The Basics of Real Estate Transactions
Buying, selling and owning real estate is a complex venture, and when one adds to that a transaction in Tellurides remote mountain environment, coupled with strong personalities and the varying degrees of professionalism, things can get even more convoluted.
Purchase and sale issues include real estate brokerage aspects, contractual terms and obligations, and due diligence disclosures and review including physical condition, title and other legal matters and homeowner association operations.
Real Estate Brokerage
One of the first decisions a Buyer needs to make is whether or not to use a real estate broker, and if so, who. Ask around. Try to get some trusted recommendations.
Many Buyers find property listed for sale, and end up using the services of the broker listing the property (aka the listing broker). While that can work, it is better to have a broker working exclusively for the Buyers interests; a Buyer's agent (confusingly called the Selling Agent), and not to use the listing broker, who thus becomes a transaction broker and is not squarely in the Buyer's corner.
Also, it is important to understand how brokerage commissions are paid, and that they are negotiable. Commissions are generally paid by the Seller, but they of course increase the purchase price and are in fact paid out of the purchase funds paid by the Buyer. Listed property will disclose the commission offered to the Buyer's broker, but this doesn't stop the Buyer from negotiating a different rate with the Buyer's broker. Sellers who list property generally specify the commission paid to Sellers broker if the Buyer has a broker, and possibly a different arrangement if the Buyer has no broker. In this latter instance, Seller's broker usually ends up acting as transaction broker, but a Seller can require that its broker not under any circumstance represent the Buyer. A Seller might consider this, to keep the broker solely as Seller's advocate.
Before making an offer to purchase, or before listing a property for sale, listing, it is wise to get a strong feel for the current market. It is not too much to ask one's broker for a competitive market analysis (basically a broker's appraisal) before taking action. Some Sellers go so far as to commission a formal appraisal before listing property. Some Buyers do the same, i.e. have property appraised before even making an offer.
Careful selection of a broker is also important because representations the listing broker makes can be imputed to the Seller. This is based upon the fact that the listing broker is an agent of the Seller. The Seller needs to ensure that Seller's listing broker not make overly aggressive promises concerning the property, such as prospective rental performance or other items.
Finally, parties need to understand that overly aggressive salesmanship by a broker, on either side of the table, will reflect poorly on the party. For example, false claims by a listing broker that there are other interested parties about to make offers, in an effort to solicit or increase an offer, can backfire and ultimately discourage the Buyer.
It is also key to understand the locale. Due to the dramatic seasonal nature of Telluride's high alpine environment, properties take on widely different characteristics over the course of the year. Issues such as access can change. Properties at 9,000 or 10,000 feet above sea level wear differently due to exposure to the sun and other elements. Snow accumulation, freeze and thaw, snowmelt, ultraviolet radiation from the sun and other weather factors can take a radical toll on roofs, walkways, foundations, paint, wood and structural elements. An understanding of required property maintenance is important, along with a comprehension of other costs such as taxes and insurance.
The Offer, aka the Purchase and Sales Contract
Complex rules apply to the exchange of offers, and while the basic Colorado form real estate contract is a good one, there are some vagaries, and there is also a detailed scheme of dates that have to be inserted, so parties are advised to engage an attorney before making an offer or listing property.
There are many dates and deadlines involved within a purchase and sales contract. A well written contract simplifies this procedure to (1) a date upon which Seller must provide Buyer with all Property information, (2) a date (ideally at least two to four weeks later) by which Buyer must have conducted all due diligence, (3) a date by which the parties must come to agreement on any property issues, and finally (4) closing date.
Other form contract selections are needed, such as what type of Survey to require. Generally, it is best to request an Improvement Survey Plat, with corners flagged.
Another matter to address in the contract is the inclusion of any personal property (furniture, furnishings, etc.). Technically, these items should be conveyed with a separate value, via bill of sale, and Seller should pay sales tax on such transaction.
Even selection of the title company is an important consideration. Not all title companies are the same. Some are more adept than others at dealing with title matters, and complicated closing issues. Also, starting in about 2008, title companies stopped listing title exceptions on warranty deeds, and started referring to exceptions disclosed during due diligence. This reference in a deed to unknown and unrecorded information makes no sense, and the contract can be written to require the deed specify all exceptions.
Little things count. One would be surprised at the number of transactions that end up in dispute because the contract was not fully signed, or was not signed and exchanged on time, or because handwritten changes were made and not initialed.
Occasionally the Owner noted in the Multiple Listing Service is not actually the correct Seller identity. The broker should have the title company pull a copy of the most recent deed, so that the Seller identity is accurate. This office has seen a Seller, regretting the contract, claim no contract existed because the Seller listed in the contract was an individual, whereas the property was actually owned by a trust.
Many rules are not common sense. For example, the form contract contains a date by which it must be accepted. The law construes the contract has been accepted the moment the Seller signs and delivers the document to Seller's own broker, a counterintuitive rule, because most professionals in the field believe the signed contract has to be returned to the Buyer, or at least the Buyer's broker. The reason for this rule is that the law views the brokers as the conveyance mechanism, so because the offer was dropped into the conveyance system of a broker's hands, the old mailbox rule applies, holding that a contract is accepted when placed back into the conveyance system (i.e. handed to a broker).
Bidding wars involve a whole host of other rules. In such a situation, for example, the Seller would be wise to contract around the above mailbox rule, to allow for more flexibility in the negotiation process.
Under the law, generally, while a Seller has no obligation to a Buyer to accept even a full price offer, presentation of a full price offer generally obligates a Seller to pay the real estate commission agreed to with Seller's broker. Because commission offer is listed in the Multiple Listing Service, the Buyer's broker has a claim to such broker's share of the commission as well.
These are just a few examples of contract preparation issues.
Due diligence is an extensive process that typically begins after the contract is signed, but there is no rule stating that some due diligence cannot be performed even prior to contracting. Due diligence includes physical inspections, title and survey analysis, surrounding property issues, review of homeowner association operations and rules and other evaluations.
Once under contract, Sellers are required to deliver to the Buyer a Seller's Property Disclosure. This six page document requires Seller to list in detail all property structural issues, legal and zoning matters, and any other property issues. This disclosure should be carefully completed, and scrutinized for clues about possible problems with the property.
- Physical inspection
Physical inspection for constructed homes is critical. It is typically better to have a very thorough and experienced home inspector do this work. A cursory interior inspection is not enough. The work should include:
- A review of as-built construction for compliance with governmentally-approved plans, including review of specs and engineering, and confirmation that there are no zoning violation issues.
- An inspection of not just the home interior, but roof, site drainage, evidence of any foundation issues and other items.
- An understanding of when the home was completed, who built it and what legal warranties remain.
- Confirmation that the approved landscaping plan has been installed.
- A compilation of all instructions for mechanical, A/V and other house systems.
- Creation of Punch List. Sometimes, work cannot be completed by closing. It is cleaner to just get a financial credit. Parties can escrow funds, and an attorney should have a good form Escrow Agreement if this will be required, giving Seller a strict timeframe to complete otherwise the funds are released to pay for completion, but again it is cleaner to simply take a financial credit and have the Buyer do the work.
- A Radon gas test, and requiring Seller to install mitigation if necessary. This test should be done, and any mitigation should be promptly installed. Radon is a serious issue and should be dealt with properly.
- Square Footage Issues
Square footage is a critical issue, because the typical measure of value is price per square foot. Buyers and Sellers need to understand that there are several different ways of measuring square footage. The plans will say one thing. The Assessors Office will likely say another. The as-built condition may yet be another size. Also, there are different areas to measure and not measure, such as foyers, garage space, livable space, mechanical rooms, etc. It may be that a Buyer would want to request the home inspector to measure square footage. Once under contract, Sellers are required to deliver to the Buyer a Square Footage Disclosure, listing what Seller believes to be the improved property square footage, and on what basis the information is provided.
- Operational Expenses
The broker should take the lead on compiling a list of all ongoing expenses of ownership, including, but not limited to power, electric, gas, telephone, water, sewer, snow melt, trash, snow removal, landscaping maintenance, taxes, homeowner association dues, etc.
- Service Provider Information
Again the broker can take the lead on assembling information on all required property subcontractors and service providers.
- Title Review
This is where the attorneys expertise will be most important. Title review should include a careful analysis of all title exceptions listed on the title commitment, a document that will be provided by the title company. This work should also involve detailed consideration of the survey, and access matters. Wetlands would ideally be disclosed on the survey, but this is not guaranteed. A walk of the property during the summer season may be the only time to see this.
An attorney will work with the title company to review title to ensure the property is free of inappropriate encumbrances. The attorney reviews the "title commitment," a document issued by the title company describing the title insurance to be provided. Title insurance is generally provided by the Seller. The title commitment generally contains ten to thirty title "exceptions." These are items which will not be covered by the title insurance. The attorney focuses on evaluating these exceptions, sometimes persuading the title company to remove inapplicable exceptions. The attorney will also work closely with the title company to ensure that the title insurance provides appropriate coverage, and includes any required special endorsements, such as access, survey/boundary, mining rights exercise, etc.
A careful review of the Survey, coupled with a site inspection, is important to see if there are any adverse rights not listed on the title commitment, such as fenceline disputes, adverse possession claims (aka prescriptive claims), public or private pathways established, encroachments from or onto the property and other matters. Often some matters can only be seen in summer, such as encroaching walls or pathways. Likewise, some property issues only become apparent in the winter season, such as extraordinary ice buildup on areas of a roof.
A review of surrounding property issues needs to include an analysis of how zoning and other rules can change. Such rules are fluid. One can purchase a home in a single family neighborhood, only to have the Town, years later, zone adjacent property to multifamily or even commercial. Buyers should require a basic analysis of surrounding property issues, including a general report concerning what activities are permissible on and about the surrounding property. For example, if there is adjacent open space, other landowners may be entitled to establish small ski access trails through this property to their lots. Also, there is active and passive open space. Active open space can be developed to some extent.
This work should also include an evaluation regarding whether the property is burdened by or benefitted by any easements, such as view, shared driveway, height restrictions, etc. Under Colorado law, a lawsuit to enforce construction in violation of a private easement must be brought within one year of the violation, otherwise the violation can remain.
If the property is adjacent to or near a ski run, the attorney should evaluate the legality of any ski trail access. Legally, one must obtain formal permission from the Town and the ski company, granted in a recorded document, if establishing a trail to connect to the ski area. Also, if the property is say one lot back from the ski run, one must obtain formal written permission from the intervening lot owner to access the ski run, granted in a recorded document.
Title review should also include a check to see if fireplace woodburning is permitted, and if the purchase comes with a woodburning permit.
Sellers may even consider having a title commitment and survey generated and examined before listing property for sale. There may be an opportunity to resolve and clean up a title matter before a Buyer even engages with the property and possibly gets dissuaded by the presence of even an easily curable issue.
Finally, title considerations also include items such as mining claims, and water rights. These specialty items generally come up for ranch and other outlying properties, and not concerning properties within municipalities.
- Homeowners Association Review
If the property is included in one or more homeowners associations (HOAs), thorough due diligence of these operations should be conducted. This include, reviewing HOA documentation, HOA corporate status, HOA meeting minutes, historical and future budgets, reserve accounts, and certificates of insurance evidencing proper insurance for all HOA common elements. The soundness of the common element structures and systems should be understood. These can include common floors, walls, decks, plumbing and heating systems, snowmelt, driveways and other items. Critical to any purchase is a clear understanding of how the HOA operates. Is it properly maintaining the building. Does it have sufficient reserves. Ideally, an HOA is following a basic written reserve study, collecting assessments for future major capital needs such as roof replacement, major mechanical equipment, drive resurfacing, etc.
- Financing and Appraisal
If the purchase is to be financed, the contract will specify a date upon which Buyer must fully apply for the loan to at least one lender, and another date by which Buyer must obtain a firm loan commitment (which typically includes an approved appraisal). Even if a property is not being financed, some Buyers elect to have an appraisal performed, and to make a satisfactory appraisal a condition of purchase.
If a financing contingency is used, it is critical the Buyer actually apply for a loan. If a Buyer were to simply fail to apply for a loan, and then seek to cancel the purchase contract based upon some title or physical objection, the Seller could claim the Buyer's stated reason for termination was a pretext, and try to keep the Earnest Money.
- Rental Issues
Buyers should understand historical rental performance. The Seller should provide this information, though being careful not to guarantee performance.
The broker can also help interview and select property management firms for rental, or even simple maintenance.
Some properties come with managed arrangements, such as condominium hotels, and can include several tiers of management agreements and associated rights. Securities laws actually apply to these projects, so Buyers need to understand what is and is not lawful under these rules.
- Business Entity Formation and Taking Title
Many Buyers elect to form a business entity to take title, both for liability protection (important if renting), or privacy, or perhaps to outline any shared ownership provisions, if the property is being purchased by say two couples. Shared ownership agreements need to be fairly detailed, and include buyout and sale provisions, among others.
Also, how to take title of your property is generally an estate planning question. Attorneys generally recommend that clients, if married and not taking title in a business entity, take title as "tenants in common." This provides the parties segregable assets such that the parties can take advantage of retaining both federal estate tax deductions.
- Vacant Land
If the purchase is of vacant land, the Buyer should have an engineer, architect and/or builder provide access and building site evaluation. It may also be wise to commission a soils report.
During due diligence, Buyers should gain an understanding of what if any insurance is required. If the property is in a homeowners association, it may be that the HOA purchases some or all of the insurance for each owner, and the cost is simply levied in the dues.
Insurance should even be purchased for vacant land. At a minimum, this should include liability insurance, in case someone gets hurt on the land.
About a week before closing, the title company will provide draft closing documents. These should be carefully reviewed, and all tax and other prorations should be double-checked.
Contract Termination Issues
A common misconception is that a contract can be terminated for no reason at all. While contracts can be written that way, some courts view that as a non-binding illusory contract. There is no clear answer here, but it is commonly believed it is better to include language that the contract can be terminated for any reason or no reason at all. While property has many variables such that virtually any well articulated reason will constitute grounds for termination, some Sellers nevertheless will seek to retain Earnest Money in the event of termination.
It is important, however, to build into the contract the realistic grounds for termination. For example, say a Buyer is subject to a long-term lease, and the Buyer wants to get out of the lease and buy a home. The Buyer should make a specific condition of purchase the termination of the lease. As stated above under the discussion concerning financing, it is important not to give the Seller a chance to claim a pretextual termination. Here, if the Buyer were to simply fail to obtain an early termination of the lease, but the contract didn't have a termination provision for that eventuality and the Buyer canceled the purchase contract based upon some title or physical objection, the Seller could claim the Buyer's stated reason for termination was a pretext, and try to keep the Earnest Money.
Rights at Termination
The form contract states that, if the Seller tries to terminate without authority, Buyer can sue for specific performance and require Seller to convey the property.
Concerning the provision addressing where the Buyer tries to terminate without authority, it can either be selected that (1) Seller can sue for specific performance and require Buyer to purchase the property, or (2) Seller's only remedy is to retain the Earnest Money. Most Buyers elect the latter provision.
Other Ownership Issues
Completion of the purchase is just the beginning. Careful management of the property, whether through personal use or as a rental property, or both, is important. Rental agent contracts, service provider agreements and leases should all be reviewed and signed with caution.
Property Tax Matters
Contiguous land taxation
If the purchase is a home with an adjacent vacant lot, the Buyer should evaluate installing some landscaping and minor improvements on the vacant lot so that the Buyer can achieve contiguous lot status with the County Assessor. This reduces the taxes by a factor of three.66%. This is a reduction authorized by law whereby if one creates the lot as a natural extension of the yard for the home, the County will reduce the taxes to the improved property rate. Another way to do this is to vacate the lot line, but the contiguous status allows one to reduce the taxes while maintaining the flexibility to sell off the lot, or build on the lot, in the future if so desired.
County Valuation for Taxation
Every two years, counties reassesses the property value. Historically, counties would value properties conservatively, assessing at around 75% of actual value. Over the past several years, counties including San Miguel County have become much more aggressive with valuation. Counties realize that the tax base is the primary source of income, and with increased operational costs, higher valuation is critical. Property owners can appeal these valuations. There are strict timeframes within which to file these appeals. Successful appeals can literally save tens of thousands of dollars a year in taxes. The message here is to read the valuation notice (issued May 1 every year, but changes every odd year). The first appeal is due to be filed by June 1. There are successive appeal steps as well, if satisfaction is not achieved on the first appeal. An appeal consists of having the broker or attorney, or both, prepare an argument based upon comparable sales during the valuation period.
Many Buyers of large ranch properties take advantage of agricultural land status. This dramatically lowers the tax rate. This requires implementation of a livestock lease.
Often parties purchase property and then immediately develop a home, or engage in a substantial remodel. The selection of contractors, contracting with such parties and overseeing these projects brings on yet another host of issues. Again, obtaining good referrals is key, as is writing up clear contracts for the work. Property owners should use an attorney experienced in construction contracts and litigation to assist here. It is also important to consider engaging an Owner's Representative, being a construction professional retained to assist with project planning, contracting, regular monitoring of construction, review of proposed change orders and other matters.
The above merely highlights some of the issues involved with buying, selling and owning real estate in the mountains. The message is, do not take anything for granted or at face value. Put some thought into the matter and concerning who helps make these things happen.