Masters Title & Escrow

DC, MD, VA, PA & FL real estate settlements

Tom Gimer

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Seller financing: a win-win?

Seller financing sounds complicated but it isn’t. Think of like this: Seller = Bank. In a typical real estate transaction with financing involved, the buyer obtains a loan from a mortgage lender or bank. With seller financing, the buyer gets that loan from the seller instead. Seller financing is sometimes referred to as “owner financing” but since title changes at closing the owner is no longer the owner, so I prefer “seller financing” when discussing the concept.

OK but is seller financing better for buyers or sellers? Often it is better for both.

For a buyer, there are several benefits to seller financing. The top benefit to most buyers is the savings they enjoy on closing costs. Mortgage lenders typically have several different types of buyer charges at closing… origination (points), underwriting, processing, document preparation and attorneys fees, plus appraisal and other third party costs. None of these fees are required with a seller-financed transaction. Next, the process of obtaining seller financing is also often much less intrusive than obtaining a loan from a traditional lender. For example, a credit check may not be necessary and document requirements are usually minimal. Lastly, depending upon how the deal is structured, the buyer may be able to get into a property without the standard down payment… often 20%+ of the purchase price. If the deal makes sense to the seller (which it often does, see below), a buyer may be able to purchase the subject property with very little cash up front.

Not every seller can offer financing (well technically that is not true, but we’ll leave a thorough discussion on subject-to for another day), but for those sellers that can, there are many great benefits to financing a buyer’s purchase. By offering or agreeing to seller financing, sellers are more likely get their asking price (or more). The up-front cost savings that buyers enjoy along with terms they secure means they should be able to offer more for the property. Next, sellers who finance can likely also sell as-is without having to make any repairs to the property. With no institutional lender involved, there are no property condition requirements to meet. Further, sellers who offer financing might also see the tax benefits of avoiding capital gains and instead receiving installment payments. The amount realized over the life of the loan (even on a 5 or 10 year balloon, let along a 30 year carry) can be significantly higher than with a standard sale. Lastly, if the buyer does default, since the seller holds a deed of trust or mortgage on the property and can foreclose if necessary, this reduces the risk of loss considerably. If things go sideways they may either take the property back (after receiving years of payments) or get paid in full at the foreclosure sale. Once a seller discovers all the benefits of this method of sale (buyers may need to do some explaining here), they may feel comfortable enough about the structure of the transaction that it almost doesn’t matter who the buyer is!

So now that you can see that seller financing is clearly a win-win for both buyer and seller, how do the parties prepare a contract for a sale with seller financing?

That’s simple. You simply add in the purchase price/payment section the details of the loan. For example, “Seller agrees to hold a Note secured by first lien Deed of Trust in the amount of $X with an annual interest rate of Y% amortized over Z years, payable in equal monthly installments of [principal and interest/interest only] in the amount of $[], with the final payment of all outstanding principal and interest due, if not sooner made, on or before [maturity date].”

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Surveys: an overview

As a buyer you may not be required to obtain a survey. However, if you decline a survey, the owners title insurance policy issued to you will exclude coverage for any matters which would have been disclosed by a survey. In that case you would not have title insurance (or legal defense) to respond to a boundary dispute, encroachment, or other survey-related problem.

Choices

For most residential property purchases, the buyer must choose whether to obtain (1) a location drawing, (2) a boundary survey, or (3) neither.

With commercial properties, upgrading to an ALTA/ACSM survey is the most common way to protect the significant investment that a commercial purchase often represents.

Differences between these survey types are outlined below.

Survey Types

Location Drawings

A location drawing is a quick and inexpensive survey of the property and the most common type of survey conducted in connection with residential property resales. This drawing locates the property lines and all improvements on the lot. A location drawing is the minimum required to satisfy the needs of the lender and title company to remove the survey exception; however, it does not establish the actual, true property lines or corners of the property, and it cannot be relied upon for construction. The cost of a location drawing is $200+, depending upon the size and complexity of the land.

Boundary Surveys

A boundary survey takes longer and is more expensive than a location drawing. Boundary surveys locate the actual, true property lines and corners or the property, as well as the location of any building setback lines or easements for utilities, driveways, sidewalks, etc.. The property corners are marked by the surveyor. A boundary survey can be relied upon to accurately erect fences or other improvements on your property. The cost for a boundary survey is $1500+.

If you plan to make any improvements to your property (such as a garage, fence, addition, etc.) it would be a good idea to order a boundary survey.

Boundary surveys are not nearly as comprehensive as ALTA/ACSM surveys.

ALTA/ACSM Surveys

ALTA/ACSM surveys are the standard for commercial property purchases. ALTA/ACSM surveys meet the highest standards recognized throughout the industry and they provide information including property boundaries; easement and encumbrances; encroachments; evidence of use by other parties; names of neighboring property owners; land improvements; roads and property features; access and legal routes to the property; zoning classification; flood zone classification; water boundaries; existence of cemeteries; legal property description.

The cost of an ALTA survey starts in the thousands of dollars. If you need an ALTA/ACSM, we can obtain quotes for you, but you will need to contract with the vendor directly and a deposit will likely be required.

Timing

A location drawing can be completed in under a week; a boundary survey will take a longer; and an ATLA can take considerable time. Actual time to complete any survey will vary depending on the complexity of the property as well as market demand.

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How COVID changed real estate settlements

Nothing’s changed, right? Wrong.

Real estate settlements used to involve the gathering of buyers, sellers, real estate agents and sometimes even lender representatives in a large conference room. This would be either at the offices of the title company or one of the agents. Parties would sit on opposite sides of the table. Coffees would be poured and snacks circulated. Sellers would sign the deed and various affidavits. Buyers would sign loan documents. Once everything was signed, sellers would deliver keys. Then everyone would wait for copies of their paperwork, take their sales proceeds or commission checks, shake hands and depart. Settlement used to be an event, a celebration to remember. That all changed with COVID.

Here is the new normal: Buyers and sellers never meet one another in person throughout the entire transaction. All communication is through their agents (if represented) or via email with the title company as intermediary. Agents confirm commissions electronically prior to closing. Lenders send instructions via email and funds via wire. The parties are definitely not meeting up on settlement day… they close separately. Once the buyer signs (remotely, or alone in the title company office) and sends the title company any additional funds due by wire transfer, the seller is then contacted to finish the closing process. The seller signs (again, remotely, or alone in the title company office) and the deal is closed. Commissions, sales proceeds and other payments are made by wire or checks are sent out via overnight courier. Copies of fully executed documents are then delivered by secure email. Rather than settlement being an event, it’s now just about getting the deal finished as safely and as conveniently as possible for the parties. It’s hard to celebrate alone!

Even though COVID fear seems to have decreased considerably of late, things are not going back to “normal” anytime soon (if ever). COVID certainly has left its mark on this industry.

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Subject-to transactions on the rise

As interest rates continue to rise, the “Subject-To” method of acquiring real estate will increase in popularity. We’re seeing an uptick in inquiries about subject-to. The extremely low mortgage interest rates we’ve experienced over the past decade are simply too low for investors to ignore. Investors who use the subject-to method keep the seller’s existing mortgage(s) in place in order to keep acquisition and holding costs low. Buyer closing costs are reduced significantly as there are no new lender fees and pre-paids. Monthly payments typically stay low as well.

As an investor-friendly title company, Masters Title & Escrow can facilitate subject-to transactions. And yes, as a buyer in a subject-to deal, you CAN get owners title insurance. The parties simply execute a few extra documents than in the typical sale.

But back to the subject of this post. While interest rates are still historically pretty low, they are now increasing rapidly. Many homeowners who purchased or refinanced recently have mortgages carrying the lowest interest rates in history. Many would-be sellers are deciding to stay where they are due to those favorable existing loan terms. But that isn’t always possible. Some owners falls on hard times and can no longer afford even the mortgage with that low rate. That’s where this investing method can come into play. If the parties can structure a deal which leaves the cheap financing in place, it can often be a win-win for both buyer and seller. The buyer gets great terms and lower closing costs (no new loan, points, fees, escrows, etc.) The seller finds someone to take over payments, put some cash in his/her pocket, and avoids foreclosure. And the seller’s interest is secured… he/she can foreclose or take back title if the buyer stops making payments.

Of course there are pitfalls to avoid when investing with this method. In our experience the major risks are (1) buyer default and the accompanying expenses, (2) failure to have a good exit strategy in the event the loan balance is accelerated by the lender, and (3) the seller filing for bankruptcy. Plus, making sure the property is properly insured can be tricky. We’ll go into each of these issues in more detail in the next few posts.

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Ground rent: an overview

This post should provide some good background information about Ground Rent to potential buyers who are not familiar with how ground rents work.

Leasehold estates

A property that is subject to ground rent is referred to as a leasehold estate. How does a property become leasehold? At some point in the chain of title, a fee simple property owner creates and records a ground lease, taking on a long-term tenant. Ground leases are typically 99-year leases which renew in perpetuity (forever) when the rent is paid. Ground rent payments are most often made in two semi-annual installments, each 6 months apart with the due dates depending upon when the ground lease was created.

Surprise, the property you are interested in has ground rent

When it is discovered that a property is subject to ground rent, some buyers become concerned. They really shouldn’t be. Ground rents have been in existence in Maryland and elsewhere since the mid-1800s. Leasehold property owners may technically have a landlord, but the lease does not contain any rules or regulations, just a promise to pay the rent. And except to the extent there are covenants, conditions and restrictions (CCRs) recorded among the land records, the property can be freely used just like a fee simple estate. For example, leasehold properties can be pledged as security for mortgages; and they can be refinanced and re-sold like any other real estate, with no limitation on the number of transfers or any landlord notice or approval requirements. Settlements on leasehold properties are just like those on other properties except for the instrument of conveyance is an Assignment (or Deed of Assignment) wherein the seller assigns the new buyer its rights under the ground lease. This gets recorded in the land records just like other deeds. Also, ground rent is prorated as of the settlement date. Ground rents are paid in arrears, meaning the rent you pay now covers the prior 6 months.

Registration and collection

Ground rents now need to be registered with the state to enable the owner of the ground to collect rent. So while a property may be still technically a leasehold estate and each subsequent transfer will be a transfer of the leasehold interest, if the owner has not registered the ground rent, there can be no ground rent collected. Why wouldn’t a ground rent owner register the ground rent? The registration requirement is relatively new. So when the owner of a ground rent dies, if the rent is not registered, his or her heirs will be unaware of the existence of the lease. So the right to collect rent essentially dies with the decedent. If the owner of a registered ground rent is unable to be located at the time of a transfer of the property, three years of rents (the maximum amount allowed to be pursued by the owner of a ground rent for past due rent) are collected and held in escrow. An additional $650.00 is escrowed above and beyond the three years to cover potential attorney fees and costs of collection. As of October 1, 2020, this escrow is not required for an unregistered ground rent.

What happens if you don’t pay ground rent?

Most ground rent owners will take action. They will make written demand for the rent and, if it remains unpaid for several months, they will then hire an attorney and pursue an action for ejectment. This is essentially an eviction and the landlord, if successful, will retake possession of the property. Since everyone with an interest in the property (such as a lender) will receive notice of the suit, most ground rents get paid before possession of the property is lost. Most ground rents of residential properties are of modest amounts — $30-$300 annually — but additional fees and expenses will also become due if the process gets that far.

Buying out the ground lease

If you’re not interested in paying ground rent forever, you don’t have to. The process of buying out ground rent (extinguishing the lease and returning the property to fee simple) is called “redemption”. Maryland law provides for the right of redemption (except in the case of irredeemable ground leases — quite rare) by the leasehold title owner at any time upon 30 days notice. The ground rent owner’s interest is said to merge with that of the lessee when a Ground Rent Redemption Deed is executed and recorded in the land records and the leasehold is extinguished. The purchase price for the ground (redemption amount) is fixed by Maryland law at a capitalization rate dictated by statute, based upon the annual rent and the date the lease was created. Just pay for a GRR redemption deed to be prepared, add transfer and recordation taxes based upon the redemption amount plus the deed recording fee and the property will be yours in fee simple.

Judgments and liens

A property which is subject to a ground rent is treated the same as a property which is not subject to a ground rent as concerns judgmens, liens and title searches. The documentation which is provided by the title company differs only in the wording of the estate on the commitment, which will read “Leasehold” rather than “Fee Simple” plus the amount and due dates of annual rent are included. The lease itself appears as an exception on Schedule B, Section II of the title commitment and the final title policy. This is necessary because a lease is a related collateral document that runs with the land just as in the case of covenants, conditions, restrictions, etc. Judgments and liens attach to leasehold interests the same way as fee simple properties.

Hopefully this information proves helpful to you in your analysis of transactions involving leasehold properties. Please do not hesitate to reach out to the MTE team if you should require any clarification or additional information on this subject.

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Tenant estoppel certificates

Real estate investors should be using tenant estoppel certificates (aka tenant estoppel letters) in connection with acquisitions of all tenant-occupied properties… even if they are not required to do so by a lender in connection with obtaining financing.

Why? Because you don’t want to find out after closing that some material fact about the tenancy has been hidden from you as a buyer taking title with a tenant in place. And you need to be able to get a tenant on the record regarding the status of the lease and “estop” them from making a different claim later.

Estoppel is a legal doctrine that says a person is prohibited from taking a different position later due to detrimental reliance upon representations previously made. The purpose of the tenant estoppel certificate is therefore to legally prevent the tenant from changing his or her story and denying the certifications made to the new landlord (you) at a later date.

Here are some common certifications to include in your tenant estoppel document:

  • That the Lease is in full force and effect and has not been modified, supplemented or amended in any respect.
  • That the commencement date of the Lease is X, and the expiration date of the Lease is Y. That the Tenant has/has no option to renew the term of the Lease.
  • That the Tenant has not paid rent or additional rent beyond the current month and agrees not to pay rent or additional rent more than one month in advance at any time.
  • That the rent has been paid through X date.
  • That there are no defenses to or offsets against the enforcement of the Lease or any provision thereof against Tenant.
  • That the tenant has deposited $X as a security deposit with Landlord pursuant to the terms of the Lease.
  • That the Landlord has not agreed to grant Tenant any free rent or rent rebatement.
  • That the Tenant is not in default under the Lease and to the best knowledge of Tenant, there exists no default by Landlord.
  • That the Lease is the entire agreement between the Landlord and Tenant pertaining to the property.
  • That the Tenant has no right of first refusal with respect to the property, option to cancel or terminate the Lease, or option to purchase all or any portion of the property.
  • That the Tenant agrees that no future amendment of the Lease shall be enforceable unless such amendment has been consented to in writing by a third party (such as a lender).
  • Since the date of the Lease, there has been no material adverse change in the financial condition of Tenant, and there are no actions, whether voluntary or otherwise, pending against Tenant under the bankruptcy, reorganization, arrangement, moratorium or similar laws of the United States, any state thereof or any other jurisdiction.

If the tenant cannot or will not make these certifications, you’ve got a problem. Each of these material certifications should be given by the tenant(s) during the investor’s due diligence/study period. If they cannot be obtained, the contract should be terminated or amended.