Property Conditions and Disclosures - Part 4 - Chapters 32-35

Question 1

Understand the use and operating restrictions placed on conduct in homeowners association (HOA) communities in exchange for every other owner-member doing the same

Answer 1

Ownership of a unit in a condominium project includes compulsory membership in the homeowners associate(HOA). The HOA is charged with managing and operating the entire project. A condominium unit is considered managed housing.

The implicit bargain in becoming an owner member of a condo unit is the consent to conform conduct to meet extensive use restrictions in exchange for every other owner member doing the same.

Question 2

Identify the obligations and assessments imposed on a buyer of a unit in a common interest development (CIT)

Answer 2

The obligations undertaken by a prospective buyer who acquires a unit in a common interest development (CID), and the HOA documentation of those obligations, fall into two classifications:

• use restrictions contained in the CCRs and
• financial obligations to pay assessments

Two types of assessment charges exist to fund the expenditures of HOAs:

• regular assessment, which fund the operating budget to pay for the cost of maintaining the common areas and
• special assessments, which are levied to pay for the cost of repairs and Replacements that exceed the amount anticipated and funded by the regular assessments.

To better understand the personal financial impact of assessment obligations, a prospective buyer of the unit needs to analyze the assessments based on:

• the present and future annual operating cost the HOA will incur and
• the amount set aside annually as reserved for future restoration or replacement of major components of the improvements.

Question 3

Determine when a seller’s agent is to request the HOA delivery the CID documents concerning use restrictions and HOA finances for delivery to prospective buyers when a CID property is listed.

Answer 3

To determine if an HOA has its finances in order, a prospective buyer may look to the financial reports held by the owner or readily available from the HOA on the owner’s request. The HOAs pro-forma/estimation operating budget make several mandatory disclosures about the states of the HOAs Finance, including:

• an estimate of the revenues from assessments, paid or delinquent
• the expenses the HOA anticipates
• a summary of the HOAs cash Reserves and
• any determination or anticipation of the HOA board of directors as to whether special assessments will be required in the future.

NOTE - it is at the listing stage when the agent prepares the owner’s request to the HOA to deliver up the CID documents concerning use restrictions and HOA finances. These documents are readily available from the HOA.

NOTE - An HOA is obligated to provide the documents requested by a seller within 10 DAYS of the seller’s written request.

NOTE - A buyer is advised to request a list of defects from an HOA to get a better idea of the probability of regular and special assessment increases in the near future.

Question 4

extraordinary expense

Answer 4

An EXTRAORDINARY EXPENSE is an emergency situation lifting the limits placed on the amount an HOA may charge for regular and special assessments. Extraordinary expenses include amounts necessitated

• by a court order
• to repair life-threatening conditions
• to make unforeseen repairs.

Question 5

homeowners association (HOA)

Answer 5

A HOMEOWNERS ASSOCIATION (HOA) is an organization made up of owners of units within a common interest development (CID) which manages and operates the project through enforcement of conditions, covenants and restrictions (CCRs). The HOA has a board of directors and committees, both consisting of owner members who are appointed to oversee the conduct of all the owner members and their guests.

Also available from the HOA is a statement on the HOAs policies for enforcing collection of delinquent payments of assessments. At issue for a prospective buyer of the unit is a method used by the HOA to enforce collection of Assessments for example,:

• does HOA record a notice of default and proceed with a trustees foreclosure on owner’s unit, a default which may be cured by the payment of delinquencies and statutorily limited foreclosure cost or
• does HOA hire an attorney and file a lawsuit requiring a response, a trial, and results in a personal money judgement against the owner, all of which has no limit on the dollar amount of costs and attorney fees to defend or prosecute and, if not paid, becomes an abstract of judgment which is a foreclosable lien on all property owned by the owner and collectible by attaching the owners wages or salary.

Question 6

pro forma operating budget

Answer 6

A PRO FORMA OPERATING BUDGET is a estimated budget which discloses the amount of assessments collected by an HOA, it’s cash reserves and whether special assessments are anticipated to occur.

Question 7

regular assessments

Answer 7

REGULAR ASSESSMENTS are reoccurring HOA assessments which fund the operating budget to pay for the cost of maintaining the common areas. Regular assessments are set annually and are due and payable in monthly installments. Annual increases in the dollar amount levied as regular assessments are limited to a 20% increase in the regular assessment over the prior year.

Question 8

special assessments

Answer 8

SPECIAL ASSESSMENTS in a common interest development subdivision, are assessments or charges, in addition to the regular assessment, levied by the Association against the owner in the development, for unanticipated repairs or maintenance on the common area or capital Improvements of the common area. Special assessments are levied to pay for the cost of repairs and replacements that exceed the amount anticipated and funded by the regular assessments. Special assessments are generally due and payable in a lump sum on a date set by the HOA when making the assessment. An increase in special assessments is limited to 5% of the prior year’s budgeted expenses.

Question 9

Capitalize on your competitive advantage of offering advice to clients on the tax consequences of a real estate transaction

Answer 9

Ideally, agents will, as a matter of basic competency, possess and understanding of certain fundamental tax concepts which are basic to the sale or ownership of real estate that they will most frequently be listing and selling.

Question 10

Develop better clientele based on your willingness to advise due to your knowledge of the tax aspects of a transaction.

Answer 10

In certain real estate transactions, a broker stands to earn an additional fee for assisting a seller in locating and acquiring a like-kind replacement property for the property being sold. This exempts the client from reporting the sale proceeds as income and thus having those proceeds taxed, known as a 1031 transaction or a 1031 reinvestment plan.

Question 11

Advise clients when they need third-party tax counsel and a contingency provision for further approval of a transaction tax consequences

Answer 11

If an agent determines information about the tax aspects of a sale might affect the client handling of the transaction, the tax aspects become material to the transaction and the agent is duty-bound to disclose the extent of their knowledge on the transactions tax implications. On a 124 unit residential property transaction, however, the agent has no duty to disclose tax information unless the client makes a direct inquiry on the matter.

NOTE - On one-to-four residential dwellings, a seller’s agent has NO DUTY TO DISCLOSE, NO AFFIRMATIVE DUTY TO DISCLOSE their knowledge of possible tax consequences.

Question 12

Avoid liability exposure for the tax information you give

Answer 12

A broker or agent who chooses to voluntarily counsel a client on such matters needs to be careful to avoid misleading their client by intentional or negligent misapplication of the tax rules, and may advise their client to seek advice from a qualified third-party advisor.

FURTHER APPROVAL CONTINGENCY - The most practical and effective method for shifting reliance to others or to the client when the broker provides their opinion on a transactions tax consequences is to insert a Further Approval Contingency in the purchase offer or counter offer.

Question 13

$1031 cooperation provision

Answer 13

A 1031 COOPERATION PROVISION is a statement in purchase agreements putting the seller and buyer on notice they are able to avoid profit reporting on the transaction and provides cooperation when a 1031 exemption is intended on the sale or purchase of a property.

When representing sellers of real estate that on a sale qualify for the 1031 profit reporting exemption an agent is to use a purchase agreement containing a 1031 cooperation provision.

A 1031 cooperation provision puts the seller on notice they are able to avoid profit reporting on the sale and have bargained for the buyers cooperation if the seller decide to act to qualify their profit for a 1031 exemption. It is not advisory disclaimer by which a broker or agent attempts to relieve themselves of their responsibility to give tax advice.

Again an agent who is not knowledgeable about the handling required for a 1031 reinvestment can initially avoid a discussion of tax aspects by including the 1031 cooperation provision in the purchase agreement. The 1031 cooperation provision conveys to the seller the sellers need to consider, plan for, and inquire about the tax consequences of the sale.

Question 14

$1031 transaction

Answer 14

A 1031 TRANSACTION is a two-step transaction in which the net proceeds from the sale of one property are reinvested in a replacement like-kind property and the profit or loss realized on the sale go unreported and untaxed.

Question 15

Agency Law Disclosure

Answer 15

The AGENCY LAW DISCLOSURE is a form containing real estate agency codes which establish the conduct of real estate licensees when representing others in a real estate transaction, which is delivered to all parties in sales transactions other than for 5 or more unit Residential Properties.

Question 16

carryback financing

Answer 16

CARRYBACK FINANCING is a form of credit extended to a buyer by a seller for payment of a portion of the purchase price, evidenced by an installment note secured by a trust deed lien on the property sold.

Question 17

Determine when to disclose a prior death on a property

Answer 17

Generally, sellers agents are not required to voluntarily disclose information to a potential buyer regarding a prior occupants:

• whose death, from any cause, occurred on the real estate more than three years prior to the purchase offer, or
• who was afflicted with HIV or Aids.

However, if a death on the property for some reason adversely affect the market price of the property, it becomes a material fact and must be disclosed.

Question 18

Assess whether a history of death on a property might affect the buyer’s valuation or desire to own the property

Answer 18

On direct inquiry by the buyer or the buyer’s agent about death on the property, the seller’s agent must disclose their knowledge of any deaths on the real estate, no matter when they occurred. Any intentional concealment of a death after a buyer makes a direct inquiry is a breach of the seller’s agent GENERAL DUTY and the buyer’s agent AGENCY DUTY.

An inquiry by the buyer into deaths on a property indicates a death on the premises is a material fact which might affect the buyers use and enjoyment of the property. This imposes an Affirmative Duty on the buyer’s agent to investigate or recommend an investigation into any deaths before an offer is made.

If a death occurs within three years - A buyer’s agent discloses any death occurring on the property within 3 years or otherwise, especially if they believe the death might affect the buyer’s decision to make a purchase agreement offer.

Question 19

material fact

Answer 19

A MATERIAL FACT is information about a listed property which may affect the property’s value or after a client’s decision to purchase or sell the property and, thus, needs to be disclosed.

Question 20

Transfer Disclosure Statement

Answer 20

A TRANSFER DISCLOSURE STATEMENT (TDS) is a mandatory disclosure prepared by seller and given to prospective buyers setting forth any property defects known or suspected to exist by the seller, generically called a condition of property disclosure.

Question 21

Determine an income property’s fair market value based on the income and expenses it experiences

Answer 21

In this chapter regarding Income Properties - we are concerned primarily with the INCOME APPROACH to valuation since income is initially used by investors to determine a property’s fair market value (FMV) and the ability of the rents to service debt.

Since the NOI represents the investors annual return on all capital invested, the information and data entered in an APOD are the fundamentals upon which the market value of an income property is initially judged.

Thus, the APOD prepared by the seller’s agent has to contain accurate representations of the expected net operating income (NOI) by providing either:

• a PROJECTION based on current operations as experienced by the seller
• a FORECAST based on the opinion honestly held by the agent about future income and expenses which a buyer will likely experience as the owner of the property.

Question 22

Prepare, analyze, and interpret and Annual Property Operating Data Sheet (APOD) on an income property

Answer 22

Operating data from an income property is gathered and entered on an Annual Property Operating Data Sheet (APOD) by the seller and a seller’s agent. The APOD provides information about the properties fundamentals, and is handed to prospective buyers or their agents.

An APOD, prepared by a seller’s agent and handed to a prospective buyer, provides operating information on the property, including:

• the estimated Net Operating Income (NOI), for setting the price to be paid on the mortgage amount which may be serviced by the income generated by the property
• the spendable income, for providing a cash flow cushion reflected by the amount of the net operating income remaining after servicing the mortgage financing (including information on mortgage balances, monthly payments, interest rates, and any due dates), and
• the income tax consequences the prospective buyer are likely to experience during the first year of ownership due to allowable deductions of interest on trust deed mortgages and IRS depreciation schedules.

Question 23

Make forecasts about the potential income and expenses a buyer is likely to experience on acquiring an income property

Answer 23

Sometimes data from comparable properties demonstrates that the listed properties current operations are producing less rental income and greater expenses than experience by owners of other properties.

The comparison likely justifies the preparation of an APOD using figures which are decidedly not reflective of the property’s current operating income and expenses. Instead, the APOD figures represent the sellers agents opinion about the properties probable future operations based on the income and expenses experienced by both the listed property and the comparable properties.

Here, the seller’s agent must have a reasonable basis for developing a rational opinion about the properties future potential when estimating the anticipated income and expenses. The estimate is the seller’s agent FORECAST of income and expenses which the seller’s agent honestly believes has a reasonable likelihood of occurring under new ownership.

Thus, two entirely different NOI estimates may logically be presented to a prospective buyer regarding the listed property:

• one based on current operations as continuing without a significant change in anticipated income and expenses, properly called a PROJECTION
• the other based on opinion of potential income and expenses likely to be experienced in the future, properly called a FORECAST.

A contingency provision in the purchase agreement calling for the buyers further approval of the income and expense is always prudent as it demonstrates that the buyer is not relying on the agents APOD estimates as a guarantee.

Question 24

Conduct a diligent investigation to verify the data contained in an APOD to best advise your buyer on an income property acquisition

Answer 24

Once the seller’s agent delivers the APOD to the prospective buyer and their agent, the special agency due to the buyer by a buyer’s agent is to review the skeletal property information received from the seller and the seller’s agent and advise the buyer on inquiries or investigations needed to understand and appreciate the ramifications of the disclosures.

In essence, the seller’s agent hands off to the buyer’s agent the duty to determine which points raised by the APOD figures (and other disclosures) need to be further investigated to produce an accurate picture of the properties earning power.

Question 25

Annual Property Operating Data Sheet (APOD)

Answer 25

The ANNUAL PROPERTY OPERATING DATA SHEET (APOD) is a worksheet used when gathering income and expenses on the operation of an income-producing property to analyze its suitability for investment. By design the APOD is intended to induce prospective buyers to rely on its content to decide just what price to offer to buy the property. Thus, with the presentation of an APOD to a prospective buyer or their agent, negotiations have begun.

Question 26

general duty

Answer 26

A GENERAL DUTY is the duty a licensee owes to non-client individuals to act honestly and in good faith with upfront disclosures of known conditions which can adversely affect a property’s value.

Question 27

net operating income (NOI)

Answer 27

The NET OPERATING INCOME (NOI) is the net revenue generated by an income-producing property as the return on capital, calculated as the sum of a property’s gross operating income minus the properties operating expenses.

Rental income and operating expenses produce a property’s NOI. In turn, the property’s NOI represents the annual return the property delivers to the owner, which is accounted for as:

• a RETURN OF the owners original capital investment, called depreciation (evidenced in part by the principal reduction on the purchase assist mortgage) and
• a RETURN ON the owners capital investment, called a yield, (including the portion of the NOI used to service interest payments on the purchase assist mortgage).

Question 28

income approach

Answer 28

An INCOME APPROACH is an appraisal method used to estimate the value of a property based on the income and expenses it produces, determined by dividing the net operating income by the capitalization rate.

Question 29

Impounded funds

Answer 29

Mortgage payments entered on the APOD reflect only the principal and interest (PI) payments, separately stated from any impounded escrowed taxes and insurance premiums (TI) funds deposited with the lender as part of the totally monthly PITI payment.

PITI = PRINCIPAL + INTEREST + TAXES + INSURANCE

Impounds, however are disclosed elsewhere on the APOD. Impounds are merely a reserve for some of the owners fixed operating expenses (already figured into the NOI), such as:

• property taxes
• improvement district bond payments
• Hazard insurance premiums.

The lender pays these expenses on behalf of the owner using the impounded funds.

NOTE - Deposits into an impound account are NOT a mortgage charge or an operating expense. However, the lenders later disbursement from the impound account represents payment of the owner’s operating expenses.

The amount of any monthly impound deposit is going to change on transfer of the property ownership, typically due to an increase in property taxes triggered by reassessment because of the change of ownership. The buyer’s agent calculate the increase in impound and enters the estimated future impound payment on the APOD. They do not enter in the current sellers present impound payment.