Pay Attention to the Property Title
Matters of title are critical. Many, though not all, of the countless possible “clouds” that can hover over land title issues are listed in the Green for Green workbook, along with a sample Title Insurance Commitment. A few examples include: Who owns the underlying mineral rights? Are these leased? To whom? Is there access, utility or other easements, or reservations for certain types of uses by others? Do the sellers own the entire property or just a portion? Do they have the full legal authority to sign your deed? Is there a break in the chain of title over the years or centuries? In other words, could some owner prior to your seller assert a claim? I highly recommend experienced legal review of the title conditions and the documents that evidence those exceptions.
The Contract process is a curious mixture of challenges, short- and long-term thought, satisfaction and, at times, frustration. Patience, an even temper, team coordination and comprehension of seller motivations are all keys to finally getting an agreement inked. If the seller becomes intractable on truly key issues, or something in your gut warns you, then walk away.
Otherwise, remember the moment the land called to you, smile, enjoy this fascinating process and get it done. If you feel your energy waning under the weight of lifting these “due diligence” rocks, take a deep breath and reconnect with the magnetic pull of the land that inspired you in the first place. Let the energy of the land refuel you and remind you of your dream.
Not everyone, of course, is looking for six-thousand-acre ranches. Many prospective buyers are searching for one-, five-, twenty- or one-hundred-acre parcels to use as getaways, vacation homes, a tangible safety deposit box for your dollars or for eventual retirement. Perhaps they are self-employed and now have the opportunity to move out of the urban, suburban or exurban living areas and run their businesses from a more remote and enjoyable location. In some cases, the current malaise of the overall economy has spurred them to accelerate their goals. Still others are looking for a good investment, with an eye toward eventual disposition or change in land use. Size, price and location are not the sole criteria to the sanctity of the procedures employed, observations made, questions propounded and research undertaken. It is the combination of want, need, heart, brain, knowledge, feel and science that play a part in a final decision to purchase rural property.
Too many people jump on the internet with a dream notion and a vision of an area and a property lodged ephemerally and non-specifically in their head. This is bound to lead to disappointment and frustration. Failure to employ “PPPPP” (prior planning prevents poor performance) will result in a waste of time, energy and money for the acquirer and their agent. In the worst case, a purchase can devolve into a bad deal.
Step-by-Step Deductive and Empirical Forethought Is a Must in Looking for that Special Place
First, write down the absolutely key components of your dream parcel, the things that you must have. Live water? Pond development potential? Fishery? Wildlife? Agriculture? A place for horses? Approximate size? Can the land be part of a subdivision, or does it need to stand on its own? Must it back to federal, state or conservation lands? What type of neighborhood do you prefer–eclectic, old-timer, newbie, new West, remote? What amenities do you require in the nearest town? Simply milk and bread, butter and eggs? Or more? Do you have horses or other livestock? Do you want to be able to pasture year-round, or are you willing to buy hay? Do you want to grow hay? Must the property already be improved with a home, or are you willing to build, or remodel an existing structure to suit your personal style and tastes? What is your budget? What proximity do you desire to metro areas, airports, skiing, recreation and bodies of water?
A property already improved with a decent residence—although there are limitations and guidelines discussed elsewhere in this book—will generally afford the opportunity to finance 60 to 85 % of all or a portion of the purchase on a fixed long-term mortgage. In some cases, the seller may carry some paper, usually short-term but with relatively beneficial terms, via a note, mortgage, deed of trust or what is called a contract for deed.
Raw land is more difficult to bank finance, particularly in slower real estate markets. This is currently exacerbated by federal and state bank examiners feeling that, generally, land is high risk. They go out of their way to “classify”—that is, downgrade—bank assets that consist of land loans. This restricts the bank’s capital and ability to lend to anyone for anything (see Chapter 12). Count on 50% as the maximum you’ll be able to borrow, and you will need very good credit to do so. Be honest with yourself. Once you understand what financing you are comfortable with and can qualify for, the difference between the price you are willing to pay and what can be financed is the amount of cash you need. It serves no purpose to spend time looking for and falling in love with a property, putting it under contract, investing the emotional and financial effort and then in the end finding out that you simply can’t afford it.1
The purchase of land, whether rural, recreational, farm or ranch property, is a distinctly individual matter. Although I have been involved in all types of properties, the land that appeals to me personally is wild, remote, improvable, at the end of the road and backs to wilderness. This may not be your preference at all. You may be more comfortable with white panel fences and ten acres surrounded by similar properties, within fifteen minutes of the mall. There is no good or bad, no right or wrong. This is about personality, lifestyle, needs, wants, must-haves and can’t-stands, all encompassed in a longer-term plan.
The FIVE Great Rules of Real Estate
Some may know they want to be in the Carolinas along the coast, or somewhere high up in the Rockies near skiing or with horses, or in the mountains of California within striking distance of the teeming metropolitan areas, but with some peace and solitude on the fringe of more densely settled areas. Even those who don’t have a specific geographic location in mind need to realize that the rules are the same.
When purchasing real estate, pay attention to these five rules:
1) Never trust your neighbor’s taste. Particularly on smaller properties, you may find the perfect place, only to be saddled with neighbors whose idea of great land use is a jacked-up truck without wheels and hot pink paint. You want to avoid the anguish of having someone else’s taste ruin your dream.
2) Never purchase a property without seeing it or having the absolute right to see it before your earnest money goes hard (becomes non-refundable), or your contract becomes irrevocable.
3) The government can and will change the playing field. Keep your nose to the wind for trends in property rights, tax and environmental and other policies. (See Section III.)
4) Always have an exit strategy and options, even if you believe this is the place you are going to buy and never sell. Lives and lifestyles change unexpectedly. Micro- and macroeconomic events affect the best-laid intentions and carefully made plans. The long-term plan with attention to exit strategies must be integrated with your search and acquisition. While a plan is distinctly personal, there are some requisite elements for your safety net. These include: Is the property sub-dividable? Can you shave off a chunk of the land to sell if you need money in the future, without affecting the value of the rest? Who is your target market, if you ever need to unload that new home or remodel? What has been the average number of days on the market (DOM) for similar properties over the last ten year period, including at least one up and one down real estate cycle? How quickly can you get out of a deal if Chicken Little arrives and the sky is falling?
5) Prior planning prevents poor performance or The “PPPPP” Rule.
Keep in mind that the purchase of the property is just the beginning. There is ongoing home maintenance, taxes, insurance, fencing, landscape maintenance and perhaps agriculture; as well as the inevitable wish list to do to improve the property or buildings. These are all expenses, and some can be rather spendy. Include these items in your budget. Buying a property that talks to you when you lack the f
unds to fully create your dream can be frustrating and lessen your enjoyment.
Do you have an estate plan? If you get hit by a rolling hay wagon, what happens to the property and its equity? The Green for Green workbook contains a checklist to stimulate long-term planning. Do not be bashful or dishonest with yourself in setting forth clear and concise, short, medium and long-term goals for your land. This will begin to drive your property plan, management strategy and ongoing operational budget, as well as assist you in formulation of must-haves/can’t-stands, acquisition and eventually, heighten your enjoyment of your purchase.
Most of all, open yourself to the possibilities. Feel the energy of the land. Savor it. Let it speak to you—listen. If there is anything not quite right with the energy, trust your gut. The old adage applies: “Know when to hold ‘em, know when to fold ‘em, know when to walk away and know when to run.” Energy not just right?—Don’t spend another minute! Energy feels just fine, but the facts don’t check out?—Regretfully, but resolutely, walk away. Energy fine and the mechanics are sound?—Don’t hesitate, buy it!
1A detailed checklist for property searches and a worksheet for determining general financing capabilities will be found in the Green for Green DVD workbook.
Buyers are often tempted to “go partners” purchasing a piece of land, or any type of real estate. Your partner may be your parents, or your children. A partner may be a friend, or a spouse. These types of partnerships are known as a Joint Venture, or General Partnerships. Often in these types of arrangements there is no Partnership Agreement. Not a good idea! In less frequent instances, there may be more than two partners, or many “partners” in the form of a Limited Partnership (LP), Limited Liability Company (LLC) or Sub S Corporation (S-Corp), which might include people you barely know, or don’t know as well as family or friends.
A “partner” in a S-Corp is a “shareholder,” a “member” if in a LLC and a “Limited Partner” if their interest is via a LP. In all these types of entities profits, losses and tax flow to each individual partner, not to the entity. Each structure has its own peculiarities. There are slightly different tax treatments, varying rights of partners and powers of managers in the case of LLC companies, or general partners and officers in LPs or S-Corp, respectively.
Regardless of the structure you choose, certain steps must be followed for these entities to be “legal”. Articles of Organization for an LLC, Articles of Incorporation for a S-Corp and Partnership Registration via various forms must be filed with the state government. Certificates of Authority are necessary if your entity is formed in one state, but doing business in another. Some local governments require further registration. Always consult a local attorney. A tax ID—commonly referred to as a “TIN” (Tax Identification Number) must be obtained.
The above is a synopsis of creating your business entity. The paperwork is mostly forms. However, the agreements which govern the rights, responsibilities, powers, liabilities and authorities of the various parties—while required to have some “boiler plate” language—are the key to the operation of the entity, and its assets, distribution of profits or other benefits in happy times, or resolving disputes if things go wrong. Do not underestimate people’s propensity to be nasty if your best laid plans fall apart, or to be greedy if your deal is a smashing success! These documents are known as “By Laws” if for a S-Corp, and a “Limited Partnership Agreement” if for an LP. An “Operating Agreement” governs the workings of LLCs.
The folks who run the show are the officers and directors in a S-Corp, the managers in an LLC and the General Partner (many times a corporate entity) of an LP. In a GP—unless the Partnership Agreements provides differently, the partners have equal say.
A Buffet of Choices
Remember the “PPPPP” rule! How well you think and plan in advance at the inception of your entity may well determine the success—both of the heart and the wallet—of your venture.
When the sun is shining, the birds are chirping and the money is flowing partners generally have wide smiles. Even then however, a partner can go AWOL, cause angst and for ulterior personal motive allege some type of impropriety or complain about their share of proceeds, even though it was agreed upon up front. This type of adversarial and self-centered behavior will occur far more frequently when the sky is stormy and things are not going well.
While many partners will stand shoulder to shoulder with you in tough times, there will be, almost guaranteed, partners who become completely self-interested, cause uproar and, in some cases, jeopardize the interests of other partners and the land. I’ve seen and been involved in situations where partners refused to sign sales documents even though the property was being sold at a profit in tough economic times. Other partners contrive excuses to not pay their share of ongoing expenses or debt service when partnership funds run low. Marriages and family relationships can go south for reasons having nothing to do with land, the real estate or the partnership. Life happens.
I have found it highly beneficial to sit down prior to becoming involved in any of these types of entities and make a list of what can go wrong. As imaginative as you may be, the list is never 100%. Your own personal situation, the personal situations of other partners, macroeconomic events, government related interference or change in the playing field, taxation, interest-rates, market demand and costs associated with production if your land is a farm or ranch or produces other goods are but a few potential ugly circumstances. Your own incapacity, or death, even the cost of fuel, i.e., national energy policy, can affect use, transport of commodities or willingness to travel in the case of remote lands and properties. Your advisors can help you with dark ideas you haven’t thought of. If experienced, your realtor, attorney and accountant have all seen deals go bad and have witnessed partners go off the deep end.
Once you’ve developed your list of what could go wrong possibilities, you’re in a better position to put together contingency plans to handle these aberrations in the conduct of the business, of the entity, and the management and operation of your land. Equally as important, you will have a feel for what you need to build into your partnership, and LLC agreements or corporate bylaws. What will happen if the entity runs out of money and checks must be written to pay interest to the bank so the property is not lost? How should a situation in which some partners contribute and others do not be handled? What happens if a true micro or macro emergency occurs and your land or property must be dumped in an extreme exit situation? Who has the power to make day-to-day decisions? Who can sign checks or commit the entity to contracts, legal actions and other facts of business life? What happens, if for any reason partners just don’t get along? Limited partners in a LP, members in an LLC and shareholder in a S-Corp, unless the documents provide otherwise—or they sign notes or other security instruments—generally have limited liability under the laws of any state. How far do you want this limited liability to extend? If you are running the show as the manager, president or general partner do you need an indemnity from the partnership or the partners if things go wrong and you get in a jam acting on their behalf?
There’s an interesting mechanism, which is both fair and absolute that can be employed if the abrasion between partners in a deal is irreconcilable, dangerous to the respective partners or the partnership and is undermining the entity and the real estate. This is called a “Shotgun Buy-Sell”. Its ironic simplicity is stunning, and in my experiences, it works.
In a Shotgun, two or more partners who are at odds each have an opportunity to buy the other out. Either can make an offer to the other for all or portion of their partnership interest. The amount of the offer is determined by the offering partner. Here’s the beautiful twist. The partner to whom the offer is being made can either accept the offer, or can buy out the offering partner’s interest for the same amount! In other words if partner Joe want to buy out partner Sally and offered her $10 for her partnership interest, partner Sally has only two choices—accept the $10 and transfer her in
terest to Joe, or elect to buy Joe’s interest for $10. Obviously, this keeps folks honest, eliminates arguments and provides resolution. Don’t be surprised, however, in really bitter situations if a partner to whom the offer is being made simply refuses to abide by that provision of the partnership agreement and you have to go to court to enforce the Shotgun, or other provisions of the agreement.
Don’t Trip Over the Up Front Rules
If you are partnering with other than family, the government could consider a partner’s purchase of the interest in the entity a “security.” Strict rules govern the sale of securities if the transaction is to be exempt from the very stringent requirements of a public or quasi-public offering, and the attendant nightmare of paperwork and expense.
Good legal advice and an accountant who knows the vagaries of tax and other financial treatments are highly recommended especially when choosing a form of ownership that involves a partner(s). Why? There must be full disclosure, financial projections, a subscription agreement (with partners agreeing, among other covenants, that they are not acquiring their interest with intent to sell it) and that they meet minimum “sophisticated investor” financial requirements (including a minimum net worth of $1 million exclusive of their personal residence). Because we live in a time of increasing regulatory control, rising taxes, local, state and federal governments hungry for money to fuel past programs, ongoing services and—unfortunately, in many instances—unchecked expansion, outside forces will undoubtedly affect your land and the lives and other investments of your partners. In perilous economic times, folks get into trouble. They can have short memories when it comes to agreements to chip in money, contribute their share of work, be available, make timely or critical decisions—or sign on the dotted line with the bank or other lender when it comes time to extend, renegotiate financing or approve a sale.
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