Book Excerpt: Real Estate Sales and Financing

An excerpt from Chapter 26 (Real Property), dealing with the sale of real property and financing arrangements, follows below.

          26.7   Sale of Real Property
          In the business world, real property is most often conveyed through sale. Sale of real property generally involves two steps: first, the buyer and seller execute a contract of sale, setting out the terms under which the sale will take place. At some later point (sometimes several months later), the buyer and seller close on the transaction, the purchase price is paid, and the property rights are transferred by the seller giving a deed (a document granting title) to the buyer.
          Broker and attorney. Many real property sales are conducted through a broker. The broker has a contractual relationship that allows him to act as the seller’s agent in showing the property to prospective buyers and arranging the sale. In exchange, the broker receives a commission. Traditionally, this commission was earned when the seller accepted the buyer’s offer, but most modern courts hold that a broker only earns a commission at closing, when the sale price is paid.[1] Some states require that the drafting of the contract of sale, examination of title or preparation of the deed require a licensed attorney. 
          Contract. A contract for the sale of real property must be in writing. The contract must contain certain essential terms, such as the identification of the buyer and seller, a detailed, legally sufficient description of the property being conveyed, and the terms and conditions of sale (including, but not limited to, the price and form of acceptable payment). Some contracts for the sale of real property are conditional in that they are only effective if the buyer or the seller is able to perform certain acts. For example, the sale of an empty lot might be conditional on the buyer being able to obtain a building permit or securing a change in zoning regulations. Another common condition is a contingency that the buyer be able to secure financing, such as a mortgage, to assist with the purchase of the property. Such a conditional contract is only enforceable if the condition is met, but the buyer must act in good faith and make all reasonable efforts to make the condition happen.[2] Normally, when a contract for sale of real property is signed, the buyer puts a down payment of “good faith money”; in the event that the buyer backs out of the agreement, the seller keeps this money.
          Title requirements. Contracts for the sale of real property generally contain the implication that the seller has “good and marketable title” to the property being sold. This is because a seller cannot convey property to which he does not have title.[3] Marketable title means title that is sufficiently free from reasonable doubt that a prudent purchaser would be willing to accept it. Generally, this requires that the title be good enough that there is no reasonable probability that the buyer will be sued for possession of the property. In most cases, good and marketable title is demonstrated through record title, or a demonstration that the relevant government body (usually the county Recorder of Deeds) recognizes the seller’s title as legally valid. Gaps or legal defects in the property’s chain of title or certain types of easements and covenants can operate to
          Defects to conveyed property. Traditionally, the rule was that a seller could not fraudulently conceal defects in the conveyed real property, but had no duty to disclose such defects to the buyer. This followed the old Roman law of caveat emptor, or “buyer beware.” In the United States, this rule is still followed only by a tiny minority of states, and even then there are large numbers of exceptions. The majority rule is that a seller or his broker must disclose all known material defects to the buyer.[4]
          Closing and deed. At closing, held at a time and place specified in the sale contract, the seller delivers a deed to the conveyed real property to the buyer, and the buyer pays the purchase price in the manner and amount agreed upon. The deed, like the sale contract, must generally be a written document to be legally enforceable. The grantor, or seller, must sign the deed but it need not be signed by the buyer. The deed is usually acknowledged by a notary or witnesses. While this is not required for the deed to be enforceable, it may be required in some states for recordation, or filing with the Recorder of Deeds or similar government body. The deed must contain words of grant such as “I give, grant, and sell.”
          Covenants of title and quality. There are six covenants, or guaranties, that can be provided in a deed. The covenant of seisin is a promise by the grantor that he owns the real property or interest therein that is being conveyed. A covenant of the right to convey is a guaranty that the grantor has the legal power to make the conveyance. A covenant against encumbrances warrants that no easements, restrictive covenants, liens, or other encumbrances exist against the property or its owner. The covenant of quiet enjoyment is a covenant by the grantor stating that no third party can make a lawful assertion of title superior to that being conveyed to the grantee. The related covenant of warranty is a promise by the grantor to defend, on behalf of the grantee, any claim against the property existing as of the date of the sale, and that the grantor will compensate the grantee for any loss. Finally, a covenant of further assurances, is a covenant by the grantor to perform any reasonably necessary act to perfect the buyer’s title in the event it proves to be defective. 
          Types of deed. There are four main categories of deed. A general warranty deed contains most, if not all, of the previously-described covenants. Such a deed generally guarantees good title against defaults arising before and during the grantor’s period of possession and title. A special warranty deed is more limited and scope, covering defects arising only during the grantor’s ownership. A quitclaim deed is still more limited; in such a deed, the grantor warrants nothing. Instead, he transfers whatever interest, title, or possessory rights he has, if any. The grantor only obliges himself not to challenge the grantee’s ownership; he does not make any representations as to third parties. A quitclaim deed is most commonly used to settle any unclear title, as when a potential claimant abandons any claim he might have had against the property. Finally, some states have statutory warranty deeds, in which certain warranties are implied by law based on the wording of the deed.
          Remedies for breach of the sale contract. The payment of the purchase price and the delivery of the deed are dependent promises; that is, the performance of each depends on the performance by the other party. Neither buyer nor seller can create an obligation in the other without themselves performing their obligations. This means that for a buyer to place the seller in default, he must make payment and demand title on the contractual closing day. The reverse is also true; the seller cannot place the buyer in default, and therefore have a cause of action for breach of the sale contract, without delivering a deed and demanding payment.
          The remedies for a breach of the sale contract are rescission, specific performance, and monetary damages. Rescission means that if the seller breaches, the buyer may rescind, or terminate, the contract and take back his down payment. A buyer or seller may have the right to demand specific performance, or a court order compelling the seller to go through with the sale. This is because real property is considered a unique asset for which monetary compensation is often inadequate. But specific performance is an equitable remedy, and will not be granted if the balance of equities (fairness) favors the breaching party.[5] Finally, a buyer may sue the seller for monetary damages to compensate for harm suffered as a result of the breach of contract. Some contracts provide for liquidated damages, or a specific amount that each party promises to pay the other in the event of breach to avoid having to prove specific monetary harm.
          26.8   Mortgages and Related Concepts
          Real property is expensive. Very few buyers are able to make real property purchases outright for cash. In most cases buyers will borrow the money, and the lender will receive a mortgage.[6] All such loans require certain disclosures from the borrower to the lender, and from the lender to the borrower.
          Standard mortgages. A mortgage is a document that memorializes a security interest, owned by the mortgage lender (or mortgagee), in the real property purchased with the money loaned to the buyer (or mortgagor). A mortgage generally requires the mortgagor to make payments at specified times. Failure to make such payments puts the mortgagor in default, and entitles the mortgagee to foreclose, or seize possession of the property, sell it, and recoup the unpaid amount of the loan from the sale proceeds. Most mortgages are amortizing; in such cases, the mortgagor makes a series of regular payments that consist of both an interest and a principal component, until the entire amount has been paid. The majority of mortgages are for a set term of years (usually 15 or 30 years), but they are often paid off much earlier. Mortgages may be fixed rate (consistently at a single interest rate, regardless of market fluctuations) or variable rate (in which market forces may increase or decrease the interest rate over time). Some mortgages involve smaller regular payments, but include a sizable balloon payment at the end of the term to make up the balance. A mortgaged property may be subjected to subsequent, or junior mortgages, which take a lower priority to the original mortgage. 
          Most states follow “lien theory,” where a mortgage is treated as if it were a lien against the property. In such states, the mortgagor still retains title to the property, but the mortgagee has a lien which can convert into ownership under certain circumstances (e.g., default). A minority of states view mortgages under a “title theory,” in which the mortgagee actually obtains title to the property but the mortgagor is allowed to retain possession. When the mortgage is paid off in a title theory state, title reverts to the mortgagor. 
          Reverse mortgages. A reverse mortgage involves a payment by a lender to a homeowner (usually a disabled or elderly person). The reverse mortgagor does not make payments while he continues to occupy the property. Instead, when he no longer resides at the mortgaged property, the reverse mortgagee becomes entitled to a percentage of the appreciation in the property value to pay back its loan, including interest.
          Equity loans. An equity loan is a type of loan where the owner of real property borrows an amount equal to a specified percentage of his equity (the fair market value of the property minus the value of any mortgages or other encumbrances).
          Construction financing. Construction financing, or a loan used to build a new building rather than acquire an existing one, involves greater risk to the lender than a typical mortgage, because the mortgagee cannot inspect the property or accurately estimate its ultimate value. Other risks may also be involved, such as unforeseen factors that delay construction or devalue the underlying land. Therefore, most construction financing is short-term (under 18 months in most cases) and the interest rate is several percentage points higher than that for other types of property loans.

[1] In many states, if the sale falls through because of the seller’s action, the seller is still liable to the broker. Dworak v. Michals, 320 N.W.2d 485 (Neb. 1982).
[2] Bushmiller v. Schiller, 368 A.2d 1044 (Md. 1977).
[3] Wallach v. Riversiee Bank, 206 N.Y. 434 (1912).
[4] E.g., Johnson v. Davis, 480 So.2d 625 (Fla. 1985).
[5] Estate of Younge v. Hysmans, 506 A.2d 282 (N.H. 1985).
[6] Some states use a document called a deed of trust, in which the property is conveyed to a trustee until the loan is paid off. The logistics of a deed of trust are slightly different from those involved in a mortgage, in that the mortgagee need not foreclose, but rather may exercise a right of sale. Deeds of trust and mortgages, in most respects, function in the same way.