-money encumbrances (based upon use).

 

Energy Conservation Clause

            Regarding the energy conservation clause in the deposit receipt, the work is paid for by the seller, no matter who wants the work done.

 

Equity

            Equity is the amount of cash a buyer uses to purchase a parcel of real estate.  It can also be defined as the amount of cash a buyer has in a property when existing loans are paid off.

Equity is:

·        the fair market value of property less the loans on it.

·        the difference between mortgage indebtedness and market value of the property.

·        an owner's interest over and above all the liens against the property.

·        the difference between loan amount and value of the property.

·        initial down payment.

·        down payment made on a property when purchased.

 

Equity is the owner's interest in real property over the loans and liens against the property.  The best way to insure that a borrower will NOT default on a real estate loan is to have high equity in the property.

Equity and Debt

            Most real estate assets are usually acquired using debt funds and equity funds.  In fact, many successful real estate investments are initiated and put into place by the use of equity funds and mortgage funds.

 

Escrows

When a person would like to buy a home, does he give $100,000 to the seller in exchange for the keys to the home?  Obviously, the answer is no.  First, the seller transfers the home with a grant deed.  Second, an escrow is usually used to hold the $100,000 (or a significant earnest money deposit) until the buyer is allowed to inspect the property, obtain a clear pest report, inspect title, obtain a preliminary title report (an offer by a title insurance company to issue a policy of title insurance), and any other pertinent due diligence inspections required by the buyer prior to purchasing the property (close of escrow).

            Escrow is the process where money or other documents are held by a disinterested third party (stakeholder) until satisfaction of the terms and conditions of the escrow instructions have been achieved.

            The escrow officer (also called escrow holder or escrow agent) is the agent of BOTH the buyer and the seller during the escrow period.  After close of escrow, the escrow officer becomes the agent of the buyer and seller SEPARATELY. 

During the escrow period, the escrow officer must have agreement between both the buyer and the seller before she can disperse funds or anything else contained in the escrow instructions.  After escrow closes, she will disperse funds and other items contained in the escrow instructions to the buyer and seller individually without the other party's agreement.

            The escrow is used to make sure the conditions and terms of the escrow are met prior to the close.  The escrow gathers all material, fees, and documents during the escrow period.

            An escrow agent must be an unbiased third party.  However, a real estate broker can act as an escrow agent if he is the seller or listing agent.  The broker can perform an escrow, however, he will become the dual agent of the buyer and the seller.

Valid Escrow  

A valid escrow must have a binding contract between the buyer and seller.  This can be a deposit receipt, land contract, or mutual instructions of the buyer and seller.

Escrow Instructions

            Escrow instructions reflect the mutual understanding and agreement between the buyer and seller.

Executed Escrow Instructions

            Escrow instructions must be executed (signed).  This is usually accomplished by the seller, buyer, and escrow agent by signing the instructions.  When escrow instructions have been executed, escrow closes.

Unresolved Dispute

            During escrow, if an unresolved dispute should arise between the seller and buyer preventing the close of escrow, the escrow holder may legally file an interpleader action in a court of law.  An interpleader action is a civil court action if a broker anticipates trouble between a seller and buyer.

            An escrow can be terminated within a reasonable period of time, if the buyer and seller consent to it.

Prorations

            During the escrow closing process, the escrow officer may discover that the seller has paid for certain items (pre-paid taxes and insurance) ahead of time.  To make things fair to the seller, prepaid items are credited back to him on a prorated basis.  These are called prorations.  Prorations are many times impounds of taxes and insurance and are considered a recurring cost (because the buyer continues paying them each month).  Rents may also be prorated in escrow, especially if escrow closes in the middle of the month.

            If the seller had already paid his second property tax installment (January 1st - June 30th) and then closes escrow in the middle of this period, he will receive a credit (money back to him) for the amount of property taxes he has over-paid; because he will not own the property for the other half of the second property tax period.

            Rents are also prorated as of close of escrow.  This occurs when an income property is sold.

            Escrow prorations use a 360 day year.

            When taxes are pending during escrow, the seller is responsible for them until close of escrow.

 Two Pest Control Reports

            Many lenders require a "clear" pest control report prior to funding a loan.  For this reason, pest control reports have become an important part of the purchase or sale of real estate in California.

            A pest control inspection is a visual check for active infestation of pests by a licensed pest control inspector.  The most common pest in California is the subterranean termite.

            If an escrow officer receives two pest control reports, prepared on different dates and with one requiring more corrective action that the other, the escrow officer should notify the buyer and seller that they need to agree which one to use.  If a broker is involved, then escrow should notify the broker that he needs to obtain written instructions from the buyer and seller concerning the reports.

 Conveyance of a Deed of Trust

            The main reason an escrow may be used when a deed of trust is conveyed is to ensure that the conditions and instructions of the agreement are satisfied.

Escrow Terminated

            An escrow can be terminated by mutual consent of the parties to the escrow.

Prior to Close of Escrow

            According to generally accepted practices, an escrow agent is authorized to call for funding of the buyer's loan.  After mutual escrow instructions have been executed by the buyer and the seller, the escrow officer can ask the lender who will be loaning money to the buyer to fund the loan.  This is usually accomplished through a wire (most common) or cashier/bank check.

 Debits and Credits

            When money COMES INTO the buyer or seller this is called a credit.  When money GOES AWAY from the buyer or seller this is called a debit.  The purchase price would be considered a debit to the buyer because it is going away (he is paying it).  Prepaid taxes may be a credit to the seller if he has paid ahead of the time he closes escrow (he is reimbursed for the time he does not own the home).

            For example, the day before escrow closes, the buyer discovers a gate broken.  The seller should have escrow credit funds to the buyer for the repairs.

 Buyer's Inspection Damages Property

            If during escrow a buyer requests an inspection which causes damage to the seller's property, the buyer must pay for this damage.

 Buyer's Earnest Money Deposit

            When a buyer makes a deposit check payable to an escrow company and gives it to escrow, the broker does not have to record it in his trust account.  Only trust funds passing through the broker's hands need to be recorded.

Close of Escrow

            At close of escrow, the buyer receives the grant deed and the seller receives the proceeds of the sale.  When an escrow is in progress, at the time when all the conditions in the escrow agreement have been satisfied (close of escrow), the escrow officer becomes the independent agent of the buyer and the seller.

For example, the seller asks the escrow holder to wire his proceeds into three different bank accounts.  The escrow holder can do this since she is the independent agent of the seller (individually) after close of escrow.  The buyer is not required to agree to these instructions, because escrow has closed.

 Closing Statement

            A closing statement is a detailed cash accounting of a real estate transaction usually prepared by an escrow officer.  It is commonly called the Uniform Settlement Statement or HUD-1 Settlement Statement.  The Uniform Settlement Statement is required by the Real Estate Settlement Procedures Act (RESPA) and is a final statement of closing costs.  The buyer has a right to see the HUD-1/Uniform Settlement Statement at the time of settlement or one day in advance of settlement.  Escrow companies and lenders cannot charge the buyer to produce the Uniform Settlement Statement.

            The escrow closing statement shows the purchase price of the property.  It does not show interest cost.

Escrow Companies

            All escrow companies must be licensed by the corporations commissioner.

Acknowledgement, Verification, and Recordation

            Most escrow officers are also notary publics.  In the course of closing escrow, a notary public is many times used to acknowledge who the person(s) executing the documents are, verifying who they are (notarize), and recording the documents at the county recorder's office.  Recordation gives constructive notice to the world that the escrow has closed and the property has been conveyed to the new owner(s).  However, remember that a deed does NOT require acknowledgement to be valid, however, it must be acknowledged if it is going to be recorded.

 Acknowledgement

            An acknowledgement is a formal declaration made before a notary public by a person who has signed a document.  The notary public confirms that the person IS who he or she says she is and provides proof of identity.  An acknowledgement is designed to prevent fraud and forgery in the conveyance of real property.  An acknowledgement is frequently used when a person signs escrow instructions during the closing process.

            If there is no interest in the property, an employee of a corporation can acknowledge a signed legal document. 

 Verification

            When a document is notarized by a notary public, and the notary public verifies by a person's signature that he is who he says he is, this is called verification.

Recordation

            The county recorder in the county where the property is located enters recorded documents into the public records.  These entries give holders of earlier recorded documents priority based upon their recording dates.

            Generally, the first party to record a document is the first in right.  For example, the first lender to record a loan against a property holds the first trust deed and the second lender to record a trust deed holds a second trust deed. . .and so on.  The only exceptions to this rule are mechanic's liens, taxes, and subordinated liens (loans). Each are discussed later in the textbook.

 

Exchanges

When an investor sells an income property he may receive a capital gain on the property.  He must pay a tax on this capital gain received, unless he exchanges the property for another (higher priced) property and follows strict rules set by the IRS and the courts.

            There are two types of exchanges that can be performed by investors:  straight across exchange and delayed exchange.

In a straight across exchange each investor exchanges (trades) properties directly to each other.

In a delayed exchange the investor sells his property, then must reinvest the proceeds (capital gains) within a prescribed period of time.  He must purchase a more expensive property than the one he sold and the property must be of a like kind (real estate for real estate).  If he does these two things, the capital gains tax will be deferred into the future.  This delayed exchange is called a 1031 exchange because of the IRS Code referring to it.  Remember, an IRS 1031 exchange would not be allowed if the properties are not of a like kind.

Boot

            When two investors perform a straight across exchange and one property is worth more than the other, one of the investors must include some cash with his property to make the exchange even.  This cash is called boot.

            When two investors perform a straight across exchange and one property has a larger loan than the other property, then one of the investors debt is reduced.  This is called loan or mortgage relief or mortgage boot.

            Therefore, boot is used in computing the federal income tax due when real property is exchanged.

            For example, Able owns an income property valued at $160,000, with an adjusted basis of $70,000.  Baker owns another income property valued at $155,000.  Both properties are owned free and clear.  Able and Baker exchange their properties, with Baker giving Able $5,000 in cash.  For federal income tax purposes Able has a recognized gain. The $5,000 gain is called boot.

Basis in Exchanged Property

            For example, Able agrees to exchange investment real estate he owns with a fair market value of $330,000 and an adjusted basis of $220,000.  He is exchanging this property for a new one with a fair market value of $360,000.  Both properties are owned free and clear and no boot was given or received.  Able’s basis on his new property would be $220,000. By exchanging into a higher priced property his old basis ($220,000) moves over to his newly acquired property.  He now has a market value of $360,000 and a basis of $220,000.

Another example, if Able owns a commercial building having a fair market value of $660,000 and a basis of $440,000, and he exchanges it for an apartment building having a fair market value of $730,000, his basis in the property being acquired is $440,000. By exchanging into a higher priced property his old basis ($440,000) moves over to his newly acquired property.  He now has a market value of $730,000 and a basis of $440,000.

 

Exclusive Agency Listing

An exclusive agency listing is a written listing agreement where the listing agent receives a commission no matter who sells the property—except if the seller sells the property himself.  If the seller sells the property himself, the listing agent does not receive a commission.

      For example, Broker Baker has listed Seller Able's home using a four month exclusive agency listing agreement.  He expends much time and effort marketing the home and much money advertising it for sale.  Ten days before the listing expiration date Able sells the home to his own neighbor Ned.  Able owes the broker no commission.

 

Exclusive Authorization To Locate Property

      An exclusive authorization to locate property is a written agreement where the buyer agrees to pay the agent a commission if he finds a suitable property for him to purchase.

When a buyer signs an exclusive authorization to locate a property agreement there is usually a clause in the agreement which allows the broker to represent other buyers during the time limits of the agreement.

 

Exclusive Right To Sell/Exclusive Authorization And Right To Sell Listing

An exclusive right to sell listing is a written listing agreement where, no matter who sells the property, the seller agrees to pay the listing agent a commission.  

Seller Sells Property Himself

If the seller sells the property himself, he is still obligated to pay the listing agent a commission.  For example, an owner listed his property for sale with a broker, but sold it himself without utilizing any of the broker's services. He was obligated to pay the listing real estate broker a commission.  Under these circumstances, the type of listing used was an exclusive right to sell listing. 

Definite Termination Date

An exclusive right to sell listing must have a definite termination date.  Therefore, a broker licensee can legally claim a commission for the sale of a property on which he had an exclusive authorization and right to sell listing with a definite termination date.

Not Prove Procuring Cause

      A real estate broker need NOT prove that he is the procuring cause when an exclusive right to sell listing is used.  In order to be entitled to a commission, a broker must show that he was the procuring cause of the sale under an exclusive agency listing, an open listing, and a nonexclusive listing.  He does NOT have to show himself as the procuring cause for an exclusive right to sell listing.

Owner Cancels Agreement

            If an owner signs an exclusive authorization and right to sell listing agreement, and then cancels the agreement, the owner can cancel the contract but may be liable for the payment of damages under the agreement.

            For example, Owner Able gave an exclusive right to sell listing to Broker Baker for a period of 90 days.  This agreement provides that Baker will earn a 6% commission.  Baker commenced efforts to sell the property, advertising it extensively.  Thirty days later, Able sent a certified letter to Baker canceling the listing agreement, indicating that because he was giving an open listing to other brokers, he did not owe Baker a fee.  The terms of the open listing provide for a 5% commission to be paid.  Thirty days later, one of the agents to whom Able had given an open listing sold the property.  In this instance, the seller would be liable to pay commissions to BOTH Broker Baker and the broker who sold the property (11% total commission!!!)

 

Fair Housing

            Federal Fair Housing Laws

Year Enacted

The main federal fair housing law was the civil rights act of 1968.  This Act has been instrumental in prohibiting discrimination in the sale and lease of housing throughout the United States.

Applies To

The Federal Fair Housing Act applies to:

·        Single-family residences being sold through a real estate broker.

·        Single-family residences owned by individuals who own more than one residence.

·        All family dwellings of six units where the owner occupies one of the units.

Warehouses do NOT comply with the Fair Housing Act.  People do not generally live in warehouses (at least in California).

Suspend License

If a person’s rights under the 1968 Civil Rights Act are violated, the courts cannot suspend or revoke a real estate license.  The Real Estate Commissioner is the only one who can suspend and revoke real estate licenses.           

Violation Must Be Filed Within          

A violation of the Federal Fair Housing Act must be filed within 180 days of the alleged violation

 

Word Problem

A real estate broker presented an offer to purchase a home which met the terms of the listing.  The offer was from a financially qualified black person.  Later this salesperson presented to the seller an offer at a lower price from a white prospect.  The seller did not accept either offer.  Rather he sold the property to a neighbor through the same salesperson.  The neighbor wanted to buy the property so as to prevent a minority person from moving into his neighborhood.  The person who has not violated the Civil Rights Act of 1968 is the white prospect.  (The seller, neighbor, and salesperson have all violated the Act.)

State Fair Housing Laws

            There are three important fair housing laws that have been enacted in the State of California:

 

 

 

 

 

Unruh Civil Rights Act – prohibited discrimination in business establishments in California.

 

Rumford Act – prohibited discrimination in the sale and rent of residential properties in California.

 

Holden Act – prohibited discrimination in lending in California.

Unruh Civil Rights Act

            The Unruh Civil Rights Act allowed both actual and punitive damages. 

Housing Financial Discrimination Act of 1977 (Holden Act)

Higher Interest Rate Charged

            XYZ Savings and Loan Association negotiates a $200,000 loan with Maria Gomez.  Maria speaks no English.  In order to complete the transaction XYZ provides loan forms written in Spanish.  In the escrow closing statement, Maria is charged a 1/8% higher interest rate than other borrowers who speak English.  Under these circumstances the lender could NOT impose the extra charge. This is also a violation of the Housing Financial Discrimination Act of 1977.

Race And Marital Status Requested

A loan broker asks a person applying through the broker’s office for a new loan to fill out a questionnaire in which the borrower’s race and marital status are requested.  The applicant can refuse to disclose his race and marital status.

Redlining

            When a lender refuses to make real estate loans in areas that have declining socio-economic conditions he (in the past) placed a red line around that area.  Redlining is illegal and leads to increased urban blight due to the lack of available financing in economically troubled areas.

Steering

            Steering occurs when an agent steers a prospect out of communities that are not of his ethnic race.  Steering is illegal.

            The type of property an agent should show a Chicano if the Chicano does not ask to look at properties in a Chicano community is any property that is available.

The agent is showing a Chicano some single family residences.  In doing so, the agent avoids certain areas in which Asians reside.  This is called steering.

            A real estate licensee has a practice that when he is approached by members of minority groups who want to be shown property, he avoids showing them property in integrated areas.  This would be an example of steering.

Agent Refuses To Show Property To A Member Of A Minority Group

            Real estate agent refuses to show a single family residence to a member of a minority group, if the owner has directed the agent to show the property only when he is physically present, the salesperson should not show the property if the seller is not at home.

Panic Peddling and Blockbusting

            Panic peddling and blockbusing are very similar terms.  When an agent goes into a neighborhood and informs the homeowners that they should sell their homes now because minorities are coming into the neighborhood and their homes will suffer a loss in value, this is called panic peddling or blockbusting.  Both of these activities are illegal.

            For example, a real estate broker undertakes to canvas a neighborhood area that is very near to a section into which minorities have recently moved telling the people to whom he talks that they should sell now as their property might suffer a loss in value in the future.  That broker is guilty of panic peddling and blockbusting.

            A licensee contacts owners of homes in an area indicating that they should list their homes for sale with him because Blacks may be moving into the area.  This practice would be blockbusting, panic peddling, and illegal. Legal but unethical would not apply in this case.

Race Restrictions On A Deed

            Regarding the conveyance of a deed including race restrictions, the deed is valid, but the race restrictions are unenforceable.

The conveyance is unaffected as the covenant is unlawful and unenforceable.  The deed is lawful and effective. Remember: race restrictions on a deed are unenforceable because they violate the U.S. Constitution.

Marital Status Discrimination

            It is illegal for a landlord to require a tenant to have a co-signor because he is not married.  This is marital discrimination and illegal.

            A landlord cannot require that unmarried (single) tenants have a co-signor.

Department of Fair Employment and Housing  and Fair Employment and Housing Commission

            The Department of Fair Employment and Housing and the Fair Employment and Housing Commission receive complaints concerning fair housing laws.

 

Federal Housing Administration (FHA)

The Federal Housing Administration (FHA) is under the Department of Housing and Urban Development (HUD).  FHA insures loans made by approved lenders.  FHA charges mutual mortgage insurance (MMI or MIP) to pay for the insurance of high loan-to-value loans.

            The Federal Housing Administration’s role in financing the purchase of real property is to insure loans made by approved lenders.  Therefore, the main purpose of FHA is to promote homeownership by insuring home loans.

            If a person borrows money to purchase a personal residence, the loan most likely will be insured by FHA or a private mortgage insurer.

Where To Secure An FHA Insured Loan

            A borrower would look to a lender to secure an FHA insured loan. If the property is hypothecated (placed as collateral for a loan) by a deed of trust, the borrower would look to the beneficiary (lender) to secure a loan.  However, if the property is hypothecated by a mortgage, the borrower would look to a mortgagee to obtain an FHA insured loan.

FHA Loan Terms

            The down payment required by the borrower securing an FHA insured loan depends upon the type of FHA loan being considered.  There are several different programs available for one-to-four unit properties.

FHA Interest Rate

            The interest rate on an FHA insured loan is set by market conditions.  The interest rate floats with market rates and, therefore, the government does not set the rates.

FHA Discount Points

            The buyer or seller can pay discount points charged on an FHA insured loan. 

FHA Insured Loan On A Mobilehome

            The maximum term for an FHA insured loan on a mobile home is 20 years.  Because of the shorter useful life of a mobile home versus a single-family home.

 

Federal Savings and Loan Association

            A principal lender of money for financing the purchase of residential properties is federal savings and loan associations.  These associations have traditionally been very active in making loans for single-family homes.  These loans are either portfolio (through their own deposits) or sold on the secondary mortgage market.

 

Fee Appraiser

A fee appraiser is an appraiser who is self-employed and appraises properties for the payment of a fee.  The fee is usually paid by the buyer of the property.  Not only is an appraisal a good idea for a person purchasing a property, a lender will almost always require an appraisal before funding a loan.  In this way the lender is assured of the property's collateral position if there is a foreclosure.

            A fee appraiser is a person who is self-employed and prepares appraisals for individual clients.  As the name "fee appraiser" implies, he is paid a fee for his appraisal services.  Appraisers do not, however, charge standardized fees for similar appraisal reports.  A fee appraiser can only discuss his findings with the owner of the property.

 
Fee Simple Absolute

A fee simple absolute estate is the highest form of ownership recognized by law.  The owner has the entire bundle of rights without any restrictions.  The bundle of rights includes the right to use, possess, transfer, and dispose of a property.

            Fee simple estates are also called estates in fee and estates of inheritance.  The term "fee" denotes the highest form of ownership and is commonly used in preliminary title reports and policies of title insurance.  Since a fee simple estate is an estate of indefinite duration and can be inherited, it is also called an estate of inheritance.

 

Fee Simples Defeasible

A fee simple defeasible (also called fee simple qualified or fee simple condition subsequent) estate is a fee simple estate with a restriction placed on the title to the property.

            A condition subsequent is a condition placed on the title where some specified occurrence in the future (subsequent) will cause a loss of title (condition).

            If a fee simple absolute owner disposes of a property (sale, will, or gift) and places a restriction on the use of the property, then the new owner has a fee simple defeasible or qualified title to the property. 

For example, Aunt Alice owns a piece of real property as fee simple absolute title.  She has the entire bundle of rights at her disposal and can use the property, will it, sell it, and convey it.  Her nephew William is aware of her activism in prohibiting the consumption of alcoholic beverages in all of society and is not surprised when she states in her will, "I leave the Teetodler Restaurant to my nephew William; however, if he ever sells alcoholic beverages on the property he will forfeit the estate, and my nephew Charles (or someone else Great Aunt Alice designates) will take over the fee simple defeasible title to the property."

            Fee simple defeasible title to the property can be "defeated."  Fee simple qualified is used interchangeably with fee simple defeasible.

            In addition, contract law states that when a condition is placed on the title to a property and it is breached, loss of title may result.  Therefore, when Great Aunt Alice placed a condition subsequent on the title to her devised (willed) property, she was able to "come back from the grave" and make sure her nephew obeyed her wishes.

 

Flashing

            Flashing is the metal material placed in the valleys of a roof to prevent water seepage into the home.  It protects the building from water seepage.

 

Footing

            A footing is the spreading portion of the foundation wall.

 

Foundation/Cracks in Foundation

When an appraiser observes cracks in the foundation of a hillside residence and notices doors and windows do not close properly, he will probably recommend a soils engineering report. 

            However, if he sees cracks in the corner of a basement he will probably attribute this to property settling.

 

Foundation Plan

A foundation plan shows where the piers, columns, and footings are placed.

 

Franchise

            When a business firm awards a person the right to market its name, products, and services this is called a franchise.           

            An offer to sell a franchise in California must be registered with the Department of Corporations unless it is exempted because the franchisor has a net worth of not less than $5 million.

 

Freehold Estates

Freehold estates originally came from England many years ago.  When the King of England wanted outlying lands protected from conquest, he appointed someone of good fighting ability to pledge his allegiance to the King in return for ownership of the lands.

            The new landowner was called a "freeman" and, therefore, held title as a freehold estate in land.  All of the other people living on the new landowner's property were called tenant farmers and held less-than-freehold estates, also called leasehold estates (possession).

            For example, in the movie "Braveheart," Mel Gibson suddenly ended the careers of a couple of noblemen who double-crossed him in an earlier battle.  The King immediately offered Braveheart (Mel's character) the departed noblemens' lands in return for allegiance to him.  Of course, as movie scripts go Mel could not accept the King's offer because it would have ended the movie and denied Mel's chances for an Oscar, so he rejected the King's offer and was later killed in a spectacular manner (and the movie won the Oscar).  In the real world, Mel would have jumped at the chance to become the freehold owner of a vast empire of land.  The large number of people who were killed in the mass battles in the movie were tenant farmers who owned less-than freehold estates (leasehold estates). They merely had possession of the property.

            With freehold ownership there are several rights that come into existence: 

·        the estate is of indefinite duration,

·        it is an estate of inheritance/it can be willed,

·        it is the greatest interest a person can own in land, and

·        it is usually not free of encumbrances (loans, etc.) on it. 

Let's discuss the above rights. . . .

Estate Of Indefinite Duration

            The ownership interest continues for an indefinite period of time.  The period of ownership is not for a set or stated period, but continues on into infinity.

Estate of Inheritance/ Can Be Willed

            The ownership interest can be willed to the owners' heirs. . .and to their heirs, etc., down through the generations.  Also, the freehold estate can be willed to anyone the freehold owner wishes.

Greatest Interest A Person Can Own In Land

            There is no higher form of ownership.

Not Free Of Encumbrances

            Encumbrances are things that limit title to the property.  These include easements, loans (trust deeds

 

Government Patent

A government patent is an instrument that conveys real property from the state or federal government to an individual.  During the 19th century many farms were occupied during the migration west.  After each farm was occupied and improved over a two year period, the land was deeded to the occupier (farmer) using a patent deed (a type of grant deed). 

 

Government Survey Method

The Government Survey Method of land description is used for large parcels of rural acreage.

            California has 3 principal base and meridian line intersections.

            Starting from the intersection of (for example) the Mt. Diablo base line and meridian, there are squares that spread out in all directions from the point of intersection.

            Each of the above mentioned squares is 6 miles x 6 miles on each side = 36 square miles or 6 miles square (a square 6 miles on each side) and is called a township.

            There are 36 smaller squares within each township. Each smaller square is 1 mile x 1 mile = 1 square mile and is called a section. 

            There are 640 acres in one section (1 square mile). 

            There are 43,560 square feet in one acre.

            One-half of a township contains 18 square miles.

            A parcel 36 miles square contains 36 townships!!!

Key numbers to remember:

Ø      There is one square mile in a section.

Ø      A parcel 36 miles square contains 36 townships (a square 36 miles on each side).  This is a very large parcel of land!!!

Ø      One-half of a township contains 18 square miles.

Ø      5,280 linear feet= 1 linear mile.

Ø      43,560 square feet = 1 acre

Ø      640 acres = 1 square mile

Ø      1 section = 1 mile x 1 mile

Ø      36 sections = 1 township

Ø      1 township = 6 miles x 6 miles

Ø      1 township = 6 miles square

Ø      1 township = 36 square miles

 

A commercial acre is an acre less the amount of land dedicated for public improvements (sidewalks, alleys, etc.).

            A commercial acre can be much less than the 43,560 square feet in a regular acre of land.

           

Grant Deed

A grant deed is a document that transfers title to real property from one party to another.  It uses a granting clause with the words "grants to" appearing in the center of the grant deed document.

            The grantor is the person transferring the property (usually the seller) to the grantee who is the new owner (usually the buyer).

            To be valid, a deed must contain a granting clause. In addition, it must be signed by the grantor (the grantee is NOT required to sign the grant deed) with legal capacity (over 18 years old), intentionally delivered by the grantor and accepted by the grantee, have a property description (all real estate instruments require a property description before they can be recorded), the names of the grantor and grantee, and it must be in writing.

Executed

            A grant deed is executed when it is signed by the grantor.

Acknowledged

            Acknowledgement of a grant deed is NOT required; however, if the grant deed is recorded, then it requires acknowledgement.  A notary public is generally used to acknowledge the person signing the grant deed is indeed that person and not a forgery.  However, an employee of a corporation who does not have a personal interest in the conveyance can also acknowledge the document.  After acknowledgement, the notary notarizes (verifies) the grantor's identity and records the document.

            If a grant deed is used as prima facie evidence in court, then it must be acknowledged.  The acknowledgement is made by the grantor.

Delivery

            A grant deed passes title when it is delivered.  A grant deed must be delivered and accepted by the grantee to pass title.   Delivery shows intent; therefore, effective delivery of a deed depends upon the intention of the grantor.  Delivery of a grant deed is required in the conveyance of real property.

Recordation

            When a grant deed is recorded it presumes delivery.  However, as mentioned earlier a grant deed is not required to be recorded (or dated) to transfer title.  For this reason, when a seller hands a deed to a buyer and the buyer forgets to record it, the delivery is valid.

            Assignment

            A grant deed CANNOT be assigned.  A new grant deed would be used to transfer title from one party to another.

Reservations

            When a grantor includes certain reservations in the grant deed, they are usually for the benefit of the grantor.

County Recorder

            The county recorder indexes deeds by grantor and grantee.

Fictitious Person vs. Fictitious Name

            A grant deed to a fictitious person is void (the person does not exist).  However, a grant deed to a person under a fictitious name or assumed name is permissible (valid).

Warranties

            Grant deeds have an implied warranty that the grantor has not previously conveyed the title to someone else.  The two implied warranties are:

Ø      The grantor has not already conveyed title to another.

Ø      The estate conveyed is free from encumbrances other than those disclosed.

 

Hard Money Loan

            A hard-money loan means a cash loan.  It is a usually a second trust deed secured by real estate and given to a third party to obtain a cash loan.  Hard money loans are usually foreclosed by huge guys named “Guido and the Boys.” (only kidding).

 

Highest and Best Use

Highest and best use is defined as the use for a parcel of real property that will provide the highest return to an owner or buyer.  An appraiser looks at a parcel of vacant land and tries to determine what type of use (building/improvement) will provide the highest return on the parcel.

If an appraiser uses site analysis to appraise an undeveloped parcel, he will probably find that an office building is the best use for the property if the surrounding properties are office buildings and the parcel is zoned for office buildings.  Due to the principal of conformity, an office building of similar design and construction as the surrounding buildings will cause an increase in value for the properties in the area.

Site Analysis

An appraiser uses site analysis to appraise an undeveloped parcel (vacant land) and considers the highest and best use for the property.  A site analysis analyzes the physical site of the property looking at all possible uses for an undeveloped or unimproved parcel of real property.  The first step in the appraisal of vacant land is to determine the highest and best use for the property, which will produce the highest net income from the property.

Net Income

            Highest and best use relates to the highest net income attributable to the land.

Principle of Conformity

            In a well-planned residential community, conformity to proper land-use objectives contributes the most to the maintenance of value.  Conformity causes a stability of value.  Stability of value is threatened when quality housing is mixed with average housing.

            Therefore, by conforming to proper land use objectives such as building retail along busy streets and residential properties away from congestion and noise, property values are maintained.

Building Adds No Value

When an appraiser determines that a building on a parcel of real property adds no value to the land, according to the highest and best use he would subtract the cost of demolishing the building from the value of the land.

Interim Use

            An interim use is an existing temporary use that will change to a highest and best use in the future.  For example, a land developer plants a vineyard on land that is in the path of progress.  Several years later, single-family homes will be built on the land that is now occupied by the vineyard.  The highest and best use is single-family homes.  The interim use is a vineyard.

 

Hip Roof

            A hip roof slopes on all four sides.

 

HVAC/Heating, Ventilating, and Air Conditioning

            An HVAC systems is the heating, ventilating, and air conditioning system that heats and cools the home. 

 

Illegal Referral Fees

            It is legal to give a $500 microwave oven to someone who purchases from a real estate broker, as long as he discloses this fact to all parties in the transaction.

            However, salespersons cannot receive commission income or referral fees directly to them.  The monies must be paid to their broker and then from the broker to the salesperson.  If a salesperson is receiving referral fees directly from anyone, both the salesperson and broker must notify the Real Estate Commissioner immediately in writing relating the circumstances of the infraction.

            For example, a broker indicates that he will give a $500 microwave oven if a person buys one of his listed properties.  This is legal if all required disclosures are made.

A real estate broker advertises that he will give a seller a $50 credit in escrow on his commission to any seller who lists with him and that he will pay $50 to any buyer who purchases a property from him.  This type of advertising is legal if disclosure is made to all parties in the transaction.

A broker has discovered that one of his salespersons received a referral fee from a lender.  The Broker does only the following two things:  he fires the salesperson and warns the rest of his office salespeople not to do the same thing.  The effect of this would be that both the salesperson and the broker are subject to disciplinary action by the Commissioner.  The broker must immediately notify the Commissioner in writing that the infraction occurred.

 

Impounds

            When a lender institutes a high loan-to-value loan with a small down payment, he assumes a risk that the borrower may keep making principal and interest payments however, stop paying tax and/or insurance payments.

            If the borrower does not pay taxes on the property, the lender will probably end up paying them during the foreclosure process.  As we already know, taxes are always paid before voluntary liens such as deeds of trust. Therefore, the lender would be in second position behind payment of taxes at the foreclosure sale. Insurance could also become an issue if the property burns to the ground.

            The term impound means reserves.  The lender collects tax and insurance reserves through impounds of taxes and insurance and then pays them for the borrower as they become due.

 

Income/Capitalization Approach

The income or capitalization approach is used to appraise the value of income producing properties.  This approach converts an income stream into value.  The concept is simple.  The application is not.

            Price x Capitalization Rate = Net Operating Income

            If an investor pays $1,000,000 cash for a property, he will expect a return on his money commensurate with his risk.  The risk-return tradeoff applies. Therefore, an investor will accept a 7% return for an apartment building, however, he will require a 9% return for an office building.  Office buildings have inherently greater risk and therefore generally require a greater return than apartment buildings.  Capitalization rate is the return an investor receives if he pays all cash for the property.          Net operating income is the income received from the property if the investor pays all cash.  It does not take into account mortgage interest from loans on the property.

            Annual Operating Information:

            Gross (Scheduled) Income

            less Vacancy

            less Bad Debts

            less Rent (Collection) Losses

Effective Gross Income (income actually collected)

less Operating Expenses (management fees, maintenance expenses, etc.)

            Net Operating Income                    

less Mortgage Interest or Debt Service or Mortgage Debt

            Cash Flow

 

            We have come up with the "IRV" formula that is easy to apply:

            I/R = V

            or

Net Operating Income ("I")

Capitalization Rate        ("R") = Value of the Property ("V")

 

Effective Gross Income

            Effective Gross Income is the income actually collected by the landlord, but before operating expenses are paid.  In the Annual Operating Information above, Effective Gross Income less Vacancy, Bad Debts, and Rent Collection Losses equals Effective Gross Income.               

Net Operating Income

            Net Operating Income is defined as Gross Scheduled Income less Vacancy, Bad Debts, Rent Collection Losses, and Operating Expenses.  Mortgage Interest is NOT included in the calculation.  Therefore, leverage resulting from financing is not a factor in the calculation.  Interest rates are also not a factor.

Capitalization Rate

            Capitalization is a process where an appraiser converts income into capitalized value.  It is value from an income flow.  In other words, how much would an investor pay for an $80,000 income flow.  The answer utilizes the capitalization rate to determine how much an investor would pay for this income. With an 8% capitalization rate, an investor would be willing to pay $1,000,000 for an $80,000 income flow.

            The income approach places the greatest emphasis on the present worth of future benefits.  How much is an investor willing to pay (present worth) for an $80,000 income over his five to seven year holding period (future benefits).

Principle of Anticipation

            The capitalization approach is based on the appraisal principal of anticipation.  An investor would be willing to pay $1,000,000 cash in anticipation of $80,000 per year in income over the holding period.

Determine Capitalization Rate

            The most critical and difficult step in the income capitalization approach is to determine the correct capitalization rate based on the risk of the investment.  Capitalization rate is determined by the band of investment theory, comparison approach, and summation.

Band of Investment Theory

            The band of investment theory considers the risk free rate of return, adds market risk to this amount, and then adds property risk to determine the overall capitalization rate.

Comparison Approach

            The comparison approach can be used to determine a capitalization rate by comparing capitalization rates on other similar investments.  By comparing three other apartment buildings near the subject property, an investor may determine that a 7% capitalization rate is what other investors are obtaining from similar investments.  This would, in turn, give the investor a benchmark to evaluate the subject property's income flow in relation to the capitalization rate.

Summation

            For State Exam purposes, please consider this approach similar to the band of investment theory.

IRV Word Problems:

1.  Leonard owns a 40-unit apartment building for which he uses an 8% capitalization rate.  If the building produces $174,000 net income, which of the following is most nearly the value of this property?

(A)  $1,392.00

(B)  $1566.00

(C)  $2,175,000

(D)  Not enough information to calculate

Correct answer is C.                            

$174,000 divided by 8%          = $2,175,000

     I                        R             V   

2.  An $800,000 apartment building has an annual net income of $72,000 when using a 9% rate of return.  If the rate of return increased to 12%, how much would an investor pay for the property?

(A)  $300,000

(B)  $600,000

(C)  $423,000

(D)  $960,000

Correct answer is B.                

$72,000 divided by 12%          = $600,000                                                  I                     R           V  

 

 

 

 

 

 

3.  When estimating the value of an income property by the capitalization method, the difference between an annual net income of $30,000 capitalized at 5%, and the same amount capitalized at 6% is:

(A)  $30,000

(B)  $100,000

(C)  $120,000

(D)  $300,000

Correct answer is B.                            

$ 30,000 divided by 5%           = $600,000      $ 30,000 divided by 6%           = $500,000                                                                                                         $100,000   Difference

 

4.  An apartment building has $80,000 gross income, operating expenses of $25,000, depreciation of $10,000, vacancy rate of 10%, and a value of $450,000. What is the capitalization rate?

(A) 10%

(B) 10.4%

(C) 8%

(D) 7%

Answer:  B

$80,000 gross income minus $8,000 (10%) vacancy = $72,000 effective gross income minus $25,000 expenses = $47,000 net income. The formula is: Income divided by rate = value (I/R=V); therefore, $47,000 net income divided by $450,000 value = .104 or 10.4% capitalization rate.

Gross Rent Multiplier

            Gross rent multiplier is the number of times the Gross Scheduled Income of a residential income property will divide into the price of the property.  Rent multipliers are used exclusively with residential properties.  Commercial properties do not use rent multipliers.  However, all income properties use capitalization rates.

A rent multiplier is not as effective as a capitalization rate; however, it can be accomplished in one mathematical operation (elementary school math again). 

Most gross rent multipliers for income properties use an annual gross rent multiplier; however, single-family and small residential income properties use a monthly gross rent multiplier instead of an annual one.

A gross rent multiplier would be computed as sales price divided by gross monthly rent (small residential income property).

Applicability of Income/Capitalization Approach

            The Income/Capitalization Approach can be used by an appraiser to value a shopping center, retail/commercial properties, restaurant building, office building, or any other income producing property.

Office Building

            An appraiser will consider maintenance costs, property taxes, and net operating income in appraising the value of an office building.

 

Insurance Companies

            Insurance companies have traditionally made very large multi-million dollar loans.  They like to make loans with the assistance of mortgage companies (mortgage bankers). 

Conversely, commercial banks make small, short-term loans such as construction loans (an insurance company would be least likely to make a construction loan).  Savings and loan institutions and mutual savings banks make small, long-term loans (mostly on single-family homes).

            If a developer needs a $3,500,000 loan to finance a development project, he most likely would apply to an insurance company.  Again, insurance companies like to make large loans. This size loan would probably qualify.

            If a person owns free and clear a single-family residence that is appraised at $83,000 and wants to secure a $7,000 15 year loan on it, an insurance company would most likely turn him down.  An insurance company would be interested in a $7,000,000 loan not a $7,000 loan.  A commercial bank would be a better choice for this size loan.

 

 

Interest

            Interest is the cost to rent money. When a person borrows money she must pay a rental charge for the use of the money.  This rental charge is called interest.  Interest in real estate loans is always simple interest and is not compounded. 

            Interest is the cost of homeownership. Most homebuyers use equity and debt funds to purchase a home.  The interest associated with the debt portion is the largest cost of homeownership.

Conversely, loss of interest income from equity or down payment is a cost of homeownership.  One of the costs of homeownership is the lost income that could have been derived from the equity or down payment used to purchase the home.

Nominal Interest Rate

            The nominal interest rate is the actual interest rate named or specified in the note or contract.  The nominal rate does NOT include the up-front garbage fees that include document preparation fees, processing fees, and other charges used to increase the lender's yield on a loan. 

Effective Interest Rate

            The effective rate is the actual rate of interest the borrower pays including all the garbage fees usually charged by lenders when making a loan.  For example, the nominal rate (actually named in the promissory note) is 7%.  However, when all the garbage fees are factored into the rate, the effective rate is actually 11%.  The effective rate is also called the Annual Percentage Rate (APR) that will be discussed later.

            Therefore, the effective rate is the interest rate actually paid by the borrower for the use of the money and is the ultimate rate of interest (including discount points).

Word Problem:

            Able secures a loan from a bank. The loan is secured by a second trust deed on his condominium. A friend asks Able what the nominal and effective rates are for his promissory note.  Able is knowledgeable concerning real estate and finance and states,

"The effective interest rate is the rate actually paid by the borrower for the use of the money.  The nominal interest rate is the rate specified in the note.

 

Interest-Only

            An interest-only loan is a loan where interest payments are made over the life of the loan, and the entire principal balance is paid in one lump sum (along with the last interest payment) at the end of the loan term.  Many 2nd trust deeds (junior loans) use interest-only payments and hence utilize a straight note (a promissory note called a "straight note") as evidence of the debt obligation.

            A note where only the interest is paid (interest-only) during the term of the loan is called a straight note.  For this reason, a straight note will have no principal payments during the term of the loan, except on the last payment.

 

Joint Tenancy

Joint tenancy is a form of concurrent ownership where each joint tenant has four common unities:

 

The joint tenants must:

Ø      take title at the same time;

Ø      with the same title instrument (usually a grant deed);

Ø      their interests must be equal; and

Ø      the must have equal possession.

 

If all four unities are satisfied, then the ownership may be held as joint tenants.  Husband and wife commonly hold title as joint tenants, however, any group of two or more persons (except a corporation) can hold title as joint tenants.  Vesting would read, "Husband and Wife, as joint tenants."  

For five hunting buddies who own a hunting cabin in joint tenancy, it would read "Hunters A,B,C,D, and E, as joint tenants."

            Joint tenants also share a right of survivorship.  For example, if husband and wife hold title in joint tenancy and the husband dies, the wife merely presents the death certificate to the county recorder and his half of the property automatically transfers to her.  No probate is required (because of survivorship).  Thus joint tenants CANNOT will their interest in real property.

 

                        Husband                                  Wife

                        50% ownership                        50% ownership

                        Cannot will                               Cannot will

 

                                Both have right of survivorship

 

            A corporation cannot hold title as joint tenants because a corporation never dies.  Survivorship will never be attained with a corporation as a joint tenant.

            Time, title, interest, and possession are referred to as T-TIP.  T-TIP refers to right of survivorship. 

1.      Time - Take title at the same time.
  1. Title/One Title - One grant deed. If five or six people take title to property in joint tenancy, there is ONE TITLE.
3.      Interest/ Undivided interest/Equal shares - Always equal.
4.      Possession - all joint tenants possess the property.

 

            A joint tenancy can be created by a deed from:

Ø      a husband to himself and his wife as joint tenants,

Ø      joint tenants to themselves and others as joint tenants, and

Ø      tenants in common to themselves as joint tenants.

 

Free of Unsecured Debts

            When one joint tenant borrows money against the property WITHOUT the other joint tenants' consent and then dies, the other joint tenant(s) are not responsible for the debt.  A lender would be well advised to obtain joint and several liability on the debt before making the loan.  Joint and several liability would require both joint tenants to sign the note jointly (both) and severally (individually).

Right of Survivorship

            Joint tenants cannot will their interests in real property.  When one joint tenant dies, his interest goes to the other joint tenant(s).  Joint tenants can sell, encumber, and convey the property; however, they cannot will the property.

Joint Tenancy Word Problems:

1. Able, Baker, and Charlie own a vacant lot as joint tenants.  Able dies, what happens to Baker and Charlie's interests?

Answer:  Able's interest terminates and Baker and Charlie each own 50% of the property.  

2.  Able, Baker, and Charlie hold title as joint tenants.  Charlie dies:

Answer:  Able and Baker remain as joint tenants.

3. Able died and in his will he left his nephew Baker and Baker's wife Doris real property as follows:  Baker was left a 2/3 interest and Doris was left a 1/3 interest jointly with right of survivorship. They will most likely take title as:

Answer:  tenants in common.  (Even though they would like a joint interest with right of survivorship, they do not have equal interest and, therefore, must take title as tenants in common.)

4.  A father places his sons Able, Baker, and Charlie as joint tenants.  Charlie sells his interest to David.  Baker dies and his sole heir is Eric. Able would:

Answer:  hold 2/3 title with David as tenants in common.

Other Points To Consider

            An interest in joint tenancy is not terminated or transferred with a lease of the property.  Joint tenancy and community property share in (both have) equal interests.

 

Joint Venture

A joint venture is for two or more people to enter into a real estate venture for one property only.  Tenancy in partnership can use one partnership agreement for several properties.  A joint venture is for one specific property and is not designed to continue on to other properties.

 

Joist

            Joists are located in the ceiling of a house.  They are parallel wooden members used to support floor and ceiling loads.

 

Kiosk

            A kiosk is a small booth located within a shopping mall.  It may also be a small structure located in the parking lot of a shopping center.

 

Land Contract

Another security device that is used in California is called a land contract.  A land contract has seven other names on the State Exam:  conditional installment contract, conditional sales contract, legal sales contract, real property sales contract, land contract of sale, contract of sale, and agreement of sale.

            A land contract is a purchase agreement and security agreement all in one document, and is ordinarily used when a buyer does not have a large down payment. 

A land contract is comprised of two entities:  the seller who is called the vendor and the buyer who is called the vendee.

Vendor

            The vendor is the seller and holds legal title to the property.

Vendee

The vendee is the buyer and holds equitable title, which is possession of the property.  The vendee has a right of possession and makes the loan payments.

Foreclosure

Land contracts are foreclosed either through a quiet title action where the courts give equitable title (possession) back to the vendor, or the vendee signs (executes) a quitclaim deed relinquishing his rights (equitable title) to the property.

Disadvantage of Land Contract

            One problem with land contracts is if the vendor (seller) dies.  Legal title could be tied up within the vendor's estate for years, and cannot be conveyed to the vendee when he pays off the land contract.  For this reason, land contracts are a suitable instrument for Cal-Vet to use, because Cal-Vet will (probably) not die in the future.

            The sale of real estate by conditional installment contract gives the buyer a right of possession, an estate of inheritance, and a freehold estate.

Late Payment

A trustor may be assessed a late charge if loan payments are made after 10 days after the due date or more than 10 days after the due date.

 

Land Project

A land project is a rural subdivision where the subdivider uses a substantial amount of direct mail to find prospective buyers.  In addition, the subdivider sells the lots to individual owners and not to other subdividers and builders.

            The real estate commissioner requires that any advertisement for a land project must be approved by the Real Estate Commissioner prior to issuance of a final public report.

            If there is NOT any direct mail advertising, there is NOT a land project.  Advertising must be substantial to be a land project. 

            In California for a Federal Land Project a buyer has 14 days in which to rescind the contract.

 

Less-Than-Freehold (Leasehold) Estates

A leasehold estate, which is also called a less-than-freehold estate, is an estate of possession only.  A leasehold estate is personal property and is not real property (a lease agreement is a piece of paper that moves and is considered personal property).

            The landlord who owns the land, building, and all the appurtenances that go along with the property has  freehold ownership.  He holds the highest form of ownership and can will the property to his heirs.  The freehold owner is called the lessor (landlord).

            The owner of a leasehold estate is called a lessee (tenant).  The lessee owns a leasehold estate (merely possession) and can use the property as he wishes (reasonable use) during the period of the lease.

            Payments in advance are not a requisite of an effective leasehold agreement.

Lease Agreement

            A tenant is NOT required to sign a lease agreement accepting the leasehold estate from the lessor. The act of moving in is sufficient to imply agreement with the terms of the lease.  Only the lessor is required to sign the lease agreement. 

            An owner of a property who conveys a part of his fee estate for a term that is less than his own creates for the recipient a leasehold estate.

            The lessor (who is the freehold owner), holds the reversionary interest (estate in reversion) in the lease.  When the lease ends, possession of the property reverts back from the lessee (tenant) to the lessor (landlord).  In other words, when an owner gives possession of real property to another for a term that is less than his own, this is called a leasehold estate.

Sale-And-Leaseback (Sale-Leaseback)

            When a owner converts a fee simple estate to a less-than-freehold estate, this is called a sale-and-leaseback.  When a person has a freehold estate, a sale-leaseback would result in him receiving a less-than-freehold estate (leasehold estate). He can deduct 100% of future rents on his income taxes.

            For example, ABC Automotive Corporation purchases a lot, builds an auto parts store on the lot, and then sells both the lot and building (an all appurtenances) to an investor.  ABC Auto Corporation institutes a long-term lease on the property.  The freehold owner (ABC Auto) sells the property to an investor for $1,000,000.  ABC Auto leases the premises back from the investor for 15-20 years with options to extend after that period.  The investor receives rental payments over the term of the lease and ABC Auto may deduct 100% of the rent it pays (to the investor) from its income taxes for the year they are paid.

Types of Leasehold Estates

            There are four types of leasehold estates:  estate for years, estate from period-to-period (periodic tenancy), estate at will, and estate at sufferance.

Estate For Years

            An estate for years is an estate that continues for a definite and specified period of time.  This could be 2 months, 6 months, 1 year, or 5 years.  Do not become confused and think that an estate for years must be for a year or more. . .it can be any length, including days, weeks, or months. 

            For example, an estate for years can be from July 1st through August 31st of the same year (2 months) or from May 1st to July 1st of the same year (2 months).  An estate for years can also be from October 1st to November 5th (36 days).  

Estate From Period To Period (Periodic Tenancy)

            An estate from period to period (also called a periodic tenancy) continues from one period to another, usually on a month-to-month basis.  Each month, the tenancy ends and is renewed with the coming of the next month.

Replacement By Tenant

            In a month-to-month rental situation, replacement of the heating unit cannot be deducted by a tenant from rent.  The tenant should contact the landlord and have a defective heating unit replaced by the landlord, rather than replace it themselves and deduct it from the rental amount due.

Estate At Will

            When an estate for years expires and the tenants stays on and continues to pay rent on a month-to-month basis, while negotiating another estate for years, this is called an estate at will. An estate at will occurs when the final terms of a lease have not been agreed upon, however the tenant is occupying the space and paying rent.

            An estate at will can generally be terminated by either party (lessor or lessee) with a thirty day notice.

Estate At Sufferance (Tenancy At Sufferance)

            When a tenant stays on in a property after his estate for years or estate from period to period has ended, this is called an estate at sufferance. The tenant remains in the property after expiration of the lease and without the owner's consent.  Of course, the lessor (landlord) is the person who is suffering when an estate at sufferance occurs.  A holdover tenant who stays in the property and does not pay rent has a tenancy at sufferance.

            All four types of leasehold estates mentioned above use a lease instrument as a means of giving the tenant a leasehold estate (possession of the property).

Lease

            A lease is an instrument that transfers possession of real property, but not title.  The tenant has possession of the property and the landlord holds legal title to the property.   It is not necessary for a lessee (tenant) to sign the rental agreement (lease), the act of moving into the property implies acceptance.  The lessor (landlord) however, must sign the lease agreement.

            A lease is an estate in real property. However, it is merely possession of the property, and not title.  

            Incorporeal rights are non-possessory rights of ownership, similar to what an tenant would ownwith a leasehold estate.

            Requirements for a lease include:  amount of rental payments, length of lease, and description of the property.  A lease does not require rental payment made in advance.

A lease must have the names of the tenants, description of the premises being rented, rental amount, and duration of the lease agreement (length of the leasehold estate).

Lease Length

The maximum lease lengths are 99 years for urban property and 51 years for rural property.

Urban property. . . . . 99 years.

Rural property . . . . .  51 years.

Maximum Security Deposit

            The maximum security deposit that a lessor (landlord) can collect from a lessee (tenant) is 2 months rent for an unfurnished apartment and 3 months rent for a furnished apartment.

Unfurnished Apartment. . . . .2 months rent

Furnished Apartment. . . . . . .3 months rent

The maximum security deposit a landlord can demand depends upon the term of the lease and whether it is furnished or unfurnished.

Leasing Commissions

            There are many brokers in California who make a living leasing commercial properties.  The commissions paid to these brokers varies depending upon the property type, size, and length of the lease.  For these reasons, the maximum commission on a lease is negotiable. 

For example, a three year triple-net lease of an 800 sq. ft. space in a retail strip center may pay a commission of 5% of the total gross rents collected for year one, 4% for year two, and 3% for year three.  If the lessor collects $1,000 per month in base rent each month (not including pass-throughs of all expenses on a true triple-net lease), he will collect $12,000 in year one x 5% = $600.  For year two he collects $12,000 x 4% = $480, and $12,000 x 3% = $360 for year three.  Total commission paid by landlord is $600 + $480 + $360 = $1,440 for this small retail lease. 

Other types of leases include gross leases or full service leases for office buildings (where the landlord pays all the expenses) and industrial gross leases where the landlord pays expenses outside the building and the tenants pay expenses inside the building.

Covenant of Quiet Enjoyment

            When a tenant leases a property he receives possession of the property and a covenant of quiet enjoyment.  In other words, the landlord or his agent may not attempt to remove a tenant from the premises without following the correct eviction procedures prescribed by law.  Removing tenants through the "Guido and the Boys" method is a great way to become the protagonist a John Grishum novel.

            Eviction

            When a tenant stops paying rent and continues to occupy real property, the freehold owner (lessor/landlord) must take appropriate steps to legally evict a non-paying tenant. 

The eviction process consists of three steps:

·        3 Day Pay or Quit Notice,

·        Unlawful Detainer Action, and

·        Writ of Possession.

Let's discuss the eviction process. . .          

Three day pay or quit notice delivered to the non-paying tenant.

            A three day pay or quit notice must be delivered to a non-paying tenant.  It gives the tenant three days to pay the rent due or quit the premises.  If the tenant does not leave the premises, then the lessor must pursue a legal action in court (called an unlawful detainer action) to have the tenant legally evicted.  The landlord can evict the tenant after serving a 3 day notice to pay or quit.

Unlawful Detainer Action filed in court (usually small claims court).

            An unlawful detainer action is a court action used by a lessor/landlord to evict a non-paying tenant/lessee.   The landlord may pursue an action in court (bring a court action), called an unlawful detainer action, to have a non-paying tenant removed from the premises.  Therefore, the landlord uses the unlawful detainer action to actually evict a non-paying tenant

Writ of possession issued by the court.

            After the court reviews the unlawful detainer action and renders a judgment calling for eviction of the non-paying tenant, the tenant is then physically removed from the premises by the county sheriff.  An eviction actually occurs upon receiving a judgment that calls for an eviction of a non-paying tenant.

Next is a look at other types of leases.

Other types of leases include:

·        Percentage lease,

·        Net lease, and

·        Sublease.

Percentage Lease

            Rent on a percentage lease is computed on the gross sales of the lessee's business.  Percentage leases are frequently used in retail shopping centers where the landlord participates in any increases in the tenants' businesses.  Mall promotions are commonly used to help increase foot traffic for retailers and, thus increased tenant sales.  Increased sales results in increased rental income to the landlord and also increases the value of the retail center.

            The most favorable type of lease an owner can enter into for an improved business property, where the surrounding population is increasing, is a percentage lease.

            Percentage leases are generally set up as a base rental amount plus overages (gross sales over a predetermined base rental amount) or a base rental amount versus a percentage of sales--whichever is greater.  Remember, gross sales are used in calculating a percentage lease.

            Discount stores pay the highest percentage profit in a percentage lease.  This is because of their high amount of gross sales and low profit margins.

Net Lease

A net lease is a lease requiring the lessee (tenant) to pay the lessor's/landlord's monthly taxes, insurance, and maintenance expenses incurred by the property.

The benefit of a net lease is the lessor receives net income.  For State Exam purposes, net leases are commonly used for offices, industrial properties, and stores.  (FYI:  In the real world, net leases are most commonly used with retail properties and some industrial properties. Office buildings generally use gross or full-service leases where the landlord pays all or most of the tenant's expenses.)

Sublease Versus Assignment

            The difference between a sublease and an assignment is explained using the following scenario:

            Mr. Smith (called the lessor or landlord) leases a retail location to Carpet Company (called the lessee or tenant) for $1.00 per square foot and does not place a provision in the lease agreement preventing the Carpet Company from subleasing the premises to the Computer Store.  When the Carpet Company subleases the space to the Computer Store for $1.25 per square foot, a sublease is the result.

            Therefore, Mr. Smith is the lessor.  The Carpet Company is the lessee AND the sublessor.  The Computer Store is the sublessee.  Since the Carpet Company is sandwiched between Mr. Smith and the Computer Store, this is called a Sandwich Lease.  The interest of the sublessor is called a Sandwich Lease.

            The computer store pays the Carpet Company $1.25 per square foot each month.  The Carpet Company then pays Mr. Smith $1.00 per square foot each month. . .and pockets the difference of $.25 per square foot as profit. 

However, it is not a bed of roses. The Carpet Company has given up his rights to occupy the space, but he has not given up his obligations to pay $1.00 per square foot each moth in rent.  In other words, if the Computer Store stops paying the Carpet Company the agreed upon $1.25 per square foot per month rent, the Carpet Company remains obligated to pay $1.00 per square foot each month to Mr. Smith.  The Carpet Company has the right of return into the space if the terms are breached by the Computer Store.  Therefore, the sublease transfers the rights but not the duties attached to the lease with rights of return if the terms are breached.

If, for example, Mr. Smith leases the retail location to the Carpet Company and places a provision in the lease agreement preventing the Carpet Company from subleasing the property during the term of the lease, if the Carpet Company would like to have the Computer Store take over occupancy of the retail space, then the Carpet Company must assign its rights and obligations to the Computer Store and have the Computer Store pay Mr. Smith $1.25 per square foot per month rent (directly to him).  The Carpet Company would then be "out of the picture," since the Computer Store will take his position in the lease agreement.  Mr. Smith must give his approval for the assignment.  The owner must sign a consent of assignment to assign a lease.

            Lastly, someone who leases a rented apartment for the summer has a sublease. 

 

Leasing Commission

            Leasing commissions are usually paid over the entire amount of the lease collected by the landlord.  This arrangement provides incentive for the leasing agent to negotiate as long a term on the lease as possible, thus increasing the leasing agent’s commission amount.

            For example, a tenant leases a space for 5 years and pays $1.00 per square foot for 1,000 square feet of gross leaseable area.  The tenant will pay $1,000/month x 60 months = $60,000 over the term of the lease.  The leasing commission is 5% of this amount.  The leasing commission paid to the leasing agent would be $60,000 x 5% = $3,000.

            For example, If a real estate broker arranges a 5 year lease agreement between a tenant and landlord, the usual compensation is a percentage of the total lease to be paid monthly or annually.

 

Leverage

Leverage occurs when a borrower uses the maximum amount of borrowed funds to purchase real property or borrows the maximum amount of money.

 

Liens

A lien is an obligation, claim, or charge that a person has on the property of another.  It is an encumbrance based upon money that limits the title to real property.  A lien is also a charge imposed upon specific real property by which it is made security for the performance of an act.

 

            There are several money encumbrances called liens: 

·        trust deeds and mortgages,

·        mechanic's liens,

·        attachments,

·        judgments, and

·        taxes. 

 

Trust Deeds and Mortgages

            Trust deeds and mortgages are security devices that place real property as collateral for a loan (hypothecation).   When a loan is placed on a parcel of real property, it encumbers the property and the loan must be paid off before the property can be sold. 

            Trust deeds and mortgages are considered specific liens because they encumber one specific parcel of real property.  They are also called voluntary liens because they are voluntarily placed on the property they secure.  Therefore, trust deeds and mortgages are considered specific voluntary liens.

Recording Trust Deed

            Recording occurs when a document is brought to the county recorder's office in the county where the property is located and "recorded."  The county recorder stamps the date and time of recordation and this is constructive notice to the world that something has occurred.  Therefore, when a trust deed is recorded is creates a lien on the property. 

Word Problem

If Able purchased a home from Baker, who took back a note secured by a deed of trust, title to the property would be encumbered by a:

Answer:  specific lien.   For example, Baker owns a property with no loans encumbering it (owned free and clear).  Baker sells the property to Able for $100,000, taking back a loan (promissory note secured by a deed of trust) for $80,000 and Able gave Baker $20,000 cash as a down payment. The loan would be specific to the property and Baker could not foreclose on Able's other properties to satisfy the debt.

 

Mechanic's Liens

            When a property owner or tenant has work performed on a parcel of real property and then does not pay the (general or sub) contractor who did the work, the contractor may file a mechanic's lien on the property.

            Before mechanic's liens can be explained, priority of recording must be defined.

Priority of Recording

The priority of recording rule is: "first to record is first in right."   Whoever records their document first will be the first to receive funds if a foreclosure is necessary in the future.

A trust deed that is recorded first is called a first trust deed.  A trust deed recorded second is called a second trust deed and will receive funds after the holder of the first trust deed has received his money.

For example, if  Lender A records a trust deed on June 1st and Lender B records a trust deed on June 15th, Lender A would hold the 1st trust deed and Lender B would hold the 2nd trust deed.  If there is a foreclosure on the property, Lender A would be paid first and any money left over would go to Lender B.

There are however, three exceptions to the "first to record is first in right rule":  mechanic liens, taxes, and subordination clauses.  Taxes and subordination clauses are discussed later.  However, mechanic's liens are discussed here.

Mechanic's lien law is derived from statute.  In other words, the State Legislature in California originated mechanic's lien law to protect contractors who do work on real property.  For this reason, mechanic's liens are one of the exceptions to the "first to record is first in right" rule.

Word Problem

1.  A carpenter installed a hardwood floor in a new house.  The owner refused to pay for the work.  If a trust deed is recorded after the work was started but before a mechanic's lien was recorded, then:

Answer:  the mechanic lien reverts back to the date work commenced on the home.

 

2.  A trust deed would be impaired if:

Answer:  a trust deed was recorded subsequent to the commencement of work on the property.  The following time-line will help to understand this concept:

Mechanic's Lien Time Line

Jan. 1                           General contractor has materials delivered and begins work on a

new home.

Jan. 15                         Lender records 1st trust deed on property.

Feb. 1                          General contractor does not get paid for work completed on home

and therefore records a mechanic's lien on the property.

 

            Even though the general contractor recorded his mechanic's lien AFTER (subsequent to) the lender recorded her trust deed, first priority in foreclosure goes to the general contractor because his priority begins when he delivered the materials and started work on the property, NOT when the mechanic's lien was recorded.

 

3. If a homeowner does not pay a swimming pool contractor for installation of a pool, the contractor can file a:

Answer:  specific lien against the property.

A mechanic's lien is considered a specific involuntary lien.

 

Attachments

            An attachment is a process the courts use to hold a defendant's property pending the outcome of a lawsuit.  Therefore, an attachment is a lien.

            For example, Able likes to golf at the Wicked Slice Golf Course because it is known for its wide fairways.  Able's golf game fits the course perfectly because he has a wicked slice when he uses his driver.  In fact, Able is negligent in not correcting the slice because it is considered one of the most wicked slices the exceptionally crummy golfers at the Wicked Slice Golf Course has ever seen.

One day Able hit a monster drive over 300 yards that started out toward the hole, but soon sliced off to the right and hit Baker in the back of the head on the next fairway over.  Baker sued Able for battery and negligence on the theory that he should have corrected the wicked slice and saved Baker a badly bruised head.  Baker is afraid that Able will take all his money out of the bank and sell all his real property before the judgment is rendered in his favor.  Therefore, he attaches Able's bank accounts and  "freezes" them so funds cannot be withdrawn until the judgment has been rendered and a writ of execution has been issued by the court. 

The order is: attachment, judgment, and writ of execution.  The attachment freezes Able's bank accounts.  The judgment is rendered by the courts in favor of Baker who is entitle to compensatory damages from Able.  The writ of execution allows Baker to satisfy the judgment by taking the specified amount of funds from Able's attached (frozen) bank accounts.

Attachment Ends

            An attachment outlaws (ends) in 3 years.  In other words, an attachment lien is good for 3 years.  It can be released by court order, written release by the plaintiff, or satisfaction of the judgment. 

However, the death of the defendant will NOT release an attachment lien.          A civil action of this type will survive the defendant and be paid out of his estate.

An attachment lien is considered a general involuntary lien.

Judgment

            A judgment is the final determination of the rights of the plaintiff and defendant in a lawsuit.  A judgment is an involuntary lien.  After a judgment is rendered by the court, an abstract of judgment must be recorded in every county where the defendant has assets.

Abstract of Judgment  

            An abstract of judgment creates a judgment lien on real property in the county where it is recorded.  Therefore, a lien created by a money judgment affects real property in each county where an abstract of judgment is recorded.

            An abstract of judgment when recorded becomes an involuntary general lien.  Therefore, a judgment for punitive money damages would NOT be a specific lien, it would be a general lien.  Punitive damages are considered punishment damages of a civil nature.

            When a judgment is recorded, it is a superior lien to subsequently recorded liens.  The rule "First to record is first in right" applies to judgments.  Exceptions may be mechanic's liens, taxes, and subordination clauses.

Word Problem

Able was injured at Baker's home.  Able obtained a $10,000 judgment against Baker.  Able recorded an abstract of judgment with the county recorder in the county where the property is located.  This was a:

Answer:  general lien.  Judgments are considered general involuntary liens.

Writ of Execution

            A writ of execution is a court order authorizing the sheriff to sell the property to satisfy a judgment.  In other words, when there is a judgment obtained against real property, a plaintiff would obtain a writ of execution to cause the property to be sold.  Therefore, a writ of execution is a lien on property and is a court order to sell it. 

Word Problems:

1. When a judgment is made by the court ordering the sale of a property, the document used is called a:

Answer:   writ of execution.

2. A legal order designating an official to satisfy a judgment our of property of the debtor is called a:

Answer:  writ of execution.

3. What is the correct order of occurrence?

Answer:  Attachment, Judgment, and Writ of Execution.

Release or Satisfaction

            A release is a relinquishment or a right or claim and generally must contain consideration (bargained for exchange) to be effective.  Releases should be acknowledged and recorded in all real property transactions.

            A satisfaction is the payment of a debt or obligation, many times evidenced by a judgment.

Lis Pendens

            A lis pendens is a notice of a pending lawsuit.  It is a recorded legal document giving constructive notice to the world that a lawsuit is pending on a specific parcel of real property.  A lis pendens is a quasi lien that notifies all subsequent purchasers of the pending lawsuit and possible cloud(s) on the title to the property

A person who takes title to a property after a lis pendens has been placed on it, takes title to the property subject to any judgment made against the property. A new owner is affected by a lis pendens until it is dismissed or a final judgment is rendered.

Lis Pendens Recorded

            A lis pendens is effective when it is filed or recorded.  It remains in effect until an order of release is obtained or it is removed from the county recorder's office records by the county recorder.  The recording of a lis pendens will cloud the title and affect marketability of the property.

            A lis pendens CANNOT be recorded by anyone.  It must be recorded by the parties who are involved in a pending lawsuit involving title to the property.

            A lis pendens will have no effect on the title to a property if the owner is not involved in the lawsuit, it may affect a change in title depending on the outcome of the lawsuit, and may be removed by court action or posting of a bond.

Homestead Exemption

            A homestead occurs when a property owner records a declaration of homestead at the county recorder's office in the county where the property is located.  The parcel of real property protected by the homestead is protected against unforseable  liens (except taxes).

            In a forced sale of a homesteaded property, the owner would have to pay the real property taxes and any trust deeds and mechanic's liens prior to receiving the proceeds of the sale.  A homestead would NOT protect the homeowner against mechanic's liens.

Homestead Invalidated

            A homestead automatically invalidates if there is a prior homestead recorded on a property.  Also, a recorded homestead may be invalidated if a prior recorded homestead exists on another property. 

For example, if a person owns a home and records a homestead on it. Then he purchases another home, rents the first one out, and then records a homestead on the new home, this would invalidate the homestead on the new home.  The homeowner should record an abandonment of homestead on the first home and then record a valid homestead on the new home.

Husband or Wife May Sign Homestead

            A husband OR a wife may sign a declaration of homestead form and homestead a home.

Taxes

            The second exception to the "first to record is first in right" rule is taxes.  Taxes are always paid first.  Tax liens are divided into:

 

·        Federal and State Taxes,

·        Property Taxes, and

·        Special Assessments.

 

Federal and State Taxes

            If an owner of a property receives a federal tax lien on the property, this is called a general lien.  Federal and state taxes are general involuntary liens and, therefore, all of property owner's properties are at risk of sale to satisfy these liens.

            When a property owner does not pay his federal or state income taxes that are due, she will receive a tax lien on her property.  In most cases, when she sells the property the Internal Revenue Service (IRS) or State Franchise Tax Board will be paid the amount of their lien (plus penalties) from the proceeds of the sale.

Property Taxes

            Each property owner in California must pay taxes to the tax assessor in each county where the property is located.  If a homeowner does not pay the property taxes due on the property, they will receive a real property tax lien.  Since taxes are one of the three exceptions to the "first to record is first in right" rule, when they are liened they are SUPERIOR to a prior recorded trust deed.

             A real property tax lien is specific to the property where the taxes were not paid, therefore, it is considered a specific involuntary lien.

Special Assessments

            Special assessments provide for local improvements and are levied against those specific properties that will benefit from the proposed improvement.

For example, one hundred homes do not have street lights.        If the 100 homes would like to place street lights in front of their homes, they agree to a special assessment and only the 100 homes that benefit from the street lights pay for them.  All the other homeowners in the county who do NOT benefit from the street lights, do NOT pay for them.

            The Street Improvement Act of 1911 is a special assessment that allows the construction of road, street, and other improvements.   A developer cannot purchase land under the Act.  A lien created under this act would be superior to existing 1st and 2nd trust deeds, homesteads, and any other lien--except tax liens (including property taxes).

            Special assessments are considered specific involuntary liens.

           

Life Estates

The second type of freehold estate is a life estate.  This type of freehold estate allows a person to enjoy all  the benefits of fee simple ownership; however, only for their life or the life of another person.

            A student of real estate may wonder why someone would give a person a life estate instead of fee simple title to the property.  The reason is the life tenant cannot will the property to his heirs. 

            For example, Roger likes Pongo, but does not like Pongo's "greedy, money-grubbing" relatives.  Roger gives a life estate to Pongo.  Pongo becomes the life tenant and can do anything he wants with the property ONLY FOR HIS LIFETIME.  When Pongo dies, the property either reverts back to Roger (reversion) or goes to a designated person Roger has specified (remainder).  In either case, Pongo's greedy relatives cannot inherit the property upon Pongo's death.

When a life tenant owns a property (life estate) he has all the rights of freehold ownership.  He can encumber, lease, or sell the property; however, he cannot will or devise the property.  Devise is defined as leaving real property by will. 

If a person who holds a life estate leases the property for five years and then dies, the lease will be valid until the man died.  After he died, the lease will not be valid. 

 

Limited Partnership

Tax shelter refers to income tax.  One form of tax shelter is a limited partnership.

            Limited partnerships have traditionally been a good way to limit liability and shelter income.  A limited partnership minimizes an investor’s liability exposure because the investor can only lose what he has invested in the property.  His personal assets are not at risk.

            In addition, a limited partnership enjoys single taxation, rather than the double taxation experienced by a corporation.  A limited partnership passes the limited partner’s income directly to him without taxing it.  The limited partner then pays taxes on the partnership income on his personal tax return.

            A general partnership exists when two or more people come together to invest in a property.  The general partners have unlimited liability and are risking their personal assets.

            Therefore, the type of ownership that would minimize tax obligations for the individual investor and limit their personal liability would be a limited partnership.

            In addition, the form of business ownership that is the most widely used and protects investors against personal liability is a limited partnership

 

Liquidated Damages

            Liquidated damages is the predetermined amount of damages the parties to a contract agree to as the total amount of compensation an injured party will receive if the contract is breached.

For example, a buyer and seller initial the liquidated damages clause to a real estate purchase agreement.  The buyer removes all contingencies to the contract and then defaults on the purchase of the property (changes his mind and does not go through with the contract).  The maximum amount of damages the seller can receive from the defaulting buyer has already be predetermined by the liquidated damages clause.  This amount is usually 3% of the sales price or the earnest money deposit, whichever is lower.  This applies to for all one-to-four unit dwellings in California.

            If the liquidated damages clause in a real estate purchase contract has been initialed by both buyer and seller, and the buyer subsequently receives news of a job transfer and decides not to buy the property.  Under these circumstances, the deposit is split 50% seller/50% listing broker.

 

Liquidity

            The liquidity of a borrower is generally determined by a loan officer in considering current assets to current liabilities.  It refers to how much cash (and other assets that are easily converted into cash) is available to purchase the property.

            Liquidity in a business is total assets divided by total liabilities.                                                               

Total assets

Example:                      Liquidity =                    __________

                                                                        Total liabilities         

 

Loan-To-Value Ratio

            Loan-to-value ratio (LTV) is defined as the loan divided by the price of the property.  For example, if a property sells for $100,000 and the lender makes an $80,000 loan, the loan-to-value ratio is 80% ($80,000 loan divided by $100,000 value).  Loan-to-value ratio is the lender's first line of defense in fighting loan default and lenders look to LTV to minimize risk.

            Thus, if the loan-to-value ratio is low, the equity in the property is high.  High equity and a low loan-to-value ratio gives a borrower a personal stake in the property and reduces the risk of default.

            Industrial properties, such as warehouses, have the lowest loan-to-value ratios because of the large inherent risks associated with these types of properties.  They usually have large tenants. If a tenant goes out of business, the industrial property owner may have difficulty covering the debt service and may result in an increased risk of foreclosure.  Low down payment/high loan to value loans will cause the borrower to pay more interest over time than high down payment/low loan-to-value loans.

 

Local Building Code vs. Uniform Building Code

            The local building code specifies how buildings are required to be constructed within a local area. Local building codes are enforced by local building inspectors.  These inspectors inspect new buildings being constructed and try to minimize substandard buildings that do not conform to local building codes.  They also enforce state housing laws.

The primary purpose of city and county building codes is to set minimum building standards on new construction and remodeling projects, and to protect the health, safety, and general welfare of the public.

            When a builder constructs a building that is not within the building code, this is called a violation.

Uniform Building Code

The Uniform Building Code is a code, adopted on a national basis, that applies to new construction and demolition/relocation of properties.  If the Uniform Building Code and local building code are in conflict, the more stringent (restrictive) of the two will prevail.

 

Marginal Tax Rate

            Marginal tax rate is the tax rate on the next dollar or taxable income earned

 

Marketability and Acceptability

Marketability is the ability to market and sell a parcel of real property on the open market.  Acceptability is a measure of how acceptable the property is to the general buying public (i.e. the market).  Will a large number of buyers want to purchase the property?

Marketability and acceptability is a primary concern for appraisers.  In fact, marketability is the ultimate test of functional utility.

            Which property would a buyer purchase?  A 3 bedroom/1 bathroom home or a 3 bedroom/2 bathroom home. . .if both are priced the same?  The 3 bedroom/2 bathroom home is more acceptable to buyers based upon today's housing requirements.  Therefore,  buyers will pay more for a 3 bedroom/2 bathroom home than a 3 bedroom/1 bathroom home.  the 3 bedroom/2 bathroom home is more marketable.

 

Market Analysis

The most vital factor in planning a subdivision in which lots are sold for a profit is generally acknowledged to be a market analysis.

 

Market Value

            Market value is the value a buyer (under no duress) places on a parcel of real property.  It is what the market believes a property is worth. This is the value an appraiser considers when making an appraisal.

            Market value is the price actually paid for a property by a buyer in the open market.  It is most nearly the market price and is the amount of dollars actually paid for a property.

            Market value would be LEAST affected by the original cost of materials to build a property.  The original cost of materials would have no relation to the amount a buyer would be willing to pay for a property on the open market.

Terms and Conditions of the Sale

            The market value of a property would be affected by the terms and conditions of the sale.  When a seller is asked to carry a loan for a buyer at a lower than market interest rate, he will expect a higher sale price to compensate for the favorable terms given to the buyer.  This will be a higher sale price than an all-cash buyer would be willing to pay for the property.  An appraiser would reduce the market value for the property downward to reflect the favorable terms.

 

Metes and Bounds

The Metes and Bounds land description method describes the measurements of distances (Metes) and boundaries (Bounds) from a predetermined point, usually a monument.

Metes and Bounds is NOT a way of measuring properties.

 

Misrepresentation

            Misrepresentation falls under two categories:  intentional misrepresentation (another name for fraud or lying) and negligent misrepresentation (unintentional mistake). Obvious knowledge by the broker is considered misrepresentation.

For example, Lindley looked at some subdivision property under development.  The licensee with whom he dealt stated that this investment was as "good as gold."  The licensee also claimed that the property would more than double in value in two years.  In two years time the property was actually worth less than the price Lindley had paid to acquire the property.  Four years after the purchase Lindley wishes to take legal action. Lindley may file a civil suit against the licensee for misrepresentation and punitive damages (punishment damages).

An agent sells a 50 unit apartment complex.  The agent makes analysis in which he did not deduct for vacancy and collection losses and other expenses.  The buyer relies on the agent’s representations.  A violation occurs because of misrepresentation.

            In July, Hall bought Welch’s home through the listing broker, Cruz.  In November, when the first rain came, the tile roof leaked badly in many places.  Hall sued Welch and Cruz for the cost of the necessary new roof.  Testimony in court showed that Welch had mentioned the need of a roof to Cruz, but Cruz had not mentioned it to Hall because “he had not asked about it.”  The most likely result is that Hall will be successful in a suit against Welch, who was entitled to recover damages in turn from Cruz.

            If an agent keeps a seller's secret that the roof leaks, this is illegal.

Prima facie evidence of misrepresentation would be a misleading map showing incorrect distances between the property and possible areas of concern.

Fraudulent Misrepresentation

            Fraudulent misrepresention is the intentional misrepresentation of a property to a principal (usually the buyer).  This a nice name for lying.

Actual Fraud

            Another nice name for lying.

For example,    Agent Charlie took a listing and promised seller Able that he would advertise the property until it sold.  Agent Charlie had no intention of placing the advertising.  Charlie is guilty of actual fraud.

Negative Fraud

            Another name for nondisclosure is negative fraud. Nondisclosure is negative fraud.

Misleading Advertising

            Advertising cannot mislead a prospective buyer regarding the condition or other facts about a subject property.  A “fixer” property should be called a “fixer,” and not a “move right in” dream home.

            For example, Broker Dawson has a house listed that does not sell.  The house is over-priced, has a leak in the roof and includes structural defects.  He places a newspaper advertisement that praises the property and states that it is ready to “move right in.”  The ad is deceptive because of the leak and structural work needed.

Blind Ad

A blind ad would not include the name of the agent or broker who has listed the property for sale. 

A broker runs the following ad on his listings:

“4 BR, 3 BATH home with swimming pool and spa for sale at $154,000.  Call 991-2345.  This ad is a blind ad.

When advertising listed property for sale, real estate licensees may identify themselves in the advertisement by using the designation agt. or bro.

Broker Breaks Promise to Find Home

            If a broker makes a promise to find a seller a suitable home to purchase, he has placed himself in a difficult position.  By making this statement, he has promised to find the seller a suitable home to purchase.  This may take a large amount of time from the broker’s schedule because the client may want a $200,000 property for only $100,000.

            For example, Seller Sharp sold his home through a real estate broker.  The broker agreed verbally with the seller that he would find him an acceptable place to live when the sale was completed.  The home sold, but the broker does not keep his promise to the seller, the seller has the option of trying to recover damages in a court action against the broker.

Broker Breaks Promise to Advertise

            This is a more common occurrence.  If a broker promises to advertise a property and then does not do as promised, she may be liable for damages under actual fraud.

            In listing a single-family residence for sale, a broker promises to advertise it regularly, on a weekly basis, until it sells.  Contrary to his agreement with the owner, the broker has no intention of advertising the property weekly.  This would constitute actual fraud.

 

Mortgage

Many states in the United States us a mortgage as their primary security device for real estate loans.  California uses a deed of trust as its primary security device, however, there are a couple of questions pertaining to mortgages on the State Exam.

            There are two entities to a mortgage:  mortgagor and mortgagee.  The mortgagor is the borrower and the mortgagee is the lender.  You may get a loan on a mortgage from the mortgagee. 

            Mortgages use judicial foreclosure through the courts.  They generally allow deficiency judgments and have a right of redemption period.

 

Mortgage Bankers/Mortgage Brokers

            Mortgage bankers loan their own funds and participate directly in the secondary mortgage market.  Mortgage brokers do not loan their own funds and sell their loans to mortgage bankers and other institutional lenders.

            Mortgage loan correspondents prefer to negotiate loans that are sold on the secondary market.  Since they are selling the loans to mortgage bankers and other wholesale lenders, they can be sold more easily if the purchaser can sell the loans on the secondary market.

            Life insurance companies engaged in making real estate loans would normally create these loans with the assistance of mortgage bankers or mortgage brokers.  Mortgage bankers or brokers find the borrowers and process the loans, therefore, saving the life insurance company time and resources.

 

Mortgage Interest Deduction

            For federal income tax purposes, a homeowner may deduct the mortgage interest paid on his home loan. 

In addition, a condominium owner who only uses it for his personal use and does not rent it, may deduct the mortgage interest on the unit.  Also, he may take a deduction for his portion of the interest payments for the mortgage on the common area.

 

Mortgage Yield

            Mortgage yield is the return an investor will receive from a loan.  It includes loan origination fees and other “garbage” fees charged by a lender to specifically increase mortgage yield.  Mortgage yield is best described as the effective interest return obtained from a first trust deed by an investor.

 

Multiple Offers

            When an agent receives multiple offers on a property that is listed by her, she must present all offers to the seller at the same time.  She cannot make the seller accept or reject each offer prior to presenting the next offer.

            For example, at noon Buyer Baker made an offer to purchase a single-family residence.  In doing so, he instructed the real estate broker not to present his offer until 6pm.  By 6pm three more offers are submitted.  The real estate broker should present all offers at the same time.

When a broker has two offers on the same property, both from salespeople within his office, and both with a deposit, he is placed in a dilemma.  He decides not to present the second offer until the first offer has been accepted or rejected by the seller.  The seller is not informed of the second offer. The broker’s action is illegal and unethical.

 

Mutual Mortgage Insurance

            Mutual mortgage insurance is an old term used for insurance provided by the Department of Housing and Urban Development's (HUD) Federal Housing Administration (FHA).  FHA insures loans made by approved lenders and insures these lenders against default.

            For example, Bill and Suzy Jones have $2,350 saved toward the purchase of their first home.  Their lender has informed them that they can qualify to purchase up to a $100,000 home.  Bill and Suzy find their dream home through the help of their Realtor (who is a member of the National, California, and local associations of Realtors) and enter into a contract to purchase the property.

            Bill and Suzy will pay an upfront mortgage insurance premium (called MIP in the real world, however mutual mortgage insurance on the State Exam).  However, FHA allows the borrowers to finance the mutual mortgage insurance premium (approx. 3%) and add it to the loan amount.  Bill and Suzy will also pay a monthly insurance premium for an FHA insured loan.

            Therefore, Bill and Suzy's loan amount will be slightly more than $100,000.  The entire loan amount is insured by FHA, therefore, if there is a default in the future, the entire loan principal balance will be reimbursed to the lender by FHA.  Properties insured by FHA end up on the HUD repo list where HUD disposes of these assets to help recoup part of the costs of the program.  

 

National Association of Realtors/California Association of Realtors

            The National Association of Realtors (NAR) is a national industry group associated with the California Association of Realtors (CAR) and local associations.  A licensee MUST be a member of NAR to call himself a “Realtor.”

John Smith, a licensed real estate broker, is not a member of the California Association of Realtors or the National Association of Realtors.  In advertising he indicates that he is a Realtor.  He is subject to discipline by the Real Estate Commissioner for using the word "Realtor."

            Broker Jones, who is not a member of any trade organization, has been using the new advertising slogan:  “A new breed of Realtors.”  Concerning this practice, it is grounds for revocation or suspension of his real estate license.

            Should a dispute regarding a commission arise between two sales licensees who are members of the National Association of Realtor, by provisions of that organization’s Code of Ethics they will settle the matter by arbitration.

Approval by a  broker of pocket listings taken by his salespeople is not within the “Beneficial Conduct” guidelines of the Real Estate Commissioner’s Code of Ethics and Professional Conduct.  A pocket listing is a listing that the agent keeps in his pocket and does not expose to the office or the multiple listing service

           

Non-Money Encumbrances

Non-money encumbrances are based upon the use of the property and include:

·        easements,

·        restrictions (public and private), and

·        encroachments.

Easements

            An easement is the right to use someone else's land for a specific purpose.  An example is an easement to drive over another person's land to reach a main highway. 

It is a non-possessory interest in the real property of another that is created by a conveyance (usually a deed).  The easement holder holds no title to the property nor estate in real property (it is NOT a separate estate).

            An easement is an acquired privilege for the right of use or enjoyment, short of an estate, which one may have in land.  It may exist in perpetuity (infinite), for a stated period, or for the life of the grantor.

            Easements are sometimes known as a right of way and are considered real property.  A private easement is an exclusive right to cross the land of another.

            In addition, a tenant can give an easement to another party ONLY for the length of the lease; when the lease period ends, the easement also end. (at the same time).

Word Problem

If Tenant Able leases a parcel of land from Landlord Baker for 10 years, and Neighbor Charlie (the next door neighbor) requests an easement from Tenant Able across his land, can he do this?

Answer:  Tenant Able CAN give Neighbor Charlie an easement across the property for the length of the 10 year lease.  After the lease expires, the easement will NOT be effective.

            There are three types of easements: 

1. Appurtenant Easement

            An appurtenant easement runs with the land and passes with a change in title to the parcel which it is appurtenant.  Its rights are non-possessory and covers air, water, roads, and woods on the property.

            When a buyer purchases a property, an existing appurtenant easement transfers to the new buyer.  He has the same rights and restrictions that the seller had when he owned the property.

            The dominant tenement drives over the servient tenement, and therefore, the appurtenant easement is appurtenant to the dominant tenement's land.  An appurtenant easement is always held by the dominant tenement.

            If the dominant tenement sells a property, the appurtenant easement automatically passes to the new owner of the property.  It does not always pass, however, because if the servient tenement purchases the dominant tenement's property, this would terminate the easement (he would then own both properties).

            An appurtenant easement is required to benefit one tenement (dominant tenement) and burden another (servient tenement).  It also requires the parcels of land be owned by two different persons.  Lastly, an appurtenant easement is transferred with the transfer of the dominant tenement.

Word Problem

Charley sold Blackacre to David.  Charley's property rights in Blackacre included an easement appurtenant across Whiteacre, the adjoining property owned by Edward.  When David tries to use the easement, Edward protests.  Can he do this?

Answer:  No.  An appurtenant easement transfers with the transfer of the dominant tenement and David would acquire these rights when he purchased the property.  Therefore, Edward could not prevent him from using the appurtenant easement.

Abut or Adjoin

            A dominant and servient tenement do NOT have to abut or adjoin (touch) each other to have a valid appurtenant easement.

Terminate Easement

            An appurtenant easement can be terminated by a release signed by the dominant tenement or by a merger of the dominant and servient tenements.  An appurtenant easement or easement in gross may be terminated by using or signing a quitclaim deed.   An easement may also be terminated when the dominant tenement records a quitclaim deed.

Non-use does NOT terminate a deeded easement such as an appurtenant easement or easement in gross.  Please note, however, non-use DOES terminate a prescriptive easement (easement by prescription).

Word Problem

An easement may NOT be terminated by:

Answer:  revocation by the servient tenement.  Remember, the dominant tenement must revoke the easement, not the servient tenement.

2. Prescriptive Easement/Easement By Prescription

            A prescriptive easement or easement by prescription is a way of gaining the right to use another person's property without their permission.  The use must be open and notorious, uninterrupted for five years or more, a claim of right, and hostile to the owner's intent.  

Remember "OUCH"

Ø      Open and notorious

Ø      Uninterrupted for five years or more (also called continuous)

Ø      Claim of right

Ø      Hostile to the owner's intent (this is NOT confrontation with the land owner)

            An easement by prescription is the only easement that is lost by non-use (for five continuous years).  Non-use must be for a period of five years to fulfill the "uninterrupted use" requirement mentioned above.

            Therefore, blocking a road with a chain might stop a claim of possession through an easement by prescription.

Easement By Prescription vs. Adverse Possession

            Adverse possession is very similar (or most closely related) to a prescriptive easement.  An adverse possessor must be open and notorious, uninterrupted (used continuously) for five years or more, have a claim of right, and be hostile to the owner's intent.  In addition, an adverse possessor must pay the taxes on the property during the five years of possession.  If he does all of the above things, including paying taxes on the property, he acquires title and owns the property through adverse possession!!! Conversely, a prescriptive easement has the right to use the property (but NOT title to the property).

            An adverse possessor would use a quiet title action to perfect the title on real property in his name.  A quiet title action is a court action to quiet the title to real property.  It removes a cloud on the title and establishes clear title for the adverse possessor.

An interest in real property can be acquired by an easement by prescription or by adverse possession.  An easement by prescription would result from the right to use another's land.  Adverse possession would result in ownership of the land by the adverse possessor.

3. Easement In Gross

            When an owner of land gives someone (usually a person or a utility company) an irrevocable right to come onto his land, this is called an easement in gross.  In other words, it is the right to use another person's land that is not attached to any land owned by the easement holder.

            Bryan, the former owner of Old Hahn Ranch, sold the ranch to the Brady's.  He was able to negotiate an easement in gross over the Brady's new ranch so he could fish for trout in Hat Creek running through the property.  The Brady's thought Bryan was a nice person and he wouldn't be a problem. 

            One week after close of escrow and giving Bryan an easement in gross to fish on their ranch, they discovered (to their dismay) that he was the world's most obnoxious fly fisherman.  They observed him throwing rocks at their cows.  When this didn't start a stampede, he started throwing rocks at a large hornets nest on the property--trying to get the hornets to chase the cows. While all this was going on, he turned his radio up so loud that he scared all the other farm animals silly. 

The Brady's asked Bryan to leave and never come back.  Could they do this?  The answer is NO.  Since, Bryan had an easement in gross to use the property for fishing, they could not get rid of him.

            The Brady's should have used a license. A license is a revocable right to use another's property.  If they had used a license (instead of an easement in gross) they would have been able to revoke it and send Bryan on his merry way.  (Sometimes, a small investment in a real estate education can be quite valuable.)

Easement in Gross vs. License

            A personal, revocable, and un-assignable permission to do one or more acts upon the land of another without possessing any interest in the property is called a license.  A license is the revocable right of someone other than the owner to use the land.  The difference between an easement in gross and a license is that a license can be revoked and an easement in gross cannot be revoked.

            In addition to a person holding an easement in gross (remember Bryan the obnoxious trout fisherman), a utility company may also hold an easement in gross.  The utility company may enter a property and repair underground or above ground utility lines.  A right of way is also considered an easement in gross.

Word Problem

An easement in gross:

Answer:           

(All of the above define an easement in gross.)

Un-located Easement

            An un-located easement is valid.  For example, Able gave neighbor Baker a deed conveying an ingress/egress to enter and exit his property.  The deed did not specify the easement's exact location, the easement is enforceable, because an easement does not have to be specified in the deed.

 

Net Listing

A net listing is a listing agreement where the agent receives a commission on whatever amount he can obtain above a predetermined minimum sale price set by the seller. 

For example, the seller may say, “I want $200,000 for my property. You can keep anything you can get over that amount.”  If the agent can sell the property for $225,000 he will receive a $25,000 commission on the sale of the property.  Unfortunately, this type of listing can lead to unethical sales practices on the part of the agent.

"$50,000 after close of escrow" would indicate a net listing.

 

Novation

            A novation is the substitution of a new contract for an old one.  For example, when a lender releases a seller from the obligation to pay a loan through a loan assumption, and substitutes the buyer as the party responsible to repay the debt, this is called a novation.  Therefore, novation is most closely related to a substitution of a new contract for an old one.

 

Open-End Mortgage

An open-end mortgage is a loan that allows additional borrowing at a later date.  It allows the trustor to borrow more money if he needs it and is similar to an equity line of credit, except that the additional funds are collateralized by the deed of trust.

 

Open Listing

      An open listing is a listing given by the seller to any number of brokers to work simultaneously to sell a property.  Whoever is the procuring cause (finds a ready, willing, and able buyer) of the sale of the property receives a commission. 

            In an open, non-exclusive listing situation, the broker who most likely will be paid a commission is the one who has communicated acceptance of an offer to the offeror (buyer).

 

Option

            An option is an agreement to keep an offer to sell or lease real property open for a specified period of time (contract to keep an offer open).  Options are commonly used in the purchase of raw land, allowing the buyer to resolve zoning, entitlement, and feasibility questions prior to committing the funds necessary to purchase the property.  An option must be accompanied by consideration.  Options are assignable.

The optionor gives an option to the optionee.  If the optionee decides to exercise his or her option during the period specified, then the optionor must perform and sell the property per the contract.

            An option is also an agreement not to close an offer.

 

Out-Of-State Broker

            A broker in California can pay a commission to an out-of-state broker. You are a California real estate broker.  A prospect is referred to you by an out-of-state broker and a sale is consummated by you.  You want to split your commission with the cooperating broker.  Under the California Real Estate Law you may pay a commission to a broker from another state.

 

Planned Unit Development

            A planned unit development is a subdivision that utilizes separate units (houses, townhouses, or condominiums) along with common areas such as clubhouses and/or swimming pools.  Each owner owns the common areas in common with the other owners.

            A planned development with less than five lots is not a subdivision.

 

Plot Plan

            A plot plan shows where the building or improvements will go on a parcel of real property.

 

Portfolio Risk Management

            When a lender looks at his entire loan portfolio and tries to minimize the risks inherent in non-performing loans, this is called portfolio risk management.  A lender considers liquidity, reserves, and diversification when making loans.

 

Power Of Attorney/Attorney-In-Fact

A power of attorney is a written instrument giving authority to an agent. For example, Brother #1 is in Sydney, Australia and would like Brother #2 to sign for him in the conveyance of a home purchased by the two of them many years ago.  Brother #1 signs a power of attorney form at the American Consulate in Sydney, has it notarized (acknowledged and verified), and sends it to his brother in the U.S.  Brother #2 then acts as attorney-in-fact for Brother #1 and signs escrow instructions on his behalf.

Attorney-In-Fact

            An attorney-in-fact is a person who is authorized to act on behalf of another person.

 

Prepayment Penalty

Prepayment  of a loan is a privilege and not a right.  It provides for a certain sum to be paid by the trustor if the loan is paid off before its maturity date.   In other words, a lender may place a prepayment penalty on a loan if it is paid back early. 

A common prepayment penalty is a six months interest if the loan is paid back while the prepayment penalty is in effect. 

            If a loan on a single-family home has been in existence for more than seven years, a prepayment penalty would not be due (by law).

            VA guaranteed and FHA insured loans do not have prepayment penalties.

 

Private Individual Lenders

Private individual lenders are private people who act as a lender and extend credit.  Private Individual lenders are a primary source of secondary financing (2nd trust deeds).  Second trust deeds are in a secondary position to first trust deeds (because they were recorded second) and are therefore called junior loans.

 

Property Taxes

            In California property owners pay annual taxes on all privately held real property in the State.   These taxes are paid in two installments during the fiscal tax year and amount to approximately 1.15-1.25% of the assessed value of the property.

            The County Board of Supervisors in the county where each parcel of real property is located determined the amount of taxes paid by THE individual tax payer.  “THE” is plural and pertains to ALL taxpayers in the county.

            The County Tax Assessor in the county where each parcel of real property is located determines the amount of taxes paid by AN individual taxpayer.  “AN” is singular and pertains to each individual taxpayer personally. 

The tax assessor's records are a good way to determine the age of a property, because (rest assured) as soon as it was built the tax assessor was collecting property taxes. 

However, a property tax bill would be a terrible way to obtain a legal description for a parcel of real property.

Property Tax Year

            The fiscal tax year starts on July 1st and continues through June 30th.  The first installment of taxes are due on November 1st and delinquent on December 10th.  The second installment of taxes are due on February 1st and delinquent on April 10th.  Hence, NO DARN FOOLING AROUND is a good way to remember these dates.

            The second property tax payment is due and delinquent on February 1st and April 10th.  Real estate taxes become a lien on real property on March 1st of each year.

County Tax Assessor

            The county tax assessor assesses the value of an individual property owner's property (land and building are valued) and collects taxes due each year.

            Therefore, the main duty of the local tax assessor is to determine the proportion of tax to be paid by each property owner.  He assessed taxes.

            When a probate is being escrowed, the escrow holder will prorate the taxes based upon the existing assessed value of the property.

Over-Assessed

            When a parcel of real property has been over-assessed by the tax assessor, the property owner can make an appeal to the assessment appeals board.  The property owner sends three recent sales comparables to the board during a specified time period and the board will review the assessment and make changes as necessary.

Reassessment

            When a property is sold it is reassessed by the tax assessor.  In addition, when a long-term lease is created, as well as a gift/inheritance given,  both will cause a reassessment of a property.  Inter-spousal transfers will not trigger a reappraisal.

            If Able grants property to Able and Baker as joint tenants, this would NOT trigger a reappraisal for property tax purposes.

Supplemental Assessment

When a person purchases a property that has not been sold in many years, the seller is probably paying very low property taxes under Proposition 13.  When the buyer closes escrow the escrow officer prorates the taxes on the property based upon the seller’s existing tax bill (which is a lot less than the buyer will be paying in property taxes).  After close of escrow, the buyer will receive a supplemental assessment from the tax assessor collecting the taxes that should have been prorated in escrow but could not be collected because of the seller’s very low tax bill.

            For example, Seller Olds sells her home for $200,000.  She paid $17,000 for the home in 1961 and has lived in it during that time period.  She pays $170 per year in property taxes.  If the close of escrow occurs in the middle of the tax year, then the escrow officer will usually prorate the taxes paid ahead of time by the seller as a credit (paid to) to the seller and debit (paid from) the buyer for this same amount.  Since the amount debited the buyer is not nearly as much as she will pay with her new assessed value (sale price), she will receive a supplemental tax bill from the tax assessor to make up the difference.  This bill will usually arrive 30-60 days after close of escrow.

            For example, Able purchased a home on October 1st.  The first installment of property taxes were paid in escrow.  On November 1st Able received a property tax bill from the county tax collector.  This tax bill was a result of a supplemental assessment.

Delinquent Property Taxes

            When a property owner does not pay his property taxes on time they will become a lien on the property.  When an owner becomes delinquent in the payment of his real estate property taxes he may remain in the property undisturbed for five years.  At the end of this period, if the property is not redeemed, it is deeded to the State of California.

            Therefore, when an owner becomes delinquent in the payment of his real estate taxes he may remain in the property undisturbed for five years after the publication of intent to sell the property due to non-payment of property taxes. Tax delinquent real property that is not redeemed by the owner during the five year statutory redemption period is deeded to the State of California.

Real Property Tax Bill

            A property tax bill is sent by the tax assessor to each property owner who owes taxes.  It would be the least satisfactory method of describing a parcel of real property.

Ad Valorem

            Real property in California is taxed according to its value.  When a property is sold, its value is established for property tax purposes.  An addition of an improvement may also increase the assessed value of the property.  Assessment rolls reflect 100% of a property's true market value.

Tax Base

            The tax base is the tax assessor's tax roll of property owners who owe taxes to the county.  The county tax assessor accumulates a list of all private owners of real property in his jurisdiction.  The assessment roll is used to establish the tax base for the county.

Special Assessment

When a community would like to place street lights within their neighborhood, it would not be fair to tax all the taxpayers in the county.  Thus, a special assessment would be established to tax only the property owners who would benefit from the street lights.

Property Tax Exemption

            Each homeowner in California (who lives in the property) is eligible for a property tax exemption of $7,000 deducted from the assessed value of their home. 

For example, if a home is assessed at $100,000, the homeowner would pay property taxes on only $93,000 of the assessed value ($100,000-$7,000 = $93,000)  Therefore,   1.1% property tax rate x $93,000 = $1,023.

 

Puffing

            Puffing is an exaggeration of the features of a property.  However, puffing is a statement of opinion and usually not considered a statement of fact.

 

Purchase-Money Loan

            A purchase-money loan is a loan made by an individual lender.  It can be a seller-carry back loan, an institutional lender, or a private individual lender.  The most common type of purchase money loan is a seller carrying back  second deed of trust resulting from the sale of a home.

 

Partition Action

Occasionally, one or several partners wishes to sell her interest in real property, whereas the other owners prefer to retain the investment.  If the owners cannot reach agreement, then a partition action can be instituted to "partition out" her portion of the investment.  It usually results in the sale of the property and each owner receives his or her share

 

Percolation Test

A percolation attempts to determine the capacity of soil to absorb sewage water flowing from the home.  The sewage first goes into a septic tank and the sewage water percolates back into the soil.

 

Personal Property

Personal property is property that is movable, and therefore, does not fit the definition of real property (immovable).

            Examples of personal property include a mobile home that is not attached (not bolted) to a foundation, crops after they are harvested, fruit on a tree that has been sold (the entire fruit crop is sold, not the trees), and minerals & gas removed from the earth.

Bill Of Sale

            Personal property can be conveyed or sold with a bill of sale.

            The ownership of personal property is transferred using a bill of sale.  A bill of sale requires a description of the property being conveyed. In addition, it requires an itemization of inventory, fixtures & equipment, and trade name.   Trade fixtures and business opportunities are transferred with a bill of sale.

            However, a certificate of ownership (not a bill of sale) is used to transfer title to a mobile home.

Security Agreement    

            An instrument used to secure a loan on personal property is called a security agreement. 

            For example, your brother asks for a $2,000 loan to pay for a necessary medical surgery.  You love your brother, however, he has a history of not paying back debts. Therefore, you ask him for some collateral (security for the loan).  You insist that he sign a security agreement placing his vintage Harley Davidson motorcycle as security for repayment of the loan.  If he does not pay the loan back, you may (through legal means) take his motorcycle to repay the debt.

            Personal property provides difficulties for real estate brokers and salespersons because it can be hypothecated (placed as collateral for a loan), alienated (conveyed, sold, willed), and could become real property (fixture).

            Personal property can be hypothecated (placed as collateral for a loan).  For example, a lot with an unattached mobile home may be sold, only to later learn that the mobile home (personal property) has been hypothecated as security for a loan made on the mobile home.  When this type of loan is not paid, the lien holder (lender) who loaned the money may repossess the mobile home and remove it from the lot.  If you sold the lot with the mobile home on it, then you may have a problem when the buyer realizes that he has purchased a vacant lot without a mobile home on it.

            Under the Uniform Commercial Code (UCC), the document used to mortgage articles of personal property is called a security agreement.

Alienated

            To alienate is to convey, sell, or will property.  Personal property provides difficulties for real estate broker and salespeople because it can be sold or willed.

            A buyer has signed a purchase agreement for a lot with an unattached mobile home on it.  During the escrow period, the seller sells the mobile home for $50,000 and the mobile home buyer moves the mobile home to a lot several miles away.

            After close of escrow, the broker learns that the mobile home has been sold, the buyer has paid $100,000 for a lot worth only $50,000.

Personal Property Could Become Real Property

            Personal property can be attached to the land or incorporated in the land and become a fixture, and therefore real property.  Examples include mobile homes, satellite dishes that are affixed with concrete, and microwave ovens that are built into cabinets.

Other items considered personal property include:

            The term "chattel" means personal property.  Therefore, chattel real is personal property having some association with real property.

            Debt instruments, such as trust deeds and mortgages are considered personal property.  "Debt instruments" describe the actual paper the trust deed or mortgage is written on, and since the paper moves, it is considered personal property.

            A leasehold estate is the interest a tenant has in real property.  For example, an apartment building tenant owns the leasehold estate that is merely possession of the property.  The leasehold estate is evidenced by a lease and is considered personal property.  The lease document is written on a piece of paper that moves, therefore, it is personal property.

            An estate for years is a leasehold estate for a definite period of time.  An estate for years can be for 5 years, 1 year, 6 months, 2 months, or even 36 days.  As long as the lease is for a definite period of time, it is an estate for years.  An estate for years (because it is a leasehold estate) is evidenced by a lease agreement and is considered personal property.

            A sublease occurs when a tenant leases the premises to a tenant.  The landlord (lessor) leases to a tenant (lessee). The tenant (sublessor) then leases to a new tenant (subleasee). The sublessor is said to hold the sandwich lease.              The sublease document between the sublessor and subleasee is a piece of paper and is, therefore, personal property.

 

Pest Reports

            Many lenders require a “clear” pest control report prior to funding a loan.  For this reason pest control reports have become an important part of the purchase or sale of real property in California. 

            A pest control report is a visible check of the property by a licensed pest control inspector for active infestation of pests.  The most common pest in California is termites.  Subterranean termites generally invade a structure via earth-to-wood contract. If after escrow closes and the buyer discovers termite damage unknown to the seller or broker, the buyer must pay for this work.

            A person sells his home.  During escrow a termite inspection is made and a report written.  If all the recommended work is completed before close of escrow the seller must give a copy of the report to the buyer as soon as possible.

            The best time for an intelligent seller to obtain a pest control report is before the sale of the property.

            When a real estate sales contract provides for a termite inspection, a pest control report must be given to the buyer.

Structural Pest Control Board           

            Anyone can obtain a copy of a structural pest control report from the Structural Pest Control Board in Sacramento.

Structural pest control reports are kept on file for two years.

            Two Pest Control Reports

            An escrow officer receives two pest control reports, prepared on different dates and with one requiring more corrective action than the other.  The escrow officer should notify the buyer and seller that they need to agree which one to use.

            A pest control company did not find any evidence of termite infestation in the home that was being sold.  They did, however, find conditions that were deemed likely to lead to infestation.  The cost of correcting this condition is with the buyer.

 

Police Power

            Police power, as mentioned earlier, is the power of the State to enact laws within constitutional limits to promote the order, safety, health, morals, and general welfare of society.

General or Master Plan

            State law requires that each city or county must adopt its own general or master plan for long-term physical development.  All land-use decisions made by a city or county must be consistent with their general plan. Zoning is a major tool for implementing a local general or master plan.

 Zoning

Governmental land use, planning, and zoning are examples of police power. Enactment of zoning laws  also falls under police power.

            Within California, cities and counties have adopted zoning ordinances that divide the land up into zones of use. These zones may be single-family residences, multi-family (R3), commercial, warehouses (M1), or other uses. 

Zoning Changes Initiated By:

            Zoning changes can be initiated by individuals, subdividers, and local authorities.

Variance

            When a builder would like to build a building on a property that is not zoned for this specific use, the builder will ask for a variance that will allow him to build the building on the property anyway. 

            For example, a two acre parcel is zoned RD-20 for use as apartments.  A builder would like to build a strip shopping center on the property.  The builder asks the local city or county for a variance to build the strip center on the property with the existing zoning.   A grant of a variance will allow the builder to construct a strip center on land zoned for apartments.

            When the owner of a lot attempts to show that a proposed nonconforming use is not against public policy, the owner is probably applying for a variance.

            When the city and county authorities allow an improvement that is inconsistent with surrounding properties, this is called a variance.

Nonconforming Use

            A nonconforming use is a use that is not consistent with the surrounding properties, however, it has been in existence for a long period of time and is thus “grandfathered in.” (A variance is for NEW construction and a nonconforming use relates to existing buildings.)

No one will stop the property from operating.  However, when the property falls to the ground it will probably not be rebuilt again.  A small corner grocery store in a residential neighborhood would be an example of a nonconforming use.

            For example, a shopping center is located in an area that was later rezoned for residential use.  This change in zoning is considered a nonconforming use.

Remember, a nonconforming use is already in existence.  A variance is a proposed use.

            A large apartment building was built before the enactment of a zoning ordinance prohibiting multi-unit use in the area.  This apartment building is called a nonconforming use.

Downzoning

            Downzoning occurs when a property is zoned from a higher use (such as commercial) to a lower use (such as residential).  When a property changes from C-1 zoning to R-1 zoning, this is called downzoning.

 

Prepayment Penalty

Prepayment  of a loan is a privilege and not a right.  It provides for a certain sum to be paid by the trustor if the loan is paid off before its maturity date.   In other words, a lender may place a prepayment penalty on a loan if it is paid back early. 

A common prepayment penalty is a six months interest if the loan is paid back while the prepayment penalty is in effect. 

            If a loan on a single-family home has been in existence for more than seven years, a prepayment penalty would not be due (by law).

            VA guaranteed and FHA insured loans do not have  prepayment penalties.

 

Property

Property is defined as the rights and interests in the thing owned.  Rights and interests in the thing owned include the right to use, possess, transfer, and dispose of a thing.

 

Private Mortgage Insurance

            Private mortgage insurance is used to insure a lender for the portion of down payment over 80% against the risk of default.  Loan-to-value ratios over 80% are considered too risky for conventional lenders, therefore, private mortgage insurance is used to insure these types of loans against default.  The borrower may pay a private mortgage insurance (PMI) company an up-front fee and subsequent monthly payments. In return, the private mortgage insurer insures high loan-to-value loans for the benefit of the conventional lender.

            For example, Fred and Mary Smith have $5,000 saved toward the purchase of a home.  Both have good credit and have worked at their present jobs for over five years.  Under Fannie Mae guidelines, they are qualified to purchase a home with a $95,000 loan.  With the use of private mortgage insurance (PMI), Fred and Mary will be able to purchase a $100,000 home with only a $5,000 down payment.  This is called  a 95% loan-to-value loan.

            As mentioned earlier, the borrower generally pays an upfront premium at the close of escrow and monthly payments during the term of the loan.

            When the value of the property increases and/or the loan principal is amortized (paid down) to an 80% LTV or less, the PMI is no longer required.  It will be up to Fred and Mary to request that the PMI be removed from the loan.  An appraisal is usually required to do so.

 

 

Promissory Note

A promissory note is evidence of a debt obligation and an unconditional promise to pay a debt.  It is also a pledge agreement.  In plain terms, it is an un-collateralized IOU.  It specifies the amount and term of a loan, but does require collateral. The person who signs the note promising to repay it is called the maker of the note. The lender is called the payee.

            For example, a prospective borrower would like a loan to purchase a home. The lender will most likely have the borrower sign a promissory note obligating him to repay the loan as specified in the loan terms.

            However, what will happen if the borrower does not repay the loan?  The lender may not obtain his outstanding loan balance due because the note was similar to an "IOU" that is an un-collateralized loan and worth little more than the paper it is written on.

            A promissory note is generally secured by a deed of trust/trust deed in California.  A deed of trust places the property itself as collateral for the loan.  If the borrower defaults when making specified loan payments, then the lender may accelerate the loan balance due and payable immediately and proceed with foreclosure of the property.  The lender can force the sale of the property through a trustee's sale (non-judicial foreclosure) or through the courts (judicial foreclosure).  The trustee's sale is the most common in California and allows the lender to obtain outstanding loan funds, applicable interest, fees, and expenses incurred with the sale.

Seasoned Note

            A seasoned note is a promissory note that has a previous history of prompt loan payments.  Seasoned notes can be purchased (assigned) by another loan company who wishes to add the loan to their portfolio of performing loans.  The loan company who purchases the promissory note from the original lender is called a holder in due course.  The maker of the note (borrower) has less defenses against a holder in due course than he does against the original lender.

            A seasoned note is a loan with a previous history of prompt payments.  Seasoned loans have less risk of default than new loans, therefore, the lender can rely upon the borrower to make scheduled loan payments.

Holder In Due Course

            A holder in due course is a person or entity who purchases a loan from the original lender or someone the original lender sold the loan to (subsequent holder).  For example, when a lender makes a loan and then sells it (assigns it) to another lender who takes over the loan, this new lender is called a holder in due course.

            A holder in due course is a third person who purchases an existing promissory note in good faith,  without notice of dishonesty or any defenses against it.

            A third party who takes a promissory note that is complete and regular on its face and has no knowledge of any defects is known as a holder in due course.

Note Endorsements

            A promissory note can be endorsed (signed) as a blank endorsement, restricted endorsement, or a qualified endorsement.

            A seller sold his home and carried back a $150,000 first deed of trust.  Later, he sold the promissory note to Baker and endorsed it, "without recourse."  If the borrower defaults on the loan, Baker would have to foreclose in order to collect the balance.

Joint and Several Note

            A joint and several note obligates each borrower  jointly and severally for the note.  In other words, each borrower is responsible together with the other borrowers on the note and severally (separately).  Each borrower is responsible together and individually for repayment of the note.

            When a loan is created with more than one borrower, joint and severally is usually added to the promissory note for the protection of the lender.

            Therefore, when loaning money to two or more co-borrowers on a single promissory note, the lender would be best advised to increase the security on the note by placing joint and severally after the names of the co-borrowers.

Negotiable Instruments

            Negotiable instruments include installment notes, bank drafts, and checks.  Deeds of trust and mortgages are NOT considered negotiable instruments. 

Conflict Between Promissory Note and Deed of Trust

            If a promissory note and deed of trust are in conflict, the promissory note would likely be the prevailing instrument.

Service A Loan

            If a seller sold his home and took back a promissory note secured by a purchase money deed of trust; then selected Broker Charlie to service the loan, Charlie must have a written authorization from the holder of the note.

 

Property Management

            To manage properties for a fee, a property manager must have a real estate broker’s license.

An individual who wishes to offer his or her services for a fee to various owners as a manager of their apartments is required to have a real estate broker's license.

            An apartment building of sixteen or more units is required to have a resident manager. 

 

Quitclaim Deed

            A quitclaim deed is a deed where the grantor transfers only his present right, title, and interest in the property.   It conveys the rights of the grantor (if they have any) and buyer beware, because there are no warranties or covenants, expressed or implied with a quitclaim deed. It is executed by the grantor.

For example, Fred and Mary Smith decide to get divorced.  They own their home together (held in joint tenancy or community property) and it is agreed that Mary will keep the property.  Fred executes a quitclaim deed transferring his interest in the property to Mary.  Mary will then hold the property in severalty.

 

Real Estate Commissioner

The Real Estate Commissioner is appointed by the Governor of the State of California.  The Real Estate Commissioner has primary regulatory authority over all real estate subdividers and licensees in California.

            The Real Estate Commissioner revokes real estate licenses.  In addition, the Commissioner issues desist and refrain orders to subdividers who do not follow the real estate laws.

            In other words, if the Real Estate Commissioner determines that a subdivider has done something wrong, he can issue an order to desist and refrain.        A desist and refrain order stops a subdivider from selling properties.

            The Real Estate Commissioner has primary regulatory authority over subdivision matters involving financial arrangements to assure completion of community facilities.

Public Report

            Under the Subdivision Lands Law (which was designed to protect purchasers from misrepresentation, deceit, and fraud in subdivision sales) it is illegal to commence sale of subdivision lots (five or more lots) until the Commissioner determines that the offering meets certain affirmative standards and issues a public report.  In addition, the commissioner makes sure that the subdivider discloses in the public report pertinent facts about the property and the terms of the offering.

For example, a prospective purchaser is considering buying a lot from a non-licensee subdivider.  The purchaser wants to know about street maintenance, liens, utilities, blanket encumbrances, and sewer assessments.  The best single source for this information is the Commissioner's public report.

            The Subdivided Lands Law requires that a copy of a public report on a subdivision must be given to anyone requesting it orally or in writing.

The developer retains the receipt for a public report on a subdivision for three years.

The Real Estate Commissioner is appointed by the Governor of the State of California.  The Real Estate Commissioner has primary regulatory authority over all real estate subdividers and licensees in the state of California.

The Real Estate Commissioner revokes real estate licenses.  In addition, the Commissioner issues desist and refrain orders to subdividers who do not follow the real estate laws.

The Real Estate Commissioner has three years to take action on a violation.

The real estate commissioner regulates a broker and his employees.

            A written agreement between a broker and a salesperson is required by the Real Estate Commissioner.

            The Code of Ethics is part of the commissioner's regulations and is a legal requirement.

 

Real Estate Economics

            Tight Money Market

            The Fed (Federal Reserve) can tighten the money supply by raising the discount rate and selling bonds.

Raising the discount rate increases the cost to member banks that borrow money from the Fed and increases interest rates to consumers. 

Selling government bonds takes money out of the money supply and increases interest rates because there is more competition for the existing available money.  Supply and demand forces are at work:  prices increase as supply decreases and demand remains stable.

            In a tight money market, there will be more use of land contracts/contracts of sale, in addition there will be more cash offers and loan assumptions.

In a tight money market, an investor in real estate loans is concerned that interest rates will rise and does not want long-term investments.  In this instance, the investor should purchase short-term investments that offer more liquidity.  When interest rates increase, he can re-loan the funds at a higher interest rate and increase his return on the investment.

Mortgage Companies Charge More Points

Mortgage companies tend to charge the buyer more (discount) points during a tight money market.  Buyers are generally looking for the lowest interest rate, and are willing to pay more points to reduce the loan interest rate.

More Seller Carry Back Loans

Seller carry back loans indicate a tight money market.  A tight money market causes an increase in interest rates on new first trust deeds.  With increased interest rates, borrowers are less willing to pay a high price for a property because of the increased debt service payment caused by the increased interest rates. As a result, sellers are willing to carry a portion of the purchase price in order to obtain a higher selling price.

Federal Reserve Increases Discount Rate

If the Federal Reserve (Fed) increases its discount rate (rate it charges banks to borrow money) by 1%, then sellers will be less inclined to pay off existing loans.  An increase by the Fed of 1% will cause a rise in interest rates. This rise will make existing loans more attractive than new financing; therefore, sellers will keep their existing loans and probably not be interested in refinancing their existing loans.

The prime rate is the most favorable interest rate charged by banks for short-term loans.

Inflation

            If the Federal Reserve wants to curb inflation, it can raise the reserve requirements and sell government bonds.

When the Fed raises reserve requirements, member banks must keep more deposits on hand and cannot lend them to borrowers.  This reduces the amount of money that can be loaned to consumers and tightens the money market, thereby reducing inflation. 

Equity assets (such as real estate) are a hedge against inflation. Therefore, the best hedge against inflation is real estate. 

As inflation increases, the value of the dollar decreases.  Therefore, during inflationary periods, the appreciation (increase in value) would benefit the trustor.  In other words, debtors (people who borrow money) would benefit economically from inflation. Debtors are paying a real estate loan back with dollars that are worth less than when the loan was made.  Lenders will be hurt the most from inflation because they will receive a loss in value upon repayment of the loan (in dollars worth less than the dollars that were loaned).

Equity assets such as real estate hold their value better than other types of investment vehicles.  The reason is the dollars used to purchase a real estate property will be more valuable as inflation increases in the future.  So, when prices increase, the value of the dollar decreases.  In addition, prices will rise as a result of a decrease in the value of money.

Supply and Demand

            Prices of properties increase when demand for real estate is greater than supply. According to the demand curve, as the price goes down the quantity demanded goes up.  This also occurs in reverse:  as price goes up the quantity demanded goes down.

            Expansion and contraction of available space for rent or sale is influenced by supply and demand.   

Seller's Market vs. Buyer's Market

            It is a seller's market when there are fewer properties offered for sale and more buyers coming into the market.  Sellers have an advantage because of increased demand for real estate and a limited supply,  causes prices to go up.

            If the real estate market shifts from a buyer's market to a seller's market, prices will rise because fewer properties are available for purchase. 

Value of Rental Properties

            If interest rates increase and rents remain stable, the value of rental properties will generally decrease.  An increase in interest rates will cause a decrease in cash flow.  Even though this does not affect net operating income, it will reduce the amount an investor is willing to pay for a property.  An investor will require a higher capitalization rate which will cause a decrease in value.  For this reason, rental income must keep up with inflation for an income property to maintain its value.  The owner must raise rental rates as interest rates increase to maintain the value of the property.

            A shift in the financing terms in the marketplace will affect sales price, but not value of a rental property.  DUST (demand, scarcity, utility, and transferability) will not be affected by financing terms.

Liquidity

                        A real estate investor would probably devote the least amount of attention to liquidity of capital invested. Inflation hedging, safety of initial outlay, and annual income will be more important considerations than liquidity of capital.  Real estate investments are regarded as illiquid investments in comparison to other investment vehicles.

GNP/Employment

            When the employment rate rises and Gross National Product rises, sales of existing homes increases, new residential developments increase, and personal income rises.

Purchasing Power

            When a developer locates the best site for a shopping center, it is usually based upon an area's purchasing power.  A shopping center relies upon the surrounding area's ability to purchase its tenants' products.  The greater the income and higher the socio-economic area, the better for shopping center tenants.

                       

Real Estate Finance in a Nutshell

Real Estate Finance In A Nutshell

            For many years real estate finance has been a mystery to the general public as well as new people coming into the real estate business.  Many of the textbooks written on the subject have been either too technical or theoretical to provide a sound basis of understanding of the lending process in California.  For these reasons, we have attempted to convert difficult concepts into easy-to-understand explanations and examples.

Why we use real estate loans in California

            Let's use the following example to emphasize HOW and WHY we use real estate loans in California:

            You are a prospective homebuyer (place yourself in the homebuyer's shoes) and are looking to purchase a home somewhere in California.  The home you are interested in is listed for $200,000.  You have scraped and saved over the last two years and have $20,000 in the bank.

            You approach ABC Realty and ask about the house. When you mention that you only have $20,000 in the bank, the nice real estate agent informs you that you will need about $180,000 more money to think about purchasing this house and to give her a call when you have the money in the bank.  You realize this will be in a little over 18 years!!!  Your hopes and dreams of homeownership are smashed and you will be a tenant for many years to come.

            Without real estate loans, only a very small number of individuals would be able to purchase a home in California.  This in turn would reduce demand for homes and, therefore their values.

            You then call your banker and ask him for a loan. He replies, "why sure; however, we do need some collateral for the loan."  You cringe at the word "collateral" and wonder whether your bubble gum card collection combined with your 1946 Martin guitar will be enough collateral for the contemplated $180,000 loan. You banker informs you that your bubble gum card collection and old guitar are appraised at $4,000, and asks for additional collateral.  The big question, where do you obtain the additional collateral?

            Your banker, realizing that there is money to be made, comes up with a bright idea, why not use the home itself as collateral for the loan?!!?  But where does the banker get the money to loan???

            The banker collects deposits from his bank's customers and pays an interest rate of (for example) 4%.  He then loans the depositor's money to borrowers at a higher interest rate (for example) 8%.  The difference between what he collects from interest payments and the interest paid to depositors is called his margin (8%-4%=4% margin).

            However, the banker requires collateral for making a loan. Otherwise, if you default on your loan payments, the banker will not be able to regain his capital he loaned you to purchase the home.

            If the banker places the house as collateral for a loan and you stop making scheduled (and required) interest payments, then the banker may foreclose your home.  

He will foreclose, physically remove you from the property, sell it, and get as much of his money back as possible.  The lender may then re-loan the money to another borrower and the circle continues.

            In addition to the 4% margin charged by the lender, he also charges (for example) a 1% loan origination fee (which is 1% of the loan amount), as well as some other "garbage fees" (document preparation, processing, etc.) intended to increase his yield (effective interest rate) on the loan.

            What happens when the banker runs out of his depositors' money to loan?  Throughout the early 20th century he was forced to wait until his existing loans were paid off through refinance or sale before he could re-lend the money. 

            However, in 1938 the federal government instituted a Secondary Mortgage Market that purchased loans from lenders such as the banker in our example.

            Lenders that make loans directly to borrowers are operating in the Primary Mortgage Market.  Private Mortgage Market lenders bundle their loans up in $1 million or more increments and sell them to Secondary Mortgage Market entities on Wall Street. 

The Secondary Mortgage Market is primarily made up of the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Government National Mortgage Corporation (Ginnie Mae). Ginnie Mae is operated by the federal government, Fannie Mae and Freddie Mac are private entities.

            With the advent of the Secondary Mortgage Market, the banker in our example could then sell his loans on Wall Street and obtain his depositor's funds back in his hands.  He will be free to loan the funds again, collect a loan origination fee and all the garbage fees, the then sell them again to the Secondary Mortgage Market.

            The banker found this to be a pretty good racket!   He starts finding "warm bodies" to make loans to. . .not considering their creditworthiness, attitude toward debt, and default risk.

            Unfortunately, several of his early loans that were purchase by Fannie Mae went into default when the borrowers could not repay the loans.

            Fannie Mae became upset with the banker because he was selling them poor quality loans.  Fannie Mae informed the banker that they will only purchase loans that fit their guidelines for default risk.

            Borrowers must meet certain income, liquidity, and credit standards set by Fannie Mae, otherwise, his loans will not be purchased on the Secondary Mortgage Market.  If this occurs, then the banker would have to use his depositor's funds to make the loans (portfolio loans).

            On your particular loan, before it is sold to Fannie Mae, the banker notices that you are only placing 10% of the purchase price as a down payment.  Both the banker and Fannie Mae do not think this is enough down payment if there is a foreclosure and they must sell the home to repay the loan amount.  In other words, you have not placed enough money as a down payment to be a substantial loss to you if you walk away and force the lender to foreclose.

            Both the banker and Fannie Mae feel that a 20% down payment is appropriate for the amount of risk inherent in the loan.  Therefore, the banker will make a $160,000 loan, which Fannie Mae will then purchase on the Secondary Mortgage Market.

            You are $20,000 short of buying your dream home. With two more years of continued savings you can buy the home. . .or the banker may have another bright idea:  "What if we could have an insurance company insure the banker (and Fannie Mae after purchase of the loan) for the 10% down payment ($20,000) that he is not willing to make?"

            A private mortgage insurer is found to insure the 10% down payment the banker is not willing to loan. With private mortgage insurance, the banker is willing to make a 90% loan-to-value loan ($180,000 loan divided by $200,000 value) on your dream property. 

In fact, the private mortgage insurer will insure more than the 10% discussed above.  However, there is a price.  You will be required to pay an upfront fee at close of escrow and also monthly premium payments during the life of the loan.  (However, if the loan-to-value ratio decreases to 80% or below, private mortgage insurance will not be required by the banker or Fannie Mae and may be removed from the loan.  A decrease in loan-to-value ratio may occur from principal reduction or appreciation in the value of the property.)

            After you pay the private mortgage insurance premium to set it up, the banker moves forward with your loan.  Upon funding the loan, you close escrow on your new home and become a proud home owner.  The process doesn't stop there, however, the banker bundles your loan with other similar type loans.  While warehousing them (holding them before sale on the Secondary Mortgage Market), he seasons them also.

Seasoning is a record of prompt loan payments that assures Fannie Mae that the risk of default is minimum in light of the payment history of the loan.  Many times the banker will sell these loans to other portfolio lenders who have excess cash available to place in seasoned (quality) loans.  Lenders who purchase loans are called holders in due course.

            Even though your loan is not backed by the U.S. Government, many types of loans are either insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veteran's Affairs (VA).  These types of government-backed loans are sold through Ginnie Mae who passes them through as mortgage-backed securities and are traded as equities on Wall Street.

In other words, FHA insures and VA guarantees loans made by approved lenders. When investors purchase these loans on Wall Street (as mortgage-backed securities) they know if there is a default, either the Federal Housing Administration which is under the Department of Housing and Urban Development (HUD) or the Department of Veteran's Affairs (VA) will make up any loss suffered in the foreclosure. For this reason, these types of securities are very popular with institutional investors on Wall Street.

            Because of entities such as Fannie Mae, Freddie Mac, and Ginnie Mae credit is equalized in the United States.  Cash poor areas such as North Dakota or Oklahoma can obtain real estate loans as easily as cash rich areas like San Francisco.  This feature makes real estate loans much more liquid than they had been in the past.

            By being able to sell loans, lenders are able to originate more real estate loans to qualified buyers than they would have been able to through solely portfolio sources (depositor's funds).  In turn, interest rates are lower than otherwise because of the increased supply of funds available to lenders.

 

Real Estate Settlement Procedures Act

            RESPA was enacted in 1974 to ensure that buyers and sellers have knowledge of all settlement costs when purchasing a 1-4 unit residential dwelling, if it is financed by federally related mortgages.  Federally related mortgages have a broad definition: 

·        Loans made from savings banks and other lenders whose funds are insured by federal agencies.

·        Loans insured by HUD or guaranteed by the VA.

·        Loans sold to FNMA or other agency on the secondary mortgage market.

Thus, RESPA covers almost all institutional loans.

RESPA Applies To

            RESPA applies to loan disclosure.  It only covers FIRST loans (first trust deeds).  Second and subsequent loans are not covered under RESPA.

            RESPA applies to 1-4 unit owner-occupied residential properties (also called dwellings).  This includes owner-occupied single-family homes, fourplexes, and even mobile homes. It does NOT apply to agricultural property because someone is not living on the property (except scarecrows).

            RESPA also applies to a federally-regulated loan that is a first loan where the proceeds are used to finance the purchase of a lot upon which a mobilehome is located.

            RESPA does NOT apply to loans on properties over 25 acres in size and when land contracts are used.

Primary Purpose of RESPA

            The primary purpose of RESPA is to require that disclosures be made by lenders that make loans on 1-4 unit dwellings.  RESPA was passed to establish uniform procedures regarding disclosures, prorations, etc.

Prohibition Against Kickbacks

RESPA specifically prohibits kickbacks or unearned fees to be paid to referring entities.  For example, a referral fee from a lender to an insurance agency for referring a client is illegal under RESPA.

            Builders had been known (before RESPA) to require a buyer to use their own lending company to purchase one of the builder's homes. This is illegal under RESPA because a buyer can insist on securing a loan from a certain financial institution. Today, builders many times offer financial incentives to borrowers to induce them to use the builder's own lender. In this manner the builder can be assured the borrower will qualify for the loan long before construction of the home is completed.

Special Information Booklet

A lender must give to every loan applicant a copy of the HUD-published booklet entitled, “Settlement Costs and You.”  This booklet provides the borrower with information on settlement/closing costs, explains RESPA, and gives an explanation of the HUD-1 Settlement Statement.

      The "Settlement Costs and You" booklet must be given to the borrower within 3 business days of receipt of the loan application.

Good-Faith Estimate Of Settlement Costs

Within 3 business days of a borrower applying for a loan, the lender must provide the borrower with a good-faith estimate of settlement costs the buyer is likely to incur. 

      RESPA requires that a good faith estimate be delivered to the borrower within 3 business days after applicaton of the loan is made.  In other words, the lender must provide to the borrower a good faith estimate of charges needed to close the sale.  Again, this must be provided within 3 business days after the loan application is made.

Violation of RESPA

The buyer cannot pay or accept kickbacks and/or pay or accept any fee for services unless services are performed. The seller may not insist that a certain title insurance company be used.

If a licensee violates RESPA, he may receive a fine of not more than $10,000 and imprisonment of not more than one year.

RESPA Limits Impounds

            When a federally-related lending institution makes a loan on a single-family dwelling, RESPA sets the limits to the amount of money a lender can hold in an impound account for future taxes and insurance costs. 

Uniform Settlement Statement (HUD-1)

RESPA requires that loan closing information must be prepared on a special HUD form (HUD-1 Statement).  This statement itemizes all charges imposed by the lender, as well as all other closing costs.

            A lender CANNOT charge a fee to prepare the HUD-1 Uniform Settlement Statement.

            A Uniform Settlement Statement (HUD-1) would show an appraisal fee; however, it would NOT show finder's fees, illegal kickbacks, or fees to prepare the statement.

            Discount points paid by the buyer would be a debit to the buyer on a HUD-1 Settlement Statement.

Mortgage Loan Disclosure Statement

            When a licensee negotiates a loan secured by real property, the licensee must deliver a mortgage loan disclosure statement to the borrower when it is signed by the borrower.

RESPA Administered By

            RESPA is administered by the Office of the Assistant Secretary for Consumer Affairs and Regulatory Functions at the Department of Housing and Urban Development (HUD).

 

Real Estate Transfer Disclosure Statement

            A  Real Estate Transfer Disclosure Statement (TDS) must be completed by the seller prior to the sale of all one-to-four unit residential properties in California (with several exceptions, most notably foreclosures do not require this disclosure).

            The TDS asks, “Mr. and Mrs. Transferor (seller), are you aware of any structural defects, material facts, or any other items that the buyer should be made aware of in the purchase of your home?

Agent Inspection

The agents in the transaction must make a visual inspection of the property and report their findings on the form.  The broker must visually inspect the property and reveal pertinent information.  He may also inspect the property and make notes concerning his findings on the form.

During an inspection of a seller’s residence, the agent noticed cracks in the walls and slab floor.  In addition, the windows and doors were jammed and would not open and close properly.  The agent should advise the owner to obtain  a soils report.

Who Completes The Form

Under California law, the person who must prepare the Transfer Disclosure Statement is the transferor (seller).

If the seller refuses to sign the Transfer Disclosure Statement, the broker should notify the buyer of their rights to get the Transfer Disclosure Statement.       

A listing agent can NEVER legally complete the entire Real Property Transfer Disclosure Statement.

 For Sale By Owner or "As Is" Sale

            A private person lists his home for sale “as is,” he is obligated to provide a real property disclosure statement to prospective buyers.

The Real Estate Transfer Disclosure Statement required by the Civil Code must be provided if a single-family residence is offered for sale by owner.

Seller Refuses To Fill Out Form

            If a seller refuses to state on a Real Estate Transfer Disclosure Statement that his property is in a slide area, when it is, the real estate agent should refuse to take the listing.

If a seller refuses to fill out his/her section of the Real Property Transfer Disclosure Statement, the seller's agent should complete the listing agent's portion and deliver it to the buyer.

 

Real Property

Real property is usually immovable and remains in one place. 

Real property is comprised of land, anything affixed to the land, and anything appurtenant to the land. 

1. Land

Land is comprised of the surface area, land below the surface to the center of the earth (including oil and mineral rights such as gold or silver), and airspace above the surface all the way to the heavens.  Modern day controlled airspace has limited an owner's airspace to how much he can reasonably use.

            Mineral rights are considered real property and transfer with the land unless specifically reserved.  Reservation of mineral rights may be used by a developer who wishes to keep the mineral rights after the land has been sold.  The owner of oil and mineral rights can generally enter the land and drill.

2. Anything Affixed To The Land

Some examples include:  a home (including the bearing walls that support the house), fences, satellite dishes, trees (both planted and naturally occurring), kitchen cabinets, built-in microwave ovens, and mobile homes.

            If the item is stationary and does not move, it is probably real property.  Conversely, if it moves it is most likely personal property.

            When personal property is incorporated into or affixed to the land it becomes a fixture, and is considered real property.

Fixtures

Fixtures are incorporated into the land and become real property. An example is a satellite dish. When it is on a truck in route to an owner's backyard it is probably personal property.  However, once it is attached with concrete in the backyard it is probably real property and considered a fixture. 

            There are five tests for a fixture.  A good acronym used to remember them is MARIA. 

Method of Attachment

This is the method used to incorporate personal property into the land. The degree of permanence of the attachment is also important.  If a fixture is attached by concrete, it is probably a fixture, and therefore considered real property. When cabinets are permanently attached to a home, the cabinets become real property because they are incorporated into the land and become a fixture.

Adaptability

Personal property that is attached to the land and is ordinarily being used in connection with the land, is good evidence of being a fixture.

Does the item fit the neighborhood?  Does a satellite dish belong in the backyard of a personal residence?  The answer is yes, and therefore a satellite dish is probably a fixture and considered real property.

Relationship

The relationship between the person who placed the item (possible fixture) on the property and the person who is disputing its classification  is another test for a fixture. Examples include buyer/seller, landlord/tenant, and owner/tax assessor.  Buyer/seller is an adversarial relationship and minimal help in determining whether the item is a fixture.

Intent

            Intent is the most important test for a fixture.  Examples include a satellite dish, valances, and window coverings.  The intent of the seller is for these items to be personal property and go with him when he sells the property.  The intent of the buyer is they are real property and will stay with the house. 

Agreement

            A clear agreement between the parties indicating what is real property and personal property is a good way to determine whether an item is a fixture and, therefore, real property.  The agreement confirms the intents of the buyer and seller and saves misunderstandings after close of escrow.

However, when an item was purchased (time) and how much the item cost (cost) are NOT tests for a fixture.  "T" and "C" are not included in MARIA. 

Other items that may be affixed to the land are called emblements.

Emblements:  Planted Trees, Trees in Nature, and Vegetation

In addition to fixtures, the land may have trees in nature, planted trees, and vegetation growing on the property.  These items are considered real property because they are attached to the land by a root system and are called emblements.

However, when emblements are severed (cut down) they become personal property.

Another item that is affixed to the land is a bearing wall.
Bearing Wall

            A bearing wall of a home is considered real property.  Bearing walls hold up the entire house, are usually made of stronger structural members (2x6's instead of 2x4's), can be at any angle to a door (arches, etc.), and usually remain intact during remodeling (the house will fall down if they are removed).           

Mobile Homes

As mentioned earlier, the principal difference between real and personal property is mobility.  If it moves it is probably personal property.  Mobile homes are either unattached and sitting on their wheels (personal property) or bolted down to a concrete foundation (real property).

3.  Anything Appurtenant To The Land

An appurtenance is anything that is used with the land for its benefit.  Hence the name "runs with the land."  An appurtenance runs with the land and is considered real property. Examples include easements, water company stock, covenants, right of ways, and streams/watercourses.

Easements

Easements give a property owner or individual the right to use another's land. 

            If Owner Smith (who owns Parcel A) decides to sell it, the easement across Parcel B (which is in the deed) must stay with the property.  Smith cannot take the easement with him when he leaves the property. Any future owners of Parcel A will be able to drive across Parcel B. 

Mutual Water Company Stock

            Each home in a subdivision may have one or more shares of water company stock issued by a mutual water company.  When a homeowner sells his home, the stock passes to the new owner and is appurtenant to the land.  Since the water company stock "runs with the land" (appurtenant), the seller cannot take it with him when he sells the property. Water company stock automatically transfers to the new owner of the property, so he may enjoy the benefits of the appurtenance.

Covenants

Covenants are the first "C" in CC&R's (covenants, conditions, and restrictions).  A covenant is a promise.  The breach of a covenant is a minor breach and is remedied by monetary damages. 

For example, your subdivision (Stuffy Acres) has very tight and strict CC&R's.  One day you purchase the original Partridge Family bus from Universal Studios.  Being the prudent collector of TV memorabilia, you decide to drive it to your home in Stuffy Acres so you can keep an eye on it.  You park your new treasure on the street in front of your home and start singing "Daydream Believer" (until you realize it was a Monkeys hit), while waxing the outside of your bus.  However, when you try to take the bus out for a drive the engine will not start.  Disgusted, you decide to move on to other things and the bus sits there for a few days.  The local Stuffy Acres Homeowners Association takes a different view and sends you a notice to "move it or lose it" because they will have it towed if you do not move the bus immediately.  You go on a business trip and decide to deal with it when you get back.  When you arrive home from your trip the bus is gone and a note attached to a bill on your door informing you that the homeowners association had your bus towed and you must pay the towing fee.  Irate, you storm into the association meeting demanding your bus back and proclaiming "I'll never pay this towing bill!"  However, the homeowners association shows you a copy of the CC&R's you signed when you purchased your home in Stuffy Acres.  Covenants in the document specifically state that homeowners cannot have vehicles parked on the street for more than twelve hours.  You violated this covenant and the homeowner's association had the right to tow your bus and send you the bill.  The mere payment of the bill by you will remedy the breach and restore everyone to the happy tranquility that existed before you purchased the psychedelic bus.

As can be seen from the above example, the towing of the bus was only a minor breach of the subdivision's CC&R's and was remedied by payment of monetary damages. 

Right-of-Way

            A right-of-way is similar to an easement.  Right-of-ways are commonly used on public lands, such as the Bureau of Land Management (BLM).  The BLM has granted over 87,000 right-of-ways in the Western U.S.  Oil and gas pipelines are common right-of-way uses.

 

Recovery Fund/Account

            The Recovery Account is a fund of last resort for a member of the public who has obtained a final judgment against a real estate licensee and who has been unable to satisfy the judgment through normal post-trial proceedings.

            The judgment must be based upon fraud, misrepresentation, deceit, or conversion of trust funds.

            If payment from the Recovery Account is made, the license of the judgment debtor is automatically suspended until he or she has repaid the amount plus interest.

            Maximum limits are $20,000 per occurrence and $100,000 maximum per licensee.  The Recovery Account is funded by license fees.

            The primary purpose of the Department of Real Estate’s Recovery Fund is for members of the general public, who hold un-collectable judgments against a licensee, to collect limited damages.      

When a licensee has been suspended due to the payment of a claim from the Real Estate Recovery Account, the license cannot be reinstated until the licensee has repaid the total amount paid plus interest.

 
Regression

When a person over-improves a home that results in an increase in value less than the cost of the improvements, this is called regression. 

            For example, a homeowner adds another 1,000 square feet to his existing 1,000 square foot home.  The surrounding neighborhood consists of 1,000 square foot homes valued at $100,000.  The homeowner may believe that his newly expanded mansion (real estate agents refer to it as the "Winchester Mystery House) is now worth $200,000; however, because of the principle of regression, the home is probably work approximately $125,000.  The homeowner has lost $75,000 in value because the neighborhood is not comprised of similar size (2,000 square foot) homes.  The value of his home will seek the level of the homes surrounding it.

            Therefore, regression occurs when a house of greater value is adversely affected by houses of comparably lesser value.

 

Restrictions

            A restriction is a limitation placed on the use of a property.  It can be placed by an owner (private deed restrictions), developer (private deed restrictions), or the government (public).  Remember, deed restrictions are based upon use, therefore, they are an encumbrance but NOT a lien.

Private Deed Restrictions

            Private deed restrictions restrict the free use of the land by the owner and are commonly called CC&R's or covenants, conditions, and restrictions.  CC&R's are designed to maintain the value of real property by limiting certain things an owner can do to the property.  CC&R's may be created by deed, written agreement, or by a recorded declaration of restrictions.

            Developers many times place deed restrictions on subdivisions.  This is an attempt to restrict certain uses in the subdivision and maintain property values in the area.

Covenants

            A covenant is a promise to do or not to do something.  When a covenant is breached (broken) it is considered a minor breach and the remedy is monetary damages.

Conditions

A condition is similar to a covenant; however, when a condition is breached it is considered a major breach and is remedied by loss of title and a return of the property to the grantor (usually the developer or homeowner's association).  Since the breach of a condition results in loss of title, a condition can be created only by a grant of an estate through a deed.  Therefore, a condition may cause a possible forfeiture of ownership.

Covenant Differs From A Condition

            A covenant differs from a condition in that a condition can be created only by a deed.  A condition is a qualification of ownership and can only be imposed on conveyances, such as a deed.

Additional  Private Restrictions

            There may be additional restrictions in addition to covenants and conditions restricting the use of the land.  Examples include a private deed restriction not allowing a homeowner to raise chickens or a milk cow in his backyard.  Farm animals may detrimentally affect the value of the homes in the area.

Word Problem

A grant deed in a new subdivision contains a restriction prohibiting the placement of a "For Sale" sign of reasonable size on the property.  This restriction is unenforceable because it infringes on the:

Answer:            owner's power of alienation (convey the property).

Injunction

            An injunction is used to stop a violation of a private deed restriction (CC&R's).    It is a court order restricting a party (stopping them) from doing an act such as violating private restrictions.        

 

Public Restrictions

            When the government places restrictions on land, they will place them on the land using three (of the four) sovereign powers of the State:  police power (including zoning), escheat, and eminent domain.  Taxation is not included in the discussion.

Encroachments

An encroachment occurs when an owner of one property places a permanent improvement on an

adjacent property owner's property. When an encroachment occurs, the property owner

who has been encroached upon must sue his neighbor on the grounds of trespass, if less than five years have elapsed since the encroachment was created.  If five or more years have elapsed, then the property owner who created the encroachment may have created an easement by prescription over the adjacent property (if OUCH is present).

 

Ridgeboard

            The ridgeboard is the highest member of a frame house.

 

R-Value

            R-Value or R-Rating represents the amount of heat or cooling resistance insulation provides in the home.  For example, R-38 insulation is a better insulator than R-10 insulation.  The higher the R-rating, the greater the resistance to heat loss.  "R" stands for resistance to heat flow.

 

Sale-Leaseback/Sale-And-Leaseback

For federal income tax purposes, when an owner of a building sells it and immediately leases it back from the new owner, the former owner (now the tenant) can deduct 100% of rent paid for commercial purposes.

            If the owner of a hardware store who owns the land and building housing the store decides to sell the land and building to an investor and lease back the premises for a certain period of time, this is called a sale-leaseback (also called sale-and-leaseback).  100% of the rents paid by the hardware store owner to the new owner of the land and building are deductible by the hardware store owner against his ordinary business income.

 

Secondary Mortgage Market

            The term secondary mortgage market refers to the resale or transfer of existing loans secured by deeds of trust.  These loans pass between mortgagees (lenders).

            Some common term must be defined as they relate to the secondary mortgage market, before we can discuss the three secondary mortgage market entities that exist in the United States.

            On the State Exam, there are three entities operating in the secondary mortgage market:  Federal National Mortgage Association (FNMA) called Fannie Mae, Federal Home Loan Mortgage Corporation (FHLMC) called Freddie Mac, and Government National Mortgage Association (GNMA) called Ginnie Mae.

            Fannie Mae is involved in the secondary mortgage market.  It purchases loans made by primary mortgage market lenders.

Fannie Mae is NOT a demand source for real estate loans.  Demand sources include real property sales, refinancing, and construction.

Lastly, FHA does NOT operate on the secondary mortgage market.  FHA insures loans made by approved lenders and has nothing to do with the secondary mortgage market.

GNMA guarantees securites backed by pools of mortgages.  Securites holders receive pass-throughs of principal and interest payments from the pool.  GNMA guarantees monthly payments will be made on time.

GNMA passes through principal and interest payments, less servicing costs and other fees.  Also, GNMA passes through additional principal reduction payments made by borrowers.

Pass throughs include GNMA, FNMA, and private investors.

 

Secret Profit

            A licensee may not receive a secret profit from the sale of one of his listings or other purchases he is involved in as a licensee.

            A person who is NOT a licensee may make as many secret profits as desired from a transaction.

            A person who is not a licensee closed escrow on the purchase of a property for $5,000 knowing that he had a buyer for $20,000.  In this instance, the party had done nothing wrong. Since he was not a licensee, he could receive a secret profit.  He is merely a good, sharp businessman.  However, if he had a real estate license it would be considered a secret profit, and  he will be taking unconscionable advantage of a member of the general public.

            For example, Able, who is not a licensee, made an offer to purchase Baker’s property.   The offer was accepted by Baker.   While in negotiations with Baker, Able received a higher offer from Charlie.  Able purchased the property from Baker and then sold it to Charlie, making a nice profit.  Able learned of this sale and consulted a real estate attorney.  The attorney would inform Baker that he has no recourse against Able.  Able was NOT a licensee.

            An owner may make a secret profit on the purchase of real property.  However, a broker or salesperson cannot make a secret profit.

 

Securing  A Commission

            A real estate broker would look to the courts to secure a commission on the sale of  real property.

            For example, a broker with an open listing contract on a property agrees orally with another broker to share a commission upon the sale of the property.  The property sells.  The listing broker is paid a commission, but he refuses to share the commission as promised, the selling broker would have a good chance to secure a judgment against the listing broker in a suit filed in court.

            To secure a commission a real estate agent would file a civil suit in court against the person owing him a commission.  Of course, this would be through his broker.

            If a broker accepts an oral contract to earn a commission on the sale of real property and the seller actually pays him the money, the broker can accept the commission.

            If a real estate broker is paid his commission in cash and part of a business opportunity, this is legal.

 

 

Security Deposit

            A landlord has twenty-one days to return the unused portion of a security deposit.

 

Severalty

Real property owned by one person or entity (corporation) is owned in severalty.  Sole ownership is held in severalty.  If Joan Smith takes title to a parcel of real property in her name only (with no one else on title with her), this would be in severalty.  Therefore, severalty means to "severe out" and means to be held by one person.

            Property owned by a city would be held in severalty.  In addition, property held by a corporation could be held in severalty.

 

Soil Conditions

Soil conditions include expansive, adobe, and alkalinity.  One term that is NOT associated with soil conditions is deciduous.  Deciduous refers to trees and other plants that lose their leaves every year.  The leaves you rake up in the Fall came from deciduous trees.

Soil Pipe

            The soil pipe refers to sewer lines.

 

Soils Report

A soils report shows the type of soil under a property and whether it is a type that will shrink and swell, thus causing cracks in the walls and causing doors to not close properly.  Settling may also cause cracks in concrete foundations and walls.

 

Sole Plate

The sole plate is the bottom board that supports the studs that hold up the walls of the house.  Therefore, studs of an interior wall are supported and nailed to the sole plate.

 

Specific Performance

            Specific performance is a court action brought to force a party to carry out the terms of a contract.  Specifically, specific performance is usually used to force a party to convey real property as stated in a purchase agreement.  Each piece of real estate is considered unique and legal damages are many times not adequate to compensate a buyer for a seller’s breach of contract.  Therefore, the courts may force the seller to convey the property to the buyer under the terms of the contract.  Consideration for the contract, however, must be reasonable or sufficient relative to value for the courts to require specific performance.

 

Standby Loan

            A standby loan refers to an agreement by a lender to provide a loan upon the demand of a borrower.  Therefore, when a buyer receives a commitment from a lender to provide funds if needed by the buyer, this is called a standby loan.

 

State Board of Equalization

            The State Board of Equalization collects (levies) sales tax on tangible personal property, and also appraises public utility properties for tax assessment.

A taxpayer would not ordinarily pay property taxes on INTANGIBLE personal property.

Successor's Liability

            The BUYER is responsible for sales tax collected prior to the sale and not yet paid to the State Board of Equalization.

 

Statute of Limitation

            The statute of limitations is the amount of time a person can bring an action in court.  For State Exam purposes, a purchaser of real property has four years to bring a claim in court.  If this time period is exceeded, then the statute of limitations takes effect and the person is prevented from bringing an action in court.

 

Street Improvement Act of 1911

            According to the Street Improvement Act of 1911, developers can use the Act to construct streets, sewers, and improve streets; however, they cannot use the Act to purchase land for subdividing.  It is a type of special assessment. 

 

Stud

The studs are the boards used to frame a wood frame house.  The maximum space between wall studs is 16 inches on center.

 

Subdivided Lands Law

            The Subdivided Lands Law or Subdivided Lands Act relates to subdividers who are subdividing a parcel of real property into five or more parcels.  Under these circumstances, a subdivider must go to the real estate commissioner to obtain approval to sell the parcels of land. 

The real estate commissioner issues a public report thus allowing a subdivider to commence selling the parcels covered under the report.  If the subdivider tries to sell the parcels before the public report is issued, the real estate commissioner may issue a desist and refrain order to stop the sale of the parcels.

The Subdivided Lands Law applies to a subdivision with five or more parcel.

 

Subdivision Map Act

            The Subdivision Map Act relates to anyone who subdivides two or more parcels of real property.  The subdivider must go to the local government officials in the area where the property is located and get approval to subdivide a property.

Subdivision Map Act Applies To

The Subdivision Map Act applies to two or more lots.  Anytime real property is subdivided into two or more lots, the subdivision map act applies.

Subdivision Map Act Requires

            The Subdivision Map Act requires that submissions for approvals be made to local government officials.            The planning commission is considered a local government official.

The Subdivision Map Act requires a subdivider to prepare a tentative map and file it with the city or county where the subdivision is located.  It also authorizes cities and counties to enact subdivision regulations.

            The Subdivision Map Act gives local entities the ability to determine the physical features of a subdivision.

Subordination/Subordination Clause

A subordination clause allows a first trust deed to change positions with a second trust deed with regard to priority of recording. It gives priority to liens (loans) subsequently recorded against the property.

            The main purpose of a subordination clause is to make one loan or encumbrance take an inferior position to another loan or encumbrance.  In other words, it permits the buyer to place a future loan that will have priority on the property.

            For example:  A promissory note and first deed of trust are given to a seller to finance the purchase of a parcel of vacant land.  The buyer intends to use a second deed of trust construction loan to build the improvements on the property.  Therefore, the first deed of trust (used for the purchase of the land) will most likely contain a subordination clause.  The subordination clause benefits the trustor.

            Another example:  If an owner wants to refinance a first deed of trust and a second deed of trust exists on the property, the lender on the first trust deed will probably require the second trust deed to contain a subordination clause.

            Therefore, a subordination clause allows a mortgagor (borrower) to issue additional security devices on property, which receive higher priority.

 

Substandard Building

            A substandard building is a building that does not conform to local or national building codes.  However, a home that has an outdated, yet functional electrical system would not be considered a substandard building.

 

Substitution/Principle of Substitution

The principle of substitution is defined as substituting one property for another.  When a property that has sold is substituted (compared) with another  property, a comparison of the two properties can be made.  This comparison is commonly used when appraising single-family homes.

            The principle of substitution examines the use of the substitute property, its design, and its income generation (earnings that are produced). 

            The slogan "No prudent person would pay more," sums up the principle of substitution. 

            Lastly, a real estate appraiser would use the principle of substitution when applying the comparison approach, capitalization approach, and cost approach.

 

Take-Out Loan

            A take-out loan is a long-term loan taken out after construction of a property.  It usually has a 15 or 30 year amortization period

 
Tenancy

The mode or method of holding title is called tenancy.  Vesting (how the buyer takes title) is usually decided after escrow is opened and is usually taken solely by one person or concurrently by two or more people.

 

Tenancy In Common/Tenants in Common

A tenancy in common must have two or more real property owners.  The owners are called tenants in common.  Tenancy in common is a form or ownership that is well suited for a brother and sister to hold title to real property (however, remember ANY group of two or more people can hold title to real property as tenants in common, they are not required to be brother and sister).

 

Brother                                                            Sister

25% interest in the property                              75% interest in the property

Can will his portion to his heirs                          Can will her portion to her heirs

 

            The only unity the brother and sister share is possession.  They both possess the property.

 

            Tenants in common share in the matter of possession; and this allows each tenant in common to use the entire property.  Each tenant in common does not own a specific part of the property. 

When a property is held as tenants in common, each of the owners' interests may be conveyed or sold separately. 

Both tenants in common and joint tenancy share in the matter of possession.  Vesting would read, "Brother and Sister, as tenants in common.

 

Tenancy in Partnership

When real property is owned by two or more persons who come together for business purposes it is called a tenancy in partnership.

            A tenancy in partnership can be formed by any number of people (2 or more), interests are determined by agreement between the parties, there is equal possession, and there is no right of survivorship.

            A partnership can take title in the name of the partnership (ABC Partners), in the individual names of one or more of the partners (John Able Investors), or in the name of a third party as trustee for the partnership (usually an attorney's name).

            Partnerships take the form of a general partnership and a limited partnership.

General Partnership

            A general partnership is a form of business organization where two co-owners carry on the business for a profit.  All general partners have full liability for all obligations and debts of the partnership.  A written agreement is NOT required for a general partnership (although, highly desirable).  An oral agreement is enforceable.

            In a business partnership (general partnership) if one of the partners dies, the surviving partner becomes the exclusive operator of the business and retains title to the assets of the business until he can wind up the partnership affairs.

            An advantage of a partnership over the sole ownership of a business is that each partner is considered a co-owner of the partnership assets of the other partner.

Limited Partnership

            A limited partnership is a group of passive investors, called limited partners, who share in the profits of the partnership and have limited liability for the debts and obligations of the partnership.  In fact, a limited partner can only lose the amount of his investment in the partnership.  Creditors cannot come after his personal assets to satisfy the debts and obligations of the partnership.

            There are also tax advantages for a limited partnership.  Income from real estate assets owned by the partnership is taxed on the individual limited partner's personal tax return.  Therefore, one advantage of a limited partnership over a corporation is double taxation.  A corporation is taxed at the corporate level and then the individual investor is taxed at the personal level in the form of dividends.  Limited partnerships are taxed only at the personal level and not at the partnership level.

            Lastly, limited partnership agreements must be in writing.

Syndication

Many times a general partnership is combined with a limited partnership to form a syndication (also called a syndicate venture). In the syndication form of ownership, there is a managing general partner combined with several limited partners.  The general partner has unlimited liability for the debts and obligations of the partnership.  The limited partners can only lose their investment and, therefore, have limited liability for the operations of the syndication. 

When the limited partners have no property descriptions nor financial data concerning the property to be acquired at the time of investment this is called a blind pool type of syndicate venture.

 

Time Is Of The Essence

The words "time is of the essence" appear in the deposit receipt and purchase agreement.  This phrase informs the buyer and seller that they need to move forward quickly to complete the contract.  Time is of the essence is required in all real estate purchase agreements.

 

Timeshare

            A timeshare is a form of ownership where the owner has the right to use a specific property for usually one or two weeks each year.  The timeshare owner purchases the timeshare and then pays yearly maintenance fees to keep the timeshare ownership.  Timeshares may or may not include fee simple ownership of the real property.

            Many timeshare developers have offered prizes to prospects who listen to their sales presentation.  The developer must disclose this attendance requirement to each prospect who attends the sales presentation.

             For example, a developer has a mailing which offers prizes without stating any requirement for persons to listen to a sales presentation concerning the property in order to qualify for a prize.  However, the developer requires prospects to listen to the sales presentation.  This is illegal because it did not disclose the attendance requirement.

 

Title Insurance

            A purchaser of a parcel of real property may find that someone else claims title to the property, there are existing liens against the property, there are existing enroachments on the property, or any number of other problems that may affect the title to the property.  For this reason, title insurance has come into being in California.

            Title insurance allows a buyer of a parcel of real property to purchase a policy of title insurance that will cover the buyer against title-related problems at the time of close of escrow.  In other words, a buyer of a parcel who obtains a policy of title insurance has a means to remedy her losses if she finds something wrong with the title to her property.

            Therefore, one insures title through title insurance that takes effect at close of escrow.  Any problems that occur AFTER close of escrow are NOT covered under a policy of title insurance (only existing conditions).

Chain of Title

            The chain of title is the recorded history of encumbrances, liens, and (especially) ownership interests that affect a subject parcel of real property.

            Each change of ownership is chronologically (oldest to most recent) placed to form a "chain" representing all of the owners of a parcel of real property from the beginning of recorded title to the present.  If there are any breaks in the chain of title, then the present owners do not have valid title to the property or there may be a cloud on the title.

            Before issuing a title insurance policy, a title insurance company checks the chain of recorded title searching for defects that may impact a purchaser's clear title to the property.  In fact, in making a decision of whether or not to issue a title insurance policy, the title insurance company (title company employee) would be most concerned with those documents that appear within the chain of title.

            In order to research the chain of title, a title company searches the records of the county recorder, court clerk, and federal court clerk.  The may also search the federal land office.

            The primary reason for including a legal description in a real estate sales contract is so the title company can locate the property.

            Title company records are public records and anyone can see them.

Marketable Title

            From a practical standpoint, marketable title is title that is free of reasonable objections.   Paramount title is superior or foremost to all other forms of title.

Abstract of Title

            An abstract of title is a written summary of all recorded items (chain of title) for a specific parcel of real property.  The abstractor (person who compiles the abstract of title) searches the public records in search of grants, conveyances, judicial proceedings, and wills.

The abstract of title lists the items that affect title in a chronological sequence from oldest to the most recent.  The abstractor of title does not reveal encroachments or forgery, only matters of public record.  For these reasons, every recorded change of ownership and/or claim of ownership on a property is in the abstract of title.

Preliminary Title Report

            A preliminary title report is an offer by a title insurance company to issue a policy of title insurance.  It is usually made and distributed to the buyer, seller, and brokers immediately after escrow is opened and before a title insurance policy is actually issued at close of escrow.  It reports items having an affect on title such as encumbrances.  Only the seller's items are reported until escrow closing and recording. A preliminary title report is not as complete as an abstract of title and is not binding upon the title insurance company to issue a policy of title insurance.

            There are two types of title insurance policies used in California: 

·        California Land Title Association Standard Coverage Policy of Title Insurance (CLTA owner's policy) and

·        American Land Title Association Extended Coverage Policy of Title Insurance (ALTA lender's policy).

California Land Title Association Standard Coverage Policy of Title Insurance (CLTA Owner's Policy)

            The CLTA Owner's Standard Coverage Policy of Title Insurance is the most common type of title insurance policy and covers the owner against recorded items, forgery, incompetence, and lack of capacity.  Most people buy the standard policy of title insurance.

CLTA =           All Recorded Items + Forgery +

Incompetence + Capacity

Recorded Items

All recorded items in the chain of title include  documents that have been recorded at the county recorder's office in the county where the property is located. It also protects the owner from improper delivery of a recorded deed.

For example,  Seller Able sells a property to Buyer Baker, and then sells the same property to Buyer Charlie.  If the sale to Buyer Baker was recorded, then Buyer Charlie would be indemnified (reimbursed) for his losses by the title insurance company that issued a title insurance policy to Buyer Charlie.

            Forgery

Forgery occurs when someone signs a document (such as a grant deed) when he is not the grantor (seller) of the property.  This includes forgery in the chain of recorded title, grantor's signature was forged on the deed, delivery of a previous deed in the chain of title without the grantor's intent, and lack of signatures of both husband and wife.

Incompetence

When a person is declared incompetent in a court of law his contracts are void and have no legal force or effect.  This includes an incompetent grantor or a previous grantor who was declared legally incompetent.

Lack of Capacity

A person under 18 years of age (called a minor on the State Exam) cannot contract for real property.  All of their contracts are void and have no legal force or effect. This includes the lack of capacity of the grantor to convey the property and overall capacity of the parties to legally sign a contract for real property.

American Land Title Association Extended Coverage Policy of Title Insurance (ALTA lender's policy)

            The ALTA Extended Coverage Policy of Title Insurance covers property owners for all CLTA coverages PLUS a physical or formal survey of the boundary lines of the property looking for encroachments AND unrecorded encumbrances.

ALTA policy    =         All CLTA +    

1.  physical survey

                                                2.  boundary liens

3. location of correct property lines and improvements

4.  encroachments (encroachment by an adjoining property owner)

5. unrecorded encumbrances (unrecorded easements, unrecorded mechanic's liens, unrecorded leases, and unrecorded liens)

            The ALTA lender's policy covers a survey of the property's boundaries or the location of property lines according to a formal survey.  The CLTA does NOT cover a survey of boundaries. 

            Title insurance is designed to provide protection against most possible defects in title; however, there is no such title insurance policy that provides protection against all possible defects in the condition of title.

 

Toxic Waste Report

If an appraiser sees an old abandoned gasoline station adjacent to a subject property he is valuing, he would obtain a toxic waste report.  This would determine whether the adjacent property had leaky fuel tanks that leached into the subject property.

Since gasoline has been considered a carcinogen (causes cancer), leaching into the subject property could cause a loss of value in the subject property.  This loss of value would be considered economic obsolescence because it is external to the subject property being valued.

            Therefore, when a residence is located next to an abandoned gas station, an appraiser would recommend that an owner obtain a toxic waste report.

 
Trade Fixtures

When a business tenant solidly attaches personal property (shelves, business office shelves, etc.) these items are called trade fixtures.  When a business tenant leaves the space, he can take trade fixtures with him.  They are considered personal property and are transferred (sold) with a bill of sale.

            Example of trade fixtures include shelves and items within a business office.   If a lessee (tenant) attached items to the wall during his tenancy, at move out he may remove them because they are trade fixtures.  Since they are personal property and not real property, they do not run with the land and therefore, are not an appurtenance to the land.

            To transfer an interest in trade fixtures upon the expiration of a lease, the lessee (tenant) would use a bill of sale.  A bill of sale transfers trade fixtures because they are personal property. 

 

Trust Fund/Trust Account

            Trust funds are funds held in trust by a broker for his principal.  Trust funds fall into two categories, (1)  earnest money deposits collected in the course of sales transactions and (2)  property management rents collected from tenants.

            Real estate brokers keep trust account checks for 3 years.

            The person who legally can withdraw funds from the broker's trust fund is a bonded employee specifically authorized in writing to do so.

 

Truth-In-Lending (Regulation Z)

            According to the Truth-In-Lending Act, consumers must be informed of credit terms by the lender.

Annual Percentage Rate (APR)

            Annual percentage rate is all the direct and indirect costs a borrower will pay.  It is the effective interest rate paid by borrower and includes the finance charge and all the "garbage fees" paid by the lender.  Garbage fees include document preparation, processing, and several other fees charged by a lender as a cost of making the loan.

            Under the Federal Truth-In-Lending Law, finance charge and annual percentage rate (APR) are two of the most critical facts which must be disclosed to buyers and borrowers.

            For example, if a lender advertises $10,000 down 9% interest, the annual percentage rate (APR) must be disclosed.

Graduated Payment Mortgage Disclosure

            When a mortgage company is advertising a graduated mortgage, under the Truth-In-Lending Act, the difference in monthly payments must be disclosed.  A graduated mortgage results in scheduled increases in the interest rate over the life of the loan.  The scheduled increases must be disclosed to the borrower.

"Mega Bucks Trust Deeds"

            If a broker advertises the sale of "Mega Bucks Trust Deeds" in a newspaper and the advertisement offers a specific yield which he arrives at by looking at his yield for the past year, this advertisement is LEGAL if the yield is based on the actual interest rate and the amount of discount from the outstanding balance on the note. 

Illegal Advertising

            The Real Estate Commissioner would NOT allow the following advertising slogan:  "We loan up to 75% of the value of the property based on our staff appraiser's report."  This implies a 25% down payment and would require a disclosure of the annual percentage rate (APR). 

            In addition, "Call our toll free number 1-800-FOR-A-LOAN" would also be considered illegal according to the commissioner's regulations.

3 Day Right of Rescission/Federal Right To Rescind Notice

Under the Truth-In-Lending Act, the right to rescind a loan is allowed when refinancing a home loan.  The rescission period is for 3 business days after the signing of the note. The right to rescind applies to refinances NOT to purchases.  Therefore, a lender must comply with the Federal Right To Rescind Notice when the borrower is refinancing his personal residence.

If the owner of a home applied for a home-improvement loan, his rescission period would be 3 days.  Since the home-improvement loan is secured by the owner's personal residence and is considered a refinance, the 3 day rescission period would apply.

3 Day Right of Rescission Does NOT Apply

            The 3 day right of rescission does NOT apply to agricultural loans.  Since a vacant field is not a person's personal residence, it does not apply.

            Also, when a borrower uses the same creditor to refinance a loan already secured by his home, there is NO right of rescission, unless new money is also advanced. Then the transaction is rescindable only to the extent of the new money.

 

Turnkey Property

A turnkey property is a subdivision project completely finished and ready to move in.

 

Unearned Increment

When a property increases in value because of outside factors out of the control of the property owner, this is called an unearned increment.  One example of an unearned increment is an increase in population.  When the surrounding population increases, the demand for housing usually increases.  Increased demand will cause less supply, resulting in  an increase in house prices.  The homeowner who sells his property after an increase in population and resulting increase in house prices has taken advantage of an unearned increment.

 

Uniform Commercial Code

            A UCC-1 is a financing statement.  (NOT financial statement).  A UCC-1 is recorded with the Secretary of State.  After recording the document, a lien is created on personal property used as security for a loan to purchase a business opportunity.

Bulk Sale Law

            According the bulk sale law, a buyer would assume responsibility and liability for the inventory being sold if no notice of the sale is given to creditors and other third parties. (It is the buyer’s responsibility to publish the sale and alert creditors.)           

            According to the bulk sale law under the Uniform Commercial Code (UCC), the seller is required to publish a notification of sale.

 

VA Loan (Department of Veterans Affairs)

Veteran’s Administration loans (VA) are under the Department of Veterans Affairs.  The VA guarantees loans made by approved lenders.  One of the advantages to veterans who qualify for a VA guaranteed loan is 100% financing.  VA loans have the lowest down payment, however Cal-Vet has the lowest closing costs.

No Down Payment

            VA financing allows a person to purchase a residential property with no down payment.  This is 100% financing and the loan amount is determined by the Certificate of Reasonable Value (CRV).

Certificate of Reasonable Value (CRV)

            The CRV determines how much the VA will guarantee for a loan on a property.  A VA-approved appraiser appraises a property and sets the CRV amount.  Therefore, the amount of a VA guaranteed loan and corresponding down payment is limited by the amount of the CRV.

VA Discount Points

            The seller can pay discount points on the buyer's loan.  If the seller does so, the discount points paid by the seller are a credit to the buyer (credits go in, and debits go out).

Pest Inspection Required On All VA Guaranteed Loans

            A structural pest inspection is required for the purchase of any residence with a VA guaranteed loan.

 

Value

Value is the relationship between a thing desired and the potential purchaser.  Value is the same as the worth of a thing.  When an appraiser determines the worth of a parcel of real property for a specific reason, as of a definite date, he is making a valuation.

            Forces that affect value include economic, social, government, and environmental.

            In addition, the neighborhood where a property is located is the most important concern for future profit when buying a property.  For this reason, the most important factor in the decision to purchase property is location.

            Other changes that impact real estate value include popularity of consumerism issues, the real estate industry itself, and land use controls (zoning).

Elements of Value

            Elements of value include

·        demand,

·        utility,

·        scarcity, and

·        transferability. 

 

The acronym "DUST" is a good way to remember the elements of value.

Demand

Demand is the demand for properties in a given geographical area.  This relates to personal income, land available for development, commute time to the central business district, as well as many other factors.

Utility

Utility is the ability to use a property for its desired use.  For example, as long as a homebuyer can use a property to live in, the utility value of the property has served its purpose.  However, if other factors cause the property to be unsuitable for use as a home (i.e. drive by shootings, crime, and violence), then the utility of the property will be hampered and  reduce the value of the property.

Scarcity

Scarcity is a lack of available and suitable properties in a given geographical area.  When there is a minimal amount of land available for development (e.g. San Francisco Bay Area or Orange County),  homebuyers must purchase from a limited supply of existing homes.  There are not enough homes available for the number of aspiring homebuyers (demand).  Scarcity of housing in the Silicon Valley has driven housing prices to unheard of levels in that region.

Transferability

Transferability is the ability to transfer a property to someone else.  If a property cannot be sold or willed, the value of the property will decrease as a result of the owner's inability to alienate (convey) the property.  Transferability is the least important element of value (demand, utility, and scarcity are more important elements).

Assessed Value

            When an appraiser appraises a property he usually does NOT consider the assessed value of the property.  The assessed value is the value the tax assessor places on an individual property (land and improvements).  It does not correlate to the market value of the property.  An appraiser would consider the property identification, a definition of value (DUST), and the property rights to be valued (use, possess, transfer, dispose; also all appurtenances that run with the land).

Size and Physical Characteristics, Bundle of Rights, and Utility

            An appraiser would consider the size and physical characteristics, bundle of rights, and the general utility of a property when trying to establish the value of a parcel of real property.

 

Vesting

If three investors take title to an industrial property as "Reliable Engineering Company, a joint venture of Able, Baker, and Charlie,"  title would vest in the entity "Reliable Engineering Company."

 

Walk-Thru Inspection

            During a walk-thru inspection, the buyer discovers several items that need to be completed. The agent should inform the seller about the repairs before closing or credit the buyer for the repairs in escrow.

The day before escrow closes the buyer asks for the gate to be repaired.  The seller should have escrow credit funds to the buyer for the repairs. Prior to close of escrow, the buyer would like to make repairs on the property, the broker should obtain the seller's written approval.

 

Warehousing

            Warehousing occurs when a lender, who is accumulating loans to sell in the secondary mortgage market, holds these loans until he has a bundle of $1 million or more in loans.

            A warehousing operation may occur when a mortgage banker collects loans before reselling them or prior to sale.

 

Will

A will is a written instrument used to dispose of real and personal property after a person's death.  To devise is to leave real property by will.  A devisor is a person who wills real property to his heirs after death.  A devisee receives real property by will (usually an heir).  A legacy is personal property willed to a person's heirs after his death.

            There are two types of wills:  written and holographic. 

Written Will

A written will is usually prepared by an attorney and is signed by the maker of the will and witnessed by two individuals.  Therefore, there are three parties involved--the devisor and two witnesses.

Holographic Will

            A holographic will is a will written in the devisor's own handwriting and signed by him.  Therefore, a holographic will is not a printed form.

            When a person dies with a will, the court starts probate proceedings that continue for a minimum of six months after the devisor's death. 

Probate

During probate the superior court tries to correctly ascertain the claims of creditors and beneficiaries, and make sure that the wishes of the devisor are carried out. 

Probate is a formal court proceeding to:

Ø      confirm the validity of a will;

Ø      determine the heirs to an estate;

Ø      collect the assets of an estate;

Ø      pay the taxes of an estate; and

Ø      pay the debts of an estate.

The real estate commission for a property that is in probate is set by court order (NOT set by law).

      When a person dies with a will, he or she usually appoints an executor to carry out the devisor's requests in the will. 

Executor

            An executor is a person appointed by the testator (person leaving the will) to carry out his requests set forth in the will.  This includes disposing of his property according to the will.  If the person appointed is male, he is called an executor.  If the person appointed is female, she is called an executrix.

Administrator

      When a person dies with a will, but has forgotten to appoint an executor, the courts will appoint an administrator to disperse the deceased persons real and personal property according to the will.

Intestate Succession

            When a person dies without a will, but does have heirs, the law provides for disposition of his assets.  This is called intestate succession.  There are many specialized circumstances surrounding the division of property under intestate succession, the most basic situations are described as follows:

Ø      Separate property is divided equally between the spouse and the surviving child:  50% to the spouse and 50% to the child.

Ø      Separate property is divided equally among the surviving spouse, and two children:  33 1/3% to the spouse, 33 1/3% to the first child, and 33 1/3% to the second child.

Escheat

            When a person dies without a will and without heirs, his real property will escheat to the State of California.  Since it is presumed that there are some heirs in existence to claim the property, escheat is not automatic and the State must wait five years before  claiming the property.

Word Problem

A person dies intestate and left no heirs.  His sizeable estate in California will:

Answer:            escheat to the State of California if no claims are made by possible heirs within a five year period.

            Escheat is a state power, therefore, an individual would not be able to use it.

 

Wood Shingles

            Wood shingles are nailed to the sheathing.

 

Worker’s Compensation Insurance

Worker compensation insurance covers anyone employed by the broker full time or part time.

Worker's compensation insurance is required for janitorial staff, office staff, and sales staff (including brokers).

 

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