In the current housing market and sub-prime mortgage shakeout, the number of properties going into foreclosure is going to increase and will provide opportunities to those with available funds and strong credit to purchase real bargains at foreclosure sales. To take advantage of this market opportunity, investors need to understand the mortgage process. Under Virginia law, both in-court and out-of-court foreclosures are possible. Generally, out-of court, also known as non-judicial foreclosures are the most prevalent. Typically, once initiated, a non-judicial foreclosure in Virginia takes less than two months. The majority of this article will focus on the non-judicial foreclosure process. Purchaser at foreclosure sales need to be familiar with the foreclosure process and some of the deadlines and hidden pitfalls that can trip up the unwary.
1. JUDICIAL FORECLOSURE:In Virginia, a deed of trust (in common parlance, a mortgage) may be foreclosed by filing a lawsuit known as a bill in equity. When and if necessary, a deed of trust could also be foreclosed through court action. In either case, a court order can be issued which specifies the terms and conditions of the sale, which are controlled by the deed of trust provisions. Special Commissioners are appointed by the Court to handle such sales and the ultimate deed to the foreclosure purchaser will be executed by the Special Commissioner. The court must confirm any such sale.
2. NON-JUDICIAL FORECLOSURE:Except for in unusual situations or where there is ongoing litigation between the mortgagor and mortgagee, non-judicial foreclosures are the typical means by which a deed of trust is foreclosed. Upon direction from the noteholder, the trustee under the deed of trust, or more commonly a substitute trustee specializing in foreclosure proceedings who has replaced the original trustee, will accelerate the note, give the necessary preliminary notices, and arrange the fore closure sale.
•A. Preliminary Notices; Contents and Mailing Requirement: In general, the trustee/substitute trustee must give notice as provided in the deed of trust. In addition, Section 55-59.1, Code of Virginia of 1950, as amended, provides as follows concerning notices to be given by the trustee:
The trustee or the party secured shall give written notice of the time, date and place of any proposed sale in execution of a deed of trust, which notice shall include either (i) the instrument number or deed book and page numbers of the instrument of appointment filed pursuant to § 55-59, or (ii) said notice shall include a copy of the executed and notarized appointment of substitute trustee by personal delivery or by mail to:
•(i) the present owner of the property to be sold at his last known address as such owner and address appear in the records of the party secured,
•(ii) any subordinate lienholder who holds a note against the property secured by a deed of trust recorded at least 30 days prior to the proposed sale and whose address is recorded with the deed of trust,
•(iii) any assignee of such a note secured by a deed of trust provided the assignment and address of assignee are likewise recorded at least 30 days prior to the proposed sale,
•(iv) any condominium unit owners' association which has filed a lien pursuant to § 55-79.84,
•(v) any property owners' association which has filed a lien pursuant to § 55-516, and
•(vi) (vi) any proprietary lessees' association which has filed a lien pursuant to § 55-472.
Written notice shall be given pursuant to clauses (iv), (v) and (vi), only if the lien is recorded at least 30 days prior to the proposed sale.
Mailing of a copy of the advertisement or a notice containing the same information to the owner by certified or registered mail no less than 14 days prior to such sale and to lienholders, the property owners' association or proprietary lessees' association, their assigns and the condominium unit owners' association, at the address noted in the memorandum of lien, by ordinary mail no less than 14 days prior to such sale shall be a sufficient compliance with the requirement of notice.
The written notice of proposed sale when given as provided herein shall be deemed an effective exercise of any right of acceleration contained in such deed of trust or otherwise possessed by the party secured relative to the indebtedness secured. (Emphasis added)
Obviously, in order to give proper notice, the trustee will need to have a title examination performed to confirm what, if any subordinate lienholders must be notified of the sale. The notice must also give the name of the trustee and the address and phone number of a person who will be able to respond to inquiries about the foreclosure sale. A sample notice (as well as a sample Notice to be advertised) is attached hereto as Exhibit A.
•B. Advertisement of Sale: Generally deeds of trust will specify the number of times that notice of the sale must be published prior to the foreclosure sale. To be safe, a trustee should review the advertisement provisions of the deed of trust and consult Section 55-59.2, Code of Virginia of 1950, as amended, which sets out the statutory advertisement requirements:
§ 55-59.2. Advertisement required before sale by trustee. A. Advertisement of sale by a trustee or trustees in execution of a deed of trust shall be in a newspaper having a general circulation in the city or county wherein the property to be sold, or any portion thereof, lies pursuant to the following provisions:
1. If the deed of trust itself provides for the number of publications of such newspaper advertisement, which may be done by using the words "advertisement required" or words of like purport followed by the number agreed upon, then no other or different advertisement shall be necessary, provided that, if such advertisement be inserted on a weekly basis it shall be published not less than once a week for two weeks and if such advertisement be inserted on a daily basis it shall be published not less than once a day for three days, which may be consecutive days, and in either case shall be subject to the provisions of § 55-63 in the same manner as if the method were set forth in the deed of trust. Should the deed of trust provide for advertising on other than a weekly or daily basis either of the foregoing provisions shall be complied with in addition to those provided in such deed of trust. Notwithstanding the provisions of the deed of trust, the sale shall be held on any day following the day of the last advertisement which is no earlier than eight days following the first advertisement nor more than thirty days following the last advertisement.
2. If the deed of trust does not provide for the number of publications of such newspaper advertisement, the trustee shall advertise once a week for four successive weeks; provided, however, that if the property or some portion thereof is located in a city or in a county immediately contiguous to a city, publication of the advertisement five different days, which may be consecutive days, shall be deemed adequate. The sale shall be held on any day following the day of the last advertisement which is no earlier than eight days following the first advertisement nor more than thirty days following the last advertisement.
B. Such advertisement shall be placed in that section of the newspaper where legal notices appear or where the type of property being sold is generally advertised for sale.
C. Sale Procedures:
1.Time of Sale. The sale must be made no earlier than eight days after the first ad and no more than 30 days after the last advertisement.
2. Special Procedures. Written one-price bids may be made and received by the trustee for entry by announcement at the foreclosure sale. Any bidder who attends the foreclosure may inspect the written bids.
3. Manner of Sale. The sale is to be made at auction to the highest bidder. Unless otherwise required by the deed of trust, the trustee may require a bidder to make a 10 percent nonrefundable cash deposit. The trustee must apply the proceeds of the sale first to expenses of the sale, including a 5 percent trustee's commission, second to unpaid taxes, assessments and levies, third to liens in order of their priority and the balance, if any, to the borrower. At the sale, a Memorandum of sale will be executed by the trustee and the successful high bidder confirming the sales price and closing deadline.
4.Deadline for Closing of Sale. Generally, the notice of sale will specify how soon after the public auction the highest bidder must complete the sale. Ten or fifteen days are fairly typical deadlines for closing. The trustee will execute and deliver a deed to the buyer.
5. Deficiency. If the sales proceeds are insufficient to satisfy the amounts incurred for the costs of sale and all unpaid principal and interest due under the note, a lender may pursue a borrower for a deficiency judgment in Virginia. No limits are imposed.
6. Redemption. In a court-ordered foreclosure sale the court may give the borrower a redemption period. Otherwise, contrary to popular misconception, Virginia does not give borrowers any redemption rights.
7. Trustee Accounting. Under Section 26-15, Code of Virginia of 1950, as amended, the trustee under the foreclosed deed of trust must provide the commissioner of accounts for the jurisdiction where the property is located within six (6) months of the date of the public auction. This accounting will set out how the sales proceeds were applied. The accounting for a foreclosure will contain a number of materials: (a) the original note; (b) complete copy of the recorded deed of trust and any substitution of trustee filed by the noteholder; (c) an original affidavit of publication for the advertisement; (d) proof of giving of the notice required under Section 55-59.1 of the Virginia Code; (e) copy of written high bid, if written bids were accepted prior to the sale; (f) receipt from the City Treasurer for real estate taxes paid from the sale proceeds; (g) documentation of any attorneys fees paid; (h) copy of the recorded trustee's deed; (i) documentation of disbursements made from the sale proceeds; and (j) a statement from the noteholder of the total amount due on the date of the sale.
3.INVESTOR PITFALLS TO AVOID: As initially noted, purchasing a property at foreclosure can be a means of securing a true bargain well below the true market value of the property. However, there are certain inherent dangers that need to be minimized by the prudent investor/purchaser to the extent possible. Some of these risks are as follows:
A.Lack of Inspection. The first risk is that typically, any would be purchaser/investor may not have any opportunity to conduct an inspection of the property prior to the foreclosure sale. The sale and conveyance by the trustee will provide that the property is sold "AS IS." Thus, if the property has any significant defects, the purchaser will have no recourse back against the trustee under the deed of trust. What you see is what you get.
B. Superior Liens and Title Issues. The deed delivered to the successful purchaser will be a Special Warranty Deed, which means that the trustee makes NO WARRANTY OF TITLE except that the trustee has not encumbered title to the property. This means that (1) if the deed of trust foreclosed is a second deed of trust, the purchaser takes title subject to the first deed of trust which may be accelerated under the due on sale provisions therein upon the transfer of title out of the borrowers under the foreclosed deed of trust. Therefore, it is critical that the purchaser have a plan in place to deal with paying off the first deed of trust should it subsequently be accelerated. It will do no good to find a bargain only to lose it to foreclosure.
Another problem that frequently arises is that there can be title defects that predate the deed of trust being foreclosed. While the trustee has generally obtained a current owner title examination to determine what subordinate lienholders, if any, should receive the required notice of foreclosure, this title exam does NOT identify prior title issues - e.g., prior unreleased deeds of trust; tax liens; old judgment liens and other potential title problems. Therefore, it is important that the investor/purchaser who is seriously considering buying property at a foreclosure sale obtain a full title examination of the property. This will identify issues that will need to be addressed and avoid unexpected title issues not cured by the foreclosure of the deed of trust.
C. Hazard Insurance. The typical foreclosure memorandum of sale provides that all risk of lost passes to the purchaser from the time the memorandum is signed on the court house steps. Therefore, it is critical that the successful bidder have everything in place to have insurance effective immediately. If the property is damaged by fire or casualty between the date of sale and closing, the loss will be on the purchaser.
D. Closing Deadlines. As indicated, the advertisement of the sale and the memorandum executed by the successful bidder will provide that closing must occur within a short period of time - usually 10 to 15 days from the auction date. If the successful bidder fails to close, the nonrefundable deposit will be lost. While, trustees will sometimes grant and extension of the closing deadline, there is NO guaranty that such will be the case. Therefore, prior to bidding at the sale, unless an investor has significant amounts of cash or available lines of credit, the investor MUST have a plan in place to secure the needed closing funds before bidding at the sale. High bidders who fail to close on schedule can and do lose deposits on a regular basis. This type of loss can be avoided by proper advanced planning.
EXHIBIT A
Notice of Foreclosure
VIA CERTIFIED AND FIRST CLASS MAIL
____________________
____________________
Re: Deed of Trust dated ________, recorded as Instrument No. ___________ in the Clerk's Office of the Circuit Court of the City of Norfolk, Virginia Securing Note dated _____________
Dear _________________:
Please be advised that __________________________ (the "Lender"), has requested the undersigned Trustee to advertise for sale at public auction the property located at __________________________, Norfolk, Virginia ____________, Tax ID No. _____________ (the ("Property"), which is subject to the Deed of Trust dated ________________, and recorded as Instrument No. ___________________ in the Clerk's Office of the Circuit Court of the City of Norfolk, Virginia (the "Deed of Trust"), securing that certain Note dated ____________, in the principal sum of $____________________, together with interest thereon at a rate of ______% per annum.
The Note requires consecutive monthly payments of $___________ each, commencing on _____________, and every month thereafter until ___________, at which time the entire unpaid principal amount of the Note, together with all accrued and unpaid interest thereon is due and payable in full. Contrary to the requirements of the Note, you have not paid the required monthly payments and the Note is in default.
As a result of such default, the Lender has requested us to advise you that unless the entire unpaid balance of the Note, including accrued and unpaid interest thereon, is immediately received, then on _______________, at _______ A.M., the Property will be sold at public auction at that time to the highest bidder. A copy of the advertisement that will appear in ________________ commencing ___________, is enclosed.
The Lender advises that the unpaid balance now due and owing under the Note is $________________, exclusive of expense incurred up through the date of sale, including but not limited to additional interest, late charges, newspaper advertisements, attorney's fees and trustee's fees, which sums will be itemized to you upon inquiry. Please call me at 622-2008 for complete pay off information in order to prevent foreclosure.
Very truly yours,
Michael B. Hamar
NOTICE OF TRUSTEE SALE OF
______________________
Norfolk, Virginia _______
Tax ID No. ___________
In execution of a Deed of Trust, dated _________________, and recorded as Instrument No. _________________ in the Clerk's Office of the Circuit Court of the City of Norfolk, Virginia, in the original principal amount of $_____________, and default having occurred, the undersigned having been duly appointed as Trustee and having been directed by the noteholder to foreclose under said Deed of Trust, will offer the below described property for sale at public auction to the highest bidder, for cash, _________________, at ________A.M., on the front steps of the Circuit Court of the City of Norfolk, Virginia, 23510. The aforesaid property being described as follows:
ALL THAT certain lot, piece or parcel of land, with the buildings and improvements thereon and the appurtenances thereto belonging, situate in the City of Norfolk, Virginia, and known, numbered and described as Lot _____ in Block number _____ as shown on that plat entitled "Subdivision of ________________________," which Plat is recorded in the Clerk's Office of the Circuit Court of the City of Norfolk, Virginia, in Map Book ___ at page ___.
MICHAEL B. HAMAR, TRUSTEE
MICHAEL B. HAMAR, P.C.
520 W. 21st Street, Suite J
Norfolk, Virginia 23517
(757) 622-2008
TERMS: CASH: The successful bidder will be
Required to deposit $_________ at the sale
by cashier's check and settlement held
within ten (10) days.
To be published in _____________ on ___________, __________, and __________, 200___.
During my 31 years of legal practice, I have deveoped a comprehensive set of real estate investor forms and educational articles. The following is a summary of materials available for purchase and consultation. For information e-mail me at mike@hamarlaw.com or call (757) 622-2008.
35 TITLE PROBLEMS This article summarizes some of the "latent defects" that can exist in the chain of title to property that often cannot be detected, no matter how thorough the title examination. Hence, why purchasing an owners title insurance policy is always a wise investment.
AGREEMENT OF SALE - Acreage. This form should be used when purchasing undeveloped acreage for development. The form contains an optional provision where the price can be reduced if the actual useable acreage is less than listed, with actual useable acreage being determined via survey.
ASSET PROTECTION TOOLS FOR THE REAL ESTATE INVESTOR. This article looks at methods that can be employed to protect real estate investment assets as well as limiting one's personal liability for claims and lawsuits arising out of real estate investment property.
ASSIGNMENT OF CONTRACT This form should be utilized for a simple assignment of a contract to another party without any assignment fee. For example, if a contract is executed in one's individual name, this form may be utilized to assign the contract to a related limited liability company.
AVOIDING BEGINNER INVESTOR PITFALLS. This article describes common issues and problems encountered by first time investors, particularly where properties are located in older neighborhoods - e.g., zoning issues, non-conforming lots and/or uses, and title issues - and explains (1) how the problems can be avoided or (2) once the problem has been encountered, how it can be corrected.
BASIC STEPS AND CONSIDERATIONS FOR A SECTION 1031 EXCHANGE. This article summarizes of the steps involved in a 1031 exchange and provides a preliminary overview. It does not address all issues involved in a 1031 exchange and is not meant to replace the requirement that a would be exchanger should always review the entire transaction with tax and/or legal advisors
CHOOSING AN ENTITY TYPE. This article looks at and compares the three types of legal entities most generally utilized to limit real estate investor liability: a Sub-Chapter S corporation, a limited liability company ("LLC"), or a limited partnership ("LP"). Each has certain advantages and disadvantages.
CONTRACT ASSIGNMENT - WHOLESALE. This form is used when an investor is wholesaling a purchase contract for an assignment fee and does NOT intend to do a double closing. The form allows the assigning investor to be paid and then the assignee completes the contract transaction with the seller of the property.
CONTRACT TO PURCHASE REAL ESTATE. This is a short, stripped down purchase agreement that may be used by investors looking to acquire property. NOTE: the form contemplates the property being conveyed in "AS IS" condition, but has inspection and financing contingencies for the benefit of the buyer.
CONTRACT TO SELL REAL ESTATE. This is a short, stripped down sale agreement that may be used by investors looking to sell property. NOTE: the form contemplates the property being conveyed in "AS IS" condition, but has inspection contingencies for the benefit of the buyer.
DEED OF TRUST NOTE - Hard Money. This form should be utilized for hard money loan transactions where there are no monthly payments and a single balloon payment of principal and interest on the maturity date. The form includes an optional extension provision where the extension fee is added to the balance owed at maturity.
DEED OF TRUST - Hard Money. This form should be utilized to secure a hard money loan by way of a deed of trust on the property being acquired and/or rehabbed. In the event interest will be charged over and above the points or loan fee, they should be added to the terms of the accompanying Deed of Trust Note.
EQUITY SHARING AGREEMENT. This form should be used when title to real estate is to be placed in only one partner's name for whatever reason and the parties wish to establish the basis for the other partner to share in the equity in the property in the event it is sold or the partnership is discontinued.
ESCROW AGREEMENT. This form should be utilized when funds are to be placed in escrow pending the completion of repairs or delivery of clear reports, etc. The release instructions must be customized to the specifics of the particular situation.
FIVE DAY PAY OR QUIT LETTER This form is used to give notice to a tenant that they have five days in which to pay delinquent rent or else eviction proceedings will be instituted. Duplicate originals of the letter should be sent by certified and regular mail (some tenants may refuse the certified mailing). A copy of this letter should be retained for presentation to the Court in an eviction proceeding.
FIVE DAY NOTICE TO QUIT LETTER This form is used to give notice to a tenant that they have defaulted in rent and that the default is NOT being waived by the Landlord. Therefore, the tenant must vacate the premises or else eviction proceedings will be instituted. Duplicate originals of the letter should be sent by certified and regular mail (some tenants may refuse the certified mailing). A copy of this letter should be retained for presentation to the Court in an eviction proceeding.
FOR SALE BY OWNER PURCHASE AGREEMENT. This form provides a comprehensive contract for the sale of real property when no realtor is involved. The form approximates the local multiple listing contract form and covers items required when the purchaser is a consumer intending to occupy the property.
INVESTOR ACQUISITION OF REAL PROPERTY - CHECK LIST. This form is a checklist to be used by investors purchasing property in order to make sure all applicable due diligence issues and items are properly examined. Not every transaction will involve all of the listed items.
LAND SALE AGREEMENT. This form is utilized when the purchase of real estate is to be accomplished via an installment sale transaction, with record title remaining vested in the seller until such time as the total purchase price has been paid. The form includes a form of deed to be held in escrow pending the transfer of title as well as a contract termination form for use if the sale is not completed.
LEASE WITH OPTION TO PURCHASE This form is similar to the Residential Lease Agreement except it contains an option to purchase in favor of the tenant within the lease itself. In addition, it has an optional provision where a portion of the monthly rental can be placed into an escrow account in order to allow the tenant to build up a down payment to be utilized when the purchase option is exercised.
LOAN CALCULATION FORM. This form provides a check list of costs to assist in determining (1) the total rehab costs, required loan amounts, and (3) possible profit margin.
OPTION TO PURCHASE AGREEMENT This form is used in conjunction with a separate, stand alone Lease Agreement when the Landlord desires to give the Tenant an option to purchase the leased premises.
OVERVIEW OF CLOSING A PURCHASE TRANSACTION. This article provides a brief summary of the steps involved (and timetables involved) in processing and closing a typical residential purchase transaction by the attorney's office overseeing and coordinating the closing transaction.
PREPARING A SHORT SALE PACKAGE - This article provides step by step for preparing and negotiating a "short sale" - i.e., a reduced payoff balance - for borrowers who need to sell their home because they can no longer afford to keep the payments current and are experiencing financial hardship. From the lender's perspective, a short sale saves many of the costs associated with the foreclosure process - attorney fee's, the eviction process, delays from borrower bankruptcy, damage to the property, costs associated with resale, etc. In a short sale scenario, the lender gets the cash from the property back faster, so it is able to cut its losses. Sample forms and letters are included.
PROMISSORY NOTE - REVOLVING LINE. This form should be utilized when a private lender is providing a revolving line of credit to an investor engaged in one or more rehab operations where the borrower can borrow, repay and re-borrow against the line of credit
PROMISSORY NOTE - (Unsecured). This form of note is NOT secured by a deed of trust and provides for a final balloon payment on a specified maturity date or upon the sale of designated property, whichever is the first to occur.
REAL ESTATE CLOSINGS A-Z - This article provides a step by step overview of closing a residential real estate transaction and includes sample forms,
REQUIREMENTS FOR DOCUMENTS TO BE IN RECORDABLE FORM. This document sets out the requirements for documents to be in proper recordable form in Virginia as on July, 2007. Documents that do not meet these requirements will be rejected by the Clerk's Office.
RESIDENTIAL LEASE AGREEMENT This form is a standard residential lease form that leaves the bulk of maintenance obligations on the Landlord other than yard maintenance and interior cleaning and maintenance of plumbing. It should be used in rental transactions involving single family or condominium rentals.
RESIDENTIAL SHARED PROPERTY LEASE AGREEMENT (Owner). This form is to be utilized by an owner when leasing a portion of a residential property to tenants. It is NOT intended for use when a tenant is subletting property.
SUBJECT TO CONTRACT TO PURCHASE. This form is a comprehensive purchase agreement for use where the existing first mortgage lien will remain outstanding. The form also contains an optional repurchase option in favor of the seller. Note: It is the preferred practice to have the seller execute a separate option to repurchase document.
SUBJECT TO SELLER FORMS. These forms are the minimum that should be required for execution by the seller on a subject to purchase transaction. It is absolutely essential that the seller (1) confirm that they acknowledge that the mortgage loan will continue to be out standing in their name and (2) that the purchaser has no immediate duty to pay off said loan.
THE POWER OF "SUBJECT TO" REAL ESTATE TRANSACTIONS - An overview of the advantages and pitfalls of a "subject to" transaction where the selling homeowner is still liable for the mortgage, but the investor/purchaser has (A) assisted by curing any delinquencies and reinstating the loan in return for a deed to the property, and (B) agreed to make the mortgage payments for the seller. Depending on the circumstances, the investor may (or may not) renovate the property, and then sell or lease it at a substantial profit.
UNDERSTANDING THE FORECLOSURE PROCESS. This articleexplains the foreclosure process in Virginia and states where foreclosures are accomplished without judicial action. The article also discusses certain pit falls that can entangle unwary purchasers at foreclosure sales, including but not limited to title defects and unanticipated property condition.
WAIVER OF LIENS - VIRGINIA. This form is a lien waiver form that should be required from each subcontractor in order to release potential mechanics' lien claims for work and labor completed up through the payment date.
WAIVER OF SERVICEMEMBERS CIVIL RELIEF ACT Landlords should have this form signed by tenants in the military in order to secure the waiver of certain rights under the Service Members Civil Relief Act which can significantly impede attempts to collect delinquent rent and/or possession of the leased premises.
"WRAP" DEED OF TRUST. This form is utilized where a seller is selling property and leaving the current deed of trust in place and desires to retain control over payments to the first mortgage lienholder. Thus, the form provides for a second deed of trust which "wraps" around the first mortgage and provides for the buyer to make payments to the seller who in turn makes the payments on the first mortgage.
COMMERCIAL REAL ESTATE FORMS AND ARTICLES
AGREEMENT OF SALE (Buyer Form) - This form is utilized by a purchaser of commercial property and is focused on providing maximum due diligence investigation, extensive seller representations and warranties, and maximum options for the purchaser to terminate the transaction without liability.
AGREEMENT OF SALE (Seller Form) - This form is utilized by a seller of commercial property and is focused on providing reduced due diligence investigation, minimum acceptable seller representations and warranties, and reduced options for the purchaser to terminate the transaction without liability.
APARTMENT FACILITY PURCHASE AGREEMENT This form sets out a straightforward template for preparing a contract to purchase a medium to large multifamily apartment facility and includes provisions for proper due diligence investigations. Additional representations and warranties by the seller can be added on an as needed basis to reflect circumstances particular to property.
FUNDAMENTALS OF REAL ESTATE DEVELOPMENT - a step by step analysis of how to undertake a commercial real estate transaction/development process. Sample forms are included.
OPTION AGREEMENT. An option agreement provides (i) a payment by the buyer for the right to elect to purchase the real property on or before the expiration of a specified time period, (ii) sets forth the terms of purchase transaction in the event the buyer exercises the option and elects proceed with the purchase transaction, and (iii) provisions for entry on the property for a range of due diligence inspections, and (iv) a time and place for settlement. Unlike a detailed purchase agreement, an option agreement does not need to set forth the buyer's due diligence contingencies inasmuch as the buyer can simply elect not to exercise the option if any due diligence inspections prove unsatisfactory.
NON-CONVENTIONAL FINANCING OPTIONS FOR MULTIFAMILY AND ELDERLY HOUSING PROJECTS - This article reviews tax exempt bond and/or low income housing tax credit financing for multifamily and senior housing facilities which allow developers/investors to (1) secure lower mortgage interest rates and/or (2) obtain a significant equity contribution to the project thereby reducing the amount of equity that must be funded by the developer. These financing options lend themselves to either new construction multifamily or elderly housing projects or acquisition/rehabilitation projects for existing properties that require updating and remodeling.
SAMPLE LETTER OF INTENT. This form should be used when an offer is being made to lay out the terms of a purchase transaction when the parties will, assuming a meeting of the minds occurs, have a more detailed agreement prepared.
SMALL CONSTRUCTION PROJECT CONTRACT This contract template provides the basis for an owner oriented construction contract for a small to moderate construction project. For large projects, most lenders will seek to have an AIA form used as the basic template, together with an AIA form Architect Agreement.
STEPS IN SHORT SALES A short sale is another twist on a subject to transaction. However, instead of bringing the existing financing current and leaving it in place, the goal is to negotiate a discounted pay off with the lender. A "short sale" involves four basic steps.
1. Gaining Control of Title; Authorization to Release Information. One of the most important steps in the short sales process is getting the deed. Without the deed, the homeowner can back out of the potential short sale even after you have spent hours working on their property. When the homeowner signs the deed over to you, now you control the property and you can go to work by calling the bank. If you cannot secure a deed, you must have a contract with the seller that specifies the terms of the transaction with a discounted mortgage pay off - e.g., closing is to be as soon as possible, but expressly contingent upon a successful short sale on terms approved by the buyer.
The other essential document is a signed Authorization to Release Information signed by the sellers. Without one, the lender will NOT talk or otherwise discuss the seller's loan with you.
2. Contacting the Lender. When you call the lender, you never want to tell them you are an investor. This is one of the biggest mistakes rookies make and will almost always result in the lender not accepting short sales. Therefore, when you call the lender, to request a "short salespacket" or "workout package," indicate that you are the buyer or that you represent the homeowner. Sometimes they may ask if you are a real estate attorney. Just restate what you told them before. Then you'll want to request the "short sales packet" or "workout packet". When the packet arrives it will explain exactly what you need to make this short sales deal successful. Generally among the things you will need to document are distress concerning:
(A) The distressed nature of the seller (see paragraph 3 below).
(B) The property: list out all defects to the property and needed repairs to make it marketable (including price estimates). Photos of any major defects can speak volumes to a lender.
(C) The neighborhood where the property is located: is there a crime problem? What are the number of days on market for sales that have occurred and are they below assessment and/or past sales? One web site that may help in checking comparables is http://www.zillow.com/. The other option is to secure comparables through a realtor who is experienced working with investor properties. Remember that many of your big established real estate companies may NOT be familiar with short sales, so do your homework on any realtor you decide to use.
(D) Itemize in detail the lender's cost of not doing the short sale: (1) foreclose costs, (2) bankruptcy costs if the sellers file either a Chapter 7 or 13 under the Federal Bankruptcy Code, and (3) the costs the lender will face if it ends up bidding in the property at foreclosure: (A) repair costs, (B) costs of marketing and selling the property, including realtor commission, and (C) carrying costs, including insurance and real estate taxes.
Lenders do not like to end up owning property, so the more data provided in 2.(B), (C) and (D), above, the more apprehensive the lender will be of holding out for a full payoff amount.
3. Hardship Letter. A hardship letter tells the lender why the homeowner is not making their mortgage payments. If a job loss or family illness is the cause, explain it in detail and make the lender feel sympathetic, and seek to secure for the seller a Waiver of Deficiency - i.e., a no-collection agreement where the lender agrees to write off of any discounted balance and not pursue collection against the seller. The letter should suggest that the seller is contemplating filing bankruptcy, but would prefer to avoid doing so, if at all possible. Be prepared to provide documentation: sometimes lenders will request bank statement, pay stubs, income statements, and so on to document the hardship.
Remember, you must be prepared to send them everything they ask for because if you don't, the short sale will not be accepted. They will almost always ask for a HUD-1 and a real estate purchase and sales agreement. Have your real estate attorney's office prepare a draft HUD-1 and make sure that you have included all amounts payable by the seller for judgments, delinquent taxes, if any, and any other liens (e.g., homeowner association dues). Send everything the lender asks for back ASAP. It usually takes 3 weeks or more to get an answer back from the lender, so you can't afford to wait. If the foreclosure auction is approaching, you can ask to extend the auction which in most cases they will, if they know it is a legitimate offer.
4. Broker's Price Opinion. Basically a real estate agent will come out and give their opinion on what the house is worth in the form of a Brokers Price Opinion ("BPO"). The key to short sales is the BPO. A glib letter will not suffice. The BPO needs to be documented and show supporting market time to sale and final sale information as available. You want to try everything you can to influence the BPO to come in as low as you can in order to induce the lender to discount the loan payoff.
5. Letters of Recommendation. If you have successfully closed short sales previously, obtain a letter from the lenders involved that will help convince the current lender that you can deliver.
6. How Much to Offer. Part of the answer to this question is a function of what you intend to do with the property. If the intent is to rehab it, then the offer should be calculated to allow for satisfactory rehab costs and a profit margin after sale. If the intent is to wholesale the deal, then the offer should be lower to build in an assignment fee and still leave in factors for rehab costs and a profit margin for the ultimate purchaser under the short sale.
WHY USE "SUBJECT TO" TRANSACTIONS? There are a number of reasons why "subject to" real estate transactions are attractive to real estate investors and make economic sense, whether the investor's goal is to acquire rental properties or to rehab and sell fixer upper properties.. These attractions include most significantly:
(1) The purchaser may be required to pay little or no down payment to close the purchase.
(2) Since the purchaser need not go through a loan application and approval process, there is no limit to many properties an investor can buy.
(3) Subject to loans stay in the seller's name are not on the purchaser's credit, and the purchaser is not personally liable on the loan, although record title transfers to the purchaser.
WHAT ARE THE PITFALLS AND RISKS OF "SUBJECT TO" TRANSACTIONS? There are a number of inherent risks and dangers associated with purchasing real estate pursuant to a "subject to" transaction. Among these risks are the following:
(1) Subject to sellers may be in serious arrears in their mortgage payments and may owe significant unpaid principal payments, large sums of unpaid accrued interest and/or penalties.
(2) Subject to sellers may be in foreclosure or on the brink of the commencement of foreclosure proceedings. Once a property goes into the foreclosure process, it may be either (A) impossible to stop the foreclosure without refinancing the loan or (B) more expensive to bring the loan back into good standing because of advertising and legal costs incurred by the lender.
(3) Subject to sellers may be in bankruptcy or end up in bankruptcy between the date of contract signing and closing. Once a seller is in bankruptcy, NO conveyance of the subject to property can be made without the approval of the U.S. Bankruptcy Court. Unapproved transfer of title may be set aside by the Bankruptcy Court without any assurance of compensation to the investor who may have paid delinquent amounts owed on the existing mortgage.
(4) Subject to sellers may have numerous judgment liens, tax liens, and other liens that attach to the subject to property.
(5) Conventional mortgage loans contain "due on sale" clauses and, if the mortgage lender learns that the seller has transferred title to the property, there is a very real risk that the lender will call the loan and/or commence foreclosure proceedings. Therefore, (A) monies paid by the purchaser to bring the loan current may be lost and (B) the purchaser may be faced with the need to refinance the property on an emergency timeframe.
(6) Subject to sellers with financial problems may have purchased or refinanced the property with less conventional lenders and the loans may have prepayment penalty provisions which may not be discovered except by reviewing the recorded deed of trust or by securing a pay off statement.
(7) If the purchaser acquires the subject to property for less than fair market value, other unpaid creditors of the sellers may attack the transfer if the seller subsequently files for bankruptcy protection.
(8) Many subject to sellers are unsophisticated and may claim that they did not understand (A) that their credit was to remain tied up by the existing mortgage loan and/or (B) that they could be liable for mortgage payments should the purchaser fail to make such payments.
HOW DOES A "SUBJECT TO" PURCHASER AVOID SUCH RISKS?
(1) Independently Confirm the Mortgage Status. Do NOT rely on the seller's representations as to the status of the existing mortgage on the property. Subject to purchasers or their legal counsel should ALWAYS obtain a written statement from the mortgage lender confirming the payment status of the loan. This can take the form of a payoff statement - which will reflect escrow deficiencies and prepayment penalty amounts - or other written account summary.
(2) Obtain a Title Commitment from an Experienced and Reputable Title Insurance Company. Because many subject to transaction sellers are in precarious financial condition, it is crucial that a title exam be conducted to identify (A) all mortgages that attach to the property, (B) any state or federal tax liens that may attach to the property, and (C) any other judgment liens that may attach to the property. This latter category of judgments can relate to unpaid medical bills, defaulted credit card accounts, unpaid utility bills, or even delinquent child support payments.
(3) Independently Confirm that the Seller Has Not Filed for Bankruptcy Protection. Do NOT rely on the seller's representations that he/she has not filed for Bankruptcy protection, particularly since creditors can put a debtor into involuntary bankruptcy. A purchase should NEVER make payments to bring a mortgage loan current without first verifying that the seller is not in bankruptcy. If such payments are made and the seller is in bankruptcy (or thereafter goes into bankruptcy), the purchaser will be an unsecured lender seeking payment from a seller that may have no ability to make repayment
(4) Have a Contingency Plan to Deal with Due on Sale Clauses. While many "subject to" purchasers use seller transfers to (A) land trusts where the purchaser is the actual beneficiary or (B) limited liability companies ("LLC") where the seller is the only member and then transfer the membership interest to the purchaser to attempt to avoid the mortgage lender's right to call the loan, these precautions are NOT a guaranty against a loan being called should a lender discover the transfer of title. Some lenders apply the prohibition against the transfer of any interest in the mortgaged property VERY, VERY strictly. Therefore, a transfer to a land trust or LLC (which by law constitute a separate legal "person" distinct from the seller) will sometimes trigger the due on sale clause, if discovered by the lender. Similarly, if a more lenient lender inadvertently learns that the real beneficiary of the trust or the ownership of the LLC has changed to someone other than the seller, then a mandatory call of the loan may also occur.
Because of this latent risk, a subject to purchaser should ALWAYS have a contingency plan as to how the property can be refinanced if the mortgage lender learns of the transfer of title and calls the loan. A subject to purchaser should also be mindful that even if he/she is not liable on the mortgage loan, if a foreclosure occurs and a deficiency judgment is entered against the subject to seller, the seller may attempt to recover the amount of the deficiency from the purchaser based on the purchaser's contractual agreement with the seller to pay the balance of the loan.
(5) Utilize a Purchase Contract that Affords the Purchaser Numerous Rights of Termination. Because it is often only after a purchase contract is signed that a purchaser is able to commence his/her due diligence investigation, the purchase contract should afford the purchaser the ability to terminate the contract should the due diligence investigation disclose additional judgments, liens, bankruptcy proceedings, etc. NOTE: Included in the handouts is a sample contract form.
(6) Give the "Subject To" Seller an Opportunity to Consult Legal Counsel. Often subject to purchasers act in haste to secure the seller's signature on the purchase contract in order to "beat out the competition." The danger in this approach is that the seller may later claim he/she was mislead and/or misunderstood the details of the transaction. A court would very possibly defer to the unsophisticated seller as opposed to an experienced investor.
(7) Remember that "Sometimes, No Deal is Better Than a Bad Deal." Too many investors rush to buy a property without adequately verifying delinquent mortgage payments, the existence of other liens, actual rehab costs and/or whether or not the seller has sought bankruptcy protection in a case that is not yet closed or dismissed. Properly investigating ALL relevant facts can avoid monetary loss and headaches.
(8) Purchase Proper Insurance Coverage: Remember that insurance naming the seller as the insured does NOT cover you as the subject to purchaser. Therefore, be sure to obtain hazard insurance naming your as the owner/insured. In situations where the property will be vacant and under significant rehab, a builder's risk policy should be used in stead of a homeowner policy.
Each commercial real estate development project varies in many ways depending upon the particular type and size of the project to be developed as well as the particular zoning and engineering requirements for the project. However, every project will involve the same major principal phases.
1. Identifying the desired site from potential properties: In general, new construction sites and properties available for acquisition can be identified in two principal ways.
(a) Many state or local economic development offices maintain inventory lists of existing available properties and development sites within their jurisdiction, including industrial parks they may manage.
(b) Utilizing commercial realtors who have been provided the parameters of the site requirements, business brokers or other referral sources.
(c) Any final site selection process will include among other things construction feasibility, transportation access, customer sources, usage patterns, demographic reports, physical surroundings, image, trade area, growth strategies, and competition.
2. Tying up the Land Pending Completion of Due Diligence and Closing: The most common ways to tie up property to remove in from the market pending the developer's due diligence review and completion arrangements for necessary financing consist of:
(a) Binding letter of intent specifying terms of purchase. These agreements typically provide that the seller will cease marketing the property until during the period required for the parties to complete a full contract. Letters of intent can be binding or non-binding at the election of the parties.);
(b) Option to Purchase Agreement with (i) some designated monetary payment to hold the property available to the prospective buyer for a stated period of time, (ii) an outline of the terms of the purchase transaction in the event the buyer elects proceed with the purchase transaction, and (iii) provisions for entry on the property for a range of due diligence inspections, and (iv) a time and place for settlement; if the
(c) Purchase and Sale Agreement with detailed provisions for purchase price, entry on the property for due diligence inspections, representations and warranties of the parties, and time and place of settlement.
3. Due Diligence Review and Inspections. The purpose of due diligence is simply put, to confirm marketability of title to the project site and to ensure that all construction/development requirements can be satisfied before settlement occurs. Among the usual due diligence requirements are the following:
(a) Title examination and Survey (typically commercial lenders will specify their survey requirements);
(b) Environmental inspections - Phase I and/or Phase II assessment;
(c) Soils Test Report and Engineering Study;
(d) Evidence of Utility Availability;
(e) Zoning Classification and Requirements; other Land Use Issues.
4. Settlement and Loan Closing: Settlement is when all purchase transaction and Loan Transactions are executed and delivered in order to (i) vest the buyer with marketable, insurable title to the property, (ii) convey a first lien to the lending institution and (iii) satisfy all requirements in the title commitment. These documents vary from transaction to transaction, but typically include:
(a) Documents Relating to Acquisition of Property:
(i) Deed and Bill of Sale, if applicable;
(ii) Assignment of Rents, Leases and Security Deposits, if Applicable;
(iii) Settlement Statement;
(iv) Owner/Seller Affidavit to Title Company;
(v) Documents and Materials satisfying all Title Commitment Requirements;
(vi) Tax Compliance Documents, including 1445 Certification.
(b) Documents Relating to the Loan:
(i) Commitment Letter;
(ii) Estimated Cost Breakdown;
(iii) Deed of Trust
(iv) Assignment of Rents and Leases;
(v) Security Agreement and UCC-1 Financing Statements;
(vi) Guaranties of Principals;
(vii) Assignment of Construction Documents;
(viii) Loan Agreement;
(ix) Title Commitment, with Mechanic's Lien Coverage, ALTA 8-Environmental; ALTA 6-Variable Rate; Credit Line Endorsement; Zoning Endorsement; Non-Imputation Endorsement; Same as Survey Endorsement
(x) Opinion of Borrower
B. DUE DILIGENCE ISSUES. Perhaps the most critical aspect of any commercial real estate development transaction is making sure appropriate and complete due diligence investigation is undertaken in a timely manner and in a contractual context that allows the buyer to terminate the transaction and receive a refund of its earnest money deposit should any of the investigations prove unsatisfactory. Often these same due diligence issues will tie into requirements of an institutional lender proposing to provide the acquisition and development/redevelopment funding. It is absolutely crucial that any purchase contract executed by the buyer provides an adequate inspection period for all necessary inspections to be conducted.
1. Due Diligence Inspection Period. If possible, a buyer should be able to conduct due diligence investigations right up through the date of settlement. More typically, sellers will be unwilling to have the project site tie up for an extended period. Therefore, if a seller insists upon a specified period during which all inspections must be conducted, the buyer should consider adding a provision to the contract. Whatever inspection period is designated should be realistic so as to avoid putting the buyer in a position of having to terminate the contract if the inspection period expires before all necessary inspections can be completed. Frequently, it is helpful to draft a timeline that includes necessary zoning and other approvals, the loan approval process in order to calculate a realistic inspection period. The following is a sample contract provision:
Right Of Entry; Review Period; Termination Rights Of Buyer. Buyer shall have a period of 90 days from the date that this contract is fully executed by all parties ("Review Period") to conduct all such tests and studies as Buyer may deem necessary.
(a) During the Review Period, Buyer and its agents, contractors, employees and assigns shall have the right with notice to the Seller (i) to enter upon, and have free access to, the Property for the purpose of making such studies, tests and investigations of the Property as Buyer deems necessary or advisable, and (ii) to make application for, and to obtain, any and all licenses, permits, plats, use permits and approvals necessary or desirable in connection with the use of the Property or any portion thereof required by Buyer and financing. Seller agrees to cooperate with Buyer at all times to assist Buyer in obtaining any and all licenses, permits, plats, soil borings, environmental evaluations, approvals and permits, necessary or desirable in connection with Buyer's intended use of the Property (which is a convenience store with retail gasoline facilities). Buyer shall indemnify and save Seller harmless from any liability resulting from Buyer's presence or actions on the Property and restore the Property to its original condition in the event settlement does not occur under the terms of this Agreement.
(b) If, during the Review Period, Buyer determines, in its reasonable discretion, that the Property is not suitable in all respects for Buyer's intended use thereof, or Buyer is not satisfied, in its reasonable, with the results of any tests, surveys, reports, market analysis or other studies regarding the Business and the Property or Buyer's intended use thereof, then Buyer shall have the right, exercisable by the giving of written notice to Seller on or before the expiration of the Review Period, to terminate this Agreement, whereupon all monies deposited hereunder shall immediately be returned to Buyer and none of the parties hereto shall have any further rights against, or obligations or liabilities to any party hereto.
2. Marketability of Title. Every purchase agreement - be it a letter of intent, option agreement or detailed purchase agreement - must provide the buyer with the ability to have title examined and to terminate the contract (and receive a refund of any earnest money deposit) if title proves unsatisfactory for the proposed development. Sample contract provisions for these rights are as follows:
B. Marketable Title. Seller shall convey and transfer to Buyer on the Closing Date good, indefeasible and marketable title to the Property, free and clear of all liens, encumbrances, easements and other title objections other than those to which Buyer fails to object as provided in paragraph 2.C. In addition, such title shall be insurable under an ALTA Owner's Policy (Form B, as amended) by a reputable title insurance company selected by Buyer licensed to do business in Virginia at regular premium rates.
(d) Objections to Title. Buyer, at Buyer's sole expense, shall order a commitment for a title policy ("Title Commitment") for the Property. Buyer shall deliver to Seller a copy of the Title Commitment, together with a written list of the objections to title that are disclosed in the Title Commitment that are not acceptable to Buyer in Buyer's sole discretion. In addition, Buyer shall have the right to notify Seller of any additional objections to title disclosed in any subsequent Title Commitment or any endorsement to the Commitment under the terms and conditions of this paragraph. If Buyer disapproves of any title objections that are disclosed in the Title Commitment, Seller shall have the right, but not the obligation (except for the obligation to remove existing liens or encumbrances that can be removed by the payment of money which shall be paid on or before Closing) to correct any such title objections within ninety (90) days after receipt of Buyer's notice. If Seller is unwilling or unable to correct such objections within the ninety (90) day period, Buyer shall have the option of (i) taking such title as Seller can give without abatement of the purchase price or (ii) terminating this Agreement, in which event the Deposit shall be returned, together with all interest earned, if any, to Buyer and this Agreement shall become null and void and neither party shall have any further obligations hereunder.
3. Easements, Wetlands and Survey Matters. Closely related to marketable title issues are matters that will be disclosed by a proper survey, including among others (1) an accurate metes and bounds description of the Property and determination of the actual acreage of the Property; (2) delineation of all of portions of the Property, if any, lying within wetlands areas, (3) the location of all existing easements and rights-of-way, alleys, streets and roads; (4) delineation of any encroachments upon the Property; (5) location of all existing improvements (such as buildings, power lines, fences, etc.), if any; and (6) the location of all dedicated public streets or private roadways for any access to the Property and whether such access is paved to the property line of the Property.
4. Environmental Contamination. In commercial real estate transactions, virtually every loan transaction will involve obtaining an environmental inspection of the project site. Institutional lenders will, at a minimum, require a Phase I environmental survey. Should the Phase I disclose any questionable matters, a Phase II survey will be required and/or other further testing (e.g., monitoring wells to test for the migration of contamination). Depending on the final results, remediation may be required or restrictions may be imposed on the site's usage (e.g., lead contamination limiting ground disturbing activities and/or prohibition on young children residing in the housing facility).
5. Subdivision and Zoning Compliance. Along with marketable title and survey issues, proper zoning and the legal subdivision of the property is a key due diligence issue. Depending upon the nature of the proposed development, it may be necessary to have the site re-zoned or to secure a conditional use permit (e.g., for an elderly housing facility with reduced parking requirements). The purchase agreement should provide that the seller agrees to cooperate with buyer in obtaining any rezoning of the property or conditional use permits required for buyer's intended development of the project site and operation of the project, since the seller, as record title holder, must join in the execution of the rezoning or conditional use permit application.
6. Utility Availability. Another important due diligence issues is that of availability of utilities. If utilities are not available at the boundaries of the project site, it is imperative that a cost analysis be done to determine what costs may be involved in installing such utilities. Frequently, institutional lenders will require that the borrower furnish letters from the utility providers confirming that said utilities are available.
7. Proposed Development Feasibility. If possible through the contract negotiation process, the purchase agreement should contain some variation of the following provision: "Buyer shall have determined, in its sole and absolute discretion, that the property and the project site (including, without limitation, applicable zoning restrictions, buildable area, soil condition, environmental condition, drainage, access, and on and off site utility requirements) are suitable in all respects for buyer's intended development, construction and operation of the project on the property and the project site.
8. Financing Contingency. While not a due diligence matter per se, a financing contingency should be included in the purchase agreement for two reasons: (1) to protect the earnest money deposit if financing is needed for proceeding with the development and (2) most institutional lenders will have their own due diligence requirements that must be satisfied prior to closing and, therefore, the financing contingency can serve to give the buyer "second bite at the apple," if a due diligence item is otherwise overlooked. The following is a sample financing contingency provision:
"Buyer shall have (A) obtained a commitment from a commercial lending institution for an acquisition/development loan for the property (the "Loan Commitment"). Buyer represents to seller that upon final execution of this Agreement, buyer shall promptly make application for such Loan Commitment and diligently seek the same."
II. ACQUIRING THE PROPERTY:
A. STRATEGIES FOR OPENING NEGOTIATIONS:
Commercial Realtors/Business Brokers. In many instances, the first phase of the negotiations will be undertaken by commercial realtors who have assisted a buyer in identifying a potential project site. If the property is listed for sale, the realtor will have the seller's asking price and the listing will provide preliminary zoning and utility availability information. In addition, the commercial realtor in many instances will have begun discussions with the seller's agent as to what matters may or may not be negotiable. If this is the case, often the realtor can provide the buyer's counsel with a term sheet from which a letter of intent or contract can be prepared.
1. Letter of Intent. Absent preliminary negotiations via a commercial realtor, the other most common approach to opening negotiations is to submit a letter of intent specifying proposed terms of purchase. These agreements typically provide that the seller will cease marketing the property until during the period required for the parties to complete a full contract.
2. Conference Calls or Face to Face Negotiations. From time to time, representatives of the parties will either conduct a working group conference call or schedule a meeting to work out the details of a purchase agreement. Typically, this occurs after a proposed letter of intent or proposed purchase agreement has been previously submitted. An obvious advantage of this strategy is the ability to expedite the negotiation process. Once the parties reach a meeting of the minds draft documents can be circulated for further review and comment, often via e-mail.
B. TYING UP THE LAND:
In addition to utilizing a letter of intent as described, above, the most common means of tying up the land are by way of an option agreement or a detailed purchase agreement. From a negotiating stand point, it is usually better to submit the buyer's preferred draft contract rather than endeavoring to renegotiate the seller's draft contract.
1. Option to Purchase Agreement. An option agreement provides (i) a payment by the buyer for the right to elect to purchase the real property on or before the expiration of a specified time period, (ii) sets forth the terms of purchase transaction in the event the buyer exercises the option and elects proceed with the purchase transaction, and (iii) provisions for entry on the property for a range of due diligence inspections, and (iv) a time and place for settlement. Unlike a detailed purchase agreement, an option agreement does not need to set forth the buyer's due diligence contingencies inasmuch as the buyer can simply elect not to exercise the option if any due diligence inspections prove unsatisfactory.
2. Purchase and Sale Agreement. A detailed commercial purchase agreement should include detailed provisions for purchase price, entry on the property for due diligence inspections, representations and warranties of the parties, detailed buyer contingencies, including a financing contingency, and time and place of settlement. Unless otherwise agreed by the buyer, the earnest money deposit ("Deposit") should be refundable in the event the buyer terminates the contract based upon unsatisfactory due diligence inspection results. Occasionally, if a buyer needs an extension of the due diligence period, a seller may require that (i) a portion of the Deposit will become non-refundable, or (ii) the Deposit be increased.
C. SURVEYS, ABSTRACTS AND TITLE INSURANCE
While in some states it is common that a seller provide a buyer with an abstract of title, in Virginia abstracts are not generally used. Rather, commercial title commitments are issued by title insurance companies that set forth (i) the requirements for issuance of a final title insurance policy, and (ii) all exceptions to title. If requested, the same title insurance companies will provide copies of all exceptions listed in the title commitment, which comprise a critical part of the due diligence process and which are required for the preparation of the ALTA survey required by most institutional lenders.
1. Surveys. An ALTA survey is one that meets the minimum requirements of the American Land Title Association and the National Society of Professional Surveyors. An ALTA survey will show in detail, among other things, all boundaries, easements of record, encroachments, zoning and set back restrictions, and all physical details of the property and provides the basis (a certification to the title insurance copy is included on the survey) on which the insuring title insurance company ("Title Company") will insure against all matters except as shown on said survey.
(a) Role of Buyer's Counsel. In order for an ALTA survey to be prepared, the surveyor must be provided with the record title legal description of the property to be surveyed or, in the case of an original survey, the record description of the parent parcel that contains the property to be surveyed. Buyer's counsel must coordinate with the Title Company to insure that complete copies of the record title description of the property (or, in the case of an original survey, the parent parcel), any recorded easements benefiting the property; the recorded easements or servitudes and covenants burdening the property ("Record Documents"); and any other documents containing desired appropriate information affecting the property being surveyed are provided to the surveyor for notation on the plat or map of survey.
Once the survey is delivered to the Title Company, buyer's counsel should carefully review the survey to confirm (i) exceptions listed in the title commitment are referenced on the survey and (ii) the certifications required by the Survey Standards are properly set out on the survey.
(b) Costs and Timing. Unlike the typical residential survey which can be usually be prepared in a matter of a few days and a relative low cost, an ALTA survey takes a significant period to prepare and can cost thousands of dollars. Therefore, the buyer must (i) order the survey in writing and (ii) allow sufficient time in calculating the due diligence inspection period/closing date to accommodate preparation and review of the survey.
2. Title Insurance.
(a) Owners Policy. In its simplest analysis, an owner's title insurance policy insures that the estate or interest in the land identified in Schedule A of the policy is vested in the owner named therein in respect to the covered risks, subject to (i) stated exclusions in the policy and (ii) the matters identified on Schedule B of the policy.
(b) Loan Policy. In the case of a loan policy, a mortgagee title insurance policy insures that, at Date of Policy, the land which is encumbered by the insured mortgage is fee simple (or such other estate or interest as specifically identified in the insured mortgage) subject to the exclusions from coverage, the exceptions from coverage contained in Schedule B and the conditions and stipulations vested in the borrower(s) shown in the insured mortgage. Covered risks typically include: (i) title to the estate or interest described in Schedule A being vested other than as stated therein; (ii) any defect in or lien or encumbrance on the title; (iii) unmarketability of the title; (iv) lack of a right of access to and from the land; (v) the invalidity or unenforceability of the lien of the insured mortgage upon the title; (vi) The priority of any lien or encumbrance over the lien of the insured mortgage; and (vii) the invalidity or unenforceability of any assignment of the insured mortgage, provided the assignment is shown in Schedule A, or the failure of the assignment shown in Schedule A to vest title to the insured mortgage in the named insured assignee free and clear of all liens.
(c) Role of Buyer's Counsel. In commercial real estate transactions, as in residential purchases, the role of buyer's counsel is to make sure that (A) all requirements set forth in Schedule B-1 of the title commitment are satisfied, and (B) the title policy when issued will include the special endorse required by the buyer's institutional lender. All curative documents - other than releases of deeds of trust being paid off with the sales proceeds based on written pay off letters, are submitted to and approved by the Title Company prior to closing. These requirements will vary depending upon (i) what title exceptions have been disclosed by the title examination, (ii) whether or not the buyer and seller are entities, and particular requirements specified for the endorsements required by the buyer's institutional lender (e.g., it may be necessary to secure a zoning letter confirming the zoning and permitted uses of the property).
(d) Typical Commercial Transaction Endorsement. Typically, the buyer's institutional lender will specify the endorsements it will require to be included in the mortgagee title policy in its loan instructions or commitment letter. The required endorsements will vary from transaction to transaction.
The following is a summary of the steps involved in processing and closing a typical residential purchase transaction by the attorney's office overseeing and coordinating the closing transaction.
1. RECEIPT OF CONTRACT/TITLE SEARCH ORDER: Once a fully ratified contract is received from the buyer's agent(contracts can be received either via fax 757-622-2088 or email mike@hamarlaw.com or mary@hamarlaw.com), a physical file is created and a title examination is ordered per a title order request form which results in a title commitment being generated by the title insurance company after an examination of title has been conducted. The title commitment reflects among other things (1) the name(s) of the record title owner(s) of the property, (2) the full legal description of the property per the records in the Clerk's Office of the applicable Circuit Court, (3) all liens and encumbrances against the property, including mortgage liens, any judgment liens, child support liens, etc., (4) any wills by which title has been devised, (5) real estate tax account and payment status information, and (6) the materials required for submission to the title company in order that a final title policy can be issued.
2. MORTGAGE PAY OFF REQUEST(S): The closing attorney will order pay off statements from the Seller's existing lenders, if any. To do so, the closing attorney needs (1) an authorization signed by the Sellers, (2) contact information for the seller's lender(s), (3) the loan account number for each mortgage, and (4) generally, the Sellers' social security numbers. When received, the pay off letters will set forth the amount required to pay off the existing mortgages in full and result in the lender's return a release to be recorded in the local land records. The turn around time for pay off statements varies from 24 hours to up to 10 days, so the best practice is to order pay off statements at the outset.
3. SURVEY ORDER: Unless waived by the Buyer, a survey of the property is ordered. The physical survey discloses any easements affecting the property as well as any encroachment or boundary set back issues which then become a title defect to be resolved by the Seller. If the problem is significant and cannot be resolved, then the Buyer will be in a position to terminate the purchase contract and receive a refund of the earnest money deposit. The cost of a typical residential lot survey is between $250 and $300.
4. RECEIPT OF LENDER INSTRUCTION: The lender will send the closing attorney's office preliminary instructions that specify (1) the name of the borrower(s), (2) amount of the new loan(s), (3) the manner in which the lender is to be named on the mortgagee title policy, (3) any endorsements to the mortgagee title policy (4) materials to be included in the preliminary package to be submitted to the mortgage lender for review, and (5) amounts to be collected on a preliminary HUD-1 settlement statement.
5. HOME OWNER'S INSURANCE; TERMITE/MOISTURE INSPECTION: The closing attorney's office coordinates with the Buyer or the Buyer's agent to order the hazard and/or flood insurance coverage required by the mortgage lender. Buyers are free to select whatever insurance company they prefer for the required coverage, provided the carrier is licensed in the Commonwealth of Virginia.
6. REVIEW TITLE COMMITMENT: Upon receipt, the closing attorney's office reviews the title insurance commitment (1) for the requirements to correct irregularities in title enumerated in Schedule B-1 of the commitment, (2) to insure the new mortgage lender is correctly named, the new loan amount(s) is/are correct, and that the lender-required endorsements are included, (3) for unreleased deeds of trusts, other than those for which pay offs have been ordered, (4) other liens, judgments or other title problems that prevent title from being marketable. No closing should be scheduled until ALL curative materials have been submitted to and approved by the title insurance company's underwriters. NOTE:Mortgage lenders ALWAYS require a title insurance policy on their loans, and Buyers are well advised to purchase an owners title insurance policy.
7. PREPARATION OF THE PRELIMINARY PACKAGE: Once the title commitment, hazard and/or flood insurance certificates, termite and moisture reports and any other specific lender-required materials are received, the closing attorney's office will prepare a preliminary HUD-1 settlement statement and submit the same to the Buyers' mortgage lender for review. These materials are delivered either via fax or e-mail, depending upon the lender involved.
8. REVIEW OF PROPOSED SELLER DOCUMENTS: The closing attorney will require drafts of or the information required to prepare the proposed deed, affidavits to the title insurance company, an IRS 1099, and R-5E, and certain other closing certifications. Once these documents are approved by the closing attorney arrangements will be made for their delivery to the closing attorney's office if the Sellers are not going to attend closing.
9. FINAL LENDER INSTRUCTIONS AND LOAN PACKAGE: The lender will deliver final closing instructions to the closing attorney's office which will contain final lender's fees and other costs to be collected on the final settlement statement. NOTE: often these instructions may set limits on the amount of Seller closing cost assistance to the Buyer, depending upon the loan program, etc., being utilized by the Buyer. In addition, the lender will provide a closing package of documents to the closing attorney's office. Once the loan package is received, a final HUD-1 is prepared and submitted to the lender for approval. After the HUD-1 is "APPROVED," the closing attorney will send copies to realtors and sellers' representative and confirm closing time and advise the Buyer how much money to bring to closing. Remember - by Virginia statute certified funds are required (i.e. money order, cashier's check or wire).
10. CLOSING: At the closing,the Buyers must provide valid picture IDs, and the closing attorney will review and explain the HUD-1 settlement statement and all of the loan documents being executed by the Buyers, as well as certain standard certifications. NOTE: by Virginia statute, no funds can be disbursed until (1) the closing attorney is in receipt of all required funds from the Buyer and the lender, (2) title to the property has been updated from the date of the title insurance commitment, and (3) the deed and deed of trust(s) have been filed for record - usually the morning following the closing.
11, POST CLOSING After closing, a copy of the signed HUD-1 and other required documents are faxed to the lender advising that closing occurred. The closing attorney's office will coordinate with the title insurance company to have the documents picked up and title updated to the time of filing. Upon receipt of notice from title company personnel that the documents are "in line" at the Court house, disbursement is made of all payments set forth on the HUD-1, including pay offs to the Sellers' mortgage lenders. The closing attorney should give the paid off lenders notice pursuant to Section 55-66.3, Code of Virginia of 1950, as amended, so that if the Sellers' mortgage lender fails to release the old deed of trust within 90 days, the closing attorney as settlement agent that made the payoff can file a certificate of release.
Once recorded documents are returned from the Court house, the original deed is forwarded to the Buyer and the recorded deed(s) of trust are delivered to the Buyers' mortgage lender. Copies of all such documents are sent to the title insurance company so that the final title insurance policies can be issued and delivered to the Buyer and mortgage lender. The turn around time on receiving documents back from the applicable Clerk's Office varies from city to city, with some offices returning recorded documents within a week to five or six months, in the case of the City of Chesapeake.
Introduction: A possible tax deferred exchange under §1031 of the Internal Revenue Code of 1986, as amended ("IRC"), is something every seller who has not used the property to be sold as his/her principal residence for two or more of the past five years may wish to consider as a means to avoid capital gains tax. A successful tax deferred exchange under §1031, however, requires some basic pre-planning and coordination as well as the use of a qualified intermediary in order to prevent any deemed or constructive receipt of the sales proceeds from the relinquished property which would destroy the tax deferral of such sale. This summary of the steps involved in a 1031 exchange provides a preliminary overview and does not address all issues involved in a 1031 exchange and is not meant to replace the requirement that a would be exchanger should always review the entire transaction with tax and/or legal advisors. Likewise, it does not address the issues of so-called reverse exchanges and other variations to the typical sale and purchase sequence. This said, the following is an outline of the steps in a 1031 tax deferred exchange of real property.
1. Basic Requirements: To qualify for a taxdeferred exchange, a few basic elements must be satisfied: (a) both the relinquished and replacement properties must be like kind real property - i.e., held for rental/investment; (b) typically, the taxpayer seeking to defer tax is one or more individual taxpayers reporting their real estate transactions on their individual Form 1040 tax returns (although entities such as limited liability companies can utilize 1031 exchange procedures); (c) the relinquished and replacement property are both within the United States of America; and (d) a qualified intermediary and qualified trust accounts are utilized for the proceeds of the relinquished property to ensure that the taxpayer(s) are not in actual or constructive receipt of the sales proceeds of the relinquished property.
2. Sales Contract for the Relinquished Property: The first step in a tax deferred exchange is to execute an assignable sales contract that describes the seller as the exchanger "or assigns." In addition, it is also advisable to include a "cooperation clause" in the sales contract. An example of such a clause is as follows:
Tax Deferred Exchange by Seller. Seller may structure the transfer of the Property as a tax deferred exchange to Seller pursuant to Section 1031 of the Internal Revenue Code, and Purchaser agrees to cooperate with Seller, and to take such action as Seller may reasonably request in order to consummate such transfer. Seller is granted the authority to transfer its rights to this Agreement but not its obligations under an Assignment of Rights Under Contract or similar document to be signed by a qualified intermediary to be selected by the Seller, such assignment to be acknowledged by Purchaser prior to passing title and ownership. At the request of Seller, Purchaser will sign the written Assignment of Rights Under Contract referred to in this paragraph with the clear understanding that all obligations under the Agreement remain with Seller and that Seller shall directly deed the legal title to the Property over to the Purchaser as noted in the agreements between Seller and the qualified intermediary. In connection with the foregoing, Purchaser will have no obligation to (a) acquire or enter into the chain of title to any property other than the Property, or (b) incur any cost, liability or obligations of any nature whatsoever as a result of its limited participation in the exchange for which Purchaser would not be reimbursed by Seller at Closing.
As noted below, in contracting to purchase the replacement property, similar provisions should be utilized.
3. Exchange documents: Once the sale contract is executed, the Seller must enter into exchange documents for the relinquished property sale pursuant to which among other things (a) the sale contract is assigned by the Seller to the qualified intermediary, (b) the Purchaser acknowledges the assignment of the sales contract to the qualified intermediary, (c) the qualified intermediary agrees to receive the sales proceeds and hold the same pending their application to the purchase price of the replacement property, (d) Seller agrees to deed the relinquished property directly to the Purchaser, and (e) the Seller agrees to indemnify the qualified intermediary from loss, damage or liability except for that arising from the qualified intermediary's breach of its obligations under the exchange documents.
4. Relinquished Property Sale Closes: Pursuant to the assignment agreement and exchange documents, the Seller directly deeds the relinquished property to the Purchaser and the sale proceeds for the relinquished property are transferred directly to the qualified intermediary. Note: the settlement statement will be signed by the qualified intermediary, as seller, not the exchanger.
5. 45-Day Identification Period & 180-Day Exchange Period The timelines for the 45-day identification period and 180-day (or the date the tax return is due, whichever is earlier) period for closing on the purchase of the replacement property begins on the date the sale of the relinquished property closes. The 180-day exchange period establishes a deadline that the purchase of the replacement property MUST be closed not later than 180 days from the closing date of the sale of the relinquished property.
6. Identification of the Replacement Property (or Properties): The Seller/Exchanger must properly identify replacement property (or properties where replacement properties of lesser values than the relinquished property are to be acquired) by midnight of the 45th day after the closing date of the sale of the relinquished property. This means that the Seller/Exchanger must deliver written identification of the replacement property to the qualified intermediary by midnight of the 45th day after the closing date of the sale of the relinquished property is forwarded to API.
7. Purchase Contract for the Replacement Property. The Exchanger must execute an assignable purchase sales contract that describes the purchaser as the exchanger "or assigns." In addition, it is also advisable to include a "cooperation clause" in the purchase contract similar to that described, above, for the sales contract.
8. Coordinate With Qualified Intermediary: Once the purchase contract for the replacement property (or properties) has been executed, the exchanger must notify the qualified intermediary of the terms of the purchase contract and assign the same to the qualified intermediary. The qualified intermediary will execute the exchange documents for purchase and prepare to apply the funds held from the sale of the relinquished property against the purchase price of the replacement property at settlement on the replacement property.
9. Conclusion of Exchange: At closing of the purchase of the replacement property, the qualified intermediary will direct the seller of the relinquished property to deed title thereto directly to the exchanger and will apply the funds derived from the sale of the relinquished property against the amount owed from the buyer on the settlement statement. Note: the settlement statement will be signed by the qualified intermediary, as buyer, not the exchanger.
Conclusion: When properly done, a Section 1031 tax deferred exchange can be a very powerful tool to defer tax consequences. However, to avoid potential pitfalls and to ensure that appropriate exchange documentation is utilized and that a proper qualified intermediary is used, would be exchangers should be sure to consult their with tax and/or legal advisors. Any deemed receipt of sale proceeds, a failure to identify replacement property within the statutory 45-day period, or a failure to consummate the purchase of the replacement property with in the 180-day exchange period can be fatal.
BACKGROUND: On November 7, 2006, the voters of Virginia amended the Bill of Rightsset forth in the Virginia Constitution to includes, in relevant part, the following language:
"This Commonwealth and its political subdivisions shall not create or recognize a legal status for relationships of unmarried individuals that intends to approximate the design, qualities, significance, or effects of marriage. Nor shall this Commonwealth or its political subdivisions create or recognize another union, partnership, or other legal status to which is assigned the rights, benefits, obligations, qualities, or effects of marriage."
This so-called "Marriage Amendment" gives new urgency to proper estate planning for unmarried heterosexual couples and same-sex couples. Absent a will, for example, a long-time partner regardless of gender receives nothing under Virginia's intestacy laws. Similarly, minor children of the non-legal guardian member of the couple will receive nothing under current intestacy laws and may well have legal guardianship revert to someone other than the surviving member of the couple.
Thus, it is of critical importance that unmarried couples and same sex couples have estate planning documents in place and, where relevant, have provided for issues of legal guardianship. In preparing such legal documents, it will be necessary to avoid language that "intends to approximate the design, qualities, significance, or effects of marriage," or "assigned the rights, benefits, obligations, qualities, or effects of marriage," whatever these phrases may encompass.
However, there are some things unmarried couples and same-sex couples can and should do to provide for some of the legal protection automatically conferred on married couples.
NECESSARY DOCUMENTS AND STEPS: There are some basic documents and steps that every unmarried couple and every same-sex couple should have prepared and duly signed. These include:
Will - A will specifies how you wish your property to be distributed upon your death. In a will, you designate the person you wish to handle your estate -- your partner or another individual. Without one, your partner receives absolutely nothing. Pursuant to § 64.1-46 of the Virginia Code, anyone who is over the age of 18 years and not mentally incompetent may make a will and thereby dispose of any estate to which he shall be entitled, at his death, including any estate, right or interest to which the testator may be entitled at his death, notwithstanding he may become so entitled subsequently to the execution of the will. Inasmuch as neither § 64.1-46 or other provisions of the Virginia Constitution or the Virginia Code restrict permitted devisees to spouses or blood relatives, both unmarried heterosexual couples and same-sex couples may make wills leaving assets to their partners.
Trust - A properly established and funded trust avoids publicly probating assets owned by the trust at the time of one's death and is more difficult to challenge in court than a will. In addition, a trust can provide beneficiaries with creditor protection in certain circumstances. Properly structured, a trust can provide support for one's surviving partner for the remainder of his or her life, with the remainder to pass to other relatives and designated beneficiaries, bypassing potential taxes associated with the surviving partner's estate. Chapter 4, Title 26 of the Virginia Code governing the appointment, qualification, resignation, removal of fiduciaries, including trustees, contains no provision restricting permitted trustees or trust beneficiaries to spouses or blood relatives. Therefore, both unmarried heterosexual couples and same-sex couples may create trusts naming their partners as beneficiaries in a manner that does not purport "to bestow the privileges or obligations of marriage."
Health Care Power of Attorney - A health care or medical power of attorney allows one's partner regardless of gender to make medical decisions on your behalf in the event you are not able to do so due to incompetency or other incapacity. Properly drafted, a health care power of attorney can also ensure hospital visitation rights to the designated attorney-in-fact
Advanced Medical Directive - § 54.1-2983 of the Virginia Code provides that any mentally competent adult may, at any time, make a written advance directive (i) authorizing the providing, withholding or withdrawal of life-prolonging procedures in the event such person should have a terminal condition, and (ii) appointing an agent to make health care decisions for the declarant under the circumstances stated in the advance directive if the declarant should be determined to be incapable of making an informed decision. Advance medical directives must be signed by the declarant in the presence of two subscribing witnesses who cannot be the spouse or blood relatives of the declarant. There is no statutory restriction that one's agent must be a spouse or blood relative. Rather, §54.1-2982 of the Virginia Code provides that under any such advance medical directive, an agent means "an adult appointed by the declarant under an advance directive, executed or made in accordance with the provisions of § 54.1-2983, to make health care decisions for him. . ." Such authority includes visitation rights, provided the advance directive makes express provisions for visitation. Therefore, properly drafted and executed advanced medical directives by a same-sex couple should not be deemed to have "assigned the rights, benefits, obligations, qualities, or effects of marriage."
General/Business Power of Attorney - This form of power of attorney allows a member of either an unmarried couple or a same-sex couple to authorize their partner to handle their financial affairs in the event of disability or unavailability.
Title on Deeds and Accounts - How title to property is held can effect both future ownership and tax liability. Joint tenancy with rights of survivorship, for example, will ensure that the surviving partner will have full ownership upon the death of the deceased partner and avoid ownership disputes with surviving blood relatives. However, it can create certain negative estate tax treatment depending on the size of one's taxable estate. Historically, deeds creating a tenancy by the entirety have been reserved for husband and wife couples. In light of the Virginia Marriage Amendment, such a deed conveying title to a same-sex couple even though validly married in another state such as Massachusetts would not be effective in Virginia.
Beneficiary Designations - Most securities and retirement accounts provide for the designation of beneficiaries. These should be reviewed periodically to ensure that desired goals are achieved and also should include the designation of contingent beneficiaries to ensure the desired parties are named in the event of the death of the principal beneficiary.
Life Insurance - Properly utilized, life insurance can provide funding for payment of estate taxes, outstanding mortgages, charitable trusts, education of minors, and other functions.
Parenting Agreement - If an unmarried couple or same-sex couple plan to raise a child(ren) together where only one of then is the legal parent, they should consider some sort of agreement stating their intentions and ideally addressing custody issues in the event of the death of one or both partners. Such an agreement should be prepared with the assistance of an attorney experienced in family law and child custody matters.
NOTE: This article contains a general discussion of estate planning matters for unmarried couples and should not be relied upon as a substitute for individualized legal advice addressing one's particular situation.
Introduction: In addition to conventional mortgage financing approaches which generally require a significant equity contribution by the developer due to lender loan to value criteria, several tax-exempt and/or low income housing tax credit financing options exist which allow developers/investors to (1) secure lower mortgage interest rates and/or (2) obtain a significant equity contribution to the project thereby reducing the amount of equity that must be funded by the developer. These financing options lend themselves to either new construction multifamily or elderly housing projects or acquisition/rehabilitation projects for existing properties that require updating and remodeling. All of these financing options derive from the federal tax policy of encouraging private enterprise to develop safe, clean and affordable housing for low to moderate income tenants. History has shown that private development does a far better job of providing such housing and avoids the now well known problems associated with many government owned and operated low income housing projects
While involving increased initial legal and closing costs and increased record keeping requirements that make these financing more appropriate for larger projects (e.g., over 75 units), properly structured they can make otherwise uneconomic proposals attractive and allow a developer to proceed with a project with reduced out of pocket equity infusion burdens. These options involve utilizing (1) low income housing tax credits for low to moderate income rental housing projects pursuant to Section 42 of the Internal Revenue Code of 1986, as amended (the "IRC"), (2) tax-exempt multifamily housing revenue bond financing pursuant to Section 142(d) of the IRC, or (3) a combination of low income housing tax credits and tax-exempt housing bonds to meet a particular projects financing needs.
Which option should be utilized depends upon (A) the nature of the proposed project - including the percentage of units to be set aside for low to moderate income tenants and whether or not a Section 501(c)(3) charitable entity will hold an ownership interest in the project - and (B) the financial resources of the developer. Among the key factors to a successful tax credit or tax-exempt bond financed project are (1) a careful and realistic budget for construction or rehabilitation costs, as the case may be, and (B) experienced management that has the experience and resources to compile and annually update tenant income certifications to insure continual low income unit set aside compliance. If a developer lacks such management experience, it is often the wiser course to hire an experienced management company rather than risk the loss of tax credits for a project or to have the bond financing become taxable.
1. Option One - 9% Low Income Housing Tax Credit: This type of financing is available under Section 42 of the IRC and allows projects that are owned either (A) by an entity with joint Section 501(c)(3) entity and private for profit entity ownership, or (B) a private for profit entity. Under Section42 of the IRC, 9% tax credits are available to the developer provided specified rental unit set asides are met for tenants of low to moderate income (i.e., either (1) at least 20% of the units are set aside for tenants with incomes not exceeding 50% of area median income, or (2) at least 40% of the units are set aside for tenants with incomes not exceeding 60% of area median income). If higher low to moderate income set aside levels are maintained, a larger amount of tax credit is available for a given project. Ownership of a Section 42 tax credit project is generally structured in the form of a limited partnership where the project developer holds a small - e.g., one percent (1%) - general partnership interest with the remaining partnership interest in the form of limited partnership interest that is then sold to a tax credit investor that an use the tax credits for a dollar for dollar credit against income derived from other sources. A few examples of such investors are Norfolk Southern Corporation, AIG SunAmerica, Inc., Related Capital Company, and large insurance companies. The last 9% tax credit transaction I handled yielded the developer $0.78 per each $1.00 of tax credit allocation for the project.
The following is an example of how the tax credit is calculated:
Total Development Costs: $5,000,000.00
Less Non-eligible basis (i.e., land) 500,000.00
Eligible Basis 4,500,000.00
Credit Percentage 9%
Total Annual Credits 405,000.00
Tax credit Period 10 Years
Total Tax Credits $4,050,000.00
Credit Sale Price Per $ of Credits $0.75
Equity Infusion $3,037,500.00
A similar calculation is used to determine the cash equity infusion available from 4% low income housing tax credits discussed below.
Section 42 tax credit projects are especially attractive in connection with elderly housing projects since the income certifications required consider only tenant annual income and not assets owned or controlled y a tenant. Hence, a higher caliber of tenants is possible given the fixed incomes of many of today's senior citizens. This financing approach has the following advantages and disadvantages.
Advantages:
A. The sale of 9% tax credits yields the largest infusion of equity into a project and coupled with conventional construction/permanent loan financing allows a developer lacking a significant net worth to develop projects either on their own or with other private ownership participation.
B. The often significant cost and expense of tax exempt bond issuance are avoided.
Disadvantages:
A. Awards of 9% tax credits are made via a highly competitive application and allocation process and pool. In Virginia, the process is administered by the Virginia Housing Development Authority ("VHDA"), with 9% tax credits being awarded to the highest scoring applicants based on VHDA's point system that factors in numerous variables until VHDA has awarded all tax credits available for a given tax year under the IRC. Therefore, there is no guaranty that an applicant will be successful in obtaining an award of 9% tax credits.
B. Tax Credit projects must be "rent-restricted," with the gross rent applicable to a unit in the project being limited to 30% of the applicable 50% or 60% of area median gross income limitation, whichever set aside test was elected for the project. Gross rent is calculated by assuming one person will occupy a unit with no separate bedroom and that 1.5 persons will occupy each separate bedroom. Gross rent includes a utility allowance, but does not include Section 8 payments or comparable rental assistance program payments, fees for certain supportive services which are paid to the project owner under any government program or by a 501(c)(3) organization, or fees for optional services.
C. The project will be subject to a "Qualified Project Period" that lasts generally 15 years. During this period, the low to moderate income unit set aside requirement will continue to restrict the project.
2. Option Two - Tax Exempt Housing Bonds: This type of financing is available under Section 142(d) of the IRC and allows new construction and acquisition/rehabilitation projects to be financed with tax-exempt bonds provided (A) a bond allocation is obtained from the state allocation authority - in Virginia, this is the Small Business Financing Authority- and (B) the low to moderate income set aside requirements of Section 142 of the IRC are satisfied (i.e., either (1) at least 20% of the units are set aside for tenants with incomes not exceeding 50% of area median income, or (2) at least 40% of the units are set aside for tenants with incomes not exceeding 60% of area median income). As discussed below, this financing approach also can be combined with 4% low income housing tax credits if 50% or more of the Project's basis as defined in Section 2 of the IRC is financed with the proceeds of Section 142 bonds. This structure has the following advantages and disadvantages.
Advantages:
A. While competition for bond allocation has been very intense in some years, securing a bond allocation generally is less difficult than securing an award of 9% low income housing tax credits.
B. 4% low income housing tax credits are usually available.
C. Bonds issued by a state or local municipal bond issuing authority (e.g., a local redevelopment and housing authority) are exempt from registration under the federal securities laws, although offering statements are subject to compliance with securities disclosure requirements.
Disadvantages.
A The Project owner/developer must secure a bond allocation from the State Ceiling under Section 146 of the IRC and the Virginia private activity bond regulations. (Note: These allocations are processed through the Virginia Small Business Financing Authority in a process totally separate and unrelated to the application process for 9% tax credits).
B. $7,500,000 annual cap per project on amount of tax-exempt bonds that can be issued that is imposed by the current Virginia allocation regulations. (NOTE: this bond allocation pool is totally separate and distinct from the competitive application/allocation process and pool that pertains to 9% tax credits.)
C. For acquisition/rehabilitation projects, the buildings within the project must receive rehabilitation expenditures equal to at least fifteen percent (15%) of the acquisition cost of the must be done to the project.
D. Closing and development schedule is controlled by when or whether bond allocation can be secured from the State Ceiling under the Virginia private activity bond regulations (i.e., closing must occur not later than 90 days from the date the bond allocation is awarded).
3. Option Three - Tax Exempt Bonds Combined with 4% Tax Credits: . 4% low income housing tax credits are provided (1) 50% or more of the project's basis is financed with Section 142(d) tax-exempt bonds for which an allocation has been secured from the State Ceiling under the Virginia private activity bond regulations and (2) the project meets VHDA's minimum point score criteria for low-income housing tax credits Generally, the proceeds of the sale of the 4% tax credits will satisfy much, if not all, of any applicable lender imposed equity requirements. This financing approach has the following advantages and disadvantages.
Advantages:
A. The 4% credits are not awarded on a competitive basis and will be available provided a minimum threshold score is achieved under the VHDA application and scoring guide lines (seeVHDA's website at: http://www.vhda.com/).
B. The sale of the 4% tax credits yields a significant infusion of equity into a project and coupled with conventional construction/tax-exempt permanent loan financing allows (1) a developer lacking a significant net worth to develop projects either on their own or with other private ownership participation and (2) a lower interest rate permanent mortgage.
Disadvantages:
A.The Project owner/developer must secure a bond allocation from the State Ceiling under Section 146 of the IRC and the Virginia private activity bond regulations.
B. $7,500,000 annual cap per project on amount of tax-exempt bonds that can be issued that is imposed by the current Virginia allocation regulations.
C. Closing and development schedule is controlled by when or whether bond allocation can be secured from the State Ceiling under the Virginia private activity bond regulations (i.e., closing must occur not later than 90 days from the date the bond allocation is awarded)
D. Closing costs, legal fees, underwriting fees, etc. for a simultaneous closing of a tax-exempt bond issue and a tax credit sale are general significant.
E. As with a 9% tax credit project, the project will be subject to a "Qualified Project Period" that lasts generally 15 years. During this period, the low to moderate income unit set aside requirement will continue to restrict the project.
F. For acquisition/rehabilitation projects, the buildings within the project must receive rehabilitation expenditures equal to at least fifteen percent (15%) of the acquisition cost of the must be done to the project.
Conclusion: The foregoing financing techniques are obviously not right for ever potential project multifamily or elderly housing project. However, when properly structured and with proper due diligence and construction and operation budgeting by a developer, they can provide a powerful too to provide much needed equity in a project and reduced permanent mortgage borrowing costs.
On occasion, part of running a real estate investment business or in the estate planning process may involve placing assets into an entity (1) to limit one's liability, and/or (2) to provide a vehicle through which ownership interest can be gifted to children or others on a phased basis over a period of time. In achieving these goals, three types of legal entities can be utilized: a Sub-Chapter S corporation, a limited liability company ("LLC"), or a limited partnership ("LP"). Each has certain advantages and disadvantages. The following is a comparison of each of these types of entities.
Ease and cost of formation: All three entities involve a fairly comparable level of difficulty in formation, with the limited partnership documentation being potentially the most involved in the event a corporate general partner is utilized for reasons discussed below. Differences in the amount of the initial filing fees with the Virginia State Corporation Commission ("SCC") are negligible: $75.00 for a corporation and $100.00 for a LLC or a LP. Currently, the annual registration fee for all three entities is $100.00 per year unless a corporation has in excess of 5,000 authorized shares, which would be unlikely for the typical estate planning vehicle.
Limitation of Liability: Both a corporation and an LLC afford all of those holding an ownership interest with a limitation from personal liability provided proper corporate or LLC formalities, as applicable, are followed. Therefore, maximum potential liability of each owner is capped at the value of his ownership interest in the entity. In the case of an LP, the general partner(s) will be liable for the debts of the partnership, while the liability of the limited partners is capped at the value of his/her ownership interest in the limited partnership. One method of controlling general partner liability is to form a closely held corporation to act as the general partner of the LP. This increases formation costs but may be a worthwhile investment depending upon the nature of the LP's assets and business.
Taxation: In the case of each type of entity, income passes through to the individual owners holding an interest in the entity and is taxed at the owners tax rate.
Number of Owners Allowed: A Sub-Chapter S corporation must have one or more, but less than 75 stockholders. An LLC must have at least one (1) member. An LP must have at least one general partner and one limited partner.
Ease of Transferring Interest for Estate Planning Purposes: A corporation affords the simplest method of transferring ownership interests to heirs: Shares are merely transferred and assigned and a new stock certificate is issued to the new owner in the amount of the transferred shares and a new stock certificate is issued to the grantor reflecting the reduction of shares owned. No modification or amendment of the corporation's organizational documents is required. In the case of both a LLC and a LP, some type of modification to the organizational documents will be necessary. For an LLC, this will entail amending the operating agreement for the LLC. For an LP, a modification of the limited partnership agreement will be required. In each instance, the modification is needed to (1) reflect the admission of the new owner and (2) confirm that the new owner agrees to be bound by the obligations imposed by and the terms of the organization documents of the entity.
Ability of Grantor to Retain Control: Of the three types of entities, the LP affords the general partner the most control over the entity's activities and business decisions. This is because the general partner(s) control the actions of the LP even if they only hold a one percent (1%) interest in the overall ownership of the total partnership interests. In the case of both a corporation and an LLC, once the grantor has gifted over more than fifty percent (50%) of the ownership interest, the parties holding more than 50% of the ownership, acting as a group, can take control of the entity
Handling of Entity Assets: No matter which form of entity is utilized, it is important to remember that the entity is a separate Aperson@ for legalpurposes. Therefore, it is critical that the entity's assets and income be held and managed separate form the grantors personal assets and monies. All too often, this fact is forgotten and monies are co-mingled and treated as if they were still the grantor's personal assets. The consequences of failing to remember this distinction can be significant: Loss of the limitation of liability and potential problems with the Internal Revenue Service, which may perceive tax irregularities. Therefore, a grantor must be prepared to maintain separate financial books and not divert entity funds to himself/herself.
Which Form of Entity is Better: In operating a real estate investment business or in preparing an estate plan, without information concerning the assets involved and other relevant circumstances and goals of the grantor, it is difficult to say which type of entity may be better overall. Each form of entity has certain characteristics and advantages to recommend it. Consequently, in determining which entity form to choose will depend upon (1) the particular the goals the grantor is trying to achieve, (2) how much control the grantor seeks to retain and (3) the total facts surrounding the assets to be gifted in a phased manner. To review these factors and determine the entity that will best meet the grantor's particular needs, it is wise to consult you tax advisor and your legal counsel to ensure to the maximum extent practicable that the right entity form is selected.
Disclaimer: ActiveRain Corp. does not necessarily endorse the real estate agents, loan officers and brokers listed on this site. These real estate profiles, blogs and blog entries are provided here as a courtesy to our visitors to help them make an informed decision when buying or selling a house. ActiveRain Corp. takes no responsibility for the content in these profiles, that are written by the members of this community.
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