Real Estate Transactions Outline
I. Timeline: Broker Purchase/Sale Construction Leasing II. Broker: A. Parties: 1. Seller’s Broker: responsible for listing home for sale (MLS) 2. Buyer’s Broker: cooperate w/ seller’s broker by finding buyer for property B. Why do we need them in a RE Transaction? They know what is going on (access to MLS), are experts and can negotiate the deal. C. Motivations of lawyer v. broker. 1. Broker: make money through deals that close. More deals and bigger deals that close means bigger commissions, therefore, their interest is closing the deal. 2. Attorney: lawyers do not care about the deal. They care about the client and making sure the client is protected. A good lawyer is one that wants what the client wants. D. Duties of the Broker 1. Seller’s Broker: a. Duty To seller: Broker owes a fiduciary duty i. Do for seller even if it is against broker’s own interest. b. Duty to buyer: Depends. i. Dual agency: if seller’s broker is also buyer’s broker. (a) Broker must disclose to the seller that there is a dual agency and representing both sides. Both the seller and buyer must agree to the terms. (i) If there is no formal agreement, then there is no dual agency. ii. If just the seller’s broker then you do not owe a special duty, but you must be trustworthy, honest, and competent. (a) You may not make any material misrepresentations, so disclose all material facts seen during visual inspection (patent). 2. Buyer’s Broker: (remember – they want the deal to get done) a. Duty To buyer: Depends i. CA: owe a fiduciary duty. ii. Majority of states: considered a subagent of the seller’s broker, so you have a duty to seller’s broker (counter-intuitive). b. Duty To seller: Duty of being trustworthy, honest, and competent and must disclose defects. i. Same as the duty a seller’s broker owes to a buyer in a non-dual agency relationship. E. Brokerage agreements: Listing agreements 1. Must be in writing. 2. Parties: Seller and Seller’s Broker 3. 3 types of Listing agreement: a. Exclusive Right to Sell: i. Compensation: written by seller’s broker, so lots of opportunity for seller’s broker to get paid. (a) No matter who finds the buyer (seller’s broker, other independent or even the seller), it is the seller’s broker who gets the commission.
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(b) % of final sale price: generally 6%, but up to the parties. (c) 3 ways broker can get money: (i) When offer is made at listing price or price seller is willing to accept during the listing period, but only if the buyer is ready, willing and able to buy the property. (Dilemma of the failed deal). (1) B/c of contingencies in the agreement, there is no duty on part of buyer to buy and thus no ready/willing/able buyer. Broker has no claim for commission until buyer is ready/willing/able. (ii) Allow the property to be sold w/in 5 days after the expiration of the listing period, but only to the list of buyers provided by the broker to the seller. (iii) If seller w/draws property. ii. A smart broker will allow the seller to create a list of buyers who they would not have to pay commission on, and add any other deal terms in the K that they want. iii. Need termination date (60-90-180 days) iv. Agency Relationship: some agreements allow the broker to be a dual agent, via automatic consent. b. Exclusive Agency: Regardless of who buys the property, the broker gets the commission, unless the seller finds the buyer. i. Need termination date. c. Open Listing: whoever procures the buyer gets the commission, including the seller. i. Negative: Most brokers will not work to hard here. ii. NO need for termination date and seller can end at any time. iii. Dispute over procurement: seller will pay commission so that closing the escrow is not affected and escrow holder will hold commission.
III. Purchase/Sale Agreement A. Parties: 1. Buyer 2. Seller 3. Lender 4. Title Company: dual role of (1) escrow/document holder and (2) provide title insurance (ensure ownership of company and lien). 5. Inspectors 6. Appraiser: appraise property to make sure lender getting appropriate value of collateral 7. Local Gov’t: if need permit, land-use. 8. Surveyor: determining boundary lines of property 9. Attorney 10. Homeowners Association B. Timeline: 1. Find Broker 2. BB gives offer to SB (fills out form, signs it).
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SB makes a counter-offer to BB. Agreement signed by all parties (Date of acceptance) $ Deposited to escrow holder Due Diligence begins: time period and portion of K during which the real property and any other property in question is inspected. Buyer pays for inspection. Parties negotiate what is to be inspected, during what time period and the scope of the inspection. a. Things done: all paid for by the buyer i. Financing: ii. Title: is seller owner? Encumbrances? iii. Physical iv. Leases: this is the income stream of commercial real estate. Very important thing to look at!! Also need to look at rights of tenants and if they are good tenant. v. Environmental vi. Governmental Approvals: need to make sure property is zoned for the kind of use you want. vii. Soil viii. Survey ix. Mandatory Disclosure Schedule b. Types of due diligence: right to reject i. Free Look: (a) Buyer can look at property for X period of time, and at end of period buyer must agree to buy property or not. (b) Good for buyer b/c they are not obligated to do anything at end of period, where as seller is bound. Generally given in conjunction with right to cancel agreement if there is something that they do not like. (c) TIOTE: If buyer does not disapprove by the assigned date, then buyer is deemed to have approved!! ii. Standard of Rejection (a) After buyer inspects the property, what is buyer’s right to reject? Under what terms? (b) Seller wants Rx standard, buyer wants no standard. iii. Sellers right to cure: AIR standard clause (a) Seller has the right to fix problems buyer has with property (really locks in the buyer). SO if problems arise during due diligence, seller can cure. If buyer disapproves any part of DD before required date and seller does not cure, buyer gets deposit back and is not bound by the agreement. If buyer does not disapprove, they are deemed to accept. (b) Incurable problems: (i) Financing contingency: ability of buyer to get financing; and (ii) Environmental issues. 7. Approving Due Diligence or Canceling the Deal. a. Silence = if buyer remains silent and does not raise the issue before the end of the contingency period then buyer waives his right to inspection and is deemed acceptance. 3. 4. 5. 6.
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8. If approved Closing period. a. At closing: Escrow i. In: Documents and money ii. Out: Deed to buyer and money to broker/seller C. Standard AIR Contract Terms 1. Assignment rights of buyer: a. Buyer has the right to assign K rights to anyone. (Buyer can K with new buyer and new buyer assumes your duties under the K.). Seller should put no assignment clause if do not want to give it. 2. What Property is included in deal (more important in commercial deals) real and personal property, and intellectual property as well: a. Describing Real Property: address has no legal meaning, even though it shows intent. When referring to property can use: i. Assessor Parcel Number: tax designation number of a particular parcel that tax assessor uses. ii. Legal description: Entails 3 numbers; Lot, Block, Tract. (a) Subdivision map: refers to what is recorded as a matter of title. iii. Most precise is metes and bounds (most often done if not already subdivided). Surveyor’s description. 3. Purchase Price: what is it composed of? a. Deposit: i. 2 Big issues with deposits: (a) Is it refundable; and (i) Once due diligence is approved, the deposit usually becomes nonrefundable. (b) Is it part of purchase price? ii. Purpose: (a) Show good faith that have cash and are serious about the deal. (b) Forms part of liquidated damages. (i) 2 principle damages in RE. (1) Monetary damages: only if they can be calculated, and they are difficult to calculate. (2) Specific performance: Mainly buyer has right of SP and force sale of property to buyer. CA: seller also has right to SP, but rarely used. (ii) What are damages if there is a breach? 1st ask if there is a liquidated damages clause in the agreement. Standard AIR says that Buyer and seller agree that if one seeks damages b/c of breach of other, they will fix liquidated damages at a specific amount. (1) Ask if amount allocated for damages is Rx? CA: liquidated damages accepted only if Rx under facts and circumstances. Rx will depend on parties actually trying to figure out possible damages, and a true effort to calculate effect of breach must be made. Law presumes 3% is maximum amount Rx in residential. This is commercial, but can be borrowed, not as a presumption, but as an argument.
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b. Additional deposit: to extend closing date or get additional due diligence. i. Seller: by giving extra time, they are doing something they are not obligated to do, so they will usually ask this additional deposit to be above and beyond the purchase price what does K say? ii. Get extension for one reason, but find a problem with another: what does K say? c. Loan: There are different types of non-mutually exclusive loans: New loan, Assume loan, Seller buy-back (buyer cannot get loan, investment – interest). d. Rest: down payment… 4. RE Brokers a. They are included in the K, b/c at the end of the deal, they will be looking for commissions. Each side needs to be aware of who the brokers are. This leaves no questions for future potential lawsuits and indemnifies the other party. 5. Closing Date: a. Can be a specific date or X amount of days after acceptance of agreement. b. TIOTE only if you specifically have a TIOTE clause: when there is a date and time listed in the agreement, then that is what it means and the deal must close on that date. Breach if one party cannot close on that date. 6. Due Diligence Phase: Contingencies to Closing a. Note: Once all the contingences are performed then there are no contingencies on the buyer’s part. If seller wants out of the K, it will be up to the buyer. Most likely if B wants property then he can sue for Specific performance. In AIR form he would be able to do that. SP is a remedy even if you have a liquidated damages clause. That clause only allows parties to avoid going to court to determine damages. Property is unique so entitled to SP. b. Disclosures: only one that must be done by Seller. i. CA: seller must (1) give notice to the buyer of any known material defect on the property, even in as as-is sale (always be on the safe side), and (2) provide a Mandatory Disclosure Report (MDR). (a) There is no requirement on seller to perform inspection on property. (b) Material Defect: anything that would affect the value/marketability of the property. (c) MDR: seller must disclose certain other things including potential flooding, earthquake fault zone, water heater bracing…etc. (i) Key question: when does buyer get the MDR in relation to due diligence inspection date? c. Physical Inspection of Property: Depending on the type of property and what you are using it for, may want to have some experts. Want to make sure expert is insured, that they are licensed and you have a K providing a written report including an estimate of any problems found. i. Is there a present occupant? Do you need that occupant’s space? If need current tenant’s space, buyer will want present occupant to release her possession and any other rights to the space as of the closing date. Approval of DD may depend on that party being evicted. ii. Broken HVAC Unit? Buyer can use it to negotiate the purchase price by what it will cost to fix. If seller has right to cure, they may just opt to fix it though.
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Buyer can accept this portion of DD contingent on seller fixing the problem, and maybe including a warranty. d. Environmental: Hazardous substance conditions report i. Comprehensive Environmental Response Compensation and Liability Act enacted by Congress. (a) CERCLA – Superfund: Imposed a Strict Liability scheme making liable all people who “own or operate” a contaminated property. If buy property that is contaminated, you will be sued, and there is no defense. (b) Quasi-defense/exemption from definition of “owners or operators”: if a buyer has performed due diligence of the environmental condition of the property and after Rx review has not found any recognized environmental condition/contamination then they are not considered an “o/o” under CERCLA. Problem is what is Rx review? (c) SARA came out with ASTM standard for environmental review of property that should be applied when purchasing RE to determine environmental issues. If you have complied with this standard and something is found later down the road, then can avoid litigation. (d) Series of inquiries/phases to comply with new ASTM standard. (i) Phase I review: If nothing is found that is a recognized environmental condition then you are done and can claim the innocent landowner defense. This is non-offensive testing. (1) Key: WHEN DID BUYER FIND THE PROBLEM? (2) Site location (3) Site Description (4) Adjacent and Surrounding uses: (Ground water concern). If the GW gradient goes toward your property, your site may be contaminated. Look for gas stations, mechanics, cleaners… commercial, industrial and agricultural properties. (5) Site Operation: (6) History: Way to tell what was there before is via aerial photographs which State archives for fire insurance reasons. Also can look at building permits. Dry cleaners: do Phase II testing of soil. (7) On-site observation: is there evidence on site that something does not look right (patch of dead trees). Soil, exposed pipes (8) Hydrology: Look at Physiographic Maps: Ground water review: depth and its gradient (which direction is it moving). Also want to see what soil is made of. (9) AST/UST: Storage Tanks: above (leakage scare) and below ground. LA has a lot of plumes. For tanks, a Phase II would be a geophysical inspection, looking for metal underground. (10) Hazardous Materials Generated on Site: if so, how are they being disposed of
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(11) Solid Waste (12) Wastewater: how is it treated/released, for chemical release purposes. (restaurant) (13) Databases: Environmentally Act required – LUST – where are these in relation to your property? (14) Wetlands: any area wet for more than ½ year. EPA said no net loss of wetlands allowed. (15) Mold: not a federal liability problem at this point. Need (1) cellulose and (2) moisture. Its everywhere, issue depends on concentration/how much. (16) Lead (in paint)/PCBs/Pesticides/Methane/Radone/Asbestos: look for specific chemicals and building materials. Lead: Age of property. Test areas. Row Crops/Pesticides: agriculture – DDT banned in ’78. Methane: alarms Methane is flammable and explosive, so want to make sure that the building was built in accordance to code to make sure methane does not pose a problem. (17) Conclusion: lawyers will read to ensure accuracy No contamination: done Most often: maybe contamination, but not sure. Big contamination problem located (ii) Phase II inquiry: This is a targeted review of whatever potential problem is found in Phase I intrusive testing. (1) Need to ask permission to enter the property to do your testing or before you disclose any results from investigation to the government to do remediation. (2) Timing: how long do you have to conduct these tests. (3) Parties: Seller: does not want to learn about anything b/c do not want to have to investigate it. Environmental Engineer: wants to investigate everything. Lawyer for buyer: wants it to be real testing, but wants the deal to get done. (4) Offsite problem found: if during Phase I or II this occurs, and the gov’t has targeted this problem, then those parties who caused the problem will be liable. And since it is offsite and the seller cannot cure the problem, the buyer needs to decide what they want to do. (iii) Remediation: must be done if an actual contamination problem is found in Phase II. (1) After given permission by seller, Remediation is the removal of the problem, under the auspices of a gov’t agency (DTSC (toxic substance), RWCB (water), FD (permitting of tanks – fire), and/or BD (building)). (iv) No further action (NFA) letter: once remediation is complete, the agency supervising the remediation provides this letter certifying that there is no further problem with this site.
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(v) Note: these steps are done only if the buyer still wants to buy the property. If not, they can reject the environmental portion of DD and seller has no right to cure. e. Soil Inspection: i. Buyer hires a geologist to perform study of what can be performed on the property based on the condition of the soil. f. Governmental Approvals/Land Use i. 3 Issues with Land Use (a) Use: What can you use property for? (i) Zoning: Buyer should determine the exact zoning of the property from the city under the Governmental Approvals part of her DD to make sure that the property is zoned for the use you want. (ii) 2 types of allowable uses: (1) Permissive: can do this automatically (2) Conditional: maybe allowed, but buyer needs to get a CUP (conditional use permit) from the city planning commission to undertake her desired use which will take time (notice to neighbors, public hearing and time for appeal) so buyer will Px have to extend DD. (iii) If desired use is neither conditionally or permissively allowed, but is silent or prohibits the use, buyer should get a rezoning or a variance from that zone. (iv) 2 ways to change use Get a; (1) Variance: applies if use of property is allowed, but b/c the way your property is configured, you do not have the right to do it. (tough to get b/c city must approve). (2) Rezoning: buyer wants to change the zone your property. Easier for commercial properties. Process to change zoning use: Apply: your lot needs to be unique. Give notification to neighbors within a certain radius Public hearing Result: Px some restrictions. (v) Issue: Who pays for extension to change use? Seller will want it to be added to the purchase price, and buyer will want it to be part of purchase price. Buyer can just chose to reject this part of her DD and seller would have 10 days to notify buyer of intent to cure, forcing seller to pay. This is probably a deal killer. (b) Physical: What physical improvements can be made to property (# of bedrooms, floors, parking,…)? (i) “In lieu” parking: public parking lots provided, but stores must pay for it per space required. (c) Entitlements: How can land be subdivided? (i) Vacant land: land with no improvements, but still a series of legal lots, approved by city. (different from Raw land)
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(ii) CA has a Subdivision Map Act prevents the transfer or real property unless city/country approves boundary of respective property (includes, leases, sales, mortgages/deeds of trusts…). (iii) Do you need to get entitlements and how much will they cost? g. Title Insurance i. 2 components (a) What kind of interest in Real Property is being purchased/insured? (i) Fee Simple is what you are K’ing for when you enter into an AIR purchase/sale agreement. (ii) Life Estate (iii) Lease (iv) Easement (v) Lien (right allowing lender to perfect right to property). (b) Title check to determine the Condition of the interest in property (i) Condition refers to encumbrances on title (Marketable, Insurable, Record). If title is not perfect, what is its condition? What kind of rights do 3rd parties have? Your interest will be subject to prior interests already recorded. (ii) Title insurance will ensure the quality of the interest you are buying at the time of recording. ii. Process for title insurance due diligence: (a) A Preliminary Title Report (PTR) is generated by the title insurance company selected in the agreement (usually picked by buyer) and lists the current owner’s name, the legal description of the property, the interests of other parties recorded against the property as exceptions to the coverage, and any other exceptions to coverage. (b) Owner’s title insurance policies are not required by law, but are highly advisable because they provide insurance against the possibility of 3rd Party interests in the property. The PTR is not the insurance, but rather the offer to sell insurance. (c) Lenders: require a lender’s title insurance policy at closing when they fund their loan to ensure that their lien is properly recorded and is senior in priority to all other liens, or more likely that their lien is the only lien on the property. (d) PTR: sets forth the conditions of the title to the property that the buyer will obtain at closing. (i) 2 Types of encumbrances on property found in PTR: (1) Monetary: loans, mortgages, deeds of trust, judgment liens, taxes buyer can require seller to cure all liens so he is buying property free and clear. Buyer must make certain that the owner’s title policy will not show this lien. Judgment lien: document recorded against a property that creates a lien for the repayment of a monetary judgment to a 3rd party.
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Deed of Trust: document recorded against a property that creates a lien for the repayment of a monetary debt to a lender. Buyer can make sure that the remaining debt is paid by escrow from funds at closing and that it is removed from owner’s title policy. (2) Non-monetary: easements, CC&R’s, leases, encroachments, Easements: right to use property of another. One can have an E for access, utilities, construction materials, landscaping. Key questions for buyer: where located, what rights and if there is a problem, how do you solve it? Have the surveyor map the easement to delineate its exact boundaries. Buyer should read the easement document b/c if the holder of the easement has the right to remove improvements located on the easement, buyer should only approve if he can get assurances from the holder of the easement that it will not destroy improvements. Access/Driveway: Buyer can either use it as a way to decrease purchase price or can try to amend the location of the driveway if need be. Title Insurance: ask them to give you an endorsement, an additional amount of coverage for a specific issue. CC&R’s (Covenant): document recorded against the property that tells the owner what he can, can’t and has to do (set-back requirements, types of uses, landscaping). Buyer should read the covenant b/c some items are no longer valid due to passage of time. If the covenant is still in effect, the buyer should ensure that the property is still in compliance w/ its terms as of the closing date, at the Seller’s cost. Memo of Lease: document recorded against the property revealing the existence of a lease affecting the property. If recorded, buyer should review the leases to make sure the terms are acceptable. Buyer should require an estoppel certificate to ensure the exact certainty of the terms of the leases. People buying property take subject to lease, even if not recorded. If not recorded and cannot tell there is a tenant, is there notice? If no notice than do not take subject to. From the lender’s perspective, they may require the buyer to get a Subordination and Non-disturbance agreement (SNDA). They lend money, lease is subordinated to loan and lender will not disturb tenant as long as rents are paid. Oil & Gas leases: buyer needs to find out if there are any surface rights of entry for exploration or extraction. Generally, oil leases are long-term, and do not give the lessee any rights of surface entry and affect only the mineral below 500 feet under the property. The farther down the oil is the less of a problem.
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Encroachments: Many times not in preliminary title report b/c not recorded. Not enough to kill the deal, so try and solve the problem. (ii) Commitment: looks like a PTR. If you give the insurance company the premium at closing then it is binding and you are insured. (iii) Binder: Insurance for a limited period of time. (e) Buyer goes back to seller and approves or disapproves title contingency based on something found in the PTR and its supporting documents. iii. What is covered by title insurance? (a) Section A (i) Covered against another person owning your interest in the property. (ii) Covered against the documents creating your interest being improperly signed or that they are forged. (iii) Covered if your property has no legal access to a public road. (iv) That there are no restrictive covenants. Important if want to develop property. (v) Ensures that there are no liens on the property. (vi) Insures that there are no other parties w/ rights to the property. (vii) Unmarketable title: (viii) Insured that you will not have to remove improvements (ix) Use of the property is not prohibited by zoning regulations. (b) Section B (i) General Exceptions: (1) Police power and laws generally are not covered by insurance. (if gov’t wants to sue you for Superfund b/c of environmental problems, or if gov’t wants to change zoning). (2) Condemnation: gov’t might come in and take property based on eminent domain. (3) Title risks created by the insurer: (4) Title defects that would be revealed by an inspection (5) Failure to pay consideration for property: Recording statutes only protect bona fide purchasers, so pay something. (6) Covers only your interest in this particular property. (7) Matters disclosed by a survey. (ii) Specific Items Excluded from insurance (1) Lease, easement, covenant or any other actual recorded documents that show up on title report as affecting your property. iv. Transferability: Title insurance is not transferable. (a) Stock sale v. Asset sale: Corporation owns property and sells its stock, then new owner of corporation need not get new title insurance. But if buyer buys property from corporation then needs new title insurance policy. h. Surveys (closely tied to title insurance) i. Survey is a visual representation of the boundaries of the property, improvements on the property and where the rights of other parties are on the property, licensed by the State.
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ii. Types of surveys: (a) Boundary: ensures property is inside the boundary. (b) Construction: where boundaries and space available for construction. (c) As built survey: after construction, what has been built in relation to the boundaries. iii. Buyer should give the PTR and its underlying documents to the ATLA/ACSM surveyor hired to map the property, so that any easements/encroachments can be located on the survey. iv. ATLA/ACSM surveys: (a) ALTA: governs title insurance (b) ACSM: governs mappers. Types of information a survey has to have: (i) Boundaries, improvements, map of all easements and location, parking, landscaping, encroachments. (ii) When this is read w/ PTR it gives you a good understanding of what is going on on the property. Very valuable tool! (c) If Survey shows encroachment: buyer can check if there was something on record allowing this. If there is nothing on record, then problem b/c some other party is claiming a right to the property you are buying. Buyer will want to determine what rights of those parties are when you close. Buyer can tell seller that he will only agree to deal if remove encroachment. Seller can cure or drop it. i. Existing Leases and Tenancy Statements i. To find out what is in the existing leases, the Buyer requires seller to provide an estoppel certificate (EC). The EC is signed by the tenant and sets forth all material terms of the lease, such that the buyer can rely on it at closing. The effect is that if the tenant argues that some material term of the estoppel statement is not in the lease, they are estopped from arguing that. (a) Estoppel Certificate Includes: (i) Copy of lease and its amendments attached (ii) Lease parties/Tenants (iii) Leased space: what is tenant occupying (iv) Lease term: length (v) Rent (vi) Security Deposit (vii) Landlord: did they perform everything that was promised to tenants (viii) Stmt verifying no modifications to lease except those attached (ix) Stmt verifying no ongoing uncured defaults (x) Stmt verifying no disputes outstanding (xi) No non-permitted alterations and attach all permits for alterations previously made. (xii) Has there been any assignment or subletting to leases? (xiii) Guarantees: Did landlord require guarantees from tenant? 3rd party will be liable for any unpaid expenses owed by tenant. (xiv) Make sure tenant is not in bankruptcy. (xv) Buyer can rely on these and that they are true.
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(b) Problem with EC: What if tenant does not want to give EC and their lease does not require them to give one? (i) AIR form: if tenant fails to provide an EC, then Seller should complete and execute an EC for that tenant. But, not worth anything to buyer down the road. Only recourse if seller lies is to sue seller. (ii) Tenants often use EC as a way to renegotiate their lease. (iii) Lender: sees it as a prior encumbrance if have prior lien. j. Other Agreements affecting property (in addition to leases) i. Signed K’s: When buy property, you step into seller’s shoes. Buyer wants right to terminate agreements signed by seller within 30-60 days. ii. New K’s During Executory Period: Provision in the AIR which says that the seller cannot enter into any new K’s during executory period of the lease affecting the property unless the buyer agrees, but the buyer cannot withhold consent unRx (above-market value lease). k. Financing i. Financing Contingency: not curable by seller. (a) Obligation of buyer to get financing: must apply for a loan in good faith and Rx attempt to get it. (i) If buyer does not make closing contingent on him finding financing then at end of closing they must come up with the money and will be liable for damages. (b) Sellers are cautious about the contingency. Very little they can do except hope buyer is creditworthy. Seller will like the buyer that has the best terms in their financing contingency. If the loan in you FC is too difficult to get, seller will not like this. (c) Lender wants to know value of property b/c it is collateral on the loan. ii. Buyer: find out credit and how much you can borrow before you make an offer so that you can make the most attractive offer as possible. iii. Types of loans: (a) Term loan: Loan for X amount of time (b) Revolver: borrow up to X iv. Rights parties care about: (a) Borrower: (i) Rates and amount (ii) Prepayment option: (iii) Ability to Assume/Assign (iv) Right to build/construct (b) Lender: (i) Right to accelerate the debt; (1) in case of default, (2) if sell or transfer the property, or (3) if there is an encumbrance on the property. (ii) Protection of collateral: is owner taking care of property? (iii) Borrower to comply with the laws. (iv) Property is insured
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(v) Senior lien: At foreclosure, all junior liens wiped out in terms of title matters. But if a junior lien forecloses, senior liens on still on title. Lenders, want to be the senior lien-holder. (vi) Leases on property lenders do not want to take properties at foreclosure that is subject to below market leases. So lenders require an SNDA. Lender will make the loan only if tenant with submarket lease subordinates its status to the lender so if they foreclose, bye bye lease. No tenant will agree to that. (1) SNDA agreements: Subordination of lease to this lien. Non-disturbance concept: way to encourage tenant to give subordination. Says that if tenant not in default of their lease, lender will not disrupt their tenancy. (2) Benefit of SNDA to tenant: no reason to do so unless it is in lease. (3) Benefit to lender: makes it easier to remove defaulting tenant. v. Documents for a loan (a) Promissory note/Loan Agreement: creates the debt. (i) Parties: (1) Maker – borrower (2) Payee – lender (ii) Not recorded (b) Deed of trust v. Mortgage (i) Mort: 2 party agreement (1) Mortgagor: borrower (2) Mortgagee: lender (ii) DOT: 3 parties - recorded in county records (1) Trustor: borrower (2) Trustee: 3rd party (i.e. escrow company) – to hold loan only (3) Beneficiary: lender (iii) Secures the obligation to the property – this is what is recorded and it refers to what is in the promissory note. (iv) DOT: includes (1) Assignment of leases and rents (recorded in county records) (2) UCC-1 Fixture filing (recorded in county records): secures the debt w/ respect to any fixtures on the property. (3) Financing Stmt: (not recorded, but filed at the SOS office): secures any debt to personal property (4) Other l. Damage, Destruction and Loss i. Who bears the risk depends on when D/D/L occurs: (a) Before executory period seller bears risk (b) After K for P/S has been signed, but before closing seller still owns and title has not passed during this executory period. (i) CA: Uniform Vendor and Purchaser and Risk Act implies by law that if the K is silent as to who bears risk of loss during executory
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period, the seller cannot enforce the K against the buyer. However, if title or possession has passed to buyer, then buyer cannot use excuse of D/D/L during this period to get out of K and get deposit back. (ii) AIR form: (1) If there has been $10k or less of D/D/L, then the seller must repair and buyer stuck in agreement. (2) If D/D/L is more than $10k, then the buyer has to be notified by the seller if the seller intends to repair and w/in 10 days can decide if buyer wants to remain in the agreement. Can cancel and get deposit back. If they want to stay in agreement, they can do that w/o a reduction in the purchase price, but get all insurance proceeds if there is an insurance policy. If seller has no insurance, then buyer will Px take option to not go through with the purchase, or will ask for reduction in purchase price. m. Material Change i. A change in the status of the use, occupancy, tenants or condition of the Property the Seller must give notice to the Buyer and the Buyer then has the choice of whether or not to continue the deal. (a) What if neighbors land changed? Not the Property, so cannot back out of the deal. (b) Some flexibility for buyer if something happens to Property during executory period. n. Representations and Warranties i. Negotiated Stmt by either party that the other party can rely on as being true. ii. “As-is Sale”: no reps and warranties made. Buyer can do all the due diligence they want, but the seller will not R&W on anything. Typical with homes. (a) CA: even if as is, the seller must disclose material known defects. iii. What are they? (a) Buyer: looking for seller to make R&W about things that are difficult for you to find out or that you cannot find out. (i) Examples of things buyer should ask for: (1) Notices of Violation (2) Pending Litigation (3) Bankruptcy (4) Covenants and any other agreements made (5) Construction: has a mechanics lien been filed b/c seller has not paid someone doing work for them on the property? Lien goes back to time work was provided. Possible that work finished, but lien not attached. (b) Seller: will try to limit the scope by saying “to the seller’s knowledge there is no ___.” Or say “there are no problems in violation of the law (compliance).” (c) Note: more buyer asks for, less attractive he is as a buyer. 7. Closing Process a. NY: all parties get together
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b. CA: all parties mail info to escrow company with instructions of what to do.. c. Seller must provide: i. Deed: 3 types: (a) General Warranty: provides all 6 warranties of title. (b) Special Warranty/Grant Deed: CA – statutory implied. (c) Quitclaim Deed: warrant nothing ii. Bill of Sale: Transfers any personal property involved in the deal. iii. Assignment and Assumption of K: buyer assumes all K’s dealing with the property. iv. A/A of Leases: same as above, but dealing with leases specifically. v. Estoppel Certificates d. Buyer must provide: i. Money: from buyer and lender ii. Signed A/A of K and leases iii. PCOR (preliminary change of ownership report): tax document stmt signed by the buyer describing property and its purchase price to be sent to tax assessor office who determines the value of the property. e. Fees and Prorations: calculation of amount prepaid or billed at a later date, split b/n parties (rents and taxes). i. Proration of Tax: Starts on July 1 and ends on June 30. 1st half 7/1-12/31 and 2nd half 1/1-6/30. On March 1, the assessor figures out the value of the property. No change in property value until there is a transfer. Then the auditor controller applies the tax rate to that value of the property and comes up with money that must be paid (1st half) due November 1. On 2/1 the 2nd installment is due. If on June 30, it is not paid in full, then property is in default. You have 5 years to pay until property goes to tax sale. ii. Fees: (a) Split cost of escrow fees (standard, but can K differently). (b) Buyer pays for lender’s title insurance. (c) Seller pays owner’s title insurance policy. (d) Seller pays transfer taxes. (e) Seller pays Brokers commission. (f) If seller is foreign entity, then buyer, via escrow, must w/hold some money to pay for taxes. This is avoided by getting affidavits from seller that they are not a foreign person under IRS or CA rules (FIRPTA).
IV. Construction: A. Parties: 1. Owner 2. General Contractor: manage the construction process a. Sub Contractor: fulfill individual parts of the construction/ 3. Project Manager: not mandatory and role not well defined. 4. Architect: draw plans, estimate costs, get permits, review bills sent by GC. They usually get 10% of construction costs. Architects own copyrights to their designs. 5. Inspectors: need permits to build, city inspectors ensure the work is done to spec.
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B. C.
D.
E.
F.
6. Engineers/Archeologist/Geologist 7. Lenders 8. Bonding Guarantor 9. Insurers What is being constructed? New construction or renovation/remodeling. How are things built? 5 possibilities in terms of relationships involved 1. Owner-builder: no GC involved 2. Owner hires a GC: 3. GM: owner not directly involved. Very often this is an architect. 4. Design-Build: one group does everything. 5. Turnkey: owner does not pay for work until it is completely done, so owner is not financing the project himself, rather only pays for final product. Preconstruction process (before ground broken) 1. Programmatic stage: Owner tells architect what he wants. 2. Concept Plan: Architect designs a concept plan. 3. Schematic Phase: more detailed plan 4. Cost Estimate given by Architect 5. Architectural plans done by architect. 6. Engineer is hired by architect: reviews architectural plan 7. City: 4-6 week plan check 8. Construction plan: after city approves 9. Bids: go to contractors with plans so that contractor can tell architect what they can do the project for. 10. Construction K signed with GC: chose a bid 11. Begin construction Physical Procedure of how things are built: 1. Demolition 2. Grading: soil work. 3. Excavation: dig hole 4. Lay foundation 5. Framing: build structure 6. Roof 7. Utilities/Insulation 8. Outer Walls/Floors 9. Finish work. Construction Process: from beginning to end. 1. Cannot start until you own the property. 2. Sign K: a. 3 items that should be included in the K: i. Type of payment structure: ii. Schedule of Construction: iii. Time/money to make sure project is completed by a certain date, include a liquidated damages clause and final completion language. 3. Break Ground: Date of Commencement: administration process begins 4. Substantial Completion: 5. Punchlist: to do items
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6. Final Completion: a. Substantial v. Final Completion: Substantial completion means that it can be used for its purpose in terms of the way it was built, but may not be allowed to be inhabitable b/c no CO. GC wants final completion to be the date of substantial completion and the owner wants work to be final. 7. Certificate of Occupancy (CO): given by city after all inspections performed allowing use of structure. 8. Final Payment G. Construction Contracts 1. 3 Types of Payment Structures: (these determine how much it will cost) a. Stipulated Sum: GC and owner decide on sum that will be the sum of the construction K, no matter what happens. If cost go higher, GC eats costs, but if GC can perform for less, than they keep the profit. b. Cost of Work, plus fee: fee can be b/n 10-15%. GC has incentives not to be cheap no maximum cost. c. Guaranteed Maximum Price (GMAX): owner gets benefit for GC being able to do it cheaper. But if work costs more, you are still capped on maximum amount paid. 2. Issues in K: a. K Sum/K Time: i. Change Orders: while construction is ongoing, change orders can change the cost of the project and the time it takes to complete the project. Typically these changes come from owners. (a) To be effective, you need to describe the work to be performed, permits required, and how it will affect the K time and cost. (b) All parties must sign. (c) Disagreement about cost of change order: Arbitration clause (i) Owner and GC both pick appraisers to independently determine the costs to implement the change order. If there is no agreement on cost, the 2 appraisers together pick a 3rd appraiser to make final determination. The 3rd appraiser will choose the cost closest to his determined cost, so either the Owner’s or the GC’s appraisers cost estimate will be chosen b/c it was more accurate. ii. How do you make sure project is done on time without change orders? (a) Liquidated damages clause in K: if do not complete by X date, then owe money. Courts not in favor b/c for LD clause, it must Rx reflect the reason for delay. (i) Have a carrot though rewarding GC if finish on time. iii. Other events affecting K time: Weather, terrorist attack/threat…etc. (a) Rx Fx: GC not entitled to an extension of the K time. (b) If delayed due to unFx event or condition changed unexpectedly: GC has a duty to mitigate damages and time lost. SO GC cannot increase price unless nature of work changes. b. Permits: right to build based on code only. Still may need to meet other requirements. H. Money Drives Construction
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1. Steps for Payment: Progress Payments (Timing: periodic payments, most often done monthly) a. GC submits to Owner and Architect an Application for Payment: contains all info about what has been completed to date. b. Review by Owner and Architect i. If something wrong, go back to GC to fix problem. c. Architect issues Certificate for Payment: sent to owner and lender. d. Owner/Lender will release funds: Every time payment is made, owner retains 515%, so that at end of construction process, GC has incentive to finish. 2. What’s in Application for Payment: 7 items included a. % of work completed and description of that work. b. List of Materials incorporated. c. Conditional Release: when pay money for work done described in this application, owner wants legal mechanism to make sure that the GC and the SC release you from obligations relating to work done in this application. d. Unconditional Release: deals with last payment made. Get release from last payment made to make sure that as you make payments to the GC and SC that you get released from any lien rights they have against you up to that point. e. Copies of all K’s: want all sub-K’s not previously delivered to make sure everyone releases you. f. Copies of Inspection Reports: City inspects progress of construction. If city does not inspect an aspect of the construction they can make you start over from point last inspected. g. Updated Schedule documents: keep track of cost and time every time there is an application for payment. i. Project schedule: helps you gauge if on time b/c it tells owner what work will be done and by when. ii. Cost schedule: care about this in a cost of work plus fee b/c it tells you the materials you are buying and their cost. iii. Schedule of Anticipated Future Disbursements: takes into consideration type of work that has been done and work left to be completed and makes schedule of what future disbursement will be on subsequent applications for payments. 3. Final Payment: Application for final payment will have normal info contained in all other applications for payments, but also include; a. Affidavit from GC that work is done. Can have different standards: i. In compliance with laws ii. According to permits iii. No standard b. Copy of final certificate of occupancy c. GC will Assign all of his rights under Warranties to Owner d. Notice of Completion e. Final Payment and/vs. Retainage Payment: Keep in mind that every time owner makes a payment, they retain a certain % (10-15%) i. The final payment is the final progress payment. ii. The real final payment is the Retainage Payment not to be made until any mechanics liens expire.
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4. Mechanics Lien: a. Anyone who provides labor/services/Design/Materials to a project can attach a lien to the project property, enabling them to foreclose on the property if they are not paid. b. How it works: i. Work/Material Supplied ii. If no payment Preliminary Notice: must be in writing, given to owner from party demanding payment. iii. If still no payment: claimant can record a lien, but only if done so w/in 90 days of the completion of the work. However, owners can record a notice of completion in order to shorten lien period to 60 days to file (30 for subs and material providers). iv. If still not paid claimant can undertake a judicial foreclose on property. c. Key Features of mechanic liens: i. “Relate Back”: e/t lien was recorded on 12/1, it relates back in terms of priority to point construction visibly commenced, 1/1 (completed on 11/1). Prevents owner from mortgaging property after construction begins making lien obsolete. ii. Owner can avoid mechanics lien in 2 ways: (a) Make checks jointly payable to GC and subs. Otherwise owner pays GC and is unsure the subs will be paid. (b) Have a performance bond: if no payment from GC to subs, then they look to bond for payment, not owner. Problem is that they are expensive. Most often used in public projects b/c cannot have a ML on public property. I. Termination or Suspension of GC if Delayed 1. 1st ask if the K requires Final completion or substantial completion? 2. Once get schedules showing delay in construction process, owner can issue a warning giving GC X amount of days to fix the problem to complete the project on time. If appropriate measures are not taken by the next application for payment, then she can terminate the agreement and withhold payment. Remember, the Owner has been retaining 5-15% of every pmt made to protect them in this type of situation. 3. 2 ways to terminate: for cause, w/o cause a. Without cause: owner can terminate at anytime (GC will not care as long as they get profit). Owner will need to pay GC his expected profit. b. For cause: owner can do that and find someone else, but more difficult. Owner must pay GC for all the work they have done thus far. J. Insurance: 1. Owner is responsible for insurance on the premises w/ respect to general liability. 2. Anything dealing with the construction operations, the GC is responsible for. GC must get workers comp, automobile, course of construction, completion of construction, and explosion insurance. K. Environmental Issues 1. In the AIA form, if the GC finds any type of environmental condition, they must inform the owner/primary contact and must comply w/ all laws and the owner must remediate.
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a. Issue: owner not in best position to do remediation if problem is due to current work being done. Best is to put in K for GC to handle remediation process. L. Reps and Warranties 1. P/S Agreement: revisited 2. Construction K: If you are owner you should pick your battle. Want to make sure GC is experienced in this type of construction, that they are insured, that they are actually licensed (but you should try and confirm these on your own if you can). Things you cannot verify on your own you should ask for GC to produce: no litigation, no BKR pending. Also should make GC tell you that all K documents given to GC are sufficient for them to do his job and complete work on time and within the budget. V. Leasing A. Parties: 1. Broker 2. Owner/Landlord 3. Tenant/Lessee/Sub-landlord 4. Subtenant 5. Property Management 6. Attorney 7. Maintenance/Parking B. What is a lease? An exclusion right of possession. 1. Vs. License: Different from a license in that a license gives right to non-exclusively enter property, but the lease gives you exclusive possession of an interest in real estate that is insurable. 2. Residential v. Commercial Lease: a. Residential: implied by law. b. Commercial is not implied by law so if it is not in lease than law will not imply it. C. Types of Leases: 1. Building: a. Space lease: office or floor b. Ground lease: own building in fee, but lease the land. c. Building lease: lease entire building, but not space w/in building. i. Illegal in CA to transfer a parcel of real property that is not approved pursuant to the subdivision and map act. Leasing the ground the parcel is on, so if multiple buildings on land, then cannot use a building lease, must use a space lease. 2. Rent: quoted in square feet, but as a potential tenant, make sure to walk to property. a. Base/Gross Lease: one payment, fixed sum paid to landlord periodically (typically monthly). i. If the term of the lease is long-term, then there may be rent escalation provision, increasing the rent over time. The amount of increase can be tied to an objective inflation standard (CPI) or an actual amount. b. Modified Gross/Net: pay flat fee plus at least one of the landlord’s operating costs. i. Types of operating costs that the landlord tries to pass-through to tenant:
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c.
d. e. f.
(a) Common Area Maintenance (CAM): upkeep of areas designated for the use and benefit of all tenants. Standard AIR Form items include; (i) Maintenance (ii) Repairs and Capital Expenditures (iii) Security (iv) Signage (v) Utilities (water, gas, electric) (vi) Trash (vii) Fire (viii) Property Management (ix) Parking (x) Reserves – emergency costs (b) Insurance: landlord goes and buys insurance, but tenant reimburses them. (i) Commercial Liability (ii) Casualty Liability (iii) Loss of Rent (c) Property Taxes: levied by the state Net/Triple-net Lease: A lease in which the tenant pays, in addition to rent, all expenses related to the operation of the property (3 main costs listed above). i. Tenant would pay a % share calculated by leased area/total area. Tenant would pay the % of the property that they actually lease as compared to the total square feet of the property. (a) Loss Factor: tenant pays rent not just for the useable areas, but also for the rentable area. The rentable/useable ratio is known as the loss factor. (i) Tenant should get a site plan to know exactly what is being leased. (b) What if premise not 100% leased? Landlord will want to make the % in relation to the total premises leased. (c) Note: Some L’s make a floor of costs to be paid every month, based on what was paid last year. (i) If there is an increase, then tenant pays the increase. (ii) If costs go down, then tenant still pays the floor, enabling the manager to make cash on the deal. Bond lease: Tenant pays every cost associated with the property except paying the mortgage. Percentage Rent for Shopping Centers: % of tenants gross receipts (Saks) i. This is not done in lieu of other rents, but in additional to rent. Types of Incentives given to Tenants in rents: i. Free Rent: Used by landlords to give incentives to tenants to take property. Tenants will want to decrease the cost of the couple months of free rent against the rent to be paid. ii. Tenant Improvement (TI) Allowance: If you lease out this space for X amount of time, I will give you money to build out your own space. Tenant will say he wants the credit prorated to decrease rent. iii. Built to Suit/Turnkey: Landlord will build the space out the way the tenant wants as an incentive for tenant to come lease it.
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D.
E.
F.
G.
iv. Equity Kicker: Equity in building is given by landlord to tenant as incentive for tenant to become tenant in building. Normally only done in down markets. Term of the lease: 1. Commencement/Initial/Original Term: when lease actually begins and tenant gets exclusive possession of the premises. 2. Extension/Additional Term: a. Sometimes, tenants want to lock in the location for a long time rent increases usually pre-negotiated. b. If worried, then can do a short term lease and have option to extend risk is that rent fixed during initial term with normal rent increases, then rent renegotiated if want to extend. c. Difference is who wants to take the risk. Reps and Warranties: 1. Just like in P/S agreement are negotiable. 2. Standard terms in AIR lease: a. Landlord warrants that the premise and everything inside is in “good operating condition” and that the structure does not have any material defects. b. Landlord warrants that the premise complies with applicable laws at the time that the lease is entered into. Means that when the premise was built, it was up to Code. 3. Commercial lease: responsible for what is in the 4 corner’s of the document. 4. Landlord does not warrant that the premise will be suitable for the particular purpose that the tenant wants to use it for. Alterations: (different from improvements which fall under CapX). 1. Residential leasing: standard # of bedrooms, baths…etc. 2. Commercial leasing: tenant will need to make significant changes to the premise. a. Landlord may give a tenant improvement allowance to help fix it up. 3. 2 types of alterations: a. Required by law: i. Can be required for 2 reasons (a) Because of the way tenant wants to use the premise: tenant is responsible for the costs; or (b) Due to building itself, so split b/n tenant and landlord. b. Desired: i. Who desires alteration? (a) By tenant: tenant pays. Before the tenant can make alterations they must get approval of landlord. At end of lease, any alterations become the possession of the landlord. (b) By landlord: B/c part of CAM, gets amortized over a period of time, 12 years, to be paid by the tenant based on the tenant’s total share of the premises (see different types of % calculations) (i) Intelligent tenant will ask landlord and get it confirmed in writing the expected changes. Obligations of landlord: 1. Landlord must ensure/provide quiet possession, must give premise in good condition and must keep common areas in good maintenance and repair.
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H. Damage and Destruction: AIR Standard Rules: 1. Destruction: AIR lease form divides into 2 levels. a. Partial: something that requires 3 months or less to repair and no more than 6 months of base rent of the premises that were destroyed. i. Insured: then Landlord must repair. ii. Not insured: Landlord can repair if wants, but if does not, then Tenant can terminate lease. b. Total: lease terminates if it takes more than 3 months to repair or more than 6 months in base rent to repair. 2. GR during repairs: if premises are being repaired, then tenant is not responsible for paying rent on the area that is not useable (Standard AIR). 3. Condemnation: i. If less than 10% condemned, then tenant cannot terminate the lease, but is not responsible for rent on that portion. ii. If more than 10% of the premises are condemned, then the tenant can terminate the lease. Is he will, will depend on how bad she wants to stay. iii. If it is key area, then make argument that do not have quiet enjoyment so should be released from lease. I. Assignment and Subletting: 1. Difference b/n the 2? a. Assign: AIR Form i. Transfer all interests in the lease. ii. Assignment by operation of law: same tenant, but the owner of the company has changed. (a) TBGE is tenant and is bought by IWIN, 51%. b. If any part not assigned, then it is a sublease. c. Either way, still on the hook unless get novation from landlord. 2. AIR Form: Assignment not allowed w/o prior written consent of landlord a. What if lease is silent? Court will apply a Rx standard when deciding if to allow. i. Landlord wants the standard to be: Sole and absolute discretion of landlord, which is ok in CA. 3. Tenant trying to make spread on rent by subletting: if there is a profit made on a sublease, then the tenant has to disgorge the profit. Rx landlord will be willing to share in the profits…may help get tenants. J. Memo of Lease and Subordination: 1. Tenant should record memo of lease to give world notice. 2. Landlord on behalf of new lender will ask tenant to sign SNDA, which they must do. This is done so if new lender forecloses due to lack of payment, then can kick out tenant. This is the same as already discussed. Tenants can use the request o renegotiate the lease, especially if it is unclear what should have or needs to be signed. K. Estoppel Certificate: 1. Tenant must sign AIR form when asked, if does not then landlord can sign for them. L. Options: 1. Types: a. To purchase at end of lease or right of first refusal.
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b. To release space (extension). c. To expand into adjacent property. d. To relocate 2. Generally they are recorded b/c that is the only way the world knows so if someone buys the property your option will not be dead. M. Shopping Centers: 1. Things tenants of shopping centers want: a. Exclusive use clause: only 1 coffee seller, Starbucks b. Co-tenancy provision: if a certain number of other tenants move out or a certain % of tenant space is empty, tenant wants the right to move out as well (also think magazine rack). c. Relocation rights: tenant wants to be in the mall and is already occupying a location, but wants a new location if the current tenant leaves. Sometimes the landlord can have the power to move tenants against their will. 2. Continuous Use: landlord wants store to be open, not enough just to be receiving rent. Tenant most of the time have the obligation to be in continuous use of the premise. 3. Radius Clauses: landlord wants to make sure that stores that are successful in the mall cannot open same store within a certain radius of the mall. Key factors are how long they last and what is the radius. 4. Holdover Provision: tenant goes past termination date. As an incentive to kick out tenant, the AIR Form says that if they stay beyond the termination date it does not waive rights of L to kick them out, but they have a big-time rent escalation provision, no granting them the right to stay.
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