Articles & White Papers
by James A. Castleman, Esq.
Some of the worst problems that I have seen in my office over the past few years have involved real estate. I do not know if it is because of the decline in the real estate market, or because of problems with sub prime mortgages, or because some clients just don’t seem to know what they are doing.
Buying real estate can be one of the biggest financial decisions in your life. Whether it is buying a home for you and your family, or buying a commercial property for your business, it is worth knowing what you are doing, and it is worth knowing that you need an attorney.
The topic of this article is a broad one, and could take several volumes to cover. But, following are some basics.
Before you Begin - Who is the Buyer and What are the Finances?
You may think it is easy to know who the buyer is. You are! But, are you sure you want to own real estate in your own name?
If you are buying a home, you may want to own it in your own name, or you may want to own it with a spouse or a significant other. If you are a business owner concerned about creditors, then maybe you do not want your name to appear anywhere on the title. Maybe you want your spouse to own your home. Maybe a trust can be used to protect the asset. Tax planning considerations may also come into play, as may estate planning. Do you want to own the property so that it is excluded from your taxable estate if you die? Who do you want to get the property when you die?
If you are buying commercial property, there may be additional issues. If you are running your business on the property, you may want to make sure the real estate is owned by a separate entity. For liability purposes, you may want a separate entity, so that the real estate is protected if the business gets sued. For tax planning purposes you may want to have the business pay rent to a separate entity. You need to talk to your accountant and your lawyer before you decide who the true buyer of the property should be.
Before your begin, it is also important to know your financial situation and what you can afford. There are a lot of people in trouble with their mortgage banks today, because they got in over their heads.
How much of a down payment can you come up with? How much of a mortgage will you need? Can you qualify? If you are a business owner, you actually may have more of a problem qualifying for a mortgage - even for your home - than someone that takes home a weekly wage. What will the closing costs be?
If you are buying a home, will the tax advantages allow you to afford a bigger monthly payment? After all, you will be able to deduct interest payments and real estate taxes on your personal income tax return. And, be aware that, if you have to sell a personal residence, then you may be able to exclude $500,000.00 of gain on the sale if you are married, or $250,000.00 worth of gain if you are single.
With regard to commercial real estate, look carefully at the purpose that you are buying it for. If it is rental property - either investment rental property, or property rented to your business - you will have to declare rent received as income. But, you may be able to take significant deductions for depreciation, real estate taxes, and repairs.
If you are buying commercial property, be aware that there may be expenses involved in the purchase that greatly exceed those for a home. For nonresidential property, you may have to pay for an environmental study to make sure there is no hazardous waste on the property. You will almost certainly pay higher mortgage rates, and banks are likely to insist that the rate be rewritten after only a few years. You may also have to pay to do record searches, to make sure that zoning and building laws allow your intended use.
Do not spend a lot of time looking for a piece of real estate and paying professional fees unless you know beforehand that you can afford the purchase and that it makes financial sense.
Making an Offer to Purchase
You have found the perfect piece of real estate. It is your dream house. Or, it is the spot on which you know your business will flourish. You have figured out who the buyer should be, you have calculated what you can afford, the broker is after you to do something, and you are ready to make to an offer. So what should you do?
The first thing that you should do is hire a lawyer! Some of my clients’ worst problems occurred when they came to me after already having made an offer on a piece of property. Do not be pressured by the broker. Do not think that you will be able to tie things up with a Purchase and Sale Agreement. Before you sign any document constituting an offer on a piece of property, consult an attorney.
A recent Massachusetts case ruled that an Offer to Purchase can be legally enforced as a binding Purchase and Sale Agreement, even if you had not intended that. Once you sign the document and it is accepted by the Seller, you may be stuck. You have to make sure that you know what you are going into, and you have to make sure that your offer has contingencies that protect you.
If you are making an offer on a home, you want to make sure the purchase is subject to you getting a mortgage. You also want to have the ability to inspect the property for structural defects, lead paint, termites, and radon. If you need to sell a house that you are living in before you can buy the new property, then you have to put in language that preserves that contingency. If you are buying a condominium, then you want to make sure that your lawyer has an opportunity to review the condominium documents and that you have the opportunity to review the condominium budget. After all, a condominium with a low monthly condo fee is not going to be so attractive when you find out the building needs a new roof and a new heating system, and that the condominium association has no money in reserve.
If you are buying commercial real estate, then failing to have a lawyer draw the offer for you can be disastrous. You almost certainly want a “due diligence” period, that gives you time to investigate the applicable zoning and building laws for the property, and that allows you to perform an environmental study. You may need time to apply for business permits, or to get rulings from the local Zoning Board of Appeals. Perhaps you will not be able to buy the property unless the Seller is willing to help finance the purchase by taking back a second mortgage.
There may be many other contingencies that you want to cover, depending on the type of business that you intend to operate on the property, and depending on the type of building and the location of the premises. Whatever it is, you need to specify those contingencies in your Offer to Purchase. Otherwise, it may be too late.
The Purchase and Sale Agreement
You have made your offer, there has been negotiation, and you have reached agreement on the price with the Seller. The next step is to enter into a Purchase and Sale Agreement.
The difficulty of negotiating a mutually acceptable Purchase and Sale Agreement will depend on whether you are buying a home or commercial property, as well as how detailed your Offer to Purchase is. It will almost certainly be more extensive than the Offer to Purchase, and it is now time to come up with a big deposit and put it at risk.
Any contingencies that have not been satisfied in the Offer to Purchase will have to be addressed in the Purchase and Sale Agreement. A closing date will be set and the obligations of the Buyer and of the Seller will be established.
For noncommercial residential real estate, there are certain standard forms in use for different parts of the state. In the eastern Massachusetts, a form developed by the Greater Boston Real Estate Board is the standard to be used. Nevertheless, the basic agreement is almost always changed. There are certain standard changes common among real estate lawyers. And, there are always certain provisions applicable to the particular transaction.
Among things common to a Purchase and Sale Agreement are a clear identification of the Buyer and the Seller, as well as a description of the property that is more definite than that contained in the Offer to Purchase. Whether or not the fixtures and appliances are included in the sale is specified, as is the type of deed that is to be given and the breakdown of how the purchase price is to be paid. The required condition of the property at the time of closing is set out, as are the parties’ rights if something should go wrong. What financial adjustments are to be made at the closing are noted, as is how the broker’s fee is to be paid. Contingencies specified in the Offer to Purchase are set out, along with any warranties or representations that the Seller made and the Buyer relied upon.
Again, a Purchase and Sale Agreement for commercial real estate is likely to be much more complicated and extensive than one for a home. There may be certain interim dates and deadlines that are set by which permits have to be obtained or environmental studies completed. Whatever the terms of the deal are to be, they are set out in detail in the Purchase and Sale Agreement.
It is a terrible idea to make an offer without having consulted an attorney. It is an even worse idea to sign a Purchase and Sale Agreement without having it reviewed by a lawyer. You should never rely upon real estate broker to draw a Purchase and Sale Agreement, and you should never accept an Agreement that has been tendered to you without having your lawyer review it. The stakes are just too high.
You have a signed Purchase and Sale Agreement, and now it is time to get a mortgage. Before you do, make sure you understand the deadlines that are set out in the Purchase and Sale Agreement. You usually only have a very short time in which to apply for a mortgage, and there will be a “drop dead” date by which you must obtain the mortgage or opt out of the Agreement.
It is worth shopping around for a mortgage. There are differences in the rates that banks charge and in the types of mortgages that they offer. Make sure you understand the terms of the mortgage being offered to you and what your financial obligations will be. A mortgage that has a low initial interest rate, may not be so good if the rate jumps up in five years.
When you get a mortgage commitment, make sure it is a real one. A letter that looks like a mortgage commitment, but has contingencies that still have to be met, may not be a true mortgage commitment. It still may give the lending institution an opportunity to back out. If so, you could be in trouble and lose your deposit.
If you do not obtain a firm mortgage commitment, or cannot obtain a commitment at all, be very aware of the date you must give notice to back out of the deal, and be aware of the requirements of the type of notice you have to give. A telephone call to the broker is usually not sufficient. You may have to send notice by certified mail, or by fax or e-mail, depending on the terms of the Agreement. Once the mortgage commitment date goes by, you are stuck with the deal if you have not given appropriate notice to back out. You either have to buy the property, or you will lose your deposit.
You have obtained your mortgage, you are ready to buy the property, and life is wonderful - or so you hope.
Before going to the closing, review the Good Faith Estimate of costs that the bank has given you, try to get a proposed Settlement Statement from the closing attorney in advance, and make sure that the figures in the documents match. Settlement Statements are difficult to read, but they set out all of the finances of the proposed closing, including purchase price, mortgage amounts, recording fees, tax adjustments, and other relevant financial matters. It is not uncommon for a closing attorney to make a mistake on a Settlement Statement. It is well worth reviewing, and if you have it in advance, it gives you time to look at it in depth.
So, what happens at the closing? The Seller will deliver a deed that he has signed, you will sign a bunch of papers, and, in about an hour, you will be the new owner of piece of real estate.
For residential real estate, the closing attorney will make sure the Seller has obtained a smoke detector and carbon monoxide certificate from the municipality in which the property is located, as required by law. He will get everyone to sign affidavits as to their true identities, and swearing there are no side deals between the Buyer and Seller.
Additionally, as the Buyer and Mortgagor, you will have to sign a ream of papers for the bank. There will be a note, where you obligate yourself to pay the bank huge amounts of money over a number of years. There will be a mortgage, in which you give the bank a security interest in the property you are buying, giving the bank the right to sell it if you default. There will also be numerous required federal forms, including disclosures as to the amount of finance charges and information required by the IRS to be disclosed. You will be given the opportunity to review all of the documents before you sign them. But, the bottom line is the bank will not give you the money unless you sign the documents.
When you go to the closing, bring appropriate picture identification. Title insurance companies and the federal government, especially after 9/11, want to make sure you are who you say you are.
One of the questions you will be asked is whether you want to buy an Owner’s Policy of Title Insurance. You have to pay a one time premium for title insurance, and the insurer will then guarantee you will have good title to the property, and will pay the cost of curing any defects that arise. If you are obtaining a mortgage, today almost all lenders require you buy title insurance policy that protects them. For an additional fee, you will have the option of buying an Owner’s Policy as well.
While the expense is not insignificant, based upon my experience, it is recommended that you buy Owner’s Title Insurance. Even though the closing attorney has examined deeds and other documents to make sure the Seller is able to transfer marketable title to you, there is no way to guarantee that there might not be a forged deed in the chain of title, or that some Indian tribe may claim ownership of your property in the future. I know that these problems exist, because I have seen them in my office. Title insurance will protect you against them.
If you are buying a home, a question may arise whether a Declaration of Homestead should be drawn and recorded. Again, it is recommended that you do so. The cost is low, and the protection against creditors is significant. While a Declaration of Homestead will not protect you against claims for taxes due, for alimony or child support, or for failure to pay your mortgage, it will protect your family from claims of creditors up to $500,00.00 of equity in your principal residence.
Buying a piece of real estate can be a harrowing experience. And, it can be one of the most significant events of your lifetime. It is important to know the basics of what you are getting involved in. And, I cannot over emphasize how important it is to have an attorney involved in the transaction from the very beginning.
James A. Castleman is a managing member of the law firm of Paster, Rice & Castleman, LLC, in Quincy, Massachusetts.