Sunday, October 10, 2010

Sleazy Real Estate Developers' Latest Scam Could Skim 5 Percent Off Your Home's Value

Sleazy Real Estate Developers' Latest Scam Could Skim 5 Percent Off Your Home's Value

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Consider the following scenario: you are in the process of selling your home. You've found a buyer who is willing to pay you $200,000. Your realtor has assured you that everything is going smoothly-- she says the buyer has lined up financing and there were no problems with the home inspection and the appraisal.

Then, days before the closing, your realtor gives you a call. "Uh, something has turned up during the title search that is going to be a problem," she says. "I don't know if you were aware of this, but your property has a private transfer fee covenant on it."

"What does that mean?" you say.

"It means you will have to pay an extra $2,000 fee at the closing," she informs you. "And the buyer is demanding that you reduce the sale price by $10,000 or the deal is off because of this."

Pay $2,000? To whom? The buyer wants a 10 grand discount?? And what the heck is a private transfer fee covenant?

A private transfer fee covenant is a legal agreement attached to a piece of real estate through a filing in the public records that entitles some third party to up to 1 percent of the sale price of the property each and every time it is sold. The covenant typically lasts up to 99 years.

Who creates these covenants? The covenants are typically set up by developers. Typically, 60 percent of the transfer fee goes into the pocket of whoever set it up; 10 percent goes to a broker; and 30 percent goes to a company called Freehold Capital Partners.

Why does Freehold Capital Partners get a cut? They claim they invented this legal strategy and are attempting to patent it. They also are trying to convince Wall Street to securitize the fees, so they and the developer can get a lump sum up front on the future income stream based on an actuarial guess on how many times and for how much a property will sell in 99 years. Think of the J.G. Wentworth commercial "It's my money, and I want it now!"

From your perspective as a seller, here's what this transfer fee means to you:

  1. You pay $2000, which goes to the developer and Freehold.
  2. They give you nothing in return.

But it gets even worse. Remember, in my scenario your buyer demanded a whopping $10,000 off the sale price after they discovered the transfer fee covenant? This is a likely scenario, because not only will your buyers have to pay the transfer fee when they sell, but the people who buy from them will have to pay a transfer fee after that, as will the buyer after that, as will every future owner of the property for 99 years.

A home that sells once about every seven years will have a 1 percent fee paid approximately 14 times. All those future fees represent equity that will be leeched out of the property. Cumulatively, the value of that equity which will be skimmed by Freehold and its pals is far more than 1 percent. Since future interest rates and the future value of the property are not known, the exact current value of all those transfers are not knowable, but 5 percent of the value of the home is probably a reasonable estimate, so your buyer -- who had no way of knowing about the transfer fee before the title search disclosed it -- quite reasonably asked for a 5 percent discount off the sale price.

Does this all sound kind of like a sleazy way for these Freehold Capital Partners folks to line their pockets with unearned income at the expense of homeowners? That's exactly what it is. As a homeowner, you get nothing for paying this transfer fee except a hole in your wallet when you sell.

Does it sound like these private transfer fees are also an unnecessary contrivance that have the potential to gum up and scuttle real estate transactions? You betcha.

Just in case you aren't convinced yet that you do not want to potentially lose $12k of your equity during a $200,000 sale transaction, there are a multitude of other problems with private transfer fee covenants: they create an additional source of liability for those involved in insuring title; the fees may not be enforceable; it will inevitably be hard to track down who exactly is entitled to the fee in many cases once the original developer is dead and in the ground for decades, and so forth. Even if the fee recipient can be tracked down, the work involved just represents an extra frictional cost in the real estate transaction.

Now, the good news: in the past few years, over a dozen states have banned private transfer fees. Here in Ohio, for instance, after open committee hearings on the subject attended by both proponents and critics, the legislature voted to ban private transfer fees on nearly unanimous votes, and our fine Democratic governor Ted Strickland signed the ban into law. See, the thing about private transfer fees is that when they are explained to people, most folks think they are a pretty garbage idea, no matter their political stripe.

Now, more good news: Our Democrats in Congress, including main sponsor Maxine Waters have just introduced a bill, H.R. 6220, that will effectively cripple the private transfer fee scam by prohibiting any federally insured or guaranteed mortgage on a property with a private transfer fee. I highly encourage you to contact your congressperson and tell them that you support this bill. While you are at it, tell your senators you want to ban private transfer fee covenants.

But there is some bad news, too. Even though Republicans in state legislatures like Ohio can see that private transfer fee covenants are nothing but bad news, Washington Republicans have generated legislation that will not only protect private transfer fees but has the potential to preempt state laws in places like Ohio where bans have been passed! Phil Gingrey, R-Georgia, has drafted an alternative bill that requires only non-effectual "disclosure" of these fees via a recording in the public records. What this means is that people who buy properties in new developments could easily not even know they have one of these toxic covenants attached to their property until they want to sell. The Gingery "disclosure" bill has been described as the "Hey, we are stealing your equity!" bill. (Full disclosure: I have been proud to play a tiny role in the effort that got transfer fees banned in Ohio, and I do not want to see this ban undone.)

Republicans in Congress are apparently so desperate to not let Democrats accomplish anything that they are willing to override the overwhelming consensus of wiser members of their own party in places like Ohio. Or maybe Freehold lobbyists actually convinced them that transfer fees are all about "freedom" and the consumer's "right to choose," and provide a "valuable financing tool" for developers. Whatever their malfunction is, we've had enough of financing tricks and traps like this, haven't we?

There's a sense of urgency to passing HR 6220. Freehold claims these transfer fees are already in place or soon to be in place on hundreds of billions of dollars worth of real estate. Any ban won't affect covenants already in place, so the longer it takes to cut off the head of this thing, the bigger a problem it becomes.

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