Test 9: Closings; Risk Management; Property Management

returns funds to the buyer.

If for any reason the transaction cannot be completed, the escrow instructions usually provide a mechanism for reconveying title to the seller and funds to the buyer. In such a case, both parties return to their original status as if no sale had occurred.

disclose in writing any business relationships they have with other parties involved in the transaction.

Business relationships and affiliations among real estate firms, mortgage brokers, title insurance firms and other such companies that are involved in a transaction are permitted, provided the relationships are disclosed in writing to the consumer, the consumer is free to go elsewhere for the relevant service, and the companies do not exchange fees for referrals.

The item must be prorated and recorded as a debit to one party and a credit to the other party for the same amount.

An income or expense item that affects both parties is apportioned, or prorated, to each party to reflect the proper amount that each owes or should receive. A prorated item is treated as a debit to one party and a credit to the other party for the same amount.

at some time after the expense is incurred.

Items paid in arrears are paid after the expense has been incurred.

A debit to the seller and credit to the buyer for $580.

For income the seller received in advance, the buyer receives a credit and the seller receives a debit. In effect, the seller has received some of the buyer’s income, and the seller must pay this share to the buyer. Therefore the seller is debited and the buyer is credited the $580 the buyer is entitled to earn as the new owner.

A debit to the seller and credit to the buyer for $43.

For an item the buyer will pay in arrears, the buyer receives a credit and the seller receives a debit. In effect, the seller has incurred some of the expenses that the buyer will be paying for after closing. Thus the seller must pay the buyer the used portion of the expense, or $43.

$546.00.

The daily tax expense, first, is ($2,190 ÷ 365) or $6.00. Since the buyer will pay the taxes after closing, the seller will owe the buyer his or her portion of the tax bill, which is the 91 days from the beginning of the year through closing. Therefore, credit the buyer and debit the seller ($6.00 x 91), or $546.00.

$1,916.67.

This method assumes all months are 30 days and the year is 360 days. The daily proration is therefore $3,750 ÷ 360, or $10.42. The closing occurs on the 184th day of the year. Thus, ($10.42 x 184) = $1,916.67. Note that if the day of closing is the buyer’s, there would be 183 day’s worth of prorated expense.

$735.34.

Assuming a 365 day year, the daily tax expense is ($1,100 ÷ 365), or $3.013. As taxes are paid in arrears, the buyer will be paying the annual bill. Thus, he will be owed a credit for the seller’s share of the bill, which is $3.013 x 244 days, or $735.34.

$116.03.

The buyer’s share is the unused portion, or (365 days – 244 days), or 121 days. The daily expense is ($350 ÷ 365), or $.9589. ($.9589 x 121) = $116.03. The seller receives this amount as a credit and the buyer a debit.

$5,075.00.

If the buyer pays $,5250 interest for 30 days, the daily expense is ($5,250 ÷ 30), or $175.00. If there are 29 days of pre-paid expense, the buyer’s charge is ($175.00 x 29), or $5,075.00.

$17,750.

$887,500 x .02 = $17,750. Remember, one point = 1% of the loan amount.

$22,250.

$375,000 x 6% = $375,000 x .06 = $22,500.

the buyer must pay the expense.

Explicit agreements in the sale contract supercede traditional expense-payment responsibilities which can vary from state to state.

the excess of the buyer’s debits over the buyer’s credits.

To determine how much money the buyer owes at closing, the buyer’s debits are totaled and compared with the total of the buyer’s credits. The excess of debits over credits is the amount the buyer must bring to the closing.

negligence, error or omission in carrying out professional services.

A standard E&O policy provides coverage for “damages resulting from any negligent act, error or omission arising out of Professional Services.” It does not cover dishonest or illegal acts, including environmental violations and mishandling of funds.

Failing to inform and disclose properly.

Agency risks commonly concern the requirement to inform and disclose. Most states require agency relationships to be in writing and to be disclosed to all parties to a transaction. In states that do not use agency, there is still the obligation to explain and disclose the nature of the relationship.

failing to disclose known adverse facts.

Depending on the state, the licensee may have no further duty to disclose property condition after properly informing parties of their rights and obligations. However, the licensee may still be subject to legal action for failing to disclose adverse facts the licensee knew about or should have known about.

avoid creating a false impression that the licensee is a certified appraiser.

Misuse of such terms as “appraisal” and “value” could lead to a charge of misrepresenting oneself as an appraiser.

exceeding the authority of the agreement.

Licensees must stay within the bounds of the authority granted by the agency agreement and avoid doing anything requiring permission without first getting that permission in writing

use a checklist of all items, contingencies, dates and responsibilities that must be met.

One way to reduce risk in the contracting process is to use a checklist that covers all the contract items, such as inclusions and exclusions, contingency periods, documents, forms, data checking, and milestone dates.

the principals may make changes as long as they sign or initial each change.

Real estate professionals who are not attorneys are usually limited to filling in blanks or making deletions on a preprinted contract form prepared by a lawyer. While a licensee may make deletions, additions to a form should be drafted by an attorney. The principals themselves can make changes as long as each change is signed or initialed by all signers.

obtain education in the content and intent of the laws.

Fair housing laws are complicated and compliance is not always straightforward. The risk of violating fair housing laws can be minimized through ongoing education that addresses both the intent of the laws and their current content.

being present at a conversation where the setting of commission rates is discussed.

Antitrust laws forbid brokers to band together to set a price on their services in listing and selling property. Even being overheard discussing commission rates or being present at such a conversation can lead to charges of price fixing.

License discipline, fines, and possible incarceration.

Intentional misrepresentation, as a type of fraud, is a criminal act that may result in fines and incarceration, in addition to discipline from state regulators and professional organizations.

stating that a client should seek legal counsel.

Unintentional misrepresentation occurs when a licensee unknowingly gives a consumer inaccurate information concerning a property, financing or agency service. Information that the licensee, as a professional, should have known to be false or inaccurate may be included in the definition. Telling a client that legal counsel would be advisable is not misrepresentation and, in fact, is often an important risk management technique.

avoid speculative statements in all reports.

Progress reports should be accurate, timely, in writing, and free of speculation. Speculation may encourage the consumer to believe the agent has expertise that in fact is non-existent. If a consumer has a question about the meaning of something in an inspection report, the licensee should refer the consumer to the person who wrote the report rather than trying to explain it.

It reduces the chance of presenting an offer from an unqualified buyer.

Using a lender to qualify the buyer protects the agent against leading a seller to believe a purchaser is fully qualified when this may not be the case. Also, lenders and loan agents are better able to look into the buyer’s qualifications than a real estate licensee is. If it is necessary to show a property to a potential buyer who has not been qualified by a lender, the licensee can gain some protection by performing an informal qualification and documenting the fact that it was based on the information provided by the buyer.

the agency relationship.

Maintaining the confidentiality of any information that would harm the client’s interests or bargaining position or anything else the client wishes to keep secret, unless the law requires disclosure, is one of the primary duties of agency. The duty to maintain confidentiality generally survives the termination of a listing agreement into perpetuity.

performing a comparative market analysis.

In preparing a Comparative Market Analysis, licensees should guard against using the terms “appraisal” and “value,” which are reserved for the use of certified appraisers. Misuse of these terms could lead to a charge of misrepresenting oneself as an appraiser.

make a substantial misrepresentation.

The license laws of most states list as illegal advertising activities subject to discipline such actions as making any substantial and intentional misrepresentation, making false promises, and making misleading or untruthful statements in any advertising.

fiduciary

The management agreement creates an agency relationship between the manager and the principal. This is a fiduciary relationship and, in general, the agent is charged with producing the greatest possible net return on the owner’s investment while safeguarding the value of the investment for the owner/investor.

financial reporting to the principal.

Financial reporting to the principal is a fundamental responsibility of the property manager. Reports may be required monthly, quarterly, and annually. Required reports typically include operating budget, cash flow, profit and loss, and budget comparison statements.

revenue from all sources minus losses from uncollected rents, vacancies, and evictions.

The total of scheduled rents plus revenues from such sources as vending services, storage charges, late fees, utilities, and contracts is the potential gross income. Subtracting losses caused by uncollected rents, vacancies and evictions gives effective gross income.

cost per tenant prospect generated per lease.

The efficiency of marketing activities can be judged in terms of how many prospects per completed lease they generate. The lower the cost per prospect per lease, the more effective and efficient the program.

raise rental rates.

Vacancy rates are directly related to demand and competitive supply in the market. If vacancy rates in the managed property are too high, the manager may have to lower rates or identify problems in the property or its management that are contributing to vacancy level. On the other hand, if the property’s vacancy rate is significantly lower than market rates, the manager may conclude that higher rental rates are called for.

Routine, preventive, and corrective

The foremost maintenance objective is generally to preserve the value of the physical asset for the owner over the long term. Three general types of maintenance are required to keep a property in serviceable condition: routine (day-to-day), preventive (scheduled), and corrective (repairs and replacements).

ensure that disabled employees have the same level of access to facilities that all employees have.

Employers with at least fifteen employees must follow nondiscriminatory employment and hiring practices and make reasonable accommodations to enable disabled employees to perform essential functions of their jobs. Modifications to the physical components of the building may be necessary to provide the required access to tenants and their customers. Existing barriers must be removed when the removal is ‘readily achievable,’ that is, when cost is not prohibitive.

replacement value.

The amount of coverage provided by certain types of policies may be based on whether the property is insured at depreciated value or current replacement value. Depreciated value is original value minus the loss in value over time. Current replacement value, which is more expensive, is the amount it would cost to rebuild or replace the property at current rates. Commercial policies include coinsurance clauses requiring the insured to bear a portion of the loss. Fire and hazard policies usually require the coverage to be in an amount equal to at least 80 percent of the replacement value.

cash for the management firm’s operating expenses.

Managers are responsible for proper handling of monies belonging to other parties (trust funds) that come into the manager’s hands in the course of doing business. For property managers, such trust funds include rents collected from tenants, security deposits, and capital contributions from the property owner. Funds belonging to the management firm must not be commingled with those of the client

General

Property managers are usually considered to be general agents empowered to perform some or all of the ongoing tasks and duties of operating the property, including the authority to enter into contracts.

The tenant pays a fixed rent, and the landlord pays all operating expenses.

In a gross lease, the tenant pays an established, fixed rent, and the landlord pays all property operating expenses, such as taxes, insurance, utilities, and other services. This is the arrangement commonly used in residential leases. If the tenant pays some of the operating expenses, the lease is a form of net lease.

the property manager does not have to maintain it.

The lease should set forth items that are excluded or included in the leased property. For instance, a residential lease may include built-in appliances such as dishwashers but exclude freestanding ones, such as refrigerators. At issue for the landlord is the cost of maintenance. If a refrigerator is not included, it does not have to be maintained by the property manager.

deliver a habitable property.

The landlord (by way of the property manager), is expected to deliver a property that is habitable. This means keeping heating, plumbing, cooling, and electrical systems in good repair as well as maintaining serviceability of floors, stairways, railings, roofs, and windows.

A tenant declares a landlord in default and vacates the leased premises.

A constructive eviction occurs when a tenant vacates the leased premises and declares the lease void, claiming that the landlord’s actions have made the premises unfit for the purpose described in the lease. The tenant must prove that it was the landlord’s actions that were responsible and may be able to recover damages.

the competitive market for the property.

In preparing a management plan, a manager must consider the owner’s objectives, including financial goals; the competitive market for the property, both local and regional, depending on the property type; and the features of the particular property. The plan will also include a budget and indications of what the manager intends to do with the property to meet the owner’s objectives.