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Table of Contents
Chapter 1: Part I: California The Golden State
Geography...8
Early History...8
Mission Period.9
Advent of the United States.9
The Housing Bubble10
Today12
Types of Deeds..39
Involuntary Alienation43
Adverse Possession..45
Recording47
Title Insurance..49
Chapter Quiz.53
Chapter 4: Encumbrances
Liens.56
Homestead Protection.60
Nonfinancial Encumbrances61
Easements..61
Profits65
Licenses65
Encroachments.65
Nuisances...66
Private Restrictions..66
Chapter Quiz..69
Contracts.93
Legal Classification of Contracts.93
Elements of a Valid Contract...94
Legal Status of Contracts100
Discharging a Contract102
Breach of Contract.104
Tender105
Chapter Quiz107
Disciplinary Actions..403
Examples of Unlawful Conduct.409
The Real Estate Fund...415
Trust Funds.416
Advance Fees..423
Documentation Requirements..424
Advertising Regulations..425
Antitrust Laws and Real Estate Licensees427
Chapter Quiz...432
CHAPTER 1
PART - I
EARLY HISTORY
It is thought that people from Asia first arrived in North America
over 16,000 years ago during the Ice Age, walking over the Bering
land bridge which connected what is now called Alaska and western
Russia. The mountain ranges of the Pacific Coast separated these
early settlers from the tribes that came together in Mexico to the
south and the plains to the east, so that the two regional groups
shared nothing of their language and ways.
More than 20 tribes or groups reside in what is now California.
When Europeans first reached these shores, Native American tribes
included the Modoc, Mohave and Chumash. Each tribe had a
chieftain sometimes they were women -- who settled community
disputes, assisted by a crier or assistant and a Shaman (doctors).
Native American settlements had three classes: the elite, a middle
class and finally a less successful lower class.
Tribal ways depended on the climate and conditions of the regions
where they were situated. Coastal communities made stone tools
out of mussels. The southeastern deserts spawned a people who
survived by developing many uses for the scrubby plants and trees
that were hardy enough to grow there while husbanding precious
water from oases and water courses. Then as now, the Central
Valley was home to agriculture. The mountainous ranges of the
north had plentiful fish and game, where hunting parties foraged.
It is estimated that 300,000 natives lived in what would later
become California. The first European explorers sailed from Spain
and England in the early 1500s. Balboa claimed all lands touching
the Pacific Ocean for the Spanish crown in 1513, but the many
miles of ocean that separated California from Europe kept any
permanent European settlements at bay.
MISSION PERIOD
Beginning in the latter part of the 18th century, the Spanish
missions refer to a group of military and religious settlements
established by the Franciscan religious order to spread Christianity
among the native population. Those natives were taught European
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The California Gold Rush began with the discovery of the precious
yellow mineral at Sutter's Mill near Sacramento in January 1848.
California had a population explosion of "49ers," with San Francisco
alone growing from 500 to 150,000 in between 1847 and 1870. In
1850, California became a state.
The linkage between the Central Pacific railroad with the Union
Pacific Railroad cut travel time from Chicago to San Francisco from
six months to six days. This advent of transcontinental rail lines in
1869 securely joined California to the rest of the nation and the
transportation systems that grew out of them in the century that
followed contributed to the state's social, political and economic
development.
California, befitting its status as the United States in microcosm,
was the recipient of waves of immigration from the rest of the world,
and the rest of the country, too. Los Angeles iconic film industry
had star power, but it was the defense industry that drew close to a
million new worker during World War II; after the war, they stayed,
many of them shifting to the incipient aerospace, aviation, and
shipping industries.
The state was also in the forefront of the high school movement
leading naturally to mass college education. The development of a
highly efficient public education system in the University of
California and California State University systems helped produce
an educated workforce, which in turn was a magnet for investment,
especially in areas related to high technology. By 1980, California
had become the eighth-largest economy in the world.
THE HOUSING BUBBLE
Housing prices in bigger California cities continued their rise so
that homes with modest values in the 1960s and 70s soared by the
2000s. More people preferred commuting longer hours so as to
afford a home in more rural areas and earning larger salaries in the
urban ones. People purchased houses they never intended to live in,
but expected to make a huge profit in a short period of time then
rolling over the profit money by buying more properties. Mortgage
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Chapter 1
PART-II
CHAPTER OVERVIEW
Real property includes the land and improvements and also
incorporates the rights that go with the ownership of land. This part
of the chapter will explain those rights which are known as
appurtenances. We shall also learn about natural attachments and
fixtures, sold as part of the land and also the difference between
fixtures and personal property (this is generally not transferred with
the land). The final part of the chapter will deal with methods of
legal description; the various ways in which a parcel of land may be
identified in legal documents to avoid misperceptions regarding its
boundaries or ownership.
BUNDLE OF RIGHTS
The purchase of real estate conveys the ownership of what is
termed the bundle of rights, legal rights that include:
1. The right of possession, meaning the right to live on the property
and exclude others from living there;
2. The right to use a property for any lawful purpose;
3. The right to encumber property, using it as security to borrow
funds;
4. The right to enjoy a property, without interference from others;
5. The right to transfer property, by sale or gift.
The term land refers to the earths surface, the material that
extends downward to the Earths center. Land also includes water
rights, mineral rights, airspace and surface rights.
WATER RIGHTS
The right to use water can be an appurtenant right, tied to land
ownership. Water is located on both the earths surface and below
it. If on the surface, flowing in a stream or if underground, water is
deemed percolating: real property. Surface water may be confined
to a channel or basin or it may be unconfined, like flooding or runoff.
With confined surface water, two systems apply to water rights:
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MINERAL RIGHTS
These apply to the right to take substances from the land, both
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17
1)
2)
3)
Chapter Summary
- California has a remarkably wide range of climates, and a history
of different groups and nations rising and waning in ascendancy -Native Americans, the Spanish, Mexico, and finally the U.S.
- The Gold Rush of 1849 attracted an influx of Americans leading to
the admission of California as a state.
- Californias rapid expansion and prosperity, fueled by the
railroads and immigration, followed into the next century. The
defense industry led to continued growth, the legions of defense
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CHAPTER 2
Types of Estates and Ways of Holding Title
CHAPTER OVERVIEW
Ownership is a critical component of real estate, it is considered to
be one of the basic rights in our society. Real estate ownership
tends to take various forms. Normally, an owner is understood to
have full title and possession of the property, but often this is not
the case. An owner may have limited interest in the property and
not have exclusive title to it, or she may allow a tenant to take
possession while she keeps the title to herself. Also, the property
can be co-owned by more than one person at the same time, called
concurrent ownership.
In this chapter we shall learn the various types of ownership
interests, and the type of interests that tenants may have. Then we
shall learn the types of concurrent ownership and the different
ways in which the co-owners may hold title.
TYPES OF ESTATES
An estate is essentially the ownership interest or claim of an
individual in real property. The two distinguishing features of
different of estate are:
A)
B) When exactly will the estate holder get the possession rights
(immediately or sometime in the future?)
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It is noteworthy that while all estates are interests in land, not every
interest in land is an estate. Interests that are not estates are called
non-possessory interests.
Estates are of two types:
1) Freehold estates
2) Leasehold estates (less-than-freehold)
A freehold estate is an estate of indefinite duration which can be
sold or inherited. The holder of a freehold estate is generally
referred to as an owner. A less-than-freehold estate or the
leasehold estate has a limited duration. The one who owns such
an estate is referred to as a tenant. The tenant has temporary and
limited right of use in a real property.
Each type of estate can co-exist in the same piece of property at the
same time. Also, the mutual relationship of two or more parties
having interests in the same property is known as privity.
Freehold Estates: As stated before, freehold estates are real
property estates of ownership. Also known as an estate of
inheritance, this type of estate continues for an indefinite period of
time. Freehold estates can be further sub-divided into fee simple
estates and life estates.
1) Fee simple estates can be sub-divided:
a) Fee simple absolute is the highest form of interest in land.
This estate is held by the owner without any qualifications or
limitations, like private deed restrictions. However, all
government ordinances and limitations do apply.
b) Fee simple qualified (defeasible), which is owned with a few
limitations or private deed restrictions limiting the propertys
use. A fee simple estate may be qualified at the time of transfer
from one owner to another.
c) Life estate is created by will or deed for as long as one
specified individual is alive. As a life estate is a type of
freehold, the holder has all the rights that come with fee
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Concurrent Ownership
When a property is owned by two or more persons at the same time
it is known as concurrent or co-ownership. There are four types of
concurrent ownership.
i. Tenancy in common is created when more than one person
takes title, they are not married to each other and there is
no other way of taking title. Tenants in common may take
title at different times, on separate deeds, have unequal
shares and/or have equal rights of possession. Tenants in
common do not need the consent of the co-owner to deed
their interest to someone else. None of the owners have the
right to exclude any co-owner from the property or to claim
any portion of the property for their exclusive use. Any
expenses incurred on the property including taxes, loan
payment, repairs or insurance have to be proportionately
shared.
If there are any disagreements between the co-owners
pertaining to the property, they may file a partition suit,
which will legally divide the interests in the property.
ii. Joint Tenancy: Ownership of property by two or more coowners with the right of survivorship is termed a joint
tenancy. By right of survivorship it is meant that in the
event of the death of any one of the co-owners, the joint
owner by default becomes the sole owner of the property.
Such a property cannot be willed.
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31
Chapter Summary
As society grew to become political states, important
ownership traditions took the form of laws.
To safeguard the ownership land of its people, Americans
came up with a policy of recording evidence of title or interest.
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Chapter Quiz
1. Technically speaking, property refers to:
a. A freehold estate
b. Personal property only
c. Rights or interest in the things owned
d. Land and building only
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b. Trustee
c. Sole proprietor
d. Corporate shareholder
14. A unit in a cooperative is owned:
a. By the corporation that is the owner of the building, in
which the shares are owned by the residents
b. In partnership among all residents of the building
c. In severalty by its residents
d. In tenancy in common among all residents of the building
15. A _____________ is owned by its shareholders, who purchase
shares of stock in the company as an investment.
a. Trust
b. Joint venture
c. Corporation
d. Limited liability company
e.
CHAPTER 3
TRANSFER OF REAL ESTATE
CHAPTER OVERVIEW
This chapter will examine the necessary requirements to transfer
title to land, which in California must include the proper recording
of a written document. The most often-used method of transfer is
through a deed, and we will discuss the different types of deed, the
valid elements of each, and how they are recorded. Safeguarding
ones interest in a marketable title through title insurance is looked
at, as are the different types of wills, the legal requirements for each
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iii)
community property.
The grantor must be a legally competent adult of at least 18
years with a sound mind, otherwise the deed is invalid.
iv)Proper description of the property being conveyed: A full
legal description of land is recommended although the deed
can be valid without it, if it has an identifiable description of
the property.
v) A living grantee: It is necessary for the grantee to be alive and
identifiable when the deed is executed for the deed to be
valid. However, the grantee does not have to be legally
competent for a valid deed.
vi)A granting clause: This is necessary, in which words of
conveyance are used such as grant or convey. Additional
technical language is unnecessary, since it does not affect
the validity of the deed.
vii) Acknowledgement, delivery and acceptance of deed by
the grantee: Acknowledgement is when the grantor
confirms before a legal witness that his signature is genuine
and voluntary. Note that an unacknowledged deed may be
valid but it cannot be recorded.
A valid deed becomes effective for title transfer only when it
is delivered to the grantee. The key element of delivery is
not just the physical transfer of the document but also the
intention of the grantor to transfer the title to the grantee
immediately. The conveyance is said to be completed when
the grantee accepts the delivery of the deed.
Since the delivery of a deed is a delicate legal issue, it is
advisable to consult a real estate lawyer on this point.
Important terms
Some terms that are not legally required in a deed but should be
included nonetheless include a habendum clause (also referred to as
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a to have and to hold clause). This states the nature of the interest
the grantor wants to convey. If it is not specified, the grantors
entire interest passes to the grantee by default. In case there is
more than one grantee, the deed should specify how they intend to
hold title.
Some deeds have an exclusions and reservations clause, which is a
list of any encumbrances. Having mentioned that, valid
encumbrances usually remain in force even if not listed in the deed.
A deed also often includes a recital of consideration. This is to
confirm that the transfer is a purchase and not a gift. The recital of
consideration in a deed normally does not state the actual purchase
price paid.
TYPES OF DEEDS
Grant deed: This is the most frequently used instrument to transfer
title in California. The grant deed contains the word grant(s) in its
conveyance and the grantor warrants the following:
i)
ii)
The title has not been conveyed prior to this to anyone else,
and,
There are no hidden encumbrances on the property other
than those already disclosed.
The grantor also conveys to the grantee any rights he might acquire
to the property after conveying it to the grantee. This is termed as
after-acquired title. For instance, if the grantors title was not perfect
at the time of transfer, but later on he acquires a perfect title, the
additional interest will pass on to the grantee by default under the
original deed. The grant deed is the only form of deed conveying
after-acquired title.
Gift deed: The property given as a gift to the grantee by a relative or
close friend is executed through a gift deed. The consideration in a
gift deed is called love and affection.
Quitclaim deed: This type of deed contains no warranties and
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conveys any interest the grantor may have in the property at the
time the deed is signed. A quitclaim deed is generally used to
correct a technical flaw in an earlier deed and it is often referred to
as a reformation deed. A quitclaim deed is sometimes also used to
clear a cloud on the title and to discard any future claim by the
grantor of this deed. It is advisable, however, to use a grant deed
rather than a quitclaim deed.
This type of deed is also used when the grantor is unsure of the
validity of his title and does not want to give any warranties. A
transfer of real property between family members is often done
using a quitclaim deed.
A grantor of the quitclaim deed is liable for any loans taken using
the property as security.
Trust deed: Also called a deed of trust, it is used when a property
serves as security for a debt.
When money is borrowed to finance the purchase of the property,
the borrower (new owner) is the trustor (the grantor) of the trust
deed. The party who holds the title until the debt is paid is the
trustee (the grantee). The party on whose behalf the title is held is
termed as the beneficiary (the lender). In the event of the debt not
being paid, the trustee has the power to sell the property at a
foreclosure sale and pay the beneficiary the remaining amount of
the loan from the proceeds. The balance, if any, goes to the trustor.
The buyer of the property would receive what is called a trustees
deed, from the trustee.
Reconveyance deed: The beneficiary notifies the trustee about the
clearance of the debt (by the trustor) by sending the trustee a
document called a request for reconveyance. The trustee then
returns title to the trustor by way of a reconveyance deed.
Sheriffs deed: A court-ordered sale of property is executed through
a sheriffs deed. Such a deed carries no warranties of title. Transfer
of property to the highest bidder at a court-ordered foreclosure sale
is an example of a sheriffs deed.
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will
must
fulfill
the
following
legal
i)
Must be in writing
ii)
iii)
statutory
both the buyer and the seller arrange to resolve the issues of the
title. Upon the complete satisfaction of the buyer, the transaction
comes to a close. The title company then issues a title insurance
policy in exchange for a certain premium. The entire life of the
policy is covered by one premium payment.
Different types of policies cover different levels of protection. Types
of title insurances are mentioned below:
In California, policy forms published by the California Land Title
Association (CLTA) and the American Land Title Association (ALTA)
are used by the insurance companies. There are two basic
categories of title insurance policies, as per what interest is being
insured and as per the extent of the coverage provided.
Interest insured: A title insurance policy is prepared so that it
insures the particular interest of the policy holder in the property.
The title of the buyer is insured through an owners policy whereas
the lenders security interest is insured through a lenders policy
or mortgagees policy. The buyer is supposed to pay for the
lenders policy as a condition of obtaining a loan. Another type of
policy that insures just the validity of a lease is known as a
leaseholders policy.
Extent of coverage: In California as well as some other states,
there are two main types of coverage offered by the insurers:
Standard coverage and extended coverage. A third type of coverage
recently made available is homeowners coverage.
A standard coverage policy, also known as a CLTA policy, insures
defects in titles, including forgery. It does not protect against an
adverse possessor or against title defect known by the owner but
not disclosed to the title insurer, nor will it protect against an
encroachment.
An extended coverage policy, also known as an ALTA policy, insures
against all matters covered by the standard policy in addition to
matters not of public record, like the rights of parties in possession
of the property, unrecorded mechanics liens, and encroachments.
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Chapter Summary
The process of transferring the title (ownership) to real estate
from one party to another is called alienation.
The transfer of title of real property under voluntary alienation
can be executed by a patent, by a deed, or by a will.
he transfer of real property which occurs due to the rule of
law, adverse possession, or accession may be termed as
involuntary alienation.
The process of legal determination of property ownership
which occurs in the event of the owner not making a valid will
is known as intestate succession.
The federal and state governments have the constitutional
right to acquire title to private property by compensating the
owner by way of fair market value. This is known as the power
of eminent domain and the legal process of eminent domain is
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known as condemnation.
Accession refers to man-made or natural additions to real
property.
The method of safeguarding ones interest in real property,
after it has been transferred either voluntarily or involuntarily,
is done by recording the deed that conveys the property to the
new owner.
It is the title insurance policy that protects the interest of the
buyer. A title insurance company agrees to reimburse the
policy holder for any losses caused by defective titles.
An interest in real property that is held by someone who is not
the owner of the property is called an encumbrance.
An easement is the right to use the property of someone else
for a specified purpose.
Chapter Quiz
1. Real property is transferred through a process called:
a. Acknowledgement
b. Dedication
c. Alienation
d. Will
2. A _____________ deed conveys to the grantee all after-acquired
title of the grantor.
a. Grant
b. Quitclaim
c. Trustees
d. Warranty
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d. Dedication
14. A deed that is outside the chain of title is called the:
a. Trust deed
b. Tax deed
c. Wild deed
d. Reconveyance deed
15. A standard coverage insurance policy will insure against:
a. A forged deed
b. Encroachment
c. Adverse possession
d. Unrecorded
CHAPTER 4
Encumbrances
CHAPTER OVERVIEW
An interest in real property which is held by someone who is not an
owner of that property is known as an encumbrance. The nature of
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lien.
It is necessary that a mechanics lien be verified and recorded. There
are some statutory procedures which need to be followed in order to
successfully create a mechanics lien. These procedures are:
1)
2)
3)
4)
Preliminary notice
Notice of completion
Notice of non-responsibility,
Foreclosure action
The preliminary notice: According to California law, a written
notice must be given to the owner within 20 days after the
claimant starts providing labor, services or materials in order
to file a mechanics lien.
The notice of completion: Once a project is completed, the
property owner must, within ten days, file a notice of
completion for recording. Or, the owner may file a notice of
cessation, if work on the project is stopped for a continuous
period of 30 days, whether or not the project is finished.
After the property owner has recorded a notice of
completion/notice of cessation, mechanics lien claimants
ideally must file a lien claim for recording within 30 days. But
an original contractor has 60 days after the recording of the
notice of completion/notice of cessation in which he can file a
lien claim.
In a situation where the property owner does not record a
notice of completion or a notice of cessation, all mechanics
liens may be filed for recording within 90 days after the
completion of the project.
Notice of non-responsibility: Sometimes a tenant hires
contractors, subcontractors and suppliers for work to be done
on the leased property, without the permission of the property
owner. If the tenant fails to pay for the work done, the
contractors, subcontractors and the suppliers could file
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mechanics liens against the property and the owner could end
up being responsible for the cost of the jobs done.
To protect herself from these types of situations, the property
owner, within 10 days of becoming aware of the unapproved
construction, must give a notice that she will not be
responsible for the cost of the work done. This notice must be
placed somewhere on the property and be recorded as a
notice of non-responsibility.
4) Foreclosure: The claimant of the mechanics lien has to claim
foreclosure action within 90 days after the mechanics lien has
been recorded. Otherwise, the lien is deemed void and the
claimant loses the right of foreclosure.
Attachment Lien: Someone who files a lawsuit is called a plaintiff
and the party he sues is known as a defendant. Sometimes the
plaintiff fears that by the time a judgment happens, the defendant
may sell off or conceal assets which the court might award the
plaintiff at the time of the judgment. To prevent this from
happening, the plaintiff may ask the court to grant a writ of
attachment for a particular piece of real property owned by the
defendant. Thus, an involuntary, specific lien is created against the
property which is recorded in the country where the property is
located. The validity of the attachment lien measures three years
and is renewable.
Also, the plaintiff may record a document called a lis pendens (a
Latin phrase meaning action pending") at a time when a lawsuit
that may affect title to real property is pending. Lis pendens clouds
the title thereby preventing the sale or transfer of the property until
the lis pendens is removed, the action is dismissed or a final
judgment is made.
Judgment Lien: When the court of law determines the rights of the
parties it is called a judgment. The party who wins the judgment is
entitled to a judgment lien against the losing party's property. The
lien is created by recording a document termed an abstract of
judgment which can be recorded in any or all of the state's 58
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counties.
A judgment lien is an involuntary and a general lien. After the
creation of the judgment lien by recording, it is effective against all
of the real property owned by the debtor in the county of filing. This
will also include any real property acquired by the debtor within the
lien term, which in California is 10 years.
The debtor has to pay the judgment to free the property from the
lien or else the judgment creditor can foreclose, and the property
will be sold by an official designated by the court. To execute the
sale the court issues a writ of execution on the request of the lien
holder.
Property Tax Lien: Government taxes like the income tax or
property tax which are not paid become a tax lien against the
property. Property tax liens are involuntary and specific liens.
Special Assessment Lien: Special assessments are levied against
property owners to pay for local improvements like road pavements,
sewer lines, street repairs or water projects. The share of the cost of
improvement is levied based on how much the property owner has
benefited from the improvement project. This assessment of cost of
improvement creates an involuntary and specific lien against each
of those properties.
Mortgage: A contract between the property owner (the mortgagor)
and the creditor (the mortgagee) is known as a mortgage. The
borrower or mortgagor attaches a lien as a security for repayment
against the loan which he is to receive from the lender or the
mortgagee. A mortgage is a specific and voluntary lien.
Deeds of Trust: A deed of trust (or trust deed) is similar to a
mortgage. One of the differences is that, with a trust deed, there are
three parties rather than two. Also with a trust deed, the borrower
is known as the trustor, the lender/creditor is known as the
beneficiary and the third party (which is normally a title insurance
company or an attorney) is known as the trustee.
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ii)
Easement in gross
Prescription
Reference to a recorded plat
Dedication
Condemnation
Express Grant: The servient tenement grants the easement by deed
or express agreement. This grant must be written and must comply
with all the requirements for conveyance of an interest in land.
If a tenant grants an easement in a leased property, the easement
will apply only throughout the lease term.
A fee simple owner may grant an indefinite easement, or until the
length of the grantor's life or for a specific time period.
Express Reservation: At the time of conveying a portion of his
property, the owner reserves an easement in that land to benefit the
part of land that he has retained. This is created when the property
is sold, with a deed or an express agreement.
Implication: Even though it is not mentioned in the deed, the
existence of an easement can be obvious and necessary at the time
a property is being conveyed.
This type of easement normally will arise when the property is
divided into parts, and the grantor refuses to grant or reserve an
easement on one part of the land for the benefit of the other part.
The easement is then implied by law.
To create an easement by implication, there are two requirements:
i) It has to be necessary for the enjoyment of the property
ii) There should be an obvious prior use
Prescription: An easement by prescription is similar to acquiring
an ownership through adverse possession. An easement by
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ENCROACHMENTS
When a part of an improvement extends over the boundary line
between properties it is known as an encroachment. This
unauthorized intrusion on the neighboring land can reduce it in
size and value and also limit its use. A fence or a roof eave of a
building could be examples of an encroachment. Since an
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Chapter Summary
An interest in real property which is held by someone
who is not an owner of that property is known as an
encumbrance.
When an owner chooses to use his property as a security
to obtain a loan he creates a voluntary lien.
In California, the homestead law offers protection only
against judgment liens and attachment liens.
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Chapter Quiz
1. When an owner chooses to use his property as a security to
obtain a loan he creates a _________
a. Voluntary lien
b. Involuntary lien
c. Specific lien
d. General lien
2. All mechanics liens may be filed for recording within ___ days
after the completion of the project,
a. 30
b. 60
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c. 90
d. 120
3. When a project has been completed, the property owner has _____ days in which he can file a notice of completion for
recording.
a. 10
b. 20
c. 30
d. 60
4. Since a law suit is pending against a land owner, a court of
law orders a lien to be placed on the owners land, holding it
as a security in case of a negative judgment. This is known as:
a. An easement
b. A prescription
c. An attachment
d. Adverse possession
5. The right to use another's land for a particular purpose is:
a. An encumbrance
b. A general lien
c. A license
d. An easement
6. A judgment lien is a(n):
a. Involuntary, general lien
b. Voluntary, general lien
c. Voluntary, specific lien
d. Involuntary, specific lien
7. When a lawsuit that may affect title to real property is
pending, the plaintiff records a document called:
a. Notice of non-responsibility
b. Abstract of judgment
c. Lis pendens
d. Writ of attachment
8. The personal, irrevocable, unassignable permission to use
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CHAPTER 5
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zone (or R-1 zone) and multi-family zone (or R-3 zone). An industrial
zone could be divided into light industrial zone and heavy industrial
zone.
Zoning ordinances regulates the use of the building, along with its
size, shape and height. They also determine the minimum distance
between the buildings and the property boundaries including the
setback and side-yard requirements. The purpose of these
regulations is to control the density of population, to help maintain
enough open spaces and access to air and sunlight for ideal living
conditions.
A valid zoning ordinance:
- Cannot discriminate against any parcel of property
- Cannot be applied retroactively
- Cannot create any unfair situation
Exceptions and amendments in Zoning: Since complications are
bound to arise during the enforcement of zoning regulations, some
exceptions are provided to their rules. An individual property owner,
a developer, a city or county government may request a zoning
exception or change.
Exception or changes which can be made in a zoning regulation are:
Nonconforming uses
Variances
Conditional uses, and
Rezones
Nonconforming uses may arise due to an amended zoning
ordinance or when a new area is zoned. A lawfully-settled use may
not conform to the rules laid down in the new ordinance. It is not
required to apply for a permit to continue its establishment.
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resort condominium.
Undivided Interest Subdivision: In this category, each owner is a
tenant in common with a non-exclusive right to occupy or use the
property. A campground with shared facilities is a good example of
an Undivided Interest Subdivision.
Laws Regulating Subdivisions: The state of California has made
the following laws to regulate subdivisions:
- Subdivision Map Act: This is a law that provides the
procedures which are to be followed to subdivide land.
- The Subdivided Lands Law: This law protects the consumer by
making it compulsory for the subdivider to disclose certain
information to the buyers of the lots.
- The Interstate Land Sales Full Disclosure Act: This is a federal
law for protecting consumers which applies to subdivision lots
in interstate dealings/sales.
Subdivision Map Act establishes a state-wide set of procedures to
be followed for filing of a subdivision plan when a property is
divided into two or more lots. These lots must be contiguous
(touching). The purpose of the Subdivision Map Act is to give direct
control of the physical aspects of a subdivision to the local
government; some examples are allotting parking areas, lot designs,
street and sewerage plans. The two main objectives of this Act are:
A) To co-ordinate subdivision design with the general plan, which
includes streets and utilities and;
B) To ensure that the areas of a subdivision which are meant four
public use are improved in a proper way initially, such as a public
park.
The Subdivision Map Act also provides for a tentative map, a final
map and a parcel map for most subdivisions.
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EMINENT DOMAIN
Eminent domain is another governmental power that can affect
land use. The government takes away some or all of the rights of
ownership from private individuals by exercising its power of
eminent domain. The government justly compensates the
individual when it takes the property from an individual. The owner
receives the fair market value of the real estate for his condemned
property.
The process through which the private property is taken by the
government for public use is called condemnation. The power of
eminent domain may be used by the local government to bring into
effect its general plan. For example, parts of some of the private
properties may be condemned for use for building a bridge overpass
or construct/widen a road to facilitate the traffic movements in a
particular zone.
A property owner whose residential house is condemned is also
entitled to receive relocation payments and services as per the
Uniform Relocation Assistance and Real Property Acquisition
Policies Act of 1970. This act is applicable to all federal agencies
and the agencies that use federal funds for property acquisition.
When the nearby land of an owner is put to such a use that it
diminishes the value of the owners property, he can opt for inverse
condemnation. The Tucker Act of 1887 is a federal law which
allows the landowner to file such a suit against the federal
government.
TAXATION OF REAL PROPERTY
Property taxes create liens and it affects property ownership. If the
property owner fails to pay the taxes, the government may sell his
property to collect the money owed due to non-payment of taxes.
The taxation of real property is a good and comparatively easier
method of raising revenue since the land is non-concealable and
indestructible. Real property tax collection can be more easily levied
than other types of taxes and can be collected with or without the
property owners cooperation.
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taxes are similar to general real estate taxes in some ways (as in
they can be used to pay for ongoing government services) and they
are also similar to special assessments in other way (as in special
taxing districts may be made to cover the properties which benefit
from the improvements funded by the taxes).
A special form of property assessment created by the Mello-Roos of
1982 is one such example. This law expanded the type of
improvements, facilities and services as special assessments. MelloRoos assessments are also liens on property but they may be
foreclosed on after payment has been delinquent for only 180 days,
as opposed to the five-year redemption period in general real estate
taxes.
Whenever a residential property with up to five dwelling units is to
be sold, the seller must in good faith try to provide the buyer with a
notice of the special tax from each agency that assesses the
property to levy such a tax.
Documentary Transfer Tax: In California, an excise tax is levied
on every sale of real property. This excise tax is called a
documentary transfer tax. This tax is levied based on the
propertys selling price and normally the rate is 55 cents per $500
of value, or fraction of $500.
For instance, a real property is sold for $650,500.
$650,500/$500 = $1301.00
$1301 X $0.55 = $715.55
The documentary transfer tax payable by the seller is $715.55.
In the calculation of the documentary transfer tax, the
consideration paid for the property does not include any preexisting liens or encumbrances that were not removed by the sale,
i.e., an assumed loan.
If a portion of the purchase price is not subject to the documentary
transfer tax, the information has to be declared on the deed or
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Chapter Summary
The state government uses its police power to adopt and
enforce land use control laws.
All the development and land use regulations for the area has
to conform to the general plan.
Division of land for a specific use such as residential,
commercial, agricultural or industrial is done through zoning
ordinances.
The permission of building or maintaining a structure or use
which is actually prohibited by the zoning ordinance is called
a variance.
A property owner petitions a local zoning authority for a
rezone when he feels that his property is not zoned properly.
After the approval of the tentative map from the planning
agency, the subdivider has to file a final map, depicting the
subdivision in its final form.
Through the Pollution Control Law the federal government
sets forth national standards for the quality of air and water.
When the nearby land of a landowner is put to such a use that
it diminishes the value of the owners property, he opts for
inverse condemnation.
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Chapter Quiz
1. A comprehensive long-term development plan for a
community, which is brought about by zoning and other laws
is called:
a. A buffer
b. Zoning plan
c. Master plan
d. None of the above
2. Which of the following is NOT an exercise of the police power:
a. Condemnation
b. Zoning ordinance
c. Building code
d. Subdivision regulations
3. Which of the following may be controlled by a zoning
ordinance?
a. Constructing a building on a lot
b. Use of property
c. Building height
d. All of the above
4. ______________ is permission to build or maintain a structure
or use that is normally prohibited by the zoning ordinance.
a. A non-conforming use
b. A variance
c. A conditional use permit
d. A rezone
5. A _________________ can be constructed under the conditional
use permit.
a. Hospital
b. Departmental store
c. Restaurant
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d. Paper mill
6. Subdivisions are generally residential, but they may also be:
a. Commercial
b. Industrial
c. Recreational
d. All of the above
7. A timeshare is a type of:
a. Standard subdivision
b. Common interest subdivision
c. Undivided interest subdivision
d. None of the above
8. A property owner plans to add a room to his house. Before the
construction begins, he has to:
a. Request a zoning inspection
b. File a final map
c. Submit a proposal to the planning commission
d. Obtain a building permit
9. Which of the following federal laws requires the federal
agencies to prepare an environmental impact statement?
a. CERCLA
b. NEPA
c. CEQA
d. ILSFDA
10. General real estate taxes are ad valorem taxes, which means
that they are:
a. Sales taxes
b. Excise taxes
c. Charged once at the time of transfer of property
d. Charged in relation to the value of the property taxed
11.
As a general rule, the tax rate which is fixed by the
countys Board of Supervisors should not exceed ___________
percent of the propertys full cash value.
a. 1
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b. 2
c. 5
d. 10
12. The property tax year runs from:
a. January 1 through Dec 1
b. July 1 through June 30
c. April 10 through April 9
d. January 1 through December 31
13. If taxes remain unpaid after ________, the property is
considered in default and a five-year redemption period
begins to run.
a. November 1
b. January 1
c. April 10
d. June 30
14. The power to adjust the assessed value of property lies with
the:
a. Board of Supervisors
b. Board of Equalization
c. Department of Housing and Community Development
d. Planning Commission
15. An excise tax levied on each sale of real property in California
is called:
a. Federal Income Tax
b. Documentary Transfer Tax
c. General Real Estate Tax
d. Local Improvement Tax
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CHAPTER 6
Contract Law
CHAPTER OVERVIEW
In this chapter, we examine a subject of fundamental significance to
real estate professionals: the different kinds of contracts which are
used in real estate transactions, how they are formed, the way they
operate and the penalties for their breach.
CONTRACTS
A promise made by one person to another to do something or
refrain from doing something is called a contract. The person
participating in a contract is referred to as a party to the contract.
Either the contract promise is made by only one of the parties or a
separate promise is made by each of the parties. The promise made
by each party is that partys contractual obligation. Performing a
contractual obligation is called a tender.
To be legally binding, a contract has to meet certain requirements.
In a valid contract, it becomes the duty of each party to fulfill their
specified contractual obligations. Whoever defaults (does not fulfill
the promise made) in completing the contract terms is liable to the
opposite party for breach of contract.
LEGAL CLASSIFICATIONS OF CONTRACTS
All contracts fall under a particular
classifications are:
classification.
These
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A contract can only be created when both the parties give their
mutual consent to its terms. A contract must be read and
completely understood before it is signed. Once the contract is
signed it is taken as consent granted. There has to be a sort of
meeting of the minds for creating a valid contract. This is achieved
through a process called offer and acceptance.
Offer: An offer exists only when an offeror -- the person making the
offer has communicated its term to the offeree -- the person
receiving the offer. It should be clear that an offer is being made.
Since there is a standard, detailed form which is used in almost all
real estate dealings, to know the intentions of the offeror is
relatively easy.
Termination of an offer: Either the offeror has a change of mind
and wants to terminate the offer or the offerees circumstances have
changed and he backs out. When the offer is terminated before
being accepted, then no contract is formed. Some of the situations
when the offer may terminate before being accepted are:
Revocation of an offer
Time lapse
Offerors death or incompetence
Rejection
Counteroffer
Revocation of an offer: The offeror can revoke the offer before it is
accepted by communicating the decision of revocation directly to
the offeree or through a reliable source (like the estate agent).
Lapse of time: Some offers include a deadline for their acceptance
after which the offer terminates automatically. If a time limit is not
set for an offer, a reasonable time is allowed. If a dispute between
the parties develops over what amounts to a reasonable time, the
court will decides what is reasonable.
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made
without
an
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Making a person enter into a contract against his will with use of
physical power or threatening to use physical power is called
duress.
Lawful Objective:
A lawful objective is the third requirement for a valid contract. A
valid contract cannot be made for any unlawful activity, such as
creating a contract to use real estate property for manufacturing
illegal drugs. A contract is void if the objective is not legal.
In a situation where the contract has a legal as well as illegal
objective, then the contract will be valid only to carry out the legal
objective.
Consideration:
Consideration is the fourth requirement for a valid contract.
Consideration is an obligation or a payment which each party must
abide by to enforce the contract. It may be in the form of money, a
service or a promise to do something -- or not do something -- in
the future.
For example, in a normal real estate purchase agreement, the buyer
promises to pay a certain amount of money to the seller (at a
predetermined time) and the seller, on his part, promises to convey
title to the buyer after obtaining his money. In this scenario, both
the parties have given and received consideration.
Writing:
For most contracts in real estate deals, there is a fifth element to
create a valid contract. It must be in writing.
A state law in California, the Statute of Frauds, requires certain
types of contracts to be written and signed. These are:
1. An agreement which will not be completed within one year.
2. An agreement for the sale of real estate or an interest in real
estate or a lease of real estate for more than one year.
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1. Full performance, or
2. Agreement between the parties
Full performance: It implies that the parties fulfilled all of the
obligations and thus the contract is executed. For instance, when
the deed to property is delivered to the buyer and the seller receives
the agreed-upon purchase price, their purchase agreement has
been discharged by full performance.
Agreement between the parties: Following are the ways in which the
parties to a contract may agree to discharge the contract:
- Rescission
- Assignment
- Cancellation
- Novation
Rescission: When both the parties agree to take back (rescind) the
contract they do it through a process called rescission. A rescission
is sometimes referred to as a contract to destroy a contract.
To rescind a purchase contract the buyer and the seller sign an
agreement to terminate the original agreement. If there was money
or other consideration involved, it is returned. In some cases,
rescission is carried out by court orders instead of agreement
between the parties.
Assignment: At times one of the parties to a contract assigns his
interest in the contract to another person by withdrawal. Unless the
terms of a contract prohibit assignment, a contract may be assigned
to another person. In an assignment, the assignee is the new party
who takes over the responsibilities of the assignor, the one who
makes the assignment. However, a personal service contract cannot
be assigned without the consent of the other party.
Cancellation: The parties agree to end the contract but previous
acts performed under the contract cannot be undone. For example,
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if the payment of money was one of the contract terms and was
paid before the cancellation, then it will not be returned.
Money given by the buyer to the seller, when entering into a
purchase agreement, is called the good faith deposit. It implies the
buyers intent of fulfilling the terms of the contract. The seller can
keep the good faith deposit if the buyer defaults on the contract.
With this action the contract is cancelled.
Novation: There are two types of novation. The first type is when a
new party is substituted in an existing agreement. The first party is
relieved of all liabilities attached with the contract. The second type
of novation is when the parties substitute a new agreement in place
of the original one which discharges the old agreement. Unlike
assignment, novation cannot be done without the consent of all the
parties.
BREACH OF CONTRACT
A breach of contract occurs when one of the parties fails to perform
some or all of the obligations of the contract, without a reasonable
legal excuse. The injured party is entitled to legal relief if the breach
is a material breach. A material breach is that unfulfilled
obligation which is an important part of the contract.
Time is of essence is mentioned in many standard contracts
which indicates that performing the obligations on time is
important and not meeting the deadline will be considered a breach
of contract. If a party fails to meet the deadline, the other party
decides whether to continue with the contract or to discharge it
using the time is of essence clause.
Legal Relief for Breach of Contract: There are four legal reliefs
for a breach of contract. They are:
Rescission
Compensatory damages
Liquidated damages, and
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Specific performance
Rescission: To repeat, rescission takes both parties back to their
position before contracting The rescission can either be by
agreement, or by the courts intervention, when one of the parties
has breached the contract.
Compensatory Damages: Damages are those financial losses that a
party suffers because of a breach of contract. Compensatory
damages are the most common remedy for a breach of contract. The
court orders the breaching party to pay a sum of money to the
injured party for the losses incurred due to the breach of contract.
Liquidated Damages: When the parties to a contract agree in
advance to an amount that will serve as full compensation if ever
one of the parties breaches the contract, that amount becomes the
liquidated damages of the injured party.
The provision of the liquidated damages clause is beneficial to
both parties. They can settle their disputes without
approaching the judiciary. However the liquidated damages
provision limits the amount of compensation the injured party
would receive.
In a real estate transaction, if there is a breach of contract by the
buyer, the seller is entitled to keep the good faith deposit as
liquidated damages. Generally the seller cannot sue the buyer for
any further compensation.
There is no liquidated damages clause in a typical real estate
agreement if the seller breaches the contract instead of the buyer.
In this case, the buyer can sue the seller for compensatory
damages.
Specific Performance: Specific performance is the legal action
through which the breaching party is forced to fulfill the terms of
the contract. This action is normally taken as a remedy only if
monetary damages would not suffice.
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TENDER
An unconditional offer by one of the parties to a contract to fulfill
his part of the agreement is called a tender. It is also sometimes
referred to as an offer to make an offer good. Generally made
when it seems that the other party might default, the tender is
necessary before any legal action can be taken to remedy the breach
of contract.
Sometimes there is an anticipatory repudiation by one of the
parties. A positive statement by the defaulting party stating that he
cannot/will not fulfill the terms of agreement is called an
anticipatory repudiation. In this situation, there is no need to make
a tender and a legal action can be undertaken right away.
Chapter Summary
A promise made by one person to another to do something or
not do something is called a contract.
When a contract obligation is yet to be performed or is in the
process of being performed it is said to be an executory
contract.
In California, anyone younger than 18 is a minor and cannot
make a contract concerning real estate. Such a contract will
be void.
Money given by the buyer to the seller, when entering into a
purchase agreement, is called the good faith deposit. It
implies the buyers intent of fulfilling the terms of the contract.
Time is of essence is mentioned in many standard contracts
which indicates that performing the obligations on time is
important and not meeting the deadline will be considered a
breach of contract.
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Chapter Quiz
1. A contract can be considered valid even if:
a. It does not have a lawful objective
b. It was not put into writing
c. It is not supported by consideration
d. There was no offer and acceptance
2. A sixteen-year old person can sign a contract if she:
a. Is an orphan
b. Is not living with parents
c. Has an adult cosign with her
d. Is emancipated
3. An _____________ contract is one that has not yet been
performed, or is in the process of being performed.
a. Implied
b. Express
c. Executory
d. Executed
4. ____________ is compelling a person to do something against
his will, with the use of force or constraint:
a. Actual fraud
b. Constructive fraud
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c. Undue influence
d. Duress
5. Which of the following is NOT a method of terminating a
contract:
a. Revocation by the offeror
b. Lapse of time
c. Offer and acceptance
d. Counteroffer
6. When both the parties agree to take back the contract they do
it through a process called:
a. Rescission
b. Novation
c. Cancellation
d. Assignment
7. Assignment is:
a. When one party is completely replaced by another, or one
contract is completely replaced by another
b. When one party transfers its rights and obligations under
the contract to another party, but remains secondarily
liable
c. When a contract is terminated but previous contractual
acts are unaffected
d. When a contract is terminated and any consideration given
is returned
8. A contract with a defect that gives one or both parties the
power to withdraw from the agreement is called a(n):
a. Void contract
b. Voidable contract
c. Unenforceable contract
d. Valid contract
9. As per the Statute of Frauds law:
a. Certain contracts are to be bilateral
b. Certain contracts are to be in writing and signed
c. All contracts are to be supported by consideration
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CHAPTER 7
Real Estate Contracts
CHAPTER OVERVIEW
In this chapter, we will learn how the laws of contracts are applied
to real estate listing agreements. The elements of forming, recording
and exercising of option agreements and lease agreements are also
explored.
LISTING AGREEMENTS
A listing is a contract through which the seller employs a broker to
sell a real estate property. Basically, a listing agreement is like an
employment contract between the seller and the broker. In this
bilateral agreement, the seller agrees to pay a commission (also
called a brokerage fee) if the broker finds a buyer for the property;
on his part, the broker promises to make a sincere effort to procure
a buyer. A listing agreement does not authorize the broker to accept
offers on the behalf of the seller, nor can he transfer title to the
sellers property.
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to the listing agreement the seller decides the terms (price, closing
date, payment arrangements) on which he wants to sell the
property. If a buyer makes a matching offer, the broker is generally
entitled to a commission, even if the seller decides to reject the offer
made.
However, if the offer made by the buyer does not comply with the
sellers term, the seller will not be obligated to pay the commission
to the broker.
Able Buyer: If a buyer has the financial ability to purchase and
capacity to contract, he is considered to be able.
Commission Without Closing: Once the broker finds a ready,
willing and able buyer, he should receive his commission, even if
the sale eventually fails to close. If the seller is responsible for a no
sale, the broker is still entitled to a commission, although he may
decide not to accept it. The broker will get a commission even if the
sale does not take place, in the following situations:
- The seller changes his mind and does not want to sell;
- The sellers title is not marketable;
- The seller is not able to hand over possession of the property
to the buyer; or,
- The seller and buyer reach a mutual agreement to end the
contract
If it is not mentioned in the listing agreement, it is not necessary for
the buyer and seller to prepare a written purchase agreement in
order for the broker to receive his commission. It is sufficient if both
parties have mutually agreed to the terms of the sale. The broker
can claim his commission even if the seller backs out before the
agreement is put into writing.
What happens if the seller and broker disagree as to whether the
buyer found by the broker is ready, willing and able? In California,
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a court will accept that buyer was ready, willing and able only if a
written purchase agreement was signed. The seller cannot claim
that the buyer was unacceptable since he has already entered into
the contract of sale. The same rule is applicable when the buyer
defaults due to financial problems and cannot proceed with the
purchase.
Also, if the contract is not signed and the agreement between the
two parties is not yet written and the deal collapses, the
commission will not be paid to the broker -- unless he proves the
buyer was financially able to fulfill the contract.
LISTING AGREEMENT TYPES
A brokers commission depends on the type of the listing agreement
made between the agency and the seller. There are three types of
listing agreements:
The open listing
The exclusive agency listing
The exclusive right-to-sell listing
Open Listing: An open listing gives a number of brokers the right
to sell a property. It is called a nonexclusive listing, which means it
can be given to different agents at the same time. The first broker to
find a buyer who agrees to all the terms of the listing and whose
offer is accepted by the seller is entitled to obtain the commission.
This agent is the procuring cause of the sale. The seller may even
sell the property directly, without the agents assistance and thus
owe no commission to any broker.
The open listing agreement comes with some disadvantages as well:
- If two brokers from different agencies negotiate with the same
prospective buyer who finally does buy the property, there may
be a dispute over which broker was the procuring cause of the
sale.
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example, how much money is the seller expecting from the sale (the
listing price) and other terms which would be of importance to the
seller.
Grant authority to the broker: A brokers authority is stated in
the agreement for bringing a buyer for the property. Generally, the
broker has the authority to accept good faith deposits from the
buyer and hold them on the sellers behalf. In some cases when a
broker does not have that authority, he is only acting as a buyers
agent, as far as the deposit is concerned. In such a situation, if the
broker loses or misuses the deposit the seller cannot be deemed
liable to the buyer.
Fixing the brokers commission fee: This is a very important part
of a listing agreement: the clause that states the rate/amount of
commission the broker will receive. A percentage of the purchase
price is given as a commission and it should always be negotiated
between the seller and the broker. If the brokers between them
arrange a commission rate, it amounts to a violation of state and
federal antitrust laws.
Another way of obtaining a commission is a net listing. With a net
listing the seller sets his desired net amount from the purchase of
the property, while the broker on his part tries to sell it for more
than that net amount expected by the seller. After the sale of the
property the seller keeps the net amount he asked for and the
broker retains any excess payment as his commission.
A net listing may be an open listing, exclusive agency listing or
right- to-sell listing. According to California law, the broker using a
net listing has to show his commission to the seller prior to the sale
transaction, otherwise disciplinary action may be taken against the
broker.
Payment of commission: Generally the commission is paid by check
unless agreed to otherwise by broker and seller. It may be paid in
the form of an assignment of an existing note, a promissory note or
assignment of funds to be received from the buyer.
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include an end date. The Real Estate Law requires this clause,
although the law is not binding on the length of the listing period.
BUYER REPRESENTATION AGREEMENTS
A buyer representation agreement is actually a written agreement
between a property buyer and a broker, through which the buyer
who is looking to purchase a property employs a broker who will
help him find a suitable one.
A buyer representation agreement may be exclusive or it may be
nonexclusive. As per the exclusive agreement terms, the broker is
entitled to a commission if the purchase is made during the
agreement period even if the property was not found, or the sale
terms not negotiated, by the broker.
Following the Statute of Frauds, to be enforceable the buyer
representation agreement should be in writing and signed by the
buyer. According to the Real Estate Law, there should be an
exclusive buyer representation agreement, which would mention
the termination period.
Provisions in a Buyer Representation Agreement
Normally the following provisions are found
representation agreement:
in
buyer
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conveyance of title within one year from the date of formation of the
contract.
Vendor and Vendee: Rights and Responsibilities
During the period in which the vendee pays the installments, the
vendor may encumber or transfer the property without getting
permission from the vendee. This is permitted only if the title is not
transferred to the new owner.
Before creating any liens against the property, the vendor must
apply the vendees contract payments to amounts due on the liens.
This law protects the vendee from a possible default on the liens by
the vendor, due to which the property might be foreclosed upon.
Any liens must be paid off by the vendor before the deed is delivered
to the vendee. Once the full payment has been made by the vendee,
a clear and marketable title should be handed over by the vendor.
The vendors signature has to be acknowledged for recording the
land contract. The vendee is free to record the contract, the vendor
cannot stop him. There will be more statutory restrictions on the
rights of the vendor to create a lien, if the land contract is not
recorded.
The vendor cannot encumber the property with a lien if it adds up
to more than the unpaid contract balance, without the consent of
the vendee. Also, the monthly payments on those liens should not
be more than the monthly payments of the vendee on the land
contract.
The vendees primary responsibility is to pay the required
installments to the vendor and, secondly, to pay the insurance and
property taxes in a timely manner.
The vendor can disallow prepayment (paying off all or part of the
balance amount before the due date) of installments only for the
duration of the first twelve months after the sale, this is for the land
contract for residential property of up to four units. After that
period the vendee is legally free to prepay the installments fully or
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partly.
The vendee can legally encumber the property, but the vendees
equitable interest in the property is the only security for the lender
providing the loan. After the full payment of the contract price the
vendee may sell his interest in the property and assign the right to
receive the deed. The vendee may even devise (will) his interest to a
relative.
Remedies for Default
The vendee can sue the vendor for specific performance if, after
paying the purchase price in full, he does not obtain the property
title from the vendor.
The vendor can terminate the contract by sending a proper notice to
the vendee, if the vendee defaults by failing to pay the installments.
The amount paid to the vendor must be reimbursed to the vendee.
If there are any damages incurred by the vendor, the amount can
be reduced from the vendees reimbursement amount. Also, the
reimbursement amount can be reduced by the fair market rental
value of the property for the period the vendee was in possession of
the property.
If the vendee has already paid a major part of the purchase amount
then he has the right of redemption. He can even cure the default
and reinstate the contract.
The vendor may regain the possession if the vendee does not cure
the default or redeem the property. Since the land contract was
recorded, it becomes a cloud on the propertys title. The vendor will
have to obtain a quitclaim deed from the vendee or file for a quiet
title action so that the title may become marketable again.
Use of Land Contract
A land contract may sometimes be used as an alternative to a deed
of trust or mortgage in a real estate transaction which is financed
by the seller. The seller gives credit to the buyer and, as security,
holds the title to the property (instead of creating a lien) till the time
the debt is repaid. This way, it becomes easier to reclaim the
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property if the optionee decides to buy it. The optionee does not
have a legal interest in the property and he cannot use the land
either. The optionee may assign or sell the option during the term of
the option, without the consent of the optionor.
Recording an Option
An option is essentially recorded to give the third parties an
indication of the option.
A recorded option, if not exercised. creates a cloud on the title of the
optionor. To remove the cloud the optionor will require a release
from the optionee and the release should be recorded.
RIGHT OF FIRST REFUSAL
Right of first refusal means a person is given the first opportunity to
purchase or lease a property whenever it is available. For example,
a tenant may get the right of first refusal if the landlord decides to
sell the property. The tenant who is the holder of the right of first
refusal must be given a chance to match the offer made by a third
party for the purchase of a property. The third party may be able to
purchase the property if the tenant (holder of the right of first
refusal) does not want to purchase the property or he is not willing
to match the offer made by the third party.
LEASES
A contract between an owner and a tenant which gives the tenant a
tenancy is called a lease. Tenancy allows a person (a tenant) to take
exclusive possession of land in consideration of rent through a
formal lease or an informal agreement. Conveying an interest in real
property through the terms of a lease is termed a demise. The
landlord (lessor) and the tenant (lessee) have a mutual interest in
one property, and hence they are said to be in privity. The lessors
interest is called a leased fee estate and the lessees interest is
referred to as a less-than-freehold estate in real property.
A lease contract which is sometimes referred to as a rental
agreement states the rights and responsibilities of the landlord and
the tenant. However, there are certain terms and conditions which
are implied by law in all leases irrespective of whether or not they
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TERMINATION OF A LEASE
Following are the ways by which a lease may be terminated:
Expiration of the lease
Notice of termination
Surrender
Breach of implied promise by the landlord
Non-payment of rent
Illegal/unauthorized use
Foreclosure
Destruction of the premises
Condemnation
Expiration of the lease: A term tenancy lease expires automatically
when the term ends. Notice of termination is not required.
Notice of termination: A written notice of termination by either the
landlord or the tenant may terminate the lease at any point of time
during the lease period. The notice period required is usually the
same as the term of the lease. For example, a week-to-week tenancy
requires a weeks notice and a month-to-month tenancy will require
a months notice for termination. An exception to that rule is that a
residential landlord has to give a notice of termination of 60 days to
a tenant who has been residing on the premises for a year or more.
Surrender: A mutual agreement from both the tenant and landlord
to end the lease is called surrender.
Breach of implied promise by the landlord: There is an implied
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may file a lawsuit for unlawful detainer to evict the tenant from the
premises.
The court issues a writ of possession if it finds the tenant in
default. On receiving the writ of possession, the tenant must move
out of the premises peacefully or else the sheriff may have him
removed forcibly.
Although the process of legal eviction is often a slow one, the
landlord must refrain from using unlawful methods (cutting off
utilities or threatening to use force) of evicting the tenant, or else he
may end up defending an expensive lawsuit.
Illegal/unauthorized use: For using the premises in an unlawful
manner (for example, manufacturing illegal drugs), the landlord
may ask the tenant to stop the illicit activity or vacate the premises.
If the premises are being used in a manner which is not authorized
in the lease agreement, then the landlord may terminate the lease
on the grounds of violating the agreement.
Foreclosure: If the property is foreclosed because of the landlords
default on a loan payment or other obligation, the lease is
terminated. If the existing lease has a higher priority than the
foreclosed lien, the foreclosure purchaser has to honor the lease.
In 2009 a federal law was passed under which the foreclosure buyer
of the leased residential property must honor the lease for the
remainder of its term, if the buyer herself is not intending to reside
in the premises. However, if the buyer does intend to reside on the
property, she must give the tenant a notice of 90 days before
terminating the lease.
A residential tenant whose lease is not a specific term lease (such
as a month-to-month lease) is also entitled to receive a 90-days
notice (even if the buyer is not planning to move in the premises).
Destruction of the premises: If the lease is for the use of the land,
improvements on the land or for the use of the entire building, then
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the destruction of the building does not mean the termination of the
lease, unless there is such a provision in the lease. The use and
enjoyment of the land is not disturbed because of destroying the
building and so the purpose of lease is not lost. But if the lease is
only for a particular unit of the building, like an office, commercial
warehouse or an apartment, then the destruction of the building
causes a loss of purpose of the lease and the tenant will be relieved
from his duty to pay the rent.
Condemnation: Premature termination of a lease may take place
because of condemnation. (earlier discussed in chapter 5.)
TYPES OF LEASES
The five main types of leases are:
- The fixed lease
- The graduated lease
- The percentage lease
- The net lease, and
- The ground lease
The fixed lease: The tenant agrees to pay a predetermined amount
as rent and the landlord pays other expenses such as taxes,
maintenance and insurance. The fixed lease is also called a gross
lease, a flat lease or a straight lease.
The graduated lease: This type of lease is similar to a fixed lease,
except that it has a provision for periodic increases in the rent.
These rises in rent are normally based on the Consumer Price Index
(the cost-of-living index.) Adding an escalation clause makes this
increase in rent possible. The graduated lease is also called a stepup lease.
The percentage lease: This type of lease is common in a commercial
lease, especially in shopping malls. The tenant pays a percentage of
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Chapter Summary
A listing is a contract through which the seller employs a
broker to sell a real estate property.
Normally, a listing agreement has a clause by which the
broker is entitled to a commission only if a Ready, Willing and
Able Buyer is found during a listing period.
All the elements of a valid contract must be available in a
listing agreement, which are offer and acceptance, competent
parties, consideration and a lawful intent.
A brokers commission must be negotiable according to the
real estate laws.
In a land contract, the property is purchased by the buyer on
an installment basis and not by paying the full price of the
property in one single payment.
An option agreement is a contract to keep the offer open for a
fixed-upon period of time to purchase or lease a property.
Tenancy allows a person (a tenant) to take exclusive
possession of land in consideration of a rent through a formal
lease or an informal agreement.
.
The rights and responsibilities of the landlord and tenant are
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Chapter Quiz
1. The_______________ listing has a provision for a paid
commission to the broker irrespective of who finds the buyer
for the property.
a. Exclusive right to sell
b. Open
c. Exclusive agency
d. Net
2. Under which type of listing does the seller have to pay a
commission only if the broker is the procuring cause of the
sale?
a. Exclusive agency listing
b. Exclusive right to sell listing
c. Net listing
d. Open listing
3. The provision of a safety clause_______________
a. Entitles the broker to receive a commission even if he is not
the procuring cause of the sale
b. Entitles the broker to receive the commission if the property
is sold (after the expiration of the listing) to someone with
whom the broker had previously negotiated
c. Requires a buyer to share the cost of the brokers
commission with the seller
d. Warrants the safety of the premises by the seller
4. The amount of the buyers earnest money deposit when
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d. An addendum
10. Under a land contract, initially the vendee gets:
a. Possession and title, but not the right to transfer title
b. Possession but not the title
c. Title but not the possession
d. The right to novate the contract without the permission of the
vendor
11. In order to be valid, a lease must be signed by the:
a. Landlord
b. Broker
c. Tenant
d. No need for a signature
12. What happens to the lease when the leased property is sold?
a. The lease terminates automatically
b. The lease is breached by constructive eviction
c. The lease is binding on the new owner
d. The lease is renegotiated by the new landlord and the tenant
13. What essentially is meant by the right of quiet enjoyment?
a. Non-interference from the neighboring tenant
b. Freedom from annoyance from noisy neighbors
c. Non-interference from the primary titleholder
d. Non-interference from the brokers
14. The transfer of an entire leasehold property to a new person,
whereby the primary responsibility of the lease lies with the new
lessee is called___________
a. An assignment
b. A sublease
c. A sandwich lease
d. A freehold lease
15 . A fixed lease is also called____________
a. A net lease
b. A ground lease
c. A graduated lease
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d. A gross lease
CHAPTER 8
Real Estate Agency Law
CHAPTER OVERVIEW
An agency has certain duties and liabilities, since it is a legal
relationship. Many features of a real estate agents relationships
with his clients are governed by the law of agency.
In this chapter we will study the agency relationship, and the
method of creating one. We shall also discuss agency duties and
liabilities, as well as the various types of agency relationships that
are possible in real estate transactions. This chapter also covers
Californias agency disclosure requirements and the relationship of
the brokers to salespersons.
WHAT IS AN AGENCY?
A principal authorizes an agent to act as his representative when
dealing with a third party. This legal relationship is called an
agency. An agency creates a fiduciary relationship between the
agent and the principal. A fiduciary relationship means a position of
trust and confidence, one which is between the agent and the
principal. The agent is bound by the agency law to act in the best
interest of the principal. There is also an obligation to act fairly and
honestly with third parties.
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party with skill and reasonable care. The agent has a legal and
ethical duty to be fair in his dealings with the third party. An agent
who is representing the seller has the responsibility to disclose all
material facts regarding the property to the prospective buyer. The
agent must give accurate statements to the prospective buyer.
An intentional material misrepresentation by the agent may be a
cause of actual fraud while an unintentional misrepresentation
could be deemed negligence or constructive fraud. Intentional as
well as unintentional misrepresentation may cause the buyer to
rescind the transaction and also sue for damages. This clause
applies to the real estate agent as well as the seller. The seller also
has equal responsibility to disclose material facts regarding the
property to the buyer so as to prevent misrepresentations.
Puffing is an exaggerated statement about a property which is not
factual. The buyer should never rely on such nonfactual
statements. Because it is unreasonable to rely upon puffing, such
actions cannot be the subject of a lawsuit.
Even though such statements may not be actionable, it is not
advisable for the real estate agent to make exaggerated statements
to the buyer, which he himself does not believe. In some instances,
an agent may say something he considers harmless sales talk, but
which a buyer accepts as a factual statement; this may sometimes
be judged as actionable by the court of law.
The principal and the agent have to not only try to prevent
misrepresentations but it is also their duty to disclose to the buyers
any latent defects in the property. A hidden defect which is not
noticeable by ordinary inspection is called a latent defect.
Sometimes there may be information which when revealed may
unfairly stigmatize the property. Such information need not be
disclosed to the buyer or tenant. California law provides that
property owners or the estate agent do not have to disclose if
someone died on their premises due to AIDS or that the person was
HIV-positive. If a prospective buyer raises a question about
someone having died of AIDS or if a HIV-positive person was staying
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The buyers agent has access to more homes. In fact, he may show
the buyer homes which have open listings and are put on sale
directly by the owners.
When a listed property is purchased by the buyer, the buyers agent
gets paid through a commission split with the listing agent. This
indicates that the seller is paying the buyers agent indirectly. As
per a state statute, a commission split payment option does not
create an agency relationship between the buyers agent and the
seller. Thus, the fiduciary duties of the buyers agent are not
violated.
Dual Agency: In a dual agency relationship the broker is acting as
an agent for both the seller and the buyer in a particular
transaction. The agent owes fiduciary duties to both the parties.
However, since the interest of the seller and the buyer usually
differ, it is a difficult task representing both the parties at the same
time without being disloyal to one or both of them.
The dual agency is also called a limited dual agency because it is
difficult to fully represent both parties at the same time with total
loyalty.
Disclosed Dual Agency: In California, a dual agency is legal,
provided the agency has written consent from both the seller as well
as the buyer. Not disclosing the dual agency to any one of the
parties is a violation of the Real Estate Law and may lead to
disciplinary action. The result of a legal action would be that
neither party would have to pay the commission and they could
rescind the transaction as well.
In a dual agency relationship, the agent cannot reveal confidential
information about one party to the other. Certain facts need to be
withheld from each party. Both parties have to be informed that
they will not receive full representation from the agent.
Real estate agents should take utmost care regarding the
disclosures of the dual agency. The buyers and sellers may accept
the verbal explanation given to them without understanding the
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Chapter Summary
In an agency relationship, the principal is represented by the
agent to deal with the third party. The agent may be a general
agent or a special agent as per the scope of authority granted.
The agent owes fiduciary duties to the principal which are
utmost care, loyalty, honesty and integrity. The agent must
disclose material facts to the principal and obey his
instructions to avoid a conflict of interest.
The agent has a legal and ethical duty to be fair in their
dealings with the third party. An agent who is representing the
seller has the responsibility to disclose all material facts
regarding the property to the prospective buyer.
Once the inspection is performed by the agent he can complete
a disclosure form with the proper section concerning the real
estate transfer disclosure statement.
The agency disclosure laws require the agent to disclose to the
seller and the buyer whom the agent is actually representing.
In a dual agency relationship the broker is acting as an agent
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Chapter Quiz
1. An agency relationship may be formed by all the following
except:
a. Ratification
b. Estoppel
c. Rescission
d. Implication
2. An agent normally owes duties to the:
a. Department of Real Estate
b. Principal
c. Sub-agent
d. Third party
3. A person appointed to carry out a specific transaction is called
a:
a. Special agent
b. Sub-agent
c. General agent
d. Secret agent
4. An agent acts on behalf of a seller without being authorized;
later, the seller approves of the actions taken by the agent.
This is an example of:
a. Ratification
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b. Express agreement
c. Estoppel
d. Implication
5. An agency relationship by _______________ requires the agent
to acknowledge that an agency relationship exists, to protect
the principals interests.
a. Estoppel
b. Express agreement
c. Ratification
d. Implication
6. According to general agency law, a principal may be held liable
for his agents negligent or wrongful acts. This is termed a:
a. Tort
b. Vicarious liability
c. Imputed knowledge
d. None of the above
7. A salesperson is a brokers:
a. Agent
b. Sub-agent
c. Principal
d. Partner
8. Which of the following events automatically lead to the
termination of an agency relationship, without any further
action required by either party:
a. Expiration of the term of the agency
b. Fulfillment of the purpose of the agency
c. Death or incapacity of either party
d. All the above
9. The statement, This is a dream house, the best you will ever
find is an example of:
a. Opinion
b. Prediction
c. Puffing
d. Misrepresentation
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CHAPTER 9
Financing in Real Estate
CHAPTER OVERVIEW
Financing, the lending and borrowing money is an integral part of
the real estate industry. Without financing buyers would have to
pay cash for the property, and few would be able to afford the
purchase. For closing transactions, real estate agents must possess
a good understanding of real estate finance.
In this chapter, we will discuss information about real estate cycles,
governments influences on real estate finance, and the secondary
market. We shall also learn about mortgages, the workings of other
financing instruments, the foreclosure process, and the different
types of mortgage loans.
REAL ESTATE FINANCE THE ECONOMICS
Buying a home would be unimaginable without the practical benefit
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discount rate. These two types of interest rates are charged when a
bank borrows money from another bank or from a Federal Reserve
Bank. When the Fed takes steps to raise or lower the interest rates
that its members have to pay, the banks, in turn, raise or lower the
interest rates they charge to their clients. Lower interest rates
accelerate the economy while higher interest rates slow it down. The
Fed may increase the rates, if it presumes that a slower pace might
keep price inflation in check.
Reserve Requirements: Commercial banks have to keep a
percentage of their customers funds on deposit with the Federal
Reserve Bank. These reserve requirements are imposed so that, in
case a financial panic occurs, banks can assure clients that their
funds are safe and accessible. The banks will have enough money
to meet the unusual demands of its clients.
The Fed also gains some control over the growth of credit through
the reserve requirements. The Fed can increase these requirements
in order to reduce the amount of money the banks available for
lending, causing increased interest rates. Contrarily, reducing the
reserve requirements frees more money for lending or investment,
causing decreased interest rates.
Open Market Operations: The transactions through which the Fed
buys and sells government securities are called open market
operations. These are the best means by which the Fed can control
the money supply, and along with it, inflation and interest rates.
Only money that is in circulation is actually a part of the money
supply. Therefore, the steps that the Fed takes to put money into
circulation increases the money supply and the opposite happens
when money is taken out of circulation.
The money supply increases when the Fed buys government
securities from investors, since the money used for the purchase by
the Fed goes into circulation. Money is taken out of circulation
when the buyer purchases government securities from the Fed,
thus decreasing the money supply. When the money supply
increases, interest rates tend to fall and vice versa.
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and also increase the rate of interest on the loan. In most cases, the
lender releases the original borrower from any further liability; this
is called novation.
Late Payment Penalty: The penalty which is to be imposed for late
payment must be distinctly mentioned in the finance documents.
According to California law, loans that are secured by mortgages or
trust deeds on single-family, owner-occupied homes have
restrictions on potential late charges: the late payment penalty is
not to exceed 6% of the principal and interest installment due, or
five dollars (whichever is greater), and a payment can be considered
late only if it is paid ten days after the installment due date.
Late payment penalties are not deductible on the borrowers income
tax return, since it is not considered to be interest on the loan.
Lock-in Clause: With this clause in effect, the borrower is
disallowed from prepaying the loan. This means that the borrower
is locked-in to the loan for a definite number of months or years
or for the entire term so that the lenders expected return on his
investment may be protected. As per California law, the finance
documents for a loan on residential property with four units or less
cannot have a lock-in clause; the borrower is allowed to prepay at
any time. But, a prepayment penalty is not barred for such a loan
and is subject to restrictions as given below:
Prepayment Penalty: According to the terms of some loans, the
lender may levy a penalty if the borrower prepays all or part of the
loan balance. For instance, a promissory note could provide that
the borrower may prepay 20% of the original loan amount during
any one-year period without penalty. If the prepayment is for more
than 20%, a prepayment fee equaling six months interest on the
excess paid amount will be charged.
The purpose of a prepayment penalty is to reimburse the lender for
his expected interest, which he will not receive because the
borrower pays the loan off early. The prepayment of a loan without
a penalty does not actually cause a loss to the lender, though the
lenders profit becomes less than expected.
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If the market interest rates are high then the lender may agree to
waive a prepayment penalty. When the borrower prepays the loan,
the lender has the option of lending that money at a higher interest
rate.
There are some legal restrictions on penalties levied on prepayment
of loans which are secured by owner-occupied (up to four units)
residential property. The rule generally allows the lender to charge
prepayment penalties for the initial five years of the loan term. The
common rule for the first five years is that the borrower is allowed
to prepay up to 20% of the original principal amount in any twelvemonth period without penalty. Limits are applicable in penalty
amounts.
Prepayment penalty provisions are not provided for in many
mortgage loans. Such a loan is also called an open mortgage. The
promissory note generally states that the borrower can make the
mandatory payment or more on the payment date stated, when
prepayment is permitted without penalty.
Subordination Clause: Sometimes a subordination clause is
included in a security instrument, stating that the instrument will
have secondary lien priority as against another mortgage or trust
deed to be implemented in the future. Because of the clause, a later
security instrument could take a higher priority position (normally
first lien position), despite the earlier security instrument being was
recorded first.
Most subordination clauses are found in mortgages and trust deeds
securing purchase loans for unimproved land, when the borrower
plans to obtain a construction loan in the future. Lien priority is
normally established by the recording date, but when a
subordination clause is included in the earlier land loan, it permits
the later construction loan to take the first lien position. Therefore,
the construction lenders condition that it should receive the first
lien position can be fulfilled.
The subordination clause allows the borrower to acquire additional
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FORECLOSURE
If a borrower is unable to repay a secured loan as per the
agreement. then the lender may foreclose on the property and
collect the debt from the sale of the foreclosed property. If any other
violation of the loan agreement occurs -- for example, not keeping
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were enough to pay off the debt, interest, costs and fees then the
redemption period continues for three months after the sale. It is
twelve months after the sale date if the sale amount was not enough
to pay off the full debt. On the other hand, if the lender decides to
waive the right to a deficiency judgment or is barred from obtaining
such a judgment then the statutory right to redemption becomes
non-existent.
Certificate of Sale: If the property sale is based on the statutory
right of redemption, the bid winner at the sheriffs sale is given a
certificate of sale and not a deed. During the redemption period
the borrower keeps the possession of the property but he must pay
a reasonable amount as rent to the holder of the certificate of sale.
Once the redemption period ends, the certificate holder gets a
sheriffs deed, transferring title and right of possession.
Investors usually prefer to immediately take title to a property so
this redemption period makes bidding at a sheriffs sale unattractive
to most investors. Consequently, most of the time there are no
bidders at a judicial foreclosure and the lender obtains the property
by bidding the amount owed by the borrower. This is known as
credit bidding.
In case the winning bid is made by an outside bidder, then the
excess sale amount left after satisfying all the valid liens against the
property belongs to the borrower.
Deficiency Judgments: If the sale amount is insufficient for the
debts repayment, then the lender can get a deficiency judgment
against the borrower, if the transaction is not bound by the antideficiency rules. A personal judgment favoring the lender against
the borrower for the difference between the amount owed on the
debt and the net profit from the foreclosure sale is called a
deficiency judgment.
There are anti-deficiency rules which bars deficiency judgment in
some situations:
In a non-judicial foreclosure (trustees sale)
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When the fair market value of the property is more than the
debt amount
When the loan is a purchase money loan which is secured by
a trust deed or a mortgage
When a mortgage is given as a security instrument to a thirdparty lender for financing the purchase (four or less unit
residence, occupied by the owner)
It is understood that after the foreclosure on a standard home
purchase loan, a deficiency judgment would be disallowed.
Non-judicial Foreclosure: Deeds of trust have a special provision
which mortgages do not -- the . According to this clause, the
trustee has the authority to sell the property through non-judicial
foreclosure if the borrower defaults. For non-judicial foreclosures,
filing of a lawsuit is not required nor is a judges foreclosure decree.
The trustee may sell the property at an auction known as a
trustees sale. The proceeds from this sale will be used to pay off the
debt owed to the lender. Just like the sheriffs sale, at a trustees
sale the lender may credit bid and obtain the property for the
owed amount (if no one else bids higher). Any surplus from the sale
belongs to the borrower.
Notices of Default and Sale: A non-judicial foreclosure must be
held according to statutory rules. First, a notice of default should
be recorded by the trustee in the county where the property is
located. A copy of the notice must be sent to the borrower and the
other lien holders.
Next, the trustee must issue a notice of sale, but before doing so,
he must wait a minimum of three months after the notice of default
is served. It is necessary for the notice of sale to be recorded and
posted on the security property and also to be sent to all those to
whom the notice of default was sent. Also, the notice of sale has to
be published in a newspaper at least once in a week for three
weeks. The trustees sale may occur only after 20 days have elapsed
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LAND CONTRACTS
A land contract is a type of seller financing by which the buyer
makes the payments on the purchase and takes possession of the
property but does not take title for at least twelve months from the
date of possession. The amount of the purchase price that needs to
be paid before the title is conveyed is stated in the sales contract.
The land contract is an option for such buyers who do not qualify
for a regular mortgage loan.
The land contract is also called a contract for deed or an
installment sales contract. A land contract demands very little or no
down payment. The buyer takes possession of the property but the
title remains with the seller. This involves less risk for the seller,
since he keeps the title to the property. If the buyer defaults, the
seller does not have the right to restrict the buyers interest.
The courts do not allow harsh remedies against defaulting buyers
so that the buyer may realize an accumulation of equity in the
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Chapter Summary
The periodic highs and lows in the activities of the real estate
market are called real estate cycles.
Fiscal policy refers to the method by which the federal
government manages its money.
The direct control of the federal government exerted over the
money supply and interest rates is called monetary policy.
The 12 regional, privately-owned wholesale banks form the
Federal Home Loan Bank System.
The interest paid on a real estate loan is simple interest
irrespective of the fact that the payments are interest-only or
amortized.
The alienation clause is also referred to as due-on-sale clause.
This provision gives the lender the right to accelerate the loan.
Even after a sheriffs sale, the borrower may get a last chance
to redeem the property. He can do so by paying off the full
debt, including interest, fees and other costs.
Any security instrument holding first lien position has the
highest lien priority and is called a first mortgage.
A blanket mortgage refers to an instrument when the borrower
mortgages more than one real property as security instrument
for a single loan.
A borrower can use the equity in property that he owns as
collateral, for procuring a mortgage loan. This is termed as an
equity loan and if the borrower resides on the property, it is
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Chapter Quiz
1. The Treasury issues interest-bearing securities for two to ten
years, which are called:
a. Treasury bills
b. Treasury notes
c. Treasury inflation-protected securities
d. Treasury bonds
2. Which of the following is NOT a tool used by the Fed to
implement its monetary policies to influence the economy:
a. Taxation policies
b. Key interest rates
c. Reserve requirements
d. Open market operations
3. ______________ started out as a federal agency in 1938 with the
purpose of providing a secondary market for FHA-insured
loans.
a. Ginnie Mae
b. Freddie Mac
c. Fannie Mae
d. Federal Deposit Insurance Corporation
4. A promissory note is:
a. Collateral for a loan
b. Necessary to be recorded
c. Security for a trust deed
d. Evidence of a debt
5. A mortgage loan provision which allows the lender to declare
the full loan amount balance due upon default by the
borrower is:
a. A forfeiture clause
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b. An acceleration clause
c. An escalator clause
d. A subordination clause
6. A provision which gives the borrower the right to regain title to
the security property when the debt is repaid is:
a. A subordination clause
b. A forfeiture clause
c. An escalator clause
d. A defeasance clause
7. A __________________ clause states that an instrument will
have lower lien priority than another mortgage or deed of trust
to be executed in the future.
a. Subordination
b. Alienation
c. Acceleration
d. Defeasance
8. While the foreclosure action is pending, the borrower has a
chance to cure the loan default by paying off all the previous
dues, costs and fees of the lawsuit. This is termed as a
_________
a. Redemption
b. Assumption
c. Reinstatement
d. Lien release
9. Which of the following is NOT an alternative to foreclosure:
a. Deficiency judgment
b. Loan workouts
c. Deed in lieu of foreclosure
d. Short sales
10. A _____________ loan is also called a gap loan or a bridge
loan.
a. Swing loan
b. Construction loan
c. Take-out loan
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d. Interim loan
11. After a trustees sale, any proceeds leftover after paying off
liens and foreclosure expenses belong to:
a. Sheriff
b. Trustee
c. Foreclosed owner
d. Beneficiary
12. ______________ is given by the mortgagee to the mortgagor,
when the mortgage debt is paid off, releasing the property from
the lien.
a. Certificate of discharge
b. Deed of reconveyance
c. Sheriffs deed
d. Partial release
13. When a buyer gives a mortgage to a seller instead of an
institutional lender, it is called a:
a. Participation mortgage
b. Reverse equity mortgage
c. Purchase money mortgage
d. Blanket mortgage
14. A ____________ mortgage sets a borrowing limit, but allows the
borrower to reborrow when required.
a. Wraparound mortgage
b. Participation mortgage
c. Open-end mortgage
d. Subprime mortgage
15. If a property does not provide sufficient collateral for a loan
and another property owned by the borrower is offered as
additional collateral, it is termed a:
a. Budget mortgage
b. Package mortgage
c. Blanket mortgage
d. Shared appreciation mortgage
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CHAPTER 10
Residential Loan Application
CHAPTER OVERVIEW
When it comes to choosing a lender the home buyer will look to the
real estate agent for counseling. Agents should be prepared to assist
the buyer in identifying which lender is offering what type of loan.
This chapter will explain the different types of lenders making home
purchase loans, the lenders fee, the Truth in Lending Act, and the
state finance disclosure laws. We shall also learn about the
application form, the underwriting process, and the main features
of a home purchase loan and residential financing programs. The
last part of the chapter will deal with predatory lending and
mortgage fraud.
Mortgage companies
used as the primary source of loan funds by the S&Ls. S&Ls had
no problems in making long-term home loans because the majority
of the funds held by S&Ls were long-term deposits.
The main emphasis for the S&Ls was home mortgage loans,
although they were involved in other types of lending as well. Soon,
though, other lenders became involving in the residential finance
market and the S&Ls dominance lessened.
Savings Bank: The savings bank also started in the nineteenth
century. Financial services were offered by them to the small
depositors, immigrants and working-class people. Since they were
systematized as mutual companies which were owned by and
functioned for the benefit of the depositors, they were named
mutual savings banks (MSBs).
MSBs resembled savings and loans in that their customers were
mainly individuals, not businesses, and their maximum deposits
were savings deposits. The MSBs did make residential mortgage
loans also but they were not as focused on them as were S&Ls.
MSBs also engaged in other types of lending, including personal
loans.
In the present day, savings banks can be set up as mutual
companies or stock companies, while residential mortgages remain
an important aspect of their business.
Credit Unions: Like thrifts and banks, credit unions are depository
institutions. The major difference is that credit unions generally
provide services only for members of a certain group, such as
members of a professional association or union, or employees of a
large company.
Normally, credit unions give small personal loans to their members.
Credit unions now highlight home equity loans. Quite a few credit
unions make home purchase loans, too.
Mortgage Companies: These are not depository institutions like
banks, thrifts or credit unions. Mortgage companies dont lend out
the funds of the depositors. Rather, they act as loan
correspondents, agents between big investors and property buyers
looking for financing.
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LOAN COSTS
The cost of the loan which the buyer will need to procure is the
most important consideration in choosing a lender. The rate of
interest has the maximum impact but the other charges which the
lender levies also greatly affect the cost of the loan. The two most
important charges are the origination fees and discount points.
These two are usually looked at together and referred to as points.
The term point actually is the short form used for percentage point.
A point is one percent of the loan amount.
Origination Fees: The term used for processing loan applications
and making loans is loan origination. A loan origination fee is
used to pay the administrative costs which the lender incurs in
processing a loan. This fee is also called a service fee, an
administrative charge or a loan fee. In almost all mortgage loan
transactions the institutional lender charges an origination fee
which is usually paid by the buyer.
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The Federal Fair Credit Reporting Act and the California Consumer
Credit Reporting Agencies Act regulate the actions of credit
reporting agencies. California law requires the credit reporting
agency to provide the copy of the credit information to the
consumer, if requested. If the agency fails to provide the copy of
credit information, the consumer may sue the agency for actual
damages, disciplinary damages of up to $5,000, attorneys fees, and
court costs. A consumer may challenge the information in their
credit reports. The agencies must probe and make corrections
where required.
Income: The loan applicants monthly income is another major
consideration for the underwriter, regarding whether his income is
enough to cover the proposed monthly mortgage payment, plus
other expenses of the applicant. Therefore, the underwriter must
verify the applicants income.
In the underwriters view, not all income is equal. The income must
meet the standards of quality and durability, to be able to be taken
into account for deciding whether the applicant qualifies for the
loan. The income that meets this test is called the loan applicants
stable monthly income.
A regular income from permanent employment or Social Security
retirement benefits is considered a stable monthly income, while
occasional overtime pay from a permanent job or wages from a
temporary job will not be taken into account as stable monthly
income since there is no guarantee that it will continue.
After having calculated the monthly income of the applicant, the
next step the underwriter is to find out the adequacy of the income:
Whether the stable monthly income will be sufficient for the
applicant to be able to afford the proposed monthly mortgage
payment. For this the underwriter uses the income ratios. The
reasoning behind the ratio is that if the borrowers expenses goes
beyond a certain percentage of his monthly income, then he may
find it difficult to make the payments on the loan.
The two main types of income ratios are:
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SUBPRIME LENDING
The home buyers whose credit history does not meet the standard
underwriting requirement may acquire a loan by applying to a
subprime lender. Subprime lenders make riskier loans than prime
(or standard) lenders.
Many subprime mortgage buyers have impaired credit histories and
average credit scores, but it is not always the case. Sometimes,
subprime financing may be an option for buyers who:
* Cannot (or prefer not to) meet the income and asset
documentation requirements for prime lenders, orn
* Have good credit but have more debt than allowed by the prime
lenders, or
* Wish to purchase a nonstandard property that a prime lender
doesnt consider as acceptable collateral
The underwriting standards of a subprime lender are more flexible
but would charge a higher interest rate and fees than a prime
lender. Apart from these higher rates and fees, a subprime loan
may also come with features such as balloon payments,
prepayment penalties, and negative amortization. These features
help the subprime lenders to compensate for some of the extra risks
involved in their loans, though they might be difficult for the
borrower to meet.
A boom in subprime lending which began in the 1990s continued
in the following century as well. But a substantial number of
subprime loans made in the boom period happened to be poor risk
loans. Calling for low monthly payments initially but increasing
steeply a few years into the loan term, these sudden increases (this
problem is referred to as payment shock) could not be handled by
the borrowers. This resulted in a foreclosure epidemic, which began
in the year 2008. It not only affected the mortgage industry but also
the entire economy.
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Conventional Loans
Any institutional loan that is not insured or guaranteed by a
government agency is a conventional loan.
The rules for conventional loans explained here point towards the
principles set by the secondary market agencies that purchase
conventional loans, Fannie Mae and Freddie Mac. Any loan that
does not meet the secondary market principles is considered
nonconforming and generally cannot be sold to the secondary
market agencies. As most of the lenders wish to sell their loans on
the secondary market, they customize their standards for
conventional loans to match those set by Fannie Mae or Freddie
Mac.
Conforming Loan Limits: If the loan amount is over the applicable
conforming loan limit then it will not be eligible for sale to Fannie
Mae or Freddie Mac. The conforming loan limit is different for
properties with one, two, three or four dwelling units. The basis of
the conforming loan limits is the median housing prices in the
country. These are adjusted annually to indicate changes in median
prices.
Loans exceeding the conventional loan limits are called jumbo
loans. It is normal for lenders to charge higher interest rates and
apply stringent underwriting standards while making jumbo loans.
Conventional LTVs: Traditionally, the standard loan-to-value ratio
for a conventional loan is 80% of the appraised value or sales price
of the property (whichever is less). Lenders believe that a borrower
paying a 20% down payment with his own funds is not likely to
default. Even if the borrower was to default, a foreclosure sale
would probably generate at least 80% of the purchase price.
While an 80% LTV may still be considered as the traditional
standard, many conventional loans now have a much higher loan239
loan amount. The higher the LTV, higher goes the coverage
requirements and the premiums, because the risk of default is
much greater.
If a foreclosure becomes necessary on account of a default, which
then causes losses to the lender, he can either sell the property or
renounce it to the insurer (and make a claim for the reimbursement
of losses up to the extent of the policy limit). Losses are generally in
the form of principal and interest, property taxes, attorneys fees,
sale costs, and maintenance of property costs during the
foreclosure and resale.
The loan-to-value ratio will decrease, as the loan is being paid off by
the borrower and as the value of the property increases. As the LTV
lessens, the risk of loss for the lender also declines, so the purpose
of the private mortgage insurance is satisfied.
As per the federal Homeowners Protection Act, lenders are
supposed to cancel the PMI once 80% of the propertys original
value has been paid down. As the loan balance reaches 78%,
cancellation is necessary, even if it is not requested.
Conventional Qualifying Standards: Fannie Mae and Freddie
Mac have comprehensive guidelines for evaluating a conventional
loan applicants credit history, income, and net worth. Minimum
credit scores are set by the agencies for the loans they buy. A
borrower is charged a risk-based loan fee called a delivery fee or a
loan-level price adjustment (LLPA), if his credit score is above the
minimum, yet relatively low. The fee amount can be large, as
additional LLPAs may be charged for other risk factors in the
transaction. For instance, a LLPA could be charged for a loan with
an adjustable interest rate (in an ARM there is a risk of default due
to the payment shock involved).
To ascertain whether the applicants monthly income stability is
sufficient, an underwriter might consider both the housing expenseto-income ratio and the debt-to income ratio.
There are cases where the underwriter considers only the debt-toincome ratio since debt to income takes into account all of the
applicants monthly obligations. It is supposed to indicate the
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FHA-Insured Loans
In 1934, the Congress created the Federal Housing Administration
(FHA) in the National Housing Act. The National Housing Act and
the FHA were designed with the intention of creating new jobs by
way of increased construction activities, to stabilize the mortgage
market and to promote the financing, repair, improvement and the
sale of real estate in the country. The establishment of minimum
housing construction standards was an additional byproduct of the
FHA housing program.
The FHA is now a part of HUD. Insuring mortgage loans is its main
function. The FHA reimburses lenders who make loans through
FHA programs and have suffered losses resulting from borrower
default. The FHA does not construct houses or make loans.
Effectively, the FHA performs as a huge mortgage insurance agency.
Its insurance program, also called the Mutual Mortgage Insurance
Plan, is funded with the FHA borrowers-paid premiums.
FHA approved lenders (for making insured loans) either have to
submit applications of the prospective borrowers to the local FHA
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38 years. The interest rate is set by RHS and the loan, too, is
serviced by RHS.
Guaranteed Loans: Loans made by approved lenders to the
borrowers (whose income is not more than 115% of the area median
income) are guaranteed by the Rural Housing Service.
Approved lenders comprise state housing agencies, FHA and VAapproved lenders, and lenders taking part in other RHS-guaranteed
loan programs. Loan amounta may be the full purchase price of the
property. The interest rate is fixed by the lender, its term 30 years.
VA-Guaranteed Loans
The VA-guaranteed home loan program was set up to help veterans
finance the purchase of their homes with affordable loans. There
are many advantages of VA financing over conventional financing.
The program is controlled by the U.S. Department of Veterans
Affairs (the VA).
Eligibility for VA Loans: The basis of eligibility for a VA home loan
is the length of active duty service in the U.S. armed forces.
Depending on when the veteran served, the minimum requirement
varies from 90 days to 24 months. (Longer periods will be needed
for peacetime service than for wartime service.) The basis of
eligibility may also be longtime service in the National Guard or
Reserves. The military personnel who were dishonorably discharged
are not eligible for a VA loan.
The surviving spouse of a veteran may be eligible for a VA loan,
provided that he or she has not remarried and that the veteran died
in action or died of service-related injuries. A veterans spouse is
also eligible if the veteran is listed as missing in action or if he/she
is a prisoner of war.
Application Process: A veteran is supposed to apply to an
institutional lender and provide a Certificate of Eligibility issued
by the VA, in order to acquire a VA-guaranteed loan. The loan
application will be processed by the lender and will be forwarded to
the VA. It is noteworthy that the Certificate of Eligibility is not a
confirmation that the veteran will qualify for the loan.
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lenient than
the
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of the loan term, and/or charging the penalty even if the loan
is prepaid since the property is about to be sold.
Predatory lenders and mortgage brokers purposely target potential
borrowers who do not understand the deal they are entering into, or
are unaware that better options are available. Borrowers who are
elderly citizens, have a limited income, are less educated, or
unfamiliar with the English language are more likely to be targeted.
Elderly victims who have a great deal of equity in their homes but
are mentally impaired are the most common targets of refinancing
and equity stripping schemes.
There are federal and state laws enacted to restrain predatory
lending. The federal Home Ownership and Equity Protection Act
(HOEPA) passed in 1994 which added special restrictions on highcost mortgage loans to the Truth in Lending Act. Its scope was quite
limited and it applied only to very high-cost home equity loans and
refinancing. It was not applicable to home purchase loans.
In 2008-2009, Congress and the Federal Reserve made changes to
the Truth in Lending Act and Regulation Z that made them
applicable to more types of loans along with high-cost home
purchase loans (bound by special restrictions). This was in reaction
to the subprime crisis and the foreclosure epidemic.
Lenders charging high rates and fees on loans secured by the
borrowers principal residence have to make special disclosures,
they are not allowed to be involved in certain practices, and cannot
have certain provisions in their loan agreements.
The state of California even has its own predatory lending law. It
requires special disclosures and disallows certain practices and
provisions for high-cost loans. Similar to current federal law, the
state law applies to purchase loans, home equity loans, and
refinancing secured by the principal residence of the borrower.
MORTGAGE FRAUD
Mortgage fraud occurs when deception is used to obtain a mortgage
loan by defrauding the lender. It may be executed by borrowers, by
professionals in the mortgage industry or in the real estate
industry. In certain cases, the borrowers and professionals together
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Chapter Summary
A commercial bank may be a national bank chartered
(approved for doing business) by the federal government or it
may be a state bank chartered by a state government.
The savings and loans associations and savings banks are
sometimes collectively called thrift institutions or thrifts.
In the loan underwriting process, the evaluation of the
applicant and the property he plans to buy is done to verify
whether they meet the minimum standard set by the lender.
The Truth in Lending Act (TILA) is a federal consumer
protection law dealing with the issue of comparing loan costs.
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Chapter Quiz
1. A mortgage company:
a. is the same as a mortgage broker
b. is also called a mortgage banker
c. services loan but does not make them
d. arranges loans but does not service them
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6. An ARM is a:
a. Growing equity mortgage
b. Reverse annuity mortgage
c. Graduated payment mortgage
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CHAPTER 11
Real Estate Appraisal
CHAPTER OVERVIEW
Property value is the foundation of all real estate transactions. A
propertys value affects its selling price, financing terms, rental rate,
property tax assessment, and insurance coverage, and the income
tax that will be payable.
Apart from any emotional or personal considerations, the parties to
a transaction must also know how much the property is worth. For
this purpose the parties depend upon an appraisal. In this chapter
we shall study the concept of value and the different methods used
by the appraisers to estimate value.
An unbiased estimate or opinion of the property value on a given
date is termed as an appraisal. The appraisal report is the written
statement, stating the appraisers opinion of the value of the
property as of a given date. The appraisal is also called a valuation.
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discuss the results of the appraisal process only with the client
(unless he has the permission to discuss it with the third party).
Because of the duties imposed by the agency relationship, an
appraiser must disclose in the appraisal report if he has any
interest in the property being appraised. Also, if the appraiser is not
sure about any feature of the appraisal -- for example whether to
categorize a particular item as real or personal property -- then that
information should also be mentioned in the appraisal report.
The appraisers fee is fixed in advance, on the basis of the expected
difficulty of the appraisal and the amount of time it is likely to take.
The fee cannot be calculated as a percentage of the appraised value
of the property. It can also not be calculated according to the
clients satisfaction with the appraisal report.
Fannie Mae and Freddie Mac do not allow appraisers to have any
significant communication with the mortgage loan originator (MLO)
in a transaction. This is to ensure that the appraisers can prepare
their reports in an independent and impartial atmosphere. The
appraisals for the loans that are to be sold to the secondary market
agencies need to be arranged through an independent appraisal
management company or through a different department within the
lenders organization. They should not be done through an MLO or
anyone in the loan production department. Also, real estate agents
are not permitted to choose or compensate the appraiser in
transactions which involve loans which are to be sold to Fannie Mae
or Freddie Mac.
According to California law, it is illegal for someone with an interest
in a property to try to wrongfully influence the appraisal through
coercion, extortion, or bribery. On the other hand, it is permissible
to to ask the appraiser to consider extra information regarding the
property, explain the basis for his value estimate more clearly, or
correct mistakes in the appraisal report.
VALUE
A common definition of value is the present worth of future
benefits. Another definition is the ability of an item or service to
command other items or services in exchange. Value is generally
measured in terms of money.
Elements of Value
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Types of Value
There are two general classifications for value, for the purpose of
appraisal: value in use and value in exchange. The subjective
value that a person places on a property is the value in use while
the objective value of the property as noted by the average person is
the value in exchange. According to the circumstances, a
propertys value in use and value in exchange may greatly differ.
The more important of the two types of value is the value in
exchange. The value is exchange is commonly known as market
value. The purpose of most appraisals is to estimate a propertys
market value.
Market Value: The most accepted definition of market value is
taken for the Uniform Standards of Professional Appraisal Practice.
The most probable price which a property should bring in a
competitive and open market under all conditions requisite to a fair
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scale, the buyer and the seller each acting prudently and
knowledgeably, and assuming the price is not affected by undue
stimulus.
Note that as per the definition, market value is the most probable
price and not the highest price that the property should bring and
not will bring. Appraisals are more akin to estimation and
probability than certainty.
It should also be noted that market value is the most probable price
which needs to be paid if the purchase of the property is made
under regular conditions. The regular conditions imply:
- That the sale happened between unrelated parties,
- That the property was on offer in open market for a good
length of time,
- That both parties acted cautiously and knowledgeably, and
- That neither party was incited or abnormally pressurized.
A concise explanation of market value is offered by the Federal
Housing Administration as, The price which typical buyers would
be warranted in paying for the property for long-term use or
investment, if they were well informed and acted intelligently,
voluntarily, and without necessity.
Market Value/Market Price: Lets examine the difference between
market value and market price. Market price is the actual price
paid for the property, irrespective of the kind of scenario in which
the sale took place (for example, if the sale was done under any
pressure, or if the parties to the sale were well informed). Market
value, on the other hand, is the price that that should be paid if the
sale of the property was done under normal conditions.
Principles of Value
There are four main factors that influence our attitudes and
behavior to create, support, or destroy property value:
Social ideals and standards,
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Economic fluctuations,
Government regulations, and
Physical and environmental factors.
A change in the thought process regarding family size and the
advent of the two-car family are instances of social forces that affect
the value of homes (here it would be homes with many bedrooms
and single-car garages). Economic forces would be employment
levels, interest rates and other factors affecting the peoples
purchasing power. Government regulations like zoning ordinances
are there to promote, stabilize or diminish the demand for property.
The physical and environmental factors affecting property values
are climate, earthquakes and flood control measures.
All of these four factors independently affect the value regardless of
the efforts of the owner. For example, inflation (an economic force)
causes an increase in the value of the property, even though the
owners has put forth no effort to improve the property. An increase
in the value of the property due to an outside force is referred to as
an unearned increment.
Since the last few years, appraisers have created a reliable body of
principles, called the principles of value which considers these
forces and accordingly guides appraisers in making decisions in the
valuation process. These principles are valid in any appraisal
method which is used to derive an estimate of value.
Principle of Highest and Best Use: The most profitable use a
property can be put to, the use that shall provide the best net
return to the owner over a period of time is the propertys highest
and best use. Net return generally refers to net income, but not
necessarily measured in terms of money. For example, in a
residential property, net return might be in the form of amenities -the feeling of satisfaction and pleasure of living on the property.
Deciding the highest and best use is basically a matter of
confirming that deed restrictions or an existing zoning ordinance
limit the property to its ongoing use. Usually the ongoing use of the
property is its highest and best use. Nevertheless, change is
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after the first three productive agents have been deducted are
credited to the land for its participation in the production of the
gross income. This is termed the surplus productivity.
The credited amount to the land will reflect the lands value under
its current use. If there is an imbalance and much of the gross
earnings are credited to the land, the buildings are most probably
an under-improvement and the land may not be serving its highest
and best use. Also, if too little income is credited to the land, the
buildings might be an over-improvement, again implying that the
land is not serving its highest and best use.
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Gathering Data
Gathering necessary data is the next step after the appraiser has
found out what property is being appraised and the purpose of the
appraisal. The data is divided into general data and specific data (as
mentioned previously). Lets look at the two data types in detail:
General Data
General data consists of general economic data regarding the
community and neighborhood where the property is located.
Economic trends: The economic trends are surveyed by the
appraiser to discern clues as to the direction the propertys value
might take in the future. A series of related developments that form
a pattern is called a trend. Economic trends may happen at local,
regional, national, or international levels. Local trends have the
most substantial impact on the value of a property. Usually, when
the conditions are prosperous there is a positive effect on property
values while economic downturns have a reverse effect.
The economic forces comprise:
- Population growth shifts,
- Employment and wage levels (buying power),
- Price levels,
- Building cycles,
- Personal and property tax rates,
- Building costs, and
- Interest rates.
Neighborhood analysis: The value of a property is definitely tied to
its surrounding neighborhood. A neighborhood may be a
residential, industrial, commercial or agricultural area that includes
similar types of property. The property boundaries are established
by physical barriers like highways and water bodies, land use
patterns, the age or value of homes or other buildings, and the
economic status of the residents.
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Specific Data
Specific data concerns the property itself. Generally, the appraiser
evaluates the site which includes the land, utilities and the
improvements to the site which apply separately to the buildings.
This is standard in certain perspectives. For instance, a property
tax assessment proves the distribution of value between the land
and the improvements. Land is appraised separately to determine
whether it is worth too much or too little compared to the value of
the improvements. And, if an imbalance is there, then the land is
not serving its highest and best use. The main objective of site
analysis is to ascertain highest and best use.
Site Analysis: A detailed site analysis would mean collecting a good
amount of data concerning the propertys physical features and also
the factors that affect its use or the title. The following are all
included in a sites physical features:
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2-1 rule. According to this rule, the front quarter of a lot holds
40% of its overall value, the second quarter holds 30%, the
quarter after that holds 20%, and the rear quarter holds 10% of
the value. (This is because the accessibility of the rear part of the
lot is less, so its value is also less.)
Sometimes a depth table is used to evaluate how the depth of a
lot affects its value. This table uses mathematical factors that
can be multiplied by the front foot value of a standard lot to
estimate the value of a lot with a specified depth. Depth tables
are not thought to be accurate enough for the majority of
appraisal purposes. Yet, depth tables are used sometimes by tax
assessors when they evaluate commercial property for tax
purposes.
In some cases, two or more adjoining lots are combined together
to achieve greater width, depth or area to make the parcel more
valuable than the sum of the values of its singular parcels. The
increase in the property values that results when two or more
lots are combined is called plottage. Usually, it is industrial or
commercial land development projects that are involved in this
process of assembling lots to increase their total value.
5. Shape: Lots that are uniform in width and depth, such as
rectangular lots are always more useful than irregularly shaped
lots. This holds true for residential, commercial or industrial lots.
6. Topography: An aesthetically appealing site is usually more
valuable. Rolling terrains are more preferable to flat, boring
land. Conversely, if the site is located well above or below the
street or is extra hilly, it would cost more to develop so its value
would lessen.
7. Utilities: Site analysis also involves an investigation of the
availability and cost of utility connections. Parcels located
remotely lose value because the cost of bringing utility lines to
the site may be too high or even unaffordable.
8. Site in relation to area: The location of the lot in relation to its
surrounding areas influences its value. For example, a
restaurant which is located on a corner will often be worth more,
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since it will enjoy more exposure and its customers will have
access to it from two different streets. The effect of the corner
location on the value of a business site is called corner
influence.
On the other hand, a residential propertys value is lower if it is
located on a corner, since a corner lot is exposed to more
thorough traffic than a lot in the middle of the block.
Building Analysis: The improvements to the site and special
amenities, if any, must also be analyzed. Amenities are appealing
features like a beautiful view, or a lovely landscape and so on.
Although the functional utility of a home is based on the
requirements and choices of its occupants, certain basic
considerations that apply to the majority of homes.
Quality of construction: Determining whether the quality of the
materials and workmanship is good, average or bad. Other factors
are:
1. Age and condition: How old is the home is and is its overall
condition good, average or bad. In case the foundation shows
signs of cracking, or doors and windows do not open and close
neatly, the appraiser might suggest a soil engineers report (to
check the soil stability).
2. Size of the property: The square footage is calculated using the
outside dimensions of the house. In the square footage, the
improved living area is included, but not the garage, basement,
and porches. Commercial buildings and warehouses, too, are
measured using square feet.
3. Orientation: This means the positioning of the building on the
property in regards to its views, privacy factor, exposures to
sunlight, wind and noise.
4. Basement: An operational basement, especially a finished one,
adds to value. But as mentioned before, the amount a finished
basement contributes to value is generally, not enough to cover
the cost of the finished work.
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METHODS OF APPRAISAL
After collecting the necessary general and specific data, the
appraiser starts to apply one or more of the three methods of
appraisal:
The sales comparison approach
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high and represent the ceiling of the market value range. The
appraiser may also use the prices offered by the buyers (not
necessarily accepted by the sellers), although these cannot always
be confirmed because the records of the offers are not always kept.
Offers are mostly at the low end of the range of value. Actual market
value is usually somewhere between the offers and listing prices.
Remember, assessed values established for tax purposes are not to
be used in place of comparable sales.
Adding Land Value: This is the last step of the replacement cost
process, with the value of the land being added to the depreciated
value of the improvements. The estimation of the value of the land
is done through the sales comparison method. Recently paid prices
of lots similar to that of the subject lot are compared, to arrive at
the worth of the subject lot. (This topic is discussed later in the
chapter.)
the investor, it is inserted into the formula given above. When the
net income is divided by the desired rate of return, the investor can
ascertain how much she can pay for the property and also achieve
the desired return.
Recapture: Generally, a capitalization rate has to take into account
the investors desired rate of return on the investment and also the
return of the investment. Interest is a return on an investment. It is
the investors profit on the money he invested in purchasing the
property. The return of an investment relies on the investors
proficiency in regaining the purchase price of the property at the
end of the ownership term. This return of the investment is termed
as recapture.
The part of the purchase price accredited to the land does not need
to be recaptured during the investment period as land is
indestructible and its value can be regained when the property is
sold. However, improvements will wear out. Since the purchase
price of the improvements will not be recovered when the property
sells, the majority of the investors want to include a provision for
recapturing their original investment in their capitalization rate.
This means a provision of recapture is added, in the expectation of
the accrual of future depreciation. A capitalization rate providing for
interest and recapture is called an overall rate.
Selection of capitalization rate: When the appraiser uses the
income approach to appraise a property, he should be aware of the
rate of return that normally the investors would demand for similar
properties.
There are many ways by which the appraiser may arrive at a correct
capitalization rate for a property. For example, the appraiser can
analyze recent sales of comparable income properties and suppose
that the subject property will have a similar capitalization rate. This
is the direct comparison method.
There is also the band of investment method of selecting a
capitalization rate. According to this technique, the current
mortgage interest rates are taken into account, and applied to the
investors loan, in addition to the rate of return needed on the
investors equity investment.
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residual,
is
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Chapter Summary
An unbiased estimate or opinion of the property value on a
given date is termed an appraisal.
A self-employed appraiser is hired to appraise a property for a
fee, and he is sometimes called a fee appraiser.
A common definition of value is the present worth of future
benefits.
The purpose of most appraisals is to estimate a propertys
market value.
Sometimes a depth table is used to evaluate how the depth of
a lot affects its value.
Physical deterioration that is curable is also referred to as
deferred maintenance.
Economic obsolescence is almost always incurable because it
is not under the control of the property owner.
Capitalization is the process of converting the net income into
a meaningful value.
Appraisers call the collection and analysis of all the facts that
affect the value of a property as reconciliation.
Once the final estimate of value is done, the appraisal report is
presented to the client by the appraiser. The reports are of two
types, the narrative report and the form report.
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Chapter Quiz
1. An appraisal is :
a. An estimate of a propertys value as of a specified date.
b. A mathematical analysis of a propertys value.
c. A propertys average value, as indicated by general and
specific data.
d. A scientific determination of a propertys value.
a. Cost approach
b. Sales comparison approach
c. Summation approach
d. Income capitalization approach
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12. Which of these would the appraiser use, if he has chosen the
income approach to determine the value of an apartment
building:
a. Excess rent
b. Percentage rent
c. Contract ren
d. Economic rent
13. While using the capitalization approach for appraisal, the most
challenging part is to determine the:
a. Capitalization rate
b. Net rate
c. Gross income
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CHAPTER 12
Settlement of Real Estate Transactions
CHAPTER OVERVIEW
There are certain matters that need to be finalized before a real
estate transaction can be closed. The services of real estate agents
are equally important during the closing of the deal as during the
marketing of the property prior to the sale. The guidance of the
agent throughout the closing period avoids unwanted delays and
should reflect her professional attitude.
In this chapter, we shall learn about the purpose of escrow and the
closing procedure. We will discuss the workings of the settlement
statements, the allocation of the closing costs, income tax aspects
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CLOSING
After signing the purchase agreement, the parties and their agents
begin preparations to finalize the transaction. The process of
finalizing the real estate transaction is called closing or
settlement.
Every state has a different closing process. Some states have all the
parties involved in the transaction come together in person to sign,
exchange legal documents and transfer funds. In California and
some other states, the closing process is taken care of by a neutral
third party, by creating an escrow.
ESCROW
When money and documents are held by a neutral third party on
behalf of the buyer and the seller until the transaction is about to
close, it is called an escrow arrangement. The neutral third party is
called an escrow agent. An escrow agent is a dual agent, since both
the buyer and the seller are represented by him and he owes
fiduciary duties to both the parties.
Written escrow instructions are given by the parties to the escrow
agent, which detail under what conditions and the times when the
agent will distribute the money and the documents to the proper
parties. The escrow instructions are a bilateral contract, which is
between the buyer and the seller. Escrow agent (or the terms and
conditions of the escrow) cannot be chosen by one party without the
consent of the other party.
The escrow instructions generally are a reflection of the
requirements for the transaction which were mentioned in the
purchase agreement. In case of a conflict between the purchase
agreement terms and the escrow instructions, the escrow agent
usually complies with the latter of the two contracts -- the escrow
instructions. To avoid such a conflict, the escrow instructions can
be assimilated into the purchase agreement.
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The aim of the escrow is to make sure that the seller obtains the
purchase price, the buyer receives clear title to the property, and
the lenders security interest in the property is protected. The
parties are protected by the escrow, of any parties change of mind.
For instance, if the seller suddenly refuses to sell the property as
per the agreement, he cannot simply refuse to deliver the deed to
the buyer. When a deed has been given to an escrow agent, and if
the buyer fulfills all of the conditions stated in the escrow
instructions and deposits the purchase price into the escrow, the
escrow agent must deliver the deed to the buyer. Another plus point
of escrow is convenience, since the parties do not need to be
present at the closing of the transaction.
Escrow Services
To prepare a transaction for closing, the escrow agents carry out a
wide range of services. The following steps are involved in almost all
escrow closings:
- Ordering a title report from the title insurance company,
- Ordering inspections,
- Paying off existing loans secured by the property,
- Preparing the deed and other documents,
- Depositing funds from the buyer (and the seller too, if
required),
- Requesting the funding of the buyers loan,
- Allocating expenses and closing costs,
- Preparing settlement statements,
- Acquiring title insurance policies,
- Recording of documents, and
- Disbursing funds and delivering documents.
The escrow agents services are specific in nature. For instance, an
escrow agent will order a title report according to the escrow
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instructions, but he will not examine the report for the parties and
discuss any unexpected problems revealed by the report. It is up to
the parties to review reports and deciding whether to proceed with
the transaction.
Escrow Termination
When the transaction closes, the escrow terminates. The escrow will
also terminate if the terms of the escrow instructions have not been
fulfilled by the pre-arranged closing date (if no closing date has
been fixed, then within a reasonable time). It is a general rule that
the escrow can be terminated earlier only when both the buyer and
the seller mutually agree to the termination. None of the parties can
singly terminate the escrow, without the others consent. Even the
death or incapacity of a party cannot in itself terminate the escrow.
In case of a failed transaction, there might be a conflict between the
buyer and the seller over which of them is entitled to funds and/or
other items placed into the escrow. If the conflict between the two
parties is not resolved, then the escrow agent files an interpleader
action, taking the matter to the judiciary. The court will then decide
on the rightful owner of the items in escrow. The escrow agent is
not authorized to adjudicate a dispute between the parties.
Escrow Agents
In northern California, the title companies are generally the escrow
agents and in southern California, the independent escrow agents
normally close most of the transactions. Many institutional lenders
have their own escrow departments to close their own loan
transactions.
According to the California escrow law, all escrow companies must
be licensed by the state Department of Corporations. Individuals
are not eligible to be licensed as escrow agents, only corporations
are. Banks, savings and loans, insurance companies, title
companies, attorneys and real estate brokers do not require this
license since they are regulated by other agencies.
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The exemption from the escrow licensing requirement for real estate
brokers is actually limited to activities that requires a real estate
license which takes place in the course of a real estate transaction
in which one of the parties is represented by the broker or the
broker is herself one of the parties. Due to this exemption, brokers
are able to provide escrow services to their clients. The broker may
even charge for these services. The exemption does not allow real
estate brokers to act as escrow agents for transactions in which
they do not have any legal interest other than that of providing
escrow services.
is a debit for the buyer while a sales commission is a debit for the
seller. Items payable to a party are a credit. For example, a buyer is
credited for a new loan and a seller is credited for the purchase
price.
There is more to a settlement statement than just ascertaining what
charges and credits apply to a said transaction and assuring that
each one is allocated to the appropriate party. While apportioning
expenses, an escrow agent usually follows the terms of the
purchase agreement or the escrow instructions. The allocation
could be determined by custom, too, assuming that the custom will
not conflict with the terms of the parties contract. For instance, in
most deals the buyer is the one who pays for the appraisal cost, so
that cost will be charged to the buyer by default. Nevertheless, if the
seller has agreed in the purchase agreement to pay the appraisal
fee, then the agreement takes precedence over custom and the
expense will be a debit for the seller on the statement.
Note that custom or agreement between the parties will not be
honored if they are against the local, state, or federal law.
It is true that a real estate agent normally will not be called upon to
prepare a formal settlement statement, but she should know what
closing costs are expected to be involved in a transaction and how
they are usually apportioned. The buyer and the seller may look to
negotiate the allocation of particular costs. The buyer and seller
should always know all the costs before signing a contract. A real
estate agent must have the ability to make a preliminary estimate of
closing costs for the parties.
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309
During the loan term, the borrower may be requested by the lender
to make regular payments towards the recurring costs. These
payments are usually kept in an impound account, also called a
reserve account or an escrow account. The funds in the impound
account are used by the lender to pay taxes, insurance, and other
charges whenever they are due.
When the sellers loan is paid off, the unused amount in the
impound account is refunded back to the seller. This is reflected as
a credit on the seller-side of the settlement statement. In case a
buyer is assuming the loan and the impound account, the reserves
would reflect as a credit for the seller and a debit for the buyer.
Appraisal Fee: The appraisal fee is a debit for the buyer, since
appraisals are usually required by the buyers lender.
Credit Report: This is also a debit for the buyer because the lender
of the buyer charges him for the credit analysis.
Survey: At times, a lender needs a survey as a condition for making
the loan. Most often, the cost of the survey is a debit for the buyer.
Origination Fee: This is a one-time charge for the lender, from the
borrower, for setting up the loan. This fee is a debit for the buyer.
Discount Points: If the seller has not agreed to pay for a buydown,
the discount points will be a debit for the buyer. But in case of a
buydown payment from the seller, the discount points will be a
debit for the seller.
Assumption Fee: When the buyer is assuming the sellers existing
loan, a lender then charges an assumption fee, which is a debit for
the buyer.
Mortgage Insurance Premiums: In transactions with mortgage
insurance, the lender may need a certain number of premiums to
be paid in advance. These premiums are a debit for the buyer.
Owners Title Insurance Premiums: In northern California, the
premium for the owners title insurance policy which protects the
buyer is generally paid by the buyer, while in southern California it
is the seller who pays the premium.
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PRORATION
There are different recurring expenses involved in the ownership of
real estate. These may be property taxes, mortgage interest
payments, and hazard insurance premiums. Generally, it is the
responsibility of the seller while he is the owner of the property to
pay these expenses. When the settlement statement is prepared, the
escrow agent checks whether the seller will be current in arrears, or
paid in advance with respect to these expenses on the closing date.
The expenses are then prorated by the escrow agent to determine
the portion for which the seller is responsible. Prorating an expense
means dividing and allocating them proportionately as per time,
interest, or benefit.
If the seller will be in arrears regarding a particular expense on the
closing date, the amount owed by him is entered as a debit on the
settlement statement. The seller is entitled to a partial refund if he
has paid in advance, which will be reflected as a credit on the
statement. If the expense is going to continue after closing, the
buyer is responsible for it at the point his period of ownership
begins. This reflects as a buyers credit (if the seller is in arrears) or
as a debit (if the seller has paid in advance) on the settlement
statement.
The first step in prorating an expense is dividing it by the number of
days it covers to find out the per diem rate. So, an annual expense
would be divided by 365 days or 366 days if it is a leap year. A
monthly expense would be divided by the number of days it is
applied in the month in question.
The next step is to find out the number of days during which a
party will be responsible for an expense. The last part is to multiply
that number of days by the per diem rate, to get the share of the
expense that a party is responsible for.
Property Taxes: Until the closing day, the seller is responsible for
the property taxes. The buyers responsibility starts on the day of
closing and thereafter. If the property taxes have been paid by the
seller for the year, he will be entitled to a prorated refund at closing.
This will reflect as a credit for the seller and a debit for the buyer on
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313
Rent: Thus far only prorated expenses have been discussed. But
there is also income to be prorated at closing in some transactions.
If rental income is generated by the property and the tenants have
paid for some period after the closing date, the seller is debited
while the buyer is credited for this rent paid in advance. In case the
rent is paid in arrears, the seller will be credited for the amount due
until closing and the buyer will be debited for the same amount.
Note that the security deposits of the tenants are not prorated. The
seller has to transfer all of the deposits to the buyer as the leases
will continue after closing.
Cash at Closing: As mentioned earlier, the sum of one partys
credits should always equal the sum of that partys debits on the
settlement statement, so that the final balance is zero in each
partys account. For the statement to operate in this way, it should
list the amount of cash that the buyer brings to closing, and also
the sum of cash the seller will take away from closing.
Balance Due from Buyer: All the buyers credits and all the buyers
debits should be totaled, then the buyers credits should be
subtracted from the buyers debits to calculate the balance due.
This is the amount of cash which the buyer will have to pay at
closing. This amount is to be entered as a credit for the buyer. Now
the buyers credits column must add up to exactly the same
amount as the buyers debits column.
Balance Due to Seller: All the sellers credits and all the sellers
debits should be added up, then the sellers debits should be
subtracted from the sellers credits. This will show the amount of
cash the seller will receive at closing. This amount should be
entered as a debit if credits total more than the debits, but as a
credit if debits exceed than the credits. Now the credits column of
the seller must add up to exactly the same amount as the debit
column of the seller.
Remember that the buyers two column totals should match each
other, as should the sellers. Nevertheless, the buyers column totals
may not necessarily match the sellers column totals. Yet, there is a
slight possibility that the buyers totals may match the sellers
totals in a particular transaction (although, normally they do not).
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316
which
lender
approval
is
not
It should be noted that RESPA is also not applicable to sellerfinanced transactions, because those are not federally regulated.
RESPA Requirements:
Following are the RESPA requirement for federally-related loan
transactions:
1. In a span of three days after receiving the writers loan
application, the lender/loan originator must give all
applicants:
A copy of the booklet about settlement procedures
which is prepared by HUD, which explains RESPA,
closing costs, and the settlement statement,
A mortgage servicing disclosure statement, which
states the intention of the lender to either service the
loan or transfer it to another lender, and
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319
Chapter Summary
The process of finalizing the real estate transaction is called
closing or settlement.
If the conflict between the two parties do not resolve, then the
escrow agent shall file an interpleader action, taking the
matter the judiciary.
In northern California, the title companies are generally the
escrow agents and in southern California, the independent
escrow agents normally close most of the transactions.
Apart from the purchase price: inspection fees, title insurance
charges, loan fees, and so on, there are other variety of costs
in a real estate transaction, known as closing costs.
The items listed on the settlement statement are: debits or
credits.
320
Chapter Quiz
1.
2.
3.
5.
6.
7.
8.
9.
10.
11.
12.
14.
15.
Under FIRPTA:
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CHAPTER 13
Real Estate Taxation
CHAPTER OVERVIEW
In the U.S., the income of individuals and businesses are taxed by
the federal government on an annual basis. This chapter will deal
with how the transfer or acquisition of real estate can affect the
federal income taxes that a seller or a buyer is required to pay.
Before that, though, we will learn some basic terms and theories
regarding real estate taxation, along with certain types of
transactions that receive special treatment. This chapter will also
cover the tax deductions available to real estate owners.
PROGRESSIVE TAX
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INCOME
Many people think about income only in terms of wages or salaries
they earned at a job. However the Internal Revenue Service (IRS)
has a broader outlook of income. The IRS considers any economic
benefits attained by a taxpayer as part of his income, unless it is a
kind of benefit particularly excluded from income by the tax code.
Deductions and Tax Credits
Certain expenses are authorized by the tax code to be deducted
from income. For instance, if a business suffers monetary losses in
a particular tax year, the business owner may be allowed to deduct
the loss. A taxpayer who is entitled to deductions can subract a
specified amount from his income before it is taxed. By reducing the
amount of income taxed, the amount of tax the taxpayer owes is
similarly lowered.
As opposed to deductions, tax credits are subtracted directly from
the tax amount owed. The income of the taxpayer is added up, the
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tax rate is applied, and after that any applicable tax credits are
applied to find out how much the taxpayer will actually have to pay.
Deductions and tax credits are often used by the government for
implementing social and economic policy. For example, the
government might allow homeowners to deduct mortgage interest
from their taxable income to make homeownership more affordable.
(we will study the mortgage interest deduction later in this chapter).
Gains & Losses
Whenever there is a sale or exchange of an asset real estate, for
example it almost always results in either a gain or a loss. Gains
are always considered as income, therefore any gain is taxable
unless the tax code states otherwise. Conversely, a loss may be
deducted from income only if the tax code authorizes the deduction.
Generally, the losses incurred in a trade or business or in
transactions entered into for profit are deductible losses. A business
entity can deduct all of its losses. An individual taxpayer can
deduct a loss only if it was incurred in regards to:
1. The taxpayers trade or business,
Business and Rental Property: Gains and losses on the sale of real
property used in a business or for the production of income (as in
rental property) are treated differently than gains and losses on the
sale of personal use and investment property. A gain on the sale of
a business property or a rental property which is owned for more
than a year and then sold is considered a capital gain. But a loss on
such a sale is deductible as an ordinary loss and not a capital loss.
This is a benefit, since the $3,000 annual limit on the deduction of
capital losses does not apply. The full amount of the loss can be
deducted in the year in which it is incurred.
Basis
For the purpose of income tax, the property owners basis is the
investment he has made in the property. If an asset is sold by a
taxpayer, the basis is the maximum amount received for the asset
without realizing a gain. It is important to know the taxpayers basis
in the property in question, so as to determine gain and losses.
Initial Basis: Generally, a taxpayers initial basis (which is also
called cost basis or unadjusted basis) is equal to the original cost of
acquisition (the cost of acquiring the property). For example, if she
paid $580,000 for a rental home in addition to $20,000 in closing
costs, she has an initial basis of $600,000 in the property. If the
taxpayer sells the property for $600,000, she does not have to
report a gain to the IRS.
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Realization
All gains are not taxable immediately. A gain is only considered
when it is realized. Ownership of an asset appreciating in value only
will involve a gain, and not otherwise. During a sale or exchange of
an asset, the gain is separated from the asset, for tax purposes.
The difference between the net sales price, which is called the
amount realized in the tax code and the adjusted basis of the
property equals the gain or loss realized on a transaction.
Net sales price (amount realized) Adjusted basis = Gain or Loss
While calculating the amount realized, the sales price consists of
money or other property received in exchange for the property, in
addition to the amount of any mortgage debt that is eliminated.
Therefore, if the buyer takes the property subject to the sellers
mortgage or assumes it, the amount of that debt is regarded as part
of the sales price for taxation.
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and
exclusion
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6. Dealer property.
Principal residence property: A principal residence property which
is also called a main home is the taxpayers ownership home which
he occupies as his primary dwelling. This might be a single family
home, a duplex, a condominium unit, a cooperative apartment, or a
mobile home. In case the taxpayer owns more than one home and
lives in both of them, the principal residence will be the one in
which he resides more often. A taxpayer cannot have two principal
residences at the same time.
Personal use property: Real property owned by the taxpayer for
personal use (other than the principal residence) will be classified
as personal use property. A second home or a vacation home will
come under this category.
Unimproved Investment Property: Vacant land that does not
produce any rental income is called unimproved investment
property. The only reason for holding such a land is the expectation
that it will appreciate in value.
Property Held for Producing Income: This includes residential,
commercial, and industrial property that is used to generate rental
income for the owner.
Property Used in a Trade or Business: In this category the land
and buildings owned by the taxpayer is used for his business or
trade, such as a factory owned by the manufacturer.
Dealer Property: Dealer property is not held for a long term
investment but rather mainly for sale to customers. If a developer is
subdividing the land for the sale to customers, the lots will normally
be a part of this classification till the time they are sold.
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Non-recognition Transaction
As discussed earlier, when a non-recognition provision in the tax
code is applied to a particular transaction, the taxpayer does not
have to pay taxes on a gain in the year it is realized. Recognition of
the gain is deferred to a later time. The types of real estate
transactions that are covered by non-recognition provisions are:
Installment sales,
Tax-free exchanges.
Remember that a non-recognition provision does not totally exclude
a gain from taxation. Instead, it merely defers the tax consequences
to a later tax year. These are not actually tax-free transactions.
The realized gain is determined and taxed in the following year.
INSTALLMENT SALES
According to the tax code, an installment sale is that sale in which
less than 100% of the sales price is received in the year in which
the sale is made. Almost all seller-financed sales are installment
sales. Installment sale reporting permits the taxpayer (seller) to
defer recognition of part of the gain to the year (or years) in which it
is received. Effectively, taxes are only paid on the part of the profit
that is received each year. The gain is prorated over the term of the
installment contract. Installment sale reporting is allowed for all
categories of property, although dealer property is eligible only
under special conditions.
The calculation of gain recognized in a given year, in installment
sales, is based on the ratio of the gross profit to the contract price.
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The difference between the sales price and the adjusted basis is the
gross profit.
For calculating the gross profit, the sellers adjusted basis at the
time of sale is taken and added to the amount of commission and
other selling expenses, with this sum then being subtracted from
the sales price.
To calculate the gross profit ratio (also called the gross profit
percentage), the gross profit is compared to the contract price. The
total amount of all principal payments which the buyer will pay to
the seller is essentially the contract price. If the buyer is not
assuming the sellers existing loan, then the contract price will
almost always be the same as the sales price.
Gross Profit Contract Price = Gross Profit Ratio
It is noteworthy that the gross profit ratio is not applied to the
interest the buyer pays to the seller. All the interest payments are
counted as taxable income in the year received.
In case the buyer assumes (or takes subject to) a mortgage that is
larger than the sellers basis in the property, the excess will be
taken as payment received from the buyer. Also, in case the
property is subject to recapture provisions because of depreciation
deductions, the amount re-collected will also be treated as a
payment received in the year of sale. (Depreciation deductions will
be discussed later in this chapter)
Involuntary Conversions
When an asset is converted into cash without a deliberate action on
the part of the owner -- for example, the asset is condemned,
destroyed, stolen, or lost and the owner gets a condemnation award
or insurance proceeds -- it is said to be an involuntary
conversion. A sale which is under the threat of condemnation is
also considered an involuntary conversion. Normally, the award or
proceeds represents the replacement cost or market value of the
property, and therefore the owner almost always realizes a gain on
an involuntary conversion.
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TAX-FREE EXCHANGES
There is section 1031 of the tax code in connection with property
exchanges. The so-called tax-free exchanges are actually just taxdeferred exchanges. Recognition of any realized gain will be
deferred, if unimproved investment property, income property, or
property used in trade/business is exchanged for like-kind
property. This type of deferral is not applicable to a principal
residence, personal use property, and dealer property.
The current tax expenses can be reduced or eliminated using the
tax-free exchanges. In doing this, the taxpayer may be able to
obtain a property in an exchange which would have been unfeasible
as a purchase with the after-tax proceeds from selling the old
property.
The property received by the taxpayer in exchange must be likekind, meaning it must be similar to the property given. This
requirement is concerned with the nature of the property and not
the quality of it. For the purposes of the exchange deferral, most
real estate is contemplated to be of like kind, irrespective of the fact
that it might be improved, unimproved, residential, commercial, or
industrial. For instance, if a taxpayer is to exchange an apartment
complex with a strip shopping center, the transaction can qualify as
a tax-free exchange. Both the exchanged properties should be
located in the U.S. so that they are considered like-kind property. If
only like-kind properties are exchanged, then in this case no gain or
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not. If the taxpayer was entitled to take the deduction, the basis will
be reduced. The taxpayers subsequent gain or loss on resale of the
property is affected by the deductions, since the basis is reduced.
Uninsured Casualty or Theft Loss Deductions
The property owner will generally be allowed to deduct the
uninsured loss from the taxable income, if the property is damaged
or stolen and the loss is not covered or only partly covered by the
insurance. The amount of the deductible loss is calculated first by
subtracting the estimated fair market value of the property after the
loss from its estimated value before the loss. This reduction in value
is compared to the owners adjusted basis in the property. From the
figure that is the smaller of the two, any insurance reimbursement
that the owner has received or is expecting to receive is subtracted.
For almost all types of property, the result is the amount of the
deductible loss.
The amount of the deductible loss is reduced by some additional
calculations in case of personal use property and principal
property. After following the above mentioned steps, further
subtract $100 from the loss. Then, subtract 10% of the taxpayers
adjusted gross income. This amount will be the deductible loss of
the taxpayers personal use property/principal property.
In case of the taxpayer having more than one casualty loss for the
personal use property in a given tax year, he must deduct $100
from each loss. But the 10% of the adjusted gross income is
subtracted from the total amount of those losses (and not from each
loss).
Repair Deductions
The expenditure incurred to maintain the property in normal and
efficient operating condition is called a repair expense. In almost all
property types the repair expenditure is deducted in the year paid.
Note that repair expenses are not deductible for principal
residences or other personal use property. Expenditures for
maintenance, regular wear and tear, repair and also condominium
assessments are included in this.
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Chapter Summary
Depending on how the burden of a tax is distributed among
taxpayers, the taxes may be proportional, regressive, or
progressive.
The IRS considers any economic benefits attained by a buyer
taxpayer as part of his income, unless they are the kind of
benefits particularly excluded from income by the tax code.
Deduction and tax credits are generally used by
government for implementing social and economic policy.
the
Chapter Quiz
1. Property taxes are ad valorem taxes, meaning _________
a. They are charged in relation to the value of the property
b. They are sales tax
c. They are use taxes
e. They are charged once at the time of the property transfer
d. Antique furniture
8. As per the federal income tax code, income is usually taxed in
the year it is:
a. Realized
b. Recovered
c. Deferred
d. Recognized
d. None of it.
d. $350,000
CHAPTER 14
Civil Rights & Fair Housing
CHAPTER OVERVIEW
Civil law is a legal system based on laws and regulations, without
the influence of judicial decisions as in the common law system.
The intention of the civil rights laws is to encourage fairness and
freedom. In the context of real estate, the primary aim of these laws
is to insure equal housing opportunity for all. The civil rights laws
are also in place for nonresidential real estate.
It is important for real estate agents to understand the federal and
state laws that prohibit discrimination in real estate transactions
and business activities connected to it. It is one of the professional
duties of the real estate agent to comply with these laws and also
encourage others to comply with them.
This chapter will deal with the federal and California state antidiscrimination laws affecting real estate.
in
real
estate
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transactions are also prohibited by this law. The Fair Housing Act
does not apply to nonresidential transactions, as in those involving
commercial or industrial properties.
Exemptions: there are four types of transaction that are exempt
from the Fair Housing Act:
1. The law will not apply to the sale or rental of a single-family
home by the owner, if:
- The owner does not own more than three homes of that kind,
- There is no involvement of a broker or real estate agent in the
transaction, and
-
like California, a state whose civil rights laws are much stricter
than federal law.
Prohibited Acts: The following acts are prohibited by the Fair
Housing Act if they are done on the basis of race, color, religion,
sex, national origin, handicap, or familial status:
Refusing to rent or sell residential property on receiving a bona
fide offer,
Not negotiating for the sale or rental of residential property, or
else making it unavailable,
Altering the terms of sale or lease for different potential buyers
or tenants,
Advertising with an indication of a preference or intent to
discriminate,
Expressing that the property is not available for inspection,
sale, or rent when it is actually available,
Using criteria that is discriminatory, when making a housing
loan,
Putting a limit on participation in a multiple listing service or
similar service,
Pressuring, intimidating, threatening, or interfering with
anyone owing to his/her enjoyment, attempt to enjoy, or
encouragement or assistance to others in enjoying the rights
given by the Fair Housing Act.
The discriminatory practices
redlining are also prohibited.
of
blockbusting,
steering,
and
under
2.
3.
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Architectural
barriers
and
communication
barriers should be removed for goods and services to be
accessible to disabled people.
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If
structurally
possible,
new
commercial
construction should be accessible to people with disabilities.
The Unruh Civil Rights Act: Under this act, all people are entitled
to the full use of any services provided by a business enterprise,
regardless of sex, race, color, religion, ancestry, national origin,
disability, mental condition, marital status, or sexual orientation. In
housing-related transactions, business enterprises are not
supposed to discriminate on the basis of age or familial status
(except in qualified housing for senior citizens).
The Unruh Act disallows real estate licensees from discriminating
while performing their work, as a brokerage firm is a business
enterprise. A broker is not supposed to refuse a listing or reject a
prospective buyer for discriminatory reasons.
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The Fair Employment and Housing Act also disallows anyone from
advertising housing for sale or rent in terms that are discriminating
in nature, including any ads that implies a preference for a certain
group. For example, an advertisement from a landlord that
indicates a preference for women or married couples as tenants.
The act also disallows discrimination in the financing of housing.
This act prohibits any bank, mortgage company, or any other
financial institution to discriminate against any person for his race,
color, religion, sex, sexual orientation, marital status, ancestry,
familial status, national origin, disability, or source of income.
There are some exemptions to this act. It does not apply to
accommodations managed by nonprofit religious, fraternal, or
charitable organizations. This act does not apply to the rental of a
portion of a single-family owner-occupied home to one occupant.
Also, when a rental arrangement includes shared living space, it is
allowed to state in the ad that it is available just to women, or just
to men.
The Department of Fair Employment and Housing takes care of the
housing discrimination complaints. The staff of the department
investigates the complaints. If it seems that a violation has ensued,
the department attempts to encourage the violator to stop or rectify
the violation. If this does not work, then the department issues an
accusation and a hearing will be held by the Fair Employment and
Housing Commission or in a superior court. On being found guilty,
the violator may be asked to:
Apart from the above the violator may also have to pay the injured
party actual damages, and civil penalties starting from $10,000 up
to $50,000. If the case has gone to superior court then instead of a
civil penalty the court may impose punitive damages on the violator.
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Chapter Summary
The Civil Rights Act of 1866 prohibits racial discrimination in
all property transactions.
The federal governments initiative to promote equal
opportunity in housing brought about the Civil Rights Act of
1964.
The Federal Housing Act, which is also called Title VIII of the
Civil Rights Act of 1968, makes it illegal to discriminate on the
basis of race, color, religion, sex, national origin, handicap, or
familial status in the sale or lease of residential property or
even in the sale or lease of vacant land for the constructing
residential homes.
The classification of prohibiting discrimination based on
disability or familial status was added to the Fair Housing Act
only in 1988.
The Department of Housing and Urban Development (HUD)
enforces the Fair Housing Act through its Office of Fair
Housing and Equal Opportunity.
The Americans with Disabilities Act (ADA), a federal law, has
been in effect since 1992.
The Fair Employment and Housing Act also disallows anyone
from advertising housing for sale or rent in terms that are
discriminating in nature, including any ads that implies a
preference for a certain group.
Although discriminatory restrictive rovenants still exist in
some older documents, it is a violation of federal and state
laws to try to enforce them or abide by them.
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Chapter Quiz
1. Which of the following is NOT a federal antidiscrimination law?
a. The Civil Rights of 1866
b. The Civil Rights of 1964
c. The Unruh Civil Rights Act
d. The Fair Housing Act
2. The illegal practice of telling people that the property values in
a particular neighborhood will fall because of a certain event,
like the purchase of homes by minorities, is called:
a. Panicking
b. Blockbusting
c. Steering
d. Redlining
3. Channeling prospective buyers away from or toward a specific
neighborhood based on their race, religion, or national origin
so as to maintain or change the character of that
neighborhood is __________.
a. Steering
b. Blockbusting
c. Redlining
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d. Panic peddling
4. Initially, the Fair Housing Act did not prohibit discrimination
based on disability or familial status, these classifications were
added to the law later in the year_______.
a. 1968.
b. 1978.
c. 1988.
d. 1998.
5. The California law prohibiting discrimination in the sale,
rental or financing of almost all types of housing is the________
Act.
a. California Fair Employment and Housing
b. Holden
c. Fair Housing
d. Unruh Civil Rights
6. The ______________________ is also called the Rumford Act.
a. Unruh Civil Rights Act
b. Fair Employment and Housing Act
c. Housing Financial Discrimination Act
d. Americans with Disabilities Act
7. The _________________ is also called the Holden Act.
a. Unruh Civil Rights Act
b. Housing Financial Discrimination Act
c. Fair Employment and Housing Act
d. Americans with Disabilities Act
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11.
Which of the following Act is a federal law and NOT a
California state law:
a. Fair Employment and Housing Act.
b. The Civil Rights Act of 1964.
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15.
The Law that prohibits the licensee from discriminatory
behavior is:
a. The Housing Financial Discrimination Act
b. California Real Estate Law
c. The Rumford Act
d. Unruh Civil Rights Act
CHAPTER 15
Real Estate Construction, Ownership
and Investment
CHAPTER OVERVIEW
When it comes to bringing a buyer and a seller together, the real
estate agent needs to be familiar with the following factors: property
values, contracts, financing, the fundamentals of residential
construction, the advantages of buying a home, the essentials to
look for in a home, and also the benefits of investing in real estate.
In this chapter we shall cover:
- Some features of residential construction, especially wood
frame construction,
- The comparative merits of renting or buying a home, and the
facts to consider when selecting a home as a home or as an
investment, and lastly
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Architectural styles,
ARCHITECTURAL STYLES
There are various types of architectural styles used for homes. The
style affects the cost of construction, although the style of a home
does not define the quality of a home. A particular style is not
essentially more desirable over another. The value of the style is
totally dependent on the personal preferences of the buyer.
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Homes have their own unique styles and sometimes two or more
styles are combined to provide a desired effect. Some of the popular
architectural styles in California are split-level, Spanish, California
ranch, and modern (or contemporary).
In a split-level type home, hilly terrains are effectively used and
these are also visually very attractive.
Spanish-style homes are normally one- or two-story homes and
with exteriors that are white or pastel stucco with red-colored roof
tiles. In the heat of southern California, this style looks cool and
comfortable.
These modern-style homes are generally built with large windows
and glass doors and are designed to have open interiors. The
modern homes are so flexible in design that they can be easily built
on hilly areas and other hard-to-reach sites.
California ranch homes are usually one story and low-pitched or
flat-roofed. The exteriors are wooden, masonry, or stucco.
The simplest to construct and maintain is the one-story ranch
home, but it requires more land in terms of living space than a twostory or split-level home. Where land prices are high, a one-story
home may not be economical. A split-level construction is
comparatively more expensive, but because of its effective
utilization of land (with varying topography), it is quite popular. As
with the per square foot of living space, a two-story building is most
economical, as twice the living space can be provided with one
foundation, roof and same size of land. The main drawback of the
two-story home is the inconvenience of staircases and the exterior
maintenance for the upper story.
Local Building Codes and Regulations
The types of material to be used in residential construction,
appropriate methods of construction, and the quantity and
placements of items like electrical outlets, plumbing fixtures, and
windows are all specified by the local building codes. Also the size
and placement of a building on its lot are controlled by the building
codes and other local regulations.
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is called the
to be used and
A plans and
are normally
Roofing: The highest structural member of the house -- the roof -is made up of the ridge board, rafters, and plywood or boards
arranged perpendicular to the rafters. This sheathing is then
covered with roofing felt, made of tar-impregnated paper. The last
layer of roofing could be wood shingles, tiles, or composition roofing
(tar-like shingles or rolls of material). Often hot tar is combined with
more layers of felt. This is referred to as a built-up roof. Metal
sheeting called ing is installed on top of the roofing material around
chimneys and other openings to avoid water seepage.
Floor Covering: The strength of the floor comes from the tongueand-groove floor boards or plywood attached to the floor joists, this
is called the sub-flooring. This sub-flooring is then covered with
finished flooring. Finished flooring may be carpet, tiles, linoleum,
hardwood strips, or other such materials.
Plumbing: The drain pipes, supply pipes, and fixtures are all part
of plumbing. The drain pipes may be made up of plastic, concrete,
or cast iron. Plastic, copper, or galvanized steel is used for making
supply pipes. Plumbing fixtures may be made of either cast iron or
pressed steel that is coated with enamel or fiberglass.
Electrical: Generally, modern wiring is in the form of cable. A cable
is a cord-like material consisting of two or more strands of copper
or aluminum wires. These electrical cables are enclosed in metal or
plastic piping called a conduit.
There is a supply source, such as a fuse box, or a breaker panel,
from which the electrical cables run in circuits to the various
outlets for plugs or light fixtures. A breaker panel is a series of
circuit breakers that automatically cuts off the current in a circuit
in overload conditions. The majority of outlets supply 110 volts of
power, apart from certain outlets designed for major appliances like
ranges, water heaters, dryers, and so on, which supply 220 volts.
Heating, Ventilation, and Air Conditioning (HVAC): These are
systems comprising heating and/or cooling appliances. These
appliances provide warm, cool, or fresh air to the rooms of a home
through a sequence of galvanized sheet metal tubes called ducts.
The ducts open at different places in the building called registers.
The registers may be shut off singularly in order to direct the heat
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Advantages of Buying
For many people, buying a property offers an advantage of security
and personal satisfaction along with the financial advantages of
equity appreciation and tax deductions.
Security: There is a certain amount of security in knowing that you
can stay in the home as long as the mortgage payments are made. A
renters security is limited to the term of the lease. Once the lease
term expires, he may have to vacate the premises. A month-tomonth tenant has even less security.
Privacy and No Restrictions: Mostly, a homeowner has more
freedom to use the property and greater privacy than a renter. A
homeowner is free to redecorate or remodel his house, keep pets,
and engage in other activities that may be disallowed in many
rental agreements.
Monthly Payments: Usually, a homeowners monthly mortgage
payment is higher than the rental payment for a similar rental
home. But, as time goes by, rents are likely to increase at a faster
rate than mortgage payments, especially if the mortgage has a fixed
interest rate. In such a case, the monthly payment will only
increase if the property tax or insurance portion of it increases
(which does not happens frequently). If the mortgage interest rates
are adjustable, the payment amount increases at a faster pace but
will decrease if the interest rates come down. So, eventually a
monthly rental payment may be larger than a monthly mortgage
payment.
Investment Appreciation: It is not possible to forecast whether a
particular home will appreciate in value and how much it will
appreciate. It is possible that, due to financial conditions,
maintenance issues, and neighborhood decline, it may depreciate
instead. In the past however, average home values have overtaken
the average inflation rate. With the appreciation of a home, the
homeowner generally enjoys an increase in home equity, and as a
result, increases in net worth. Contrarily, a renter can see his rent
payments increase with the appreciation of the property.
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376
THE HOME
Obviously, the aspects to be reviewed with a prospective buyer
regarding the home itself are its size, condition, and amenities. Here
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there is an entrance from the garage to the house that can protect
from bad weather.
Basement/Attic: Note if the attic or basement is connected well
through the main house and also if there is extra space for the
storage or work area. See the possibility of converting the basement
into an extra room or bedroom.
Energy-saving Features: Ever-increasing energy costs and
concerns regarding the environment have led to an increased
demand for energy-efficient homes. Some of the energy-saving
features are clock-controlled thermostats, insulation-wrapped water
heaters, insulated ducts and pipes in unheated areas, sufficient
insulation for floors, walls and attic, and weather stripping for the
doors and windows. Solar energy equipment is gaining in
popularity.
Interior Design on the Whole: A real estate agent should be aware
of some of the features of a well-designed and an efficient floor plan.
For example, a good plan will have a toilet in every bedroom.
Other design factors that are to be considered are the number and
the size of bedrooms, closets, and bathrooms. There should be
enough rooms with regard to the square footage of the home. A
good design will have a separate dining room or should have a
dining area in the kitchen or living room. The kitchen of a welldesigned home will be spacious and have good sunlight. A storage
room and a laundry room will add to the value of the home.
Considerations for Each Room: Some features are important to
the comfortable and efficient use of each room.
Living Room/Family Room: The size of the living rooms is a
factor along with if there are any family rooms. Also, note the
shape of each of the rooms for optimum furniture placement.
Dining Room or Area: The dining area should be convenient to
the kitchen, and adequately large in relation to the room size.
It should be big enough to accommodate the number of people
living there.
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380
- No space provided near the kitchen for the family to sit and
eat,
2) Debt investments.
In ownership investments, the investor has an ownership interest
in the asset. Examples of ownership investments are real estate and
stocks. Here the returns will be in form of dividends or appreciation
(or both in certain cases). Ownership investments are also called
equities.
A debt investment is actually a loan that an investor makes to an
individual or an entity. For instance, a bond is a debt owed by a
government entity or a corporation to an investor. The investor
lends the entity money for a certain amount of interest, for a set
period of time to an entity who promises to repay the loan by its
maturity date. An ordinary mortgage loan is also an example of a
debt investment.
These investments are generally diversified by the investors,
meaning they do not invest in just a single type of investment, but
rather in different types. The different types of investments that a
person/company owns in addition to any cash reserves, is called a
portfolio.
For taxation purposes, investment income like dividends, interests,
or rents is always separated from earned income like salary, wages,
or self-employment income.
Characteristics of Investment
The investment opportunity is evaluated by an investor in terms of
three possible advantages: safety, liquidity, and yield (a yield is the
total return on the investors investment). All three characteristics
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383
385
388
Chapter Summary
Real estate agents should not convey the impression of being
an expert in residential construction.
Building codes help maintain a level of uniformity in
construction.
The simplest home to construct and maintain is the one-story
ranch home. But it requires more land in terms of living space,
than a two-story or split-level home.
The drawings of the vertical and horizontal cross-sections of a
building are called the plans. They indicate the placement of
foundations, floors, walls, roofs, doors, windows, fixtures, and
wiring. The text that accompanies the plans is called the
specifications.
The wood frame building is the most common type of home
construction.
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Chapter Quiz
1. In building construction, the _______________ assure(s) uniform
standards of construction quality.
a. Planning commission
b. Zoning ordinances
c. Building codes
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a. Orientation
b. Floor plan
c. Architecture
d. View
a. Studs
b. Beams
391
c. Plates
d. Joists
6. Which one of the below is an advantage of renting over owning
a home?
a. Mobility
b. Appreciation
c. Security and stability
d. Federal tax deduction
d. Sheathing
10. What is the mix of investments owned by an individual or a
company called?
a. Leverage
b. Yield
c. Portfolio
d. Equity
CHAPTER 16
Real Estate License Law in California
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CHAPTER OVERVIEW
The real estate industry in California is strictly regulated. The Real
Estate Law governs licensing requirements and the other
responsibilities of real estate agents. In this chapter we shall learn
when a real estate license is required, who is qualified to get a real
estate license, licensing and renewal procedures, disciplinary
actions against licensees, rules regarding trust funds, and other
requirements of the Real Estate Law. We shall also learn how
antitrust laws affect the real estate business.
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need not pay the salesperson directly. They must pay the
salespersons broker, who will then pay the salesperson.
By the end of 2010, an MLO endorsement was required for
salespersons as well as the brokers who are involved in residential
mortgage loan brokerage activities.
Associate Brokers: are licensed brokers who chooses to work for
another broker rather than operating his own brokerage. A broker
who does this is called an associate broker or a brokersalesperson and he is essentially under the same limitations as a
salesperson. The associate brokers and salespersons working for a
particular broker are also called the brokers affiliated licensees.
Business Entities: A corporation can be issued a real estate
license. Under this corporate brokerage license, at least one
corporate officer needs to be appointed to perform the duties of a
broker. This officer should also have his individual real estate
brokers license, and he can only perform as a broker with regards
to corporate brokerage.
Although there is no partnership license, partners may perform
acts that require a brokers license, but every partner should be
licensed as a real estate broker.
Unlicensed Activities Penalties: The penalty for performing acts
that require a license without having a license is a fine of up to
$20,000 and/or six months imprisonment for an individual, and for
a corporation the fine may be up to $60,000.
Note it is unlawful for a broker to employ or compensate someone
who is unlicensed for performing acts that require a real estate
license. There is disciplinary action for brokers who do this and his
license may be suspended or revoked.
NON-REQUIREMENT OF A LICENSE
There are some exemptions from the real estate licensing
requirements. The exemptions could cover those who are acting on
behalf of themselves, or those controlled by another agency (for
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LICENSE QUALIFICATIONS
In order to obtain a real estate license in California, applicants need
to possess several qualifications. These requirements, particularly
the education requirement, are imposed to ensure at least a
minimum level of competence for all real estate professionals.
Salespersons Qualifications: To
salesperson, an applicant should:
procure
license
as
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404
license might have been expired does not count in the 30 year
period.) The proof of qualification of this exemption will have to be
submitted to the BRE by the licensee.
Continuing Education for MLO Endorsement: For renewing the
yearly real estate licensees mortgage loan originator endorsement,
the licensee should complete a minimum of eight hours of
continuing education each year. These eight hours should have at
least three hours on federal laws, two hours on ethics issues i.e.;
fraud, consumer protection, and fair lending, and two hours on
lending standards for non-traditional or subprime mortgage loans.
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office on the back of the certificate. The salesperson should also put
the date and his initials along with the changes made.
Discharge for Disciplinary Cause: If a salesperson is discharged
on account of bad conduct, his broker needs to file a certified
written statement of facts with the Commissioner. If he fails to do
so, the brokers license could be suspended or revoked.
Termination of Brokers License: The licenses of all the brokers
salespersons are automatically cancelled, if the brokers license is
suspended or revoked. The salespersons licenses may be
transferred to other brokers.
Upon expiration of the brokers license, the licenses of his
salespersons are at once placed on non-working status. These may
be reactivated once the broker renews his own license.
Changes in Address: The licensees have to maintain current
addresses on file with the BRE. A broker is required to provide a
mailing address, the address of his principal place of business, and
the branch office addresses, if any. A salesperson is required to
provide a mailing address and the address of his brokers principal
place of business.
Any changes in the brokers location or address of his main or
branch office should be conveyed in writing to the DRE within one
business day. All the licensees who are affected by the change need
to correct their license certificates by crossing out the old address
and writing the new one on the back, and also dating and initialing
the changes.
Fictitious Names: A real estate broker is allowed to procure a
license under a fictitious name if it is not:
Misleading or would signify false advertising,
Implying a partnership or corporation that is non-existent,
Involving the name of a real estate salesperson,
Violating certain legislative provisions, or
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SPECIAL ACTIVITIES
Prepaid Rental Listing Services: Prospective tenants are provided
with listings of residential property available for rent by the prepaid
rental listing service. Tenants have to pay a fee before or at the time
when the listing service provides the listings. The listing service
does not negotiate leases or rental agreements.
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BUSINESS OPPORTUNITIES
The sale or lease of a business is a business opportunity; this
includes inventory, fixtures, lease assignments, and goodwill.
Generally, a real estate license is required for listing a business
opportunity or representing the buyer of a business opportunity,
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413
course
of
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TRUST FUNDS
Mishandling of trust funds is the most common cause of
disciplinary action among real estate professionals. Some of the
reason behind this is confusion regarding the functions and use of
trust funds. California law is precise about the handling of trust
funds and it is essential for the licensees to be well-acquainted with
these rules. Sometimes an unintentional blunder can cause not
only a violation of the Real Estate Law, but even in a breach of the
agency duties owed by the licensee towards his clients or customers
(refer to chapter 8).
Trust Funds Definition
Learning to recognize trust funds is the first important step to
handling these kinds of financial instruments correctly. In simple
terms, trust funds are money or any other valuables that a licensee
is holding on behalf of another person. A trust fund may be in the
form of cash, a check, a promissory note, or any other item of
personal property. The licensee is simply holding the money or
property on someones behalf (normally a client or customer) while
a real estate transaction is being processed. As per the Reference
Book of the BRE, the definition of trust funds is:
Money or other things of value that are received by a broker or
salesperson on behalf of a principal or any other person, and which
are held for the benefit of others in the performance of any acts for
which a real estate license is required.
The good faith deposit that a buyer conveys to the broker along with
his offer to purchase a listed property is the most common example
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Trust Accounts
Avoiding commingling is the foremost reason for maintaining a
separate account for trust funds. (Commingling is the mixing of
trust funds with personal funds.) A broker must always keep the
trust funds separate from his general account. Similarly he must
also refrain from putting his own funds in a trust account.
Commingling is different from conversion. Conversion is the actual
misappropriation of the funds of a party for the brokers own
purposes. Conversion may be considered as theft under the
California penal code. Wrongfully removing a piece of real property
or personal property, or defrauding another person of money, labor,
or real or personal property is all considered as theft.
Borrowing trust funds by the broker is disallowed due to the
prohibition against commingling. If, in fact, the trust funds were
placed in the brokers general account then a judgment creditor
might seize those funds along with the brokers funds. Due to the
commingling rule, the trust funds are protected from any legal
actions that might be taken against the broker.
Shortages or Overages: The total amount of funds in the trust
account should at all times equal the brokers cumulative trust
fund liability. Comparing the trust fund balance to the sum of
individual transactions is called reconciliation. On reconciliation,
the trust account balance should equal the total of the balances
due to individual clients and customers.
There will be a trust fund shortage if the trust account balance is
less than the total liability. This type of shortage is a violation of the
Real Estate Commissioners regulations. If the trust account
balance is more than the total liability there is a trust fund
overage. As non-trust funds cannot be commingled with trust
funds, this will also be considered as a violation of the regulations.
A broker must always confirm that a check deposited into the trust
account has cleared before he disburses any funds against the
check. If funds are disbursed before the clearance of the check, or if
the check is returned for insufficient funds, a trust fund shortage
will occur.
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balance
on
the
basis
of
recorded
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Columnar System: A broker opting for the columnar recordkeeping system must keep three types of records:
1. A record of all received and disbursed trust funds: A record
that lists all trust funds deposited to and disbursed from the
trust accounts. Following information needs to be included:
a) Funds received date,
b) Received from whom,
c) The amount received,
d) The date of deposit,
e) For disbursements: the party to whom the funds were
paid,
f) The paid out amount,
g) The check number and date, and
h) The daily balance of the bank account.
2. A record for every client/customer or transaction: The
following information needs to be included:
a) The date of the deposit,
b) Deposited amount,
c) The name of the payee or the payer,
d) For the funds paid out, the check number, date, and
amount, and
e) The daily balance of the individual account.
3. A record of trust funds that are received and not deposited
into the trust account: This information needs to be
included:
a) The funds received date,
b) The form of the payment,
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ADVANCE FEES
As explained earlier, an advance fee is the money collected by a real
estate broker from a client in advance to pay for the expenses he
expects to incur on behalf of the client, or as advance compensation
for services to be provided later. Advance fees are also handled in
compliance with the trust funds rules that have been discussed
thus far. Advance fees should not be commingled with the funds of
the broker, and should be deposited into the trust account of the
broker within three days after receiving it.
Before advance fees in connection with any services are collected, a
broker should provide all of the materials intended to be used in
advertising or promoting those services to the Department of Real
Estate for approval, along with the advance fee agreement he is
entering into with his clients. The DRE reviews the materials to
confirm it includes a full description of the services to be provided;
states the total amount of the advance fee and when they need to be
paid; mentions a termination date for the agreement; does not
contain deceptive guarantees; and are not otherwise misleading.
The advance fees deposited in a brokers trust account cannot be
withdrawn until they are expended for the clients benefit or until
five days after an accounting has been sent to the client. This
accounting may either be a quarterly accounting or a final
accounting after the agency has ended.
DOCUMENTATION REQUIREMENTS
According to the Department of Real Estate, the brokers must keep
all of the documents connected with a real estate transaction. The
documents include:
Listings and buyer agency agreements,
Purchase agreements,
Rent collection receipts,
Bank deposit slips,
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Canceled checks,
Supporting documents for checks (e.g., invoices, receipts, or
escrow statements),
Agency disclosure statements,
Transfer disclosure statements, and
Property management agreements.
The above mentioned documents should be kept for at least three
years. The three-year period begins with the closing date (in case
the transaction does not close then the date of listing), and should
be available for inspection by the Commissioner. If required, the
records may be audited.
The below-mentioned documents have to be kept for four years
instead of three:
Real property security statements, and
Disclosure statements given to non-institutional lenders or
deed of trust purchasers.
Document Copies: Whenever a document is prepared for signature
by the licensee, a copy of the document must be conveyed to the
person signing it once signed. It is made mandatory by the Real
Estate Law for contractual documents (which includes listing
agreements,
buyer
representation
agreements,
purchase
agreements, property management agreements, all contract
addenda, and any later amendments), while other laws require it for
disclosure statements, settlement statements, and many other
documents.
Brokers Review of Documents
Brokers are supposed to supervise their salespersons; if they dont,
it is grounds for disciplinary action. Reviewing the documents
prepared by the salesperson that might have a material effect on
the rights or obligations of a party to a transaction is also part of
the brokers supervisory responsibilities.
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Broker-Salesperson Agreement
When a broker hires a real estate salesperson, he should document
this relationship in a written agreement. This agreement should be
filed and kept at the brokers office. The agreement has to be
retained for three years after the termination of the relationship.
ADVERTISING REGULATIONS
It is necessary for real estate licensee to be aware of the laws that
regulate the advertising that pertains to real estate as well as the
general advertising rules, such as the prohibition against false
advertising. The violation of state laws against false advertising also
counts as a violation of the Real Estate Law.
Licensee Designation in Advertising
The advertisements that are published or distributed by a real
estate licensee must carry a licensee designation, and any signs
that the advertiser is a license holder. An advertisement that does
fulfill this requirement is sometimes called a blind ad. The use of
single words like broker, agent, or Realtor are sufficient. Even
abbreviations like bro or agt can be used.
This rule typically applies to advertising regarding any matter for
which a real estate license is necessary. An exception to the
classified ads for rental properties is if the ad provides the phone
number or address of the rental property, then the licensee
designation is not required.
First Contact Solicitation Materials
A licensee is required to include his license identification number in
any solicitation materials that are going to be the initial point of
contact with potential clients or customers. Initial contact
solicitation materials consist of business cards, stationery,
advertising fliers, and other materials that are designed to solicit
the formation of a professional relationship with a consumer. It is
specifically stated in the law that identification numbers are not
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primarily with big steel mills, oil companies, and telephone services,
but in 1950 antitrust laws were also made applicable to the real
estate industry. In a groundbreaking case, the Supreme Court held
that mandatory fee schedules, established and implemented by a
real estate board, violated the Sherman Act. This was the United
States v. National Association of Real Estate Boards case.
A real estate agent violating the antitrust laws may face both civil
and criminal actions. A violator of the Sherman Act may be fined up
to one million dollars and/or sentenced to ten years imprisonment.
A corporation can be fined up to $100 million dollars.
Prohibited Practices and Activities
The below-mentioned business
prohibited by antitrust laws:
practices
and
activities
are
Price fixing,
Group boycotts,
Tie-in arrangements, and
Market allocation.
Price Fixing: Price fixing is defined as the cooperative setting of
prices or price ranges by competing firms. To avoid the emergence
of price fixing, real estate agents from different agencies should
refrain from discussing their commission rates. (The discussion
between competing salespersons/brokers could violate the law.
However, a broker can discuss rates with his own affiliated agents,
and agents who work for the same broker can discuss rates
amongst themselves.)
There is an exception to this general prohibition -- competing
brokers who are part of a cooperative sale are allowed to discuss a
commission split, the division of the commission between the listing
broker and the selling broker.
Even an informal pronouncement about a brokers plan on
increasing his commission rates could lead to antitrust issues.
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Chapter Summary
The Real Estate Law comprises the licensing requirements and
the responsibilities of real estate agents.
439
Chapter Quiz
440
3. If a real estate licensee does NOT renew his license before its
expiration, then the licensee:
a. Must cease all real estate activities.
b. May complete transactions in progress.
c. Is allowed to complete transactions that are almost
finished.
d. May act under authority of another agents license for a
period not more than 60 days.
7. Commingling is:
a. Paying a commission to an unlicensed person
b. Mixing personal funds with trust funds
c. The same as embezzlement
d. Any dishonest act related to trust funds
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10.
11.
A broker regularly puts the earnest money deposits in his
personal account for overnight safekeeping. This practice by
the broker is:
a. Acceptable
b. Mandated
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c. Prohibited
d. Discouraged
12.
The written agreement documenting when a broker hires
a salesperson must be retained by the broker for at least
_______ after their relationship terminates.
a. Three months
b. One year
c. Three years
d. There is no requirement to retain the agreement.
13.
A broker may keep an earned commission in a trust
account for not more than _______days.
a. Seven days.
b. 25 days.
c. 45 days.
d. 60 days.
14.
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15.
The commission rate that a listing broker charges on a
sale is determined by:
a. The buyer and the seller.
b. The seller and the broker.
c. The multiple listing services.
d. The Real Estate Commissioner
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CHAPTER 17
Real Estate Math
CHAPTER OVERVIEW
Real estate agents regularly use math for calculating their
commissions, to calculate the square footage of homes they are
listing or selling, to prorate closing costs, and so on. Although
electronic calculators make these calculations easier, it is necessary
to understand the basics of the math involved. In this chapter we
shall study step-by-step solutions of math problems that are an
important part of real estate business.
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447
A=LxW
L=AW
W=AL
A = 50 x 20
L = 1000sq.ft. 20
50 x 20 = 800sq.ft.
1000sq.ft. 20 = 50
W = 1000sq.ft. 50
1000sq.ft. 50 = 20
Once the numbers given in the problem have been substituted into
the formula, it might be difficult to decide whether to multiply or
divide. Compare the equation to a similar calculation of 2 x 3 = 6,
and it becomes easier to do the math. If the unknown component of
the equation is in the same position as the 6 in 2 x 3 = 6, then it is
necessary to multiply the other two given numbers in order to find
the unknown.
Similarly, if the unknown component is in the position of 2 or 3,
then divide. The number given in the position of 6 will have to be
divided by the other given number to find the unknown.
? x 3 = 6 becomes 6 3 = 2
2 x ? = 6 becomes 6 2 = 3
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DECIMAL PROBLEMS
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452
AREA PROBLEMS
A real estate agent regularly needs to calculate the area of a lot, a
building, or a room. Area is generally stated in square feet or square
yards. The shape of the lot should determine to which formula to
use for calculating the area. It could be a square, a rectangle, a
triangle, or a shape that is a combination of these shapes.
Squares and Rectangles
We already learned the formula for finding the area of a square or a
rectangle is A = L x W.
Example: If one wall of a rectangular room measures 15 feet and
the other wall measures 12 feet, how many square feet of carpet will
be required to cover the full floor?
1. Read the question: You have been asked to find out the square
footage of the rectangular room.
2. Write down the formula: A = L x W
3. Substitute: A = 15 x 12
4. Calculate: As the quantity of A is to be found, multiply L times
W for the answer. 15 x 12 = 180sq.ft. Thus, 180 square feet of
carpet will be required to cover the floor.
Lets take the problem a step further. If a carpet is chosen to be
purchased and it costs $15 per square yard, what would be the cost
of carpeting the room?
Read the question: First, you have been asked to find out how
many square feet are there in a square yard, and next how many
square yards make up 180 square feet. We have to know that a
square yard is a square measuring one yard on each side and there
are three feet in a yard.
Write down the formula: A = L x W
Substitute: A = 3 x 3
Calculate: As the quantity of A is to be found, multiply L times W
for the answer. 3 x 3 = 9 sq. ft.
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Thus, there are 9 square feet in a square yard. Now you will have to
divide 180 by 9 to find out how many square yards there are in 180
square feet. 180 9 = 20sq. yd.
Now, the number of square yards (20) should be multiplied by the
cost per square yard ($15). 20 x $15 = $300 will be the cost to
carpet the full room.
Triangles
The formula for finding the area of a triangle is:
Height
x Base
___________
Area
or
Street
70 ft.
100 ft.
Street
100 by 2 and then multiply the result by 70. You can even divide 70
by 2 and then multiply the result by 100. Any way it is done the
answer will be the same.
A
100 2 = 50
Step (2)
50 x 70
7,000 2
C
70 2 = 35
35 x 100
= 3,500 sq. ft.
The lot is 3,500 sq. ft. If the lots in that neighborhood are selling for
about $10 per square foot, then this lot would be priced at $35,000.
3,500 sq. ft.
X $10 per sq. ft.
$35,000 Selling price
Odd Shapes
The best way to find out the area of an odd-shaped lot is to divide it
up into squares, rectangles and triangles. Then add up the results
to get the area of the odd-shaped lot.
Example: If the lot depicted below is rented on a 50-year lease for
$5 per square foot per year on a monthly rental payment basis,
what would be the monthly rental of such a lot?
Street
80 ft.
Street
40 ft
50 ft
125 ft.
60ft
Street
180 ft.
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80 ft.
40 ft.
125 ft.
100 ft.
50 ft.
60 ft.
50 ft.
Next, find the area of each of the above triangle, and two rectangles.
The height of the triangle is determined by adding the borders of the
small rectangle and the big rectangle seen in the above figure.
First, get the area of the triangle.
1. Write down the formula: A = Base x Height
2. Substitute: A = 25 (1/2 of 50) x 100
3. Calculate: 25 x 100 = 2500 sq. ft.
Then, get the area of the large rectangle.
1. Write down the formula: A = Length x Width
2. Substitute: A = 100 x 80
3. Calculate: 100 x 80 = 8,000 sq. ft.
Now, calculate the area of the small rectangle.
1. Write down the formula: A = Length x Width
2. Substitute: A = 100 x 80
3. Calculate: 60 x 50 = 3,000 sq. ft.
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Last, add the three areas together to find the area of the whole lot.
2,500 + 8,000 + 3,000 = 13,500 (Total Square feet area of the entire
lot.)
The entire lot is 13,500 sq. ft. and at $5 per square foot per year,
the yearly rent will be $67,500.
13,500 Square feet
X $5 Rent per square foot
67,500 Amount of rent per year
The monthly rental payment will be one-twelfth of the yearly rent
i.e. $67,500 12 = $5625. So the monthly rental payment of the
odd-shaped lot will be $5625.
VOLUME PROBLEMS
To calculate the volume of a three-dimensional space: volume is
normally stated in cubic feet or cubic yards. The formula for
calculating volume = Length x Width x Height, or V = L x W x H. the
formula is same as the formula for Area with an additional element,
the height (H) of the space to be measured.
Example: A storage unit floor measures 11 feet and 6 inches by 16
feet and its ceiling is 13 feet. Find the volume of the unit in square
yards.
1. Write down the formula: V = L x W x H
2. Substitute: V = 16 x 11.5 x 13
3. Calculate:
Step 1
Step 2
PERCENTAGE PROBLEMS
Percentages are involved in many math problems in the real estate
business. There are problems regarding brokerage commissions,
interest on mortgage loans, property appreciation or depreciation,
and capitalization.
Solving Percentage Problems
When solving percentage problems, one has to generally convert the
percentage into a decimal number, calculate, and convert the
answer back into percentage form. As we know by now, a
percentage is converted into a decimal number by removing the
percentage sign and moving the decimal point two places to the left.
In case the percentage is a single digit number, such as 5%, then a
zero will have to be added, and it becomes .05. If a decimal number
is to be converted into a percentage, the above steps have to be
reversed: move the decimal point two places to the right and add
the percent sign.
Remember, in a math problem whenever something is expressed as
a percentage of another number, it means that you must multiply
that other number by the percentage. For example, if you have to
find 45% of $15,000:
Step 1:
Step 2:
COMMISSION PROBLEMS
Just as in the above example, almost all commission problems can
be solved with the general percentage formula:
Part = Whole x Percentage
The percentage is the commission rate, while the whole is the
amount on which the commission is based. In most of the problems
the whole will be the sales price of a property. The part is the
amount of the commission.
Example: A property is listed for sale with an agreement to pay the
broker a commission of 6% of the sale price. The broker decides to
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LOAN PROBLEMS
Interest problems and principal balance problems are two kinds of
loan problems. These are also solved using the general percentage
formula: Part = Whole x Percentage. In loan problems, the part is the
amount of interest, the whole is the loan amount or principal
balance, and the percentage will be the interest rate.
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Example: Mr. Brown procures a loan for $6000 and agrees to pay at
an interest rate of 6%. How much interest will he be paying?
1. Write down the formula: P = W x %
2. Substitute: P = $6000 x .06
3. Calculate:
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465
The propertys value one year ago was $247,422.68. Now apply the
same formula to $247,422.68 to get the value of the property two
years earlier. Repeat the process two more times to arrive at the
value of the property four years previously.
247422.68 .97 = 255074.92
255074.92 .97 = 262963.83
262963.83 .97 = 271096.73
Thus, the value of the property four ago was $271,096.73.
CAPITALIZATION PROBLEMS
With these kind of problems, the capitalization approach to value is
utilized. This method of real estate appraisal was discussed in
chapter 11.
The capitalization formula is another variation of the percentage
formula. Instead of Part = Whole x Percentage, the formula is stated
as: Income = Value x Capitalization Rate.
Here the value would be the investment propertys value or the
purchase price that the investor is willing to pay for the property to
get a specified rate of return. This rate of return is the capitalization
rate, the return that the investor is looking to gain on the
investment. Depending on various factors the desired rate of return
would vary. A higher desired rate of return would mean a higher
capitalization rate and a lower value for the property.
Note that the income in the capitalization formula is the yearly net
income produced by the investment property.
Example: Annual net income of an investment property is $22,000.
An investor is expecting a 12% rate of return, what should he pay
for the property?
1. Write down the formula: I = V x %
2. Substitute: $22,000 = V x .12
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(the
Thus, the investor will have to pay about $183,333 for the property.
Example: Using a 7% capitalization rate, if the value of a property is
900,000, then what is its value using a capitalization rate of 9%?
First, you will have to apply the capitalization formula to arrive at
the propertys annual net income.
1. Write down the formula: I = V x %
2. Substitute: I = 900,000 x .07
$900,000 Value
X .07 Capitalization rate
$63,000 Annual net income
We have the annual net income as $63,000. We have to now
substitute this figure into the formula to find the value at a 9% rate
of capitalization.
3. Calculate:
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469
deducted from the selling price, and then the closing costs of the
seller are subtracted from those proceeds.
Start by calculating the cost of the 6% commission.
$206,010 Selling price
X .06 Commission
$12360.60 Commission Amount
Now subtract the commission and other closing costs from the
gross proceeds and findh the sellers net proceeds.
$206,010 Selling price
$12360 Commission Amount
135,500 Mortgage balance
1,200 Repairs
- 1,950 Closing costs
$55,000 Net proceeds
PRORATION PROBLEMS
Allocation of an expense between two or more parties is called
proration. We have studied in chapter 12 that prorations are
needed in real estate closings. Based on the closing date, various
expenses are prorated.
The three main steps of the proration process are:
1. Calculate the per diem (daily) rate of the expense.
2. Fix the number of days for which one person will be
responsible for the expense.
3. Multiply the per diem rate by the number of days to find out
the share of the expense that one party is responsible for:
Share = Rate x Days.
473
To find out the per diem rate of an annual expense, you must divide
the amount of the expense by 365 days (366, in a leap year). Some
problems might instruct you to divide by 360 days, just to simplify
the calculation. Note: A 360-day year is also referred to as a
bankers year rather than a calendar year.
To calculate the per diem rate of a monthly expense when prorating
on the basis of a calendar year, divide the amount of the expense by
the number of days in that specific month. Or else, to make the
calculation easier, base the prorations on a bankers year, which
implies that every month (including February) has 30 days.
You will be given a number of examples in relation to the proration
of various expenses: property taxes, hazard insurance, rent, and
mortgage interest. (In chapter 12, detailed information on these
expenses is provided.)
30 days May
+ 30 days June
115
days
So, the per diem rate is $9.62. Now multiply this amount by 365 to
find the annual tax amount.
365 Days
X $9.62 Per diem
$3511.30 Annual taxes
Thus, the annual taxes are $3511.30
Insurance Prorations
If there is any prepaid insurance coverage extending beyond the
closing date, then a seller will be entitled to obtain a refund from
the hazard insurance company.
Example: A property is being sold and the transaction closing date
is June 15. The owner has already paid an annual hazard
insurance premium of $950. Coverage was provided until the end of
September. How much of the premium will be refunded, if the
insurance company is not charging the seller for the day of the
closing? The basis of this calculation is a 360-day year.
1. Calculate: the per diem rate for the insurance (use 360-day
year): $950 360 Days = 2.64 Per diem.
2. Add: the number of days for which the seller owes a refund (use
30-day months).
15 days June
30 days July
30 days August
+ 30 days September
105
days
3. Substitute: the rate and the number of days into the formula: (S
= R x D) and calculate.
105 Days
X $2.64 Per diem
$277.20 Sellers credit
Thus, the insurance company will refund $277.20 to the seller.
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Rent Prorations
If a rental property is being sold, the seller will owe the buyer a
prorated share of any rent that was paid in advance.
Example: A ten-unit apartment building that is being sold, with the
closing date being June 15. The rent for 5 of the units is $1,200 per
month and the other 5 units are rented out for $900 per month.
The tenants have all paid the rent for June on time. Calculate the
share of the prepaid rents that the seller owes to the buyer at
closing.
1. Find out the total rent amount owed for June.
$1,200 x 5 = $6,000
$900 x 5 = $4,500
$6,000 + $4,500 = 10,500
2. Calculate the per diem rate for the month of June:
$10,500 30 = $350 per diem
3. Determine: the number of days of rent for which the buyer is
entitled, beginning on the closing date. (June 15 to June 30 is 15
days.)
4. Substitute and calculate.
$350 Per diem
X 15 days
$5250 Prorated rent
The seller will owe $5,250 to the buyer, in prepaid rents at closing.
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Chapter Summary
Formula to find Area of squares and rectangles: Area = Length
x Width (A = L x W).
Formula to find Area of triangles: Area = Base x Height (A =
B x H).
Formula to find the Volume: Volume = Length x Width x Height
(V = L x W x H).
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b)
c)
Chapter Quiz
1. Jerry purchased a property one year ago @ $175,500. The
property rates in his neighborhood are increasing at a rate of
5% annually. Calculate the current market value of his
property.
2. Sally has borrowed $8,500 for one year and she paid $650 in
interest. Calculate her rate of interest.
480
3. Mr. Smith brought a house for $350,000 and sold it later for
$425,000. What is the rate of profit earned by him on this
sale?
4. A rectangle measuring 85 x 45 feet contains how many square
yards?
5. Margaret sold a farm house for $148,000 and made a profit of
18%. How much did she initially pay for the farm house?
6. Patrick owns a 3-acre lot, the front footage of which is 400 ft.
Calculate the depth of Patricks lot.
7. Linda sold her house on August 10. Her existing loan on the
house is $150,000. The interest on the loan is 7%. Francis
took over the loan with interest paid up to July 15. Linda also
owes property taxes of $1250 for the year.
Based on the above information calculate:
A) Prorate interest, and who is credited or debited, and
B) Prorate tax, and who is credited and debited.
8. Chris bought a building for $550,000. The yearly net income
produced by the building is $65,000. Calculate the rate of
return for Chris.
9. A triangular lot has a base of 45 ft. and a height of 55 ft.
Calculate the area of the lot.
10.
Calculate the percentage of the commission, if a property
was sold for $850,600 and the commission paid for it was
$56,500.
11.
Mr. Lee is looking to procure a home mortgage loan on
the property that he is purchasing in Palm Springs. The price
of the property is $960,000 and Mr. Lee will make a 20% down
payment. Mr. Lee has a choice of taking a 30-year loan at an
interest rate of 7% or a 15-year loan at an interest rate of 6%.
Which of the two loans will have a smaller monthly installment
and what will be the amount of that installment?
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12.
The Jensons have sold their house and are paying off the
mortgage at closing. The remaining principal balance on the
mortgage at closing will be $155,600.50. They have to pay the
interest accrued over the 10-day period between their last
mortgage payment and the closing date. If the annual rate of
interest paid by the Jensons on their mortgage was 9%. What
will be the amount of interest they will have to pay at closing?
(Base your calculation on a 365-day year.)
13.
Gerard has purchased a building for $745,000. This
building will fetch a 8.75% return on his investment. Calculate
the annual net income generated by the building.
14.
Jake, a salesman found a buyer for a property that was
listed with another broker. Jake worked as a buyers agent in
return for a commission to his brokerage firm of 3% of the
sales price. Jakes share on any commission earned would be
60 percent. Now, if the property sold for $500,000, what was
Jakes commission?
15.
Thelma paid $875,000 for a 10-unit apartment building.
The gross income per month is $750 per unit and the annual
expense is $3,500. What will be Thelmas capitalization rate on
her investment?
Chapter 2
1.
C
2.
B
3.
A
4.
C
5.
A
6.
D
7.
A
Chapter 3
1.
C
2.
A
3.
B
4.
D
5.
C
6.
D
7.
C
Chapter 4
1.
A
2.
C
3.
A
4.
C
5.
D
6.
A
7.
C
482
8.
9.
10.
11.
12.
D
B
C
D
C
Chapter 5
1.
C
2.
A
3.
D
4.
B
5.
A
6.
D
7.
B
8.
D
9.
B
10. D
11. A
12. B
13. D
14. B
15. B
Chapter 9
1.
B
2.
A
3.
C
4.
D
5.
B
6.
D
7.
A
8.
C
8.
9.
10.
11.
12.
13.
14.
15.
C
B
A
B
C
C
A
C
Chapter 6
1.
B
2.
D
3.
C
4.
D
5.
C
6.
A
7.
B
8.
B
9.
B
10.
A
11.
D
12.
A
13.
C
14.
B
15.
A
Chapter 10
1.
B
2.
B
3.
A
4.
C
5.
A
6.
D
7.
A
8.
A
8.
9.
10.
11.
12.
13.
14.
15.
C
A
D
C
A
B
C
A
Chapter 7
1.
A
2.
D
3.
B
4.
C
5.
D
6.
A
7.
C
8.
A
9.
D
10. B
11. A
12. C
13. C
14. A
15. D
Chapter 11
1.
A
2.
C
3.
B
4.
A.
5.
D
6.
B
7.
A
8.
B
8.
9.
10.
11.
12.
13.
14.
15.
D
A
C
D
A
C
C
B
Chapter 8
1.
C
2.
B
3.
A
4.
A
5.
D
6.
B
7.
A
8.
D
9.
C
10. C
11. D
12. B
13. A
14. A
15. D
Chapter 12
1.
C
2.
B
3.
D
4.
D
5.
B
6.
D
7.
B
8.
B
483
9.
10.
11.
12.
13.
14.
15.
A
A
C
A
C
C
C
9.
10.
11.
12.
13.
14.
15.
C
D
C
A
B
A
A
Chapter 13 Chapter 14
1.
A
1.
C
2.
B
2.
B
3.
C
3.
A
4.
D
4.
C
5.
D
5.
A
6.
A
6.
B
7.
B
7.
B
8.
D
8.
C
9.
A
9.
B
10. C
10. C
11. B
11. B
12. D
12. D
13. A
13. A
14. D
14. C
15. B
15. B
9.
10.
11.
12.
13.
14.
15.
A
B
A
D
A
B
B
Chapter 15
1.
C
2.
A
3.
B
4.
C
5.
A
6.
A
7.
C
8.
C
9.
A
10. C
11. C
12. D
13. C
14. A
15. B
9.
10.
11.
12.
13.
14.
15.
C
A
B
A
D
D
D
Chapter 16
1.
B
2.
D
3.
A
4.
D
5.
A
6.
C
7.
B
8.
A
9.
D
10. B
11. C
12. C
13. B
14. A
15. B
484
4. 85 x 45 = 3,825 / 9 = 425
Index
A
Abstract of title 49
acceleration clause 185, 186, 206
accession 43, 51
accretion 47, 54
acquisition cost 87
acre 79, 200, 272, 470
adjustable-rate mortgage 233
(ARM). 233
adjusted gross income 332, 335,
336
adverse possession 43, 45, 46, 49,
51, 64
age-life See age-life method
agency 79, 81, 82, 88, 89, 95, 99,
110, 112, 113, 115, 117, 138, 141,
142, 143, 144, 145, 146, 147, 153,
154, 155, 156, 157, 158, 159, 160,
161, 162, 164, 165, 166, 167, 177,
178, 179, 195, 206, 225, 235, 239,
241, 251, 257, 258, 346, 347, 392,
415, 423, 424, 426
Air rights 15
Alienation 2, 36, 53, 186, 207
Alienation Clause 186
Alquist-Priolo Act 82
ALTA 50, 51
amenities 151, 263, 267, 274, 277,
371
amortization 228, 229, 234, 252
annexation 16
Annual percentage rate 217, 218
Appraisal 5, 227, 256, 258, 261,
278, 292, 305, 317, 394, 395
appraisal license 260
appraisal process 257, 265, 267,
279, 292
appurtenant 13, 14, 20, 62, 70
arbitration 415
assessed value 84, 85, 86, 92, 459,
460, 461
assignment 103, 116, 132, 140,
184
Assignment 102, 103, 107, 132,
184
attachment 16, 20, 21, 56, 58, 60,
68, 69, 70, 115, 139
avulsion 47, 54
B
balloon payment 180, 204, 220,
222, 231, 249, 252
Bankruptcy 45, 55, 197, 198
base lines 18
bequest 28, 41
bilateral contract 94, 114, 299
blanket encumbrance 201
blockbusting 344, 408
boot 329, 338
486
C
California Veterans Farm and Home
Purchase Program 245
capital gains 322
capitalization approach 295, 297,
455
capitalization rate 286, 287, 288,
289, 456, 457, 458, 459, 471
CC&R 31, 66, 67, 71
CC&Rs 31, 66, 151, 352
Certificate of Clearance 402
Certificate of discharge 189
Certificate of Eligibility 243
Certificate of occupancy 76
Certificate of ownership 408
Certificate of qualification 29
Certificate of Reasonable Value
(CRV). 243
Certificate of sale 191
chain of title 48, 49, 55
chattel 25
Civil Rights Act 341, 342, 343, 349,
353, 354, 355, 356, 357, 358
closing 298, 299, 300
closing statement 302, 316, 317,
408
codicil 42
collateral 174, 177, 182, 183, 203,
205, 208, 227, 228
color of title 46
commercial banks 172, 209, 210
D
dealer property 326
deed 2
acknowledgement of deed 38
blanket 200
delivery 237
of reconveyance 41
deed of trust 40, 59, 99, 126, 183,
184, 193, 197, 198, 201, 202, 207,
220, 222, 304, 312, 333, 337, 392,
413, 424
default
notice of 86
depreciation 280, 282, 283, 284,
286, 287, 289, 294, 323, 327, 331,
333, 337, 378, 382, 447, 455
devisees 42
discount points 214, 215, 216, 241,
247, 277, 305, 334
Doctrine of Laches 102
Doctrine of Emblements 16, 22
dual agency 147, 160, 161
duplex 325, 380
duress 98
E
easement 2, See appurtenant
easement by deed 63
easement by implication 63
easement by prescription 64
easement in Gross 62
economic rent 285, 290
effective gross income 285, 286,
457, 458
emancipated minor 95
eminent domain 44, 52, 64, 83
encroachments 51, 61
encumbrances 39, 50, 56, 61, 68,
88, 201, 222, 318
equitable title 120, 124, 182, 184
equity loan 203
escheat 43, 44
Escrow 298
escrow account 145, 305, 417,
418
escrow agent 122, 298, 299, 300,
302, 304, 307, 308, 310, 311, 313,
315, 319, 418
escrow arrangement 298
escrow closing 299
escrow fees 220
escrow instructions 299, 300, 302
escrow termination 300
estate for years 25
estate in remainder 25
estate in reversion 25
estoppel 142, 144
eviction 133, 134, 140
exclusive listing 113, 114, 406
exclusive right to sell listing 117
executed contract See Contracts
executor 42, 96
executory contract See Contracts
express contract See Contracts
F
Fair Credit Reporting Act 225
488
frontage 272
full cash value 84, 91
functional obsolescence 282
G
general agent 143, 166
gift deed 40
Ginnie Mae (GNMA) 174, 177, 178,
179, 206, 312
graduated 136, 140
graduated payment mortgage 202
grandfather clause 75
grant deed 39, 53
grantee 37, 38, 39, 40, 53
grantor 37, 38, 39, 40, 41, 53, 63,
183
gutter 371
H
highest and best use 256, 263, 264,
267, 271, 289, 291
holographic will 42
homeowners insurance 308, 315
homeowners 266
homestead exemption 33, 70
Homestead Protection 2
Housing Financial Discrimination Act
(Holden Act) 349, 351, 356, 357,
358
hypothecation 182
I
implied warranty of habitability 134
improvements 1, 13, 16
Imputed Knowledge Rule 144
489
J
joint tenancy 27
joint venture 381
joists 363, 364, 365
judgment 33, 48, 56, 58, 59, 60, 68,
69, 70, 162, 182, 190, 191, 192,
193, 194, 207, 227, 283, 284, 292,
408, 414, 415, 418
judgment lien 56, 59
judicial foreclosure 190, 191, 192,
193, 194
K
kickback 313
L
land contract 126
land use regulations 73, 89
landlord 3
latent defects 148
Lease 3, 128-132
flat lease
gross lease 136, 140
ground lease 136, 140
step-up lease 136
straight lease 136
leasehold 1, 24, 25
legacy 41
legal title 44, 120, 182, 245
lenders 4, 178, 213, 230, 236, 249
Leverage 377, 385, 386
License 6, 76, 124, 156, 260, 387,
389, 395, 398, 399, 403
license application 6, 388, 396
licenses 2
liens 51, 56, 57, 58, 59, 60, 68, 83,
87, 88, 125, 184, 190, 191, 193,
195, 196, 200, 201, 203, 207, 302,
377, 389
life estate 24, 25
like-kind property 328, 329
limited liability company 30
line of credit 203
liquid asset 376, 377
liquidated damages 104, 109
lis pendens 48, 56, 58, 190
490
M
margin 233
marginal tax rate 321
market allocation 428
Market Data Approach 276, 283
market price 262
marketable title 36, 125
masonry 361
master plan 73
mechanics lien 56, 57, 58, 60, 200,
201
median 12, 19, 235, 239, 242
Mello-Roos Community Facilities Act
87, 151
merger 65, 67
Metes and bounds 17, 18, 22
mineral rights 14, 16, 20
minor 75, 95, 96, 106, 347
misrepresentation 98, 147, 148,
153, 250, 404, 405, 406, 407, 408,
410, 415
MLS 116, 119, 155, 157
Mortgage 4
mortgage broker 180, 212, 213,
222, 246, 248, 250, 251, 407
mortgage companies 11, 209,
211, 212
N
National Association of Realtors 156
negative amortization 234
negotiable instrument 181
net lease 136, 140
net listing 115
nonconforming uses 74,75
non-exclusive right to occupy or use
the property 78
non-financial encumbrance 56
non-freehold estates 25
non-payment of rent 133, 134
non-possessory interests 23
non-recognition provision 326
non-requirement of a license 6
notary public 53, 400
notice of cessation 57, 70
notice of default 192, 193, 194, 196
notice of non-responsibility 57, 58,
69
notice of sale 192, 193, 196
novation 102, 103, 107, 108, 132,
139
O
objective value 261
open listing 94, 112, 113, 114, 115
491
P
panic selling 345
partial payment 60
partial release clause 201
partial satisfaction clause 201
partial tax exemption 86
partition action 45
partnership 29
pension funds 211, 212
percentage lease 136
periodic payments 180, 362
periodic tenancy 26
personal property 1, 13, 14, 16, 17,
20, 27, 42, 183, 184, 199, 224,
258, 306, 402, 416, 418
physical deterioration 282, 283
plottage 273
police power 72, 73, 76, 88, 90
possessory rights 66, 182
power of attorney 38, 392
power of sale provision 192
preapproval 222
prepayment penalty 187, 188, 217,
232, 304, 334
prescription 63, 64, 65
primary mortgage market 255
principal balance 180, 181, 184,
202, 230, 231, 234, 252, 304, 377,
451, 452, 453, 471
principal, interest, taxes, and
insurance 226
PITI 226
Q
quantity survey method 281
quiet title action 45
quitclaim deed 40, 64, 126
492
R
rafters 363, 364
ranch home 361, 382
range lines 19
rate lock-in 215
ratification 141, 142, 165, 166
Real Estate Commissioner 79, 352,
387, 388, 403, 419, 431, 434, 435
Real Estate Investment Trust 31
REIT 31
Real Estate Settlement Procedures
Act 219, 298, 311
Real Property Loan Law 219
real property taxes 46
reconciliation 292, 293, 419
reconveyance deed 41, 189
recording 32, 36, 47, 48, 49, 52, 57,
59, 60, 68, 69, 110, 125, 184, 188,
307, 353, 402, 434
Recovery Account 415, 433
recurring costs 305, 313
redemption period 86, 88, 92, 191,
193, 194
redlining 344, 345, 347, 348
reformation 40
regressive tax 320
Regulation Z 216, 249
Reinstatement 190, 193, 207, 244
reliction 47
Renting 366
replacement cost 280, 281, 282,
283, 284, 328
reproduction cost 280
rescission 103, 104, 197, 218
RESPA 219, 221, 311, 312, 314,
315, 318, 408
return on the investment 286
S
safety clause 114, 116, 138
sale-leaseback 378
sales tax 402
salesperson 4, 390, 393, 398, 425
sandwich lease 132, 140
savings and loans 175, 210, 211,
251, 301
scarcity 170
secondary market 169, 175, 176,
177, 178, 179, 181, 206, 212, 224,
229, 235, 258, 381
secret profit 406
Section 1031, re property exchanges
328
section and township system 18, 22
security deposit 130, 367
security instruments 183
seller financing 204, 217, 277, 304
separate property 28, 35
setback 74
settlement statement 302, 303, 304,
305, 306, 307, 308, 309, 312, 313,
314, 315, 317, 318
severance 16
sheathing 363, 364, 365, 384
sheriffs deed 41, 191
sill 363
simple interest 180, 205
sole plate 363
493
sole proprietorship 29
special agent 143, 164
special assessment lien 56, 59
special assessments 87
specific data 268, 269, 275, 294
specific lien 56, 58, 59, 69
specific performance 120, 126, 154
Statute of Frauds 37, 99, 100, 108,
114, 117, 120
Statute of Limitations 101, 108, 109
steering 248, 344
step-up lease 136
straight lease 136
straight-line method of depreciation
283, 284
straight-lne method of depreciation
See age-life method
Street Improvement Act of 1911 87
stucco 360, 361
sub-agent 113, 157, 162
subdivision 19, 66, 71, 76, 77, 78,
79, 80, 81, 89, 90, 91, 151, 200,
279, 291, 352, 388, 401, 429
sublease 132, 140
Subordination Clause 188
successors liability 402
surface rights 14, 20
syndicate 379, 381, 401
T
take-out loan 200
tax basis 338
tax deductions 320, 368, 369
tax-deferred exchange 328
tax-free exchanges 328, 337, 378,
382
tenancy in common 27, 34
tenancy in partnership 28
V
Value
elements of 260
variance 75, 89, 90
verification 292
Veterans Administration 224
W
warehousing 212
Warranty deed 41, 53
water rights 14, 15, 20
wear and tear 130, 131, 282, 332
writ of execution 59, 70
Z
zoning ordinances 73, 76, 89, 263
495
Glossary
Abandonment:
not using it, generally indicated through some affirmative act, like
removing ones belongings from an apartment.
Abstract of judgment: Document that summarizes the result of a
legal action, which can be filed in any county where the judgment
debtor owns a property.
Abstract of title: Summation of all recorded transfers,
conveyances, legal proceedings, and any other facts relied on as
evidence of title to show ownership continuity and signify any
possible loss to title.
Acceleration clause: Provision in a real estate financing
instrument allowing the lender to declare the full debt due
immediately if the borrower breaches any of the provisions of the
loan agreement. Also referred to as a call provision.
496
497
bordering,
or
neighboring
(not
499
500
503
504
the
505
Bad
debt/Vacancy
factor:
percentage
deducted
from
506
509
511
512
Cash on cash: The ratio between cash received in the first year and
cash initially invested.
CC&Rs: A declaration of covenants, conditions, and restrictions
that is generally recorded by a developer to place restrictions on all
lots within a new subdivision.
CEQA: California Environmental Quality Act.
CERCLA: Comprehensive Environmental Response, Compensation,
and Liability Act.
Certificate of Discharge: Document given by the mortgagor to the
mortgagee when the mortgage debt has been paid in full,
acknowledging that the debt has been paid and the mortgage is no
longer a lien against the property; also called a satisfaction of
mortgage or mortgage release.
Certificate of Eligibility: Document issued by the Department of
Veterans Affairs regarding the veterans eligibility for a VAguaranteed loan.
Certificate of Occupancy: Document issued by a local government
agency (such as the building department) verifying that a newlyconstructed building is in compliance with all codes and may be
occupied.
Certificate of Reasonable Value (CRV): Based on an appraisers
estimate of the value of a property, it is mandatory for a VAguaranteed home loan to be authorized; the amount of the loan can
not be more than the CRV.
Certificate of Sale: Document given to the purchaser at a mortgage
foreclosure sale, instead of a deed which is replaced with a sheriffs
deed only after the redemption period expires.
Chain of Title: Record
pertaining to a property.
of
encumbrances
and
conveyances
513
516
519
520
Dedication: Land that is given by its owner for public use and
accepted (for that particular use) by the appropriate representative
of the government.
Deduction: Amount on which income tax is not required to be paid.
Deed: Correctly executed and delivered written instrument that
conveys title to real property (from the grantor to the grantee).
Deed, Administrators: Deed that an administrator of an estate
uses to convey a deceased persons property to his heirs.
Deed, General warranty: Deed by which the title is warranted by
the grantor against defects that may have surfaced before or after
his tenure of ownership; also called a warranty deed.
Deed, Gift: Deed in which there is no support of valuable
consideration, most frequently listing love and affection as the
consideration.
Deed, Grant: The most commonly-used type of deed in California, it
uses the word grant in its words of conveyance and holds certain
implied warranties that the property is not encumbered and has not
been deeded to someone else.
Deed, Quitclaim: Deed conveying any interest in the property that
a grantor may have at the time of executing the deed, without
warranties.
Deed, Tax: A deed that a buyer of a property obtains at a tax
foreclosure sale.
Deed, Trustees: A deed that a buyer of a property receives at a
trustees sale.
Deed in lieu of foreclosure: A deed given to the lender by the
borrower (who has defaulted) to avoid foreclosure proceedings by
the lender.
524
Deed of reconveyance: Once the debt has been repaid the security
property is released from the lien that is created by a deed of trust.
The instrument used is called the deed of reconveyance.
Deed of trust: To secure the repayment of a debt, an instrument is
used that creates a voluntary lien on real property. This lien
includes a power of sale clause that allows non-judicial foreclosure.
The parties to this deed are the grantor (borrower), the beneficiary
(lender) and the trustee (neutral third party).
Deed restrictions: Provisions in a deed that set restrictions on the
use of property. It may either be covenants or conditions.
Default: When one of the parties to a contract fails to fulfill one or
more of the obligations or duties as enforced by the contract.
Defeasance clause: There is a clause in a mortgage, deed of trust,
or lease which provides for the cancellation of a certain right if a
particular event occurs.
Deferred maintenance: Curable depreciations that ensue due to
maintenance or repairs that were postponed and thus caused
physical deterioration.
Deficiency judgment: Determination by the court that the
borrower owes more money when the security for a loan does not
completely satisfy a debt default.
Delivery: When a deed is legally transferred from the grantor to the
grantee, thus transferring title.
Demand: One of the four elements of value (other three being
scarcity, utility, and transferability). It is a desire to own along with
the ability to afford.
Demise: a) Conveying an interest in real property via the terms of a
lease.
525
by
real
estate
buyer
527
528
530
531
Fair
534
Misrepresentation
made
without
any
Front foot: Property that is measured by the front linear foot on its
street line, each front foot extending the depth of the lot.
Front money: Money needed to initiate a project, including
expenses such as attorneys fee, loan charges, feasibility studies,
and a down payment.
Fructus industriales: Plants such as crops that are cultivated by
people.
Fructus naturales: Plant growth that grow naturally, such as trees,
plants, and shrubbery.
Fugitive substance: Substance that is not stationary in nature
such as natural gas, oil, and water.
Functional obsolescence: Loss of value from causes within the
property, excluding any due to physical deterioration.
Garnishment:
537
Habendum
538
Holder in Due Course: One who has taken a note, check or similar
asset prior to it being overdue, in good faith and for value, and with
no knowledge that it had previously been dishonored.
Holdover tenant: Tenant who keeps possession of leased property
after the lease term has expired.
Home Equity Line of Credit (HELOC): Credit account secured by
equity in the borrowers home, enabling him to borrow up to a
specified credit limit.
Home Equity Loan: Loan secured by a second mortgage on a
principal residence, usually used for a non-housing purpose.
Homeowners Association: Non-profit organization comprising
homeowners from a particular subdivision, responsible for enforcing
their CC&Rs and managing other community affairs.
Homestead: Dwelling occupied by the owner along with any
appurtenant outbuildings and land.
Homestead Law: State law providing limited protection
homestead properties against judgment creditors claims.
to
Implied
539
or
physical
544
545
546
547
548
549
Package mortgage:
550
551
Quiet enjoyment:
554
556
557
558
559
Warranty:
560
561