9) Another great way to avoid disputes is to determine potential problem areas between the buyer and seller in advance. If future valuations are required, disputes can arise as to who is the proper appraiser. The easy way to fix this is ensure the documents specify that each of the parties can select an appraiser and those two appraisers will pick a third appraiser. That selection and the appraisal are binding. This type of strategy will work in virtually every instance where there might be a suspicion by either party that a consultant, appraiser, or other third-party has loyalties that lean one way or the other.
I have found it worthwhile to take some time before the closing, think about what could go wrong in the future and how those problems, if they ever arise, can be solved without litigation.
When Love and Money Collide—The Purchase
It’s the day of closing. If you’re the seller, you’re excited. You’re getting a check and moving the asset. That ebullience may be tinged with some remorse if it’s a piece of land you truly loved, or that ties in with family or other memories. If you’re the buyer, you’re about to realize a dream and are filled with enthusiasm, imagining the enjoyment of your acquisition, making improvements, and finding satisfaction in its operation.
The Labyrinth of the Closing
If you’ve done your homework and followed the “PPPPP” rule, there will be few, if any, surprises at the closing table. If you have not, a closing can be gruesome. I’ve seen many cases where shortly before closing a seller has tried to skate, twist, or completely crawfish out of the purchase and sale agreement. Perhaps somebody has approached and offered him more money. Perhaps some pressure has arisen that is clouding his judgment. I’ve seen the same thing happen on the buyer side. The buyer has suffered some type of financial reversal he didn’t count on. Maybe in the course of his wanderings between the time of the contract and the closing he found another property, which he thinks is a better deal. Desperate people do desperate things.
Sometimes one or the other of the parties just gets greedy, or they believe they have some leverage to press for last-minute concessions. These types of situations cause rancor, especially in cases where the party who’s planning to stick with the deal honestly thought there was some camaraderie and mutual respect. The shock of being wrong in your judgment about the human on the other side of the contract coupled with the unpleasant effect to your business plan causes anger that somebody is trying to change the deal, and can make for an unpleasant experience and leave a bitter taste.
In some cases the party who’s willing to stick with the deal has decisions to make. Should he/she accede to the demands of the other party? Partially accede (work out a compromise and get it done even though it is not the original deal)? Walk away from the deal and begin the arduous process all over, leaving time, effort, energy, hope and funds expended for legal and other costs on the table? Or, dig in his/her heels based on principle and business, and hold the feet of the flaky party to the fire of the agreement.
Twenty years ago, a group that I was representing and later became a partner in, made an offer on an exquisite ranch on one of the major rivers in Montana. After a month of negotiations, the purchase and sale agreement was signed. They were excited, had made their plans, had invested considerable funds in due diligence and had even begun the permit process for several improvements they planned to commence immediately after closing. This was a seller financed transaction. The sellers were extremely wealthy, lived elsewhere and spent little time on this wonderful property. As part of the deal, the buyers were required to furnish the sellers their financial statements. The sellers had the right to approve or disapprove. If they disapproved, the deal was over.
Within a few days of execution of the contract, the buyers submitted their financial statements– which I will disclose were extremely impressive, and demonstrated financial capabilities that could have purchased a property fifty times the size of the one on the table. There were no objections by the seller.
Four days before closing, almost three months after the contract was signed and financial statements had been submitted, we received an out-of-the-blue e-mail from the seller’s attorney stating that the sellers disapproved the buyer’s balance sheet and were canceling the contract.
I knew from my upfront work for the buyers that this was an exceptional deal. The minute I was informed of the sudden, suspicious shift, and unwarranted last minute attempted termination of contract, I knew that the sellers had received another offer for more money.
My buyers were distraught. Some of the group wanted to say “the hell with it.” Others wanted to force the issue. I recommended that they force the issue. A Lis Pendens was filed on the property, which means it could not be transferred to anyone else until a court decided who was right and wrong. My clients filed a complaint to enforce the specific performance1 provisions of the purchase and sale agreement.
In the meantime, I went to work via the sagebrush grapevine to gather what intelligence I could about what was really going on. My suspicions were confirmed. The sellers had indeed received a higher offer. To make matters worse they had deliberately tried to conceal it from my buyers. Several months of wrangling elapsed. In the court process, the sellers learned that the buyers knew exactly what happened, and the matter was settled shortly thereafter. Not only did my buyers get the ranch pursuant to the contract that had originally been signed, but the sellers reduced the price $100,000 as settlement of the legal action.
There are countless details in real estate. They are unavoidable. Real estate and land are multifaceted assets. I have seen, though not often, closings deteriorate into frigid silences, flushed faces and clenched jaws just because of a detail—though insignificant in the general exponentially larger scheme of the transaction—was not thought of and provided for up front.
Some of the gotchas in this category could be:
Who gets the propane and the propane tank. Many rural properties rely on a propane energy source. Generally tanks are five hundred or one thousand gallons. At $2-plus plus a gallon, a thousand gallon tank represents $2,000. A seller’s realtor should be sure the sellers are protected, the fill level of the propane tank is checked the day before closing, and the seller is paid by the buyer at closing for the propane still left in the tank. You’d be amazed at how often this detail is overlooked and astounded at the arguments that can erupt at the closing table even while consummating seven-figure transactions.
Insurance is another important detail and potential problem area. If the sellers are carrying money for the buyer, obviously the seller needs some protection if the house, barn or other flammable structure burns down or is otherwise destroyed. That’s part of the seller’s collateral. All sorts of nasty fights can erupt at closing table over whether the seller gets the insurance money in the event of a calamity, or the funds are available to the buyer to rebuild the structure thereby restoring the seller to his original collateral position.
Disputes can arise over the proration of taxes, improvement districts, homeowners association dues, the electric bill in the month of closing, assessments on water rights, the split of crops or pasture in an ongoing operation. The list is endless. There will be a helpful closing checklist in the Green for Green workbook.
The lesson here is that a layman, not involved in the real estate business, is simply not going to know about all these details. But your advisory team should. Far better to leave the closing table with a grin and a handshake then a grimace and a mutter. Then there are the frauds—despicable, distasteful and incredible.
What They Knew but Didn’t Tell You
The first rule of real estate is disclosure. It’s mandated by both law and ethics if you are a real estate professional, realtor or attorney. It’s also required that the seller disclose any material adverse facts he knows related to the property he is selling. Sometimes an untruth, or purposeful omission is caught during the due diligence process buried in the paperwork. Ten years ago a group with which I was involve
d was purchasing a small ranch. The ranch house was fed by a well. The sellers represented it was a “good, deep well” that had a flow of twenty gallons a minute.
When I’m acting as a fiduciary for partners I trust the seller, but in the wise words of Ronald Reagan, I verify. I had the hydrology consultant who was checking some other aspects of the ranch, also run a test on the well. The “good, deep well” turned out to be twenty-two feet deep, with a nine parts-per-million E. coli bacteria level (bring your hazmat suit!), and a flow rate of under six gallons a minute. Worse yet, we discovered the seller had had the well tested several years prior and knew about the problems.
One particular attempted fraud always sticks in my mind. This was another rare occasion in which I was representing a third party buyer purchasing a smaller horse property. (I keep giving examples of these “rare” occasions—but when you have been involved in 5,000+ transactions and have acted as buyer’s agent perhaps one hundred times, they are “rare”—all things are relative). There were two other realtors involved in this transaction.
My clients and I had met the sellers and their agent on the first inspection of the property, which was a twenty-two-acre small rolling farm property beautifully located near water, secluded, with a very fine home. My buyers really liked the sellers, and the seller’s realtor. I liked the seller’s realtor though I knew she was far sharper than her cloak of good ol’ girl demeanor. I liked the wife of the seller. However, there was some current of energy when I met the husband that I couldn’t quite place, but it made me uneasy and put me on guard. My clients pooh-poohed my disclosure of that impression after we left the property.
The clients had looked at several other properties, decided that this twenty-two-acre spread was perfect and wanted to submit an offer. Because everybody seemed to get along so well, we all agreed to meet in their kitchen and see if we couldn’t verbally cut a deal that would then be transferred to a purchase and sale agreement. For a while, the meeting was as cordial as a negotiating session can be.
The husband then began to explain that they had planned to build a metal barn, the contracts had already been signed with a contractor, they had paid a deposit, the contract could not be cancelled, and work was supposed to start shortly. They could not sell the property unless my client agreed to follow through on the contract and build the structure as designed, and pay for the costs of construction. This was a significant unexpected wrinkle, and strange. Why would a seller force a buyer to construct any building (much less, in my opinion, an unattractive metal box located in the wrong place on the property)?
The sellers remained in the kitchen while the buyers’ group stepped outside to discuss this most unexpected information about the barn. Birds fluttered in the sun-filled afternoon, the water sparkled and geese honked contentedly. I knew that despite my advice, my clients were going to cave in. My clients believed the sellers—that the contract could not be canceled and that they would not sell the property unless the buyer agreed to build the barn.
My antennae were at full alert. There’s virtually no construction agreement I have been associated with—and I have been associated with my share—that could not be canceled. Although, in some cases, if materials had been purchased or plans had been drawn, the agreement usually specified a penalty. That’s more than fair.
Despite my recommendations and the recommendations of the other realtor on the buyer side of the equation, the buyers decided they would accept the condition. We went back into the kitchen, and I asked what the cost of the barn was. There was a flicker in the husband’s eyes—almost imperceptible—but nonetheless real. He said the barn would cost $30,000, but that he would handle everything, the buyers could pay him and he would pay the contractor. He said he had a relationship with the contractor and was familiar with the project. He was “only too happy to assist.” My antennae were now buzzing.
I asked to see a copy of the contract. The husband made a great show of rummaging around in desks and looking for the contract he had just expressed such great concern over. In the end he “couldn’t find it.” He did find one sheet of the contract bearing his signature and that of contractor, but with no other information. I got everyone to agree that within seventy-two hours after both parties executed a purchase agreement, the contract would be supplied and would become an exhibit to the agreement, and that my buyers would have five days to approve that document. The purchase and sale agreement was drawn, greatly complicated with details and clauses to protect both buyer and seller on the future construction project that the seller wanted to supervise for the buyer. The contract was signed.
Four days later I called the selling broker and asked for the barn contract. She hemmed and hawed and said her clients had not yet located it. I suggested that the contractor must have a copy, perhaps they could get it from him. Another week went by and still no contract. By now I was certain that my immediate suspicions when the matter arose in the kitchen were correct. The seller was trying to make additional money on the barn.
I called the contractor direct. He and I got along fine and I asked him what the cost of construction was. He said it wouldn’t be more than $30,000, but there was a slight hesitation to his answer. He confirmed he had a copy of the contract, but could not release it without the seller’s permission.
I went to my clients and told them my suspicions. Again, they pooh-poohed my misgivings, but gave me the latitude to do what was necessary to confirm or dismiss my suppositions.
I sat down with the selling broker and we had a heart-to-heart. I reminded her that without the referenced exhibit of the construction contract, the purchase and sale agreement was not complete. I told her my clients would take no further steps toward closing nor incur any further due diligence expense until a full and complete exhibit of the construction agreement was provided and attached to the contract as called for in the agreement.
Another week went by. I called the selling broker several times, with no response. Finally, she got back to me with the news that the sellers were going to drop the condition that the barn be built. She hopefully suggested that the need for, and reference to that exhibit, would be removed. The only thing the sellers requested from the buyers was that the buyers pay the 50% of the contract termination fee, which was $1,000. My clients agreed to pay 50% to get rid of the morass and the long-term liability of an ugly barn in the wrong place, but now they were curious, too. I requested that they give me the authority to make their $1,000 contingent upon seeing the construction contract, which had never been furnished.
The look of relief on the selling broker’s face when I told her my clients agreed, other than one small request, could not be missed. When I told her the small request was that for the $1,000 they at least wanted to see the contract they were paying to terminate, the look of alarm that flashed across her features was also unmistakable.2
The property closed. The sellers never even attended the closing, and finally, a week after closing, the selling broker called me and said she had a copy of the barn construction contract and would trade me for my clients’ check.
The contract was for $21,000. This entire drama on an expensive property in a soft market, the associated bad feelings, distrust, abrasion and potential loss of the entire transaction, had been over the seller’s attempt to make an extra $9,000, based on a lie.
Let me emphasize that the story I just shared with you is the exception rather than the rule. Most sellers, particularly of rural land, are honest and conscientious. In most cases, they love the land they’re selling and they want the buyer to love it too—land touches hearts that way.
The conclusion? Pay attention to the details to avoid a wreck. If there’s something suspicious, or information doesn’t jive, trust your gut and investigate, and if there is a “disturbance in the Force,” i.e., the energy of the people on the other side the table changes or turns, there’s a reason.
1A remedy available to buyers and sellers if in the contract which allows the non-defaulti
ng party to force the other party to “specifically perform,” i.e., complete the transaction pursuant to the contract, and pay the legal fees of both sides.
2In the selling broker’s partial defense, I do not believe she initially knew of the attempted fraud by her clients. However, at some point in the process—perhaps when they abruptly reversed their insistence the barn be built, she did.
The tax laws of the United States are anything but simple. The entire U.S. Tax Code now consists of approximately eighty thousand pages, up from a “mere” sixteen thousand pages, thirty-plus years ago. While tax law is not straight forward for any industry or asset, I believe real estate is among the most complex and most varied. This chapter is not meant to be down in the trenches with references of cites, code sections and tax case results from the tens of thousands of lawsuits that eighty thousand pages has spawned. Rather, it is an overview, a taste of the smorgasbord of potentially advantageous, and possibly disastrous, major real estate related quirks in the Code.1
Tax Your Biggest Expense
People complain about the price of gas, the cost of food, housing, college tuitions and a host of other life expenses. But the biggest single expense in life and real estate is tax. One of these days perhaps the Code will be simplified. It could be cut down to under five hundred pages, raise more revenue for the Treasury and unleash the economic power of American industry, workers, real estate and the land’s resources. One can only hope.
Land for Love and Money Page 12