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The purchase and/or leasing of real property in the United States is governed by the laws, customs and practices of the state in which the real property is located and sometimes by local laws of the municipality or county of the state (such as zoning laws, which may limit particular uses of property, and tax laws, which may impose transfer taxes on the transaction). The purchase or leasing of federal lands is mainly governed by federal law. The general principles governing the purchase or lease of real property are fairly consistent in all jurisdictions. However, it is prudent to consult local counsel in connection with any purchase or lease transaction.
The general procedure for the purchase of real property includes the negotiation of a contract of sale, the clearance of title objections and the closing of the contract of sale when the purchase price is paid and a deed for the property is delivered by the seller to the buyer. In connection with the purchase or lease, the buyer may wish to obtain a loan, which may be secured by a mortgage upon the real property being purchased, to finance a portion of the purchase price or improvements to be made to the property.
Many types of real property may be leased or purchased. In addition to commercial buildings, which may be stand-alone properties (such as factory buildings) or be part of a commercial development (such as a shopping centre), there are residential apartment and office buildings, single-family and attached homes, cooperative apartments (which are technically not real property) and condominium apartments.
The procedure for leasing real property involves the identification of a suitable property to be leased, the negotiation of the lease terms, including any necessary improvements to the property that must be made before the tenant takes possession and arrangements for financing of such improvements.
This paper will discuss each of the steps involved in the purchase and lease transactions, from identifying the property sought to be purchased or leased through the closing of the sale transaction or the taking of occupancy of the leased property.
Residential property available for purchase or lease
There are many types of residential property. Each is available for purchase or may be leased. The most common type of residence is the single-family home. Ownership of that property includes ownership of the plot of land on which the structure is located as well as ownership of the house and all other structures (i.e., garage building, storage shed) located on the plot of land.
In many metropolitan and vacation areas, cooperative and condominium apartments are purchased and sold for residential use. When a buyer purchases a cooperative apartment, the buyer is not purchasing real property. Instead, the buyer purchases from a seller the shares of stock in a corporation that owns an apartment building, which shares are allocated to a particular apartment within the building. The buyer, due to his ownership of the shares of stock, is entitled to receive a lease, called a proprietary lease, for the apartment within the building that was occupied by the seller. The lease is for a long term of years (often more than 50 years) and is assigned by the seller to the buyer. The lease is generally extended when the original lease term expires. The rent payable is the tenant’s proportionate share of the cooperative apartment building annual expenses.
The rights and obligations of the cooperative apartment owner are determined by the provisions of the proprietary lease, house rules, and the by-laws of the cooperative corporation. The real property in which the cooperative apartment is located is owned by a corporation and is managed by the board of directors of the corporation. Generally, the board of directors of a cooperative has the power to approve or disapprove the proposed sale of an apartment (stock and lease) to a new buyer. The board also has the power to approve or disapprove the subleasing of an apartment. With such powers, the board can exclude individuals who may not be strong financially or who may be incompatible in temperament with the other cooperative apartment owners.
A condominium apartment (usually called a condominium unit) is an interest in real property. The dimensions of the condominium unit are outlined in a document called a condominium declaration. The rights and obligations of the condominium unit owner are determined by the terms of the condominium declaration, condominium by-laws and house rules. The condominium unit owners, in addition to owning their units, collectively own the common areas of the condominium property, such as the lobby, roof, and elevators. The common areas are managed by the unit owners, who are all members of a condominium association. The unit owners elect a board of managers of the condominium association that is responsible for the day-to-day operation of the condominium association property. The board of a condominium usually does not have the power to approve or disapprove a sale or lease of a condominium unit. Instead, the board is granted the right of first refusal to purchase or lease an apartment that is proposed to be sold or leased to a third party on the same terms and conditions offered by the third party. It is generally believed to be easier to resell a condominium apartment than a cooperative apartment because of the limited rights granted to the condominium board of managers.
Pre-contract considerations
Due diligence review
Before signing a contract of sale, the buyer must perform due diligence reviews to determine whether the property is suitable for use and if the purchase price is appropriate for the property given its location and physical condition. Many jurisdictions in the United States do not require the seller of real property to disclose any defective conditions of such property to the potential buyer (They are known as caveat emptor jurisdictions, for buyer beware). Other jurisdictions do require the seller to describe known defects in the property to the buyer and may require a real property condition disclosure statement in connection with the sale.
Whenever a buyer is seriously interested in a particular piece of real property, the buyer should engage an engineer or architect to examine the property for physical problems. Often serious physical problems may exist that are not evident to the casual observer. These can include problems with the roof, foundation, supporting beams, utility systems, etc. In addition, the buyer may wish to perform environmental examinations of the ground and structure to exclude the possibility of toxic substances (petroleum waste, toxic mould, radon, asbestos, etc.). The buyer should know the condition of the property before signing a contract to purchase at a particular price. If the buyer can not perform an inspection before signing the contract, the contract may have to be made conditional upon receiving a clean inspection report.
In connection with the purchase of a cooperative apartment or a condominium apartment, the buyer is also advised to review financial and other documents (by-laws, condominium declaration, proprietary lease, minutes of meetings of board of directors or board of managers) that relate to the corporation that owns the cooperative apartment building or the condominium association that manages the condominium for the benefit of the individual unit owners. These documents will explain whether the corporation or association is properly managed, whether there are outstanding claims that may increase expenses dramatically, and whether there are problems with the building or the particular apartment that the buyer wishes to purchase. The financial statements should disclose if the property is being operated at a loss, if there is any reserve fund established for contingencies, if there are mortgages on the property and if lawsuits are pending against the cooperative corporation or condominium association.
Use of a real estate broker
The buyer may wish to engage a real estate broker to assist in the search for the right property. The real estate broker should provide the buyer with a list of comparable properties and their selling prices, show the buyer any properties that are of interest and assist the buyer in the negotiation of the purchase price. Generally, a real estate broker acts as the agent for the seller and is paid a fee (commission) at the time a closing occurs by the seller. A buyer may wish to agree with a real estate broker to act solely for the benefit of the buyer. That agreement may provide for the buyer to pay a fee to the buyer’s broker or it may require the buyer’s broker to negotiate with the seller or seller’s broker for payment of the fee. Although a seller’s real estate broker is entitled to obtain a full commission for procuring a ready, willing and able buyer, the seller’s broker often shares the commission with a broker representing the buyer. Typically, one brokerage commission of 6% of the sales price is split between the seller’s and the buyer’s broker.
Due diligence in leasing transactions
Prior to signing a lease for real property, a potential tenant must also perform due diligence reviews. Important considerations will be related to the legality of or landlord-imposed restrictions upon the proposed use of the property, any alterations required to permit such use, whether other tenants of the property may interfere with the proposed use of the leased property and whether the location, condition of the building and the particular premises within the building and services provided are suitable for the tenant’s use. An examination of the property with these issues in mind, in addition to the other issues raised above, will be required.
Negotiation of the contract of sale or lease
Negotiation of a contract for the purchase of real property
Negotiation of the contract of sale may be performed by attorneys or in residential transactions by real estate brokers, depending upon the jurisdiction in which the property is located. In cases where a contract for the sale of a house, cooperative or condominium is prepared by a real estate broker, the buyer’s attorney should carefully review the contract before it is signed by the buyer. Contracts for the purchase of commercial properties are often much more complex documents and are almost always drafted and negotiated by attorneys.
Usually, the seller’s attorney will prepare the first draft of a contract of sale. In connection with many residential sales, the type of contract used is usually a commonly accepted form document with a rider attached containing any specific issues not addressed in the form document. The buyer’s attorney is expected to comment upon the contract and negotiate changes that may be required due to the buyer’s particular needs.
Items For Negotiation
There are a multitude of items that may be negotiated in connection with the purchase of real estate. Below is a checklist of items that the buyer’s attorney must consider.
Purchase Price – usually negotiated by brokers, depends upon the market and condition of the property.
Downpayment – usually 10% of the purchase price; may be less on very large deals.
Mortgage – sometimes the seller finances a portion of the purchase price by providing a purchase money mortgage; other times the buyer obtains a loan from a third party and the contract must be made conditional upon the issuance of a mortgage commitment or the closing of the mortgage loan. If there is an existing mortgage, the buyer may wish to have it assigned to his new lender or to take the property subject to the existing mortgage to avoid payment of mortgage recording tax.
Personal Property – often personal property is included in or exempted from the sale; these items must be specified and an allocation may be made so that a portion of the sales price is attributed to the personal property. Note that real property transfer taxes may be reduced as a result but sales taxes may have to be paid.
Acceptable Title and Title Insurance – most buyers require a marketable title (that the property is resalable), not just an insurable title. Exceptions from the title report must be cleared so that they can be omitted as exceptions from the final title insurance policy. A title insurance policy protects the new owner against third parties who claim an interest in the property.
Municipal Violations/Certificate of Occupancy – the buyer should require the seller to cure any violations of record up to the closing date; the seller may require the buyer to take the property subject to existing violations. The buyer should require a current certificate of occupancy from the seller showing that the proposed use of the property is permitted by law.
Closing Date – the date set for closing is not a firm date; the seller is allowed to cure title defects and may adjourn the closing to do so; the buyer may also obtain a reasonable extension of the closing. The parties can require that the closing be on a firm date by declaring time of the essence; this is usually not done unless there is an inordinate delay.
Risk of Loss – generally, the seller bears the risk of loss to the property, such as damage by fire, until the title is transferred at closing. However, sometimes the buyer wishes to take occupancy before the closing; then the risk of loss is shifted to the buyer commencing upon the date of occupancy
New Construction – if the seller is building the house for the buyer, then the plans and specifications must be detailed, provisions made for pre-closing inspection and delay of closing until substantial completion occurs (with possible credits to the buyer if the seller delays completion), warranties negotiated for work performed, appliances and systems installed. It is recommended that the buyer’s architect review the plans and specifications
Tenanted Property – if there are existing tenants in the property, the parties need to agree upon delivery of vacant possession or possession subject to the tenancies; if the latter, leases must be examined, tenant security deposits transferred to the buyer, and tenants notified to pay rent to the buyer.
Cooperatives or Condominiums – the buyer wants the seller to represent that any work that was performed in the unit was under all applicable laws and with the rules and regulations of the cooperative or condominium.
Damages – usually, the seller is only able to retain the downpayment if the buyer defaults; the buyer may be able to obtain specific performance of the contract if the seller willfully defaults, which requires the seller to convey the property to the buyer by the contract.
Pre-closing considerations – Purchase of real estate
Clearing Title Objections
Before the closing, the buyer’s attorney obtains a title report from a title insurance company that will be insuring the buyer’s title after the closing. The title report lists exceptions to the title which, if not omitted before closing, will not be insured by the title insurance company. An example of an exception is an existing mortgage on the property. The buyer’s attorney sends a copy of the title report to the seller’s attorney so that the exceptions can be removed. The buyer also obtains municipal searches, which he provides to the seller’s attorney so that any violations of record can be removed before the closing. Any issues regarding the certificate of occupancy should also be resolved before the closing.
Obtaining Financing
If the buyer requires a loan to finance the purchase, then between the time of the contract signing and closing the buyer must apply for and obtain a mortgage commitment. Generally, banks lend up to 80% of the value of the property to be purchased, depending upon the income, assets and creditworthiness of the buyer.
Sometimes the buyer must negotiate the terms of a mortgage commitment letter with the lender.
Seller Arranges for Payment of Existing Mortgages and Liens
The seller must make arrangements with its existing mortgage lender to have its mortgage satisfied (or assigned to the buyer’s lender) and to remove any liens of record that are exceptions to the title.
Seller Performs all Conditions of Closing
The seller must perform all conditions required by the contract that must be met for closing, such as removing any existing tenants, performing any required work, curing any existing violations and clearing title exceptions.
Calculation of Adjustments
Shortly before closing, the seller’s attorney and buyer’s attorney contact each other to confirm the closing date and calculate any adjustments to the contract price that may be required. For example, if the seller has prepaid property taxes for a period that includes dates that extend beyond the closing date, the seller would be entitled to a credit for the prepaid property taxes.
Closing the contract of sale of real property
The real property closing is the date when the seller delivers the deed to the buyer, the buyer pays the balance of the purchase price to the seller, the representative of the title company assures the buyer that the proper title is being delivered and the brokers are paid their commissions due on the sale. The buyer performs an inspection of the property to ensure that it is in proper condition for closing the day prior or the morning of the closing. If all is in order, the buyer and his lender attend the closing so the proper purchase price can be paid. The seller’s lender attends in person or by agent to release any existing mortgage liens and to collect any amounts due to it on its outstanding loan to the seller. The seller attends to deliver the appropriate deed (or in a cooperative apartment sale the shares of stock and lease for the apartment) and keys for the property to the buyer. All parties complete the required real property transfer tax forms for the sale. Utility companies should be notified to start providing utility services to the buyer. The buyer should also obtain liability and property insurance for the new property.
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