Top Two Legal Considerations For a Buyer of a REO
Sunday, January 9, 2011 at 7:32PM Nash Law Firm, PLLC
By: Stephen J. Nash
nash@nash-law.com
Buying a REO property is not your ordinary purchase. There are greater risks and, hopefully, greater potential rewards. To help avoid or manage the greater risks, the following are my top three legal considerations a buyer should have when purchasing a REO.
First Legal Consideration - A Totally "AS-IS" Deal
When purchasing an REO, you must assume that the purchase agreement will be controlled by the seller and will be heavily slanted in favor of the seller. The agreement will be so slanted that you will not receive any warranties with respect to the condition of the property or the condition of the title.
In other words, if you discover after the closing that the is a problem with the condition of the property, you will not be able to go back to the seller. In one instance, we represented a buyer of a property in Woodbury. The client described the purchase as follows: "We bought a $500,000.00 home for only $270,000.00!" Unfortunately, the home had a severe mold problem that to remedy would cost almost $200,000.00. The clients were, naturally, extremely upset but they bought the property as-is. They now have a $270,000.00 home that they cannot afford to remedy and cannot sell.
We have represented numerous clients who purchased a REO where there have been title problems, some minor, others severe. In situations where we reviewed the title work prior to closing, we have been either able to obtain proper title coverage, a remedy to the title problem or have gotten the buyers out of the deal. For the buyers who hired us after their closing, there was little we could do other than remedy the title problem at the buyers expense.
Potential Solutions to the First Legal Consideration
The buyer of a REO has to read and understand the purchase agreement. This can be difficult because they are often cobbled together, can be poorly written or contain phrases or terminology that is used in other parts of the country. If the buyer does not thoroughly understand the purchase agreement and the potential legal risks, they should hire an experienced real estate attorney. As a non-attorney, real estate professional you should steer clear of trying to explain the legal implications of these purchase agreements.
With respect to the physical condition of the property, the buyer must have a thorough property inspection done on their behalf. A normal residential property "visual" inspection is not sufficient for many of these properties because of the many potential hidden problems. The buyer must be sure of what his/her remedy is if the inspector misses a defect - a return of the inspection fee will not begin to cover the cost of any serious problem. The time frame for the inspection should not be cut short. Make sure there is enough time to have a thorough inspection and if there are red flags, an agreement to allow additional testing must be obtained.
With respect to title issues, the buyer must obtain an owners title policy with proper coverage. Many believe that since the buyer purchased a title policy they must be covered; however, this is a false belief. Like all types of insurance, you must make sure that you are obtaining the proper coverage. Many of the title companies hired by REO's provided limited coverage that does not thoroughly protect the buyer. This is especially risky with REO properties because if a mistake was made in the foreclosure process, the seller may not have good title and, except for title insurance, there is nobody to seek compensation or a remedy except the title company. Unfortunately, if the buyer, unknowingly, obtained limited title coverage, there may be no liability on the title companies part.
To ensure that the buyer is obtaining the proper title coverage, the title commitment must be reviewed before closing, the title commitment must be "marked" at closing to update it to the proper coverage and the title policy must be reviewed to make sure that it is the correct coverage when it is finally received by the homeowner months after closing. The buyer must be made made aware of these issues and then must determine whether they are willing to gamble that the title coverage is proper or they must hired an experienced real estate title attorney to review and negotiate the coverage for them.
Second Legal Consideration - Liability Concerns
Since many REO homes need renovation, there is always the concern that someone will get hurt on the property. It may be a person working on the property or it may be someone who is just viewing the property. This is especially a concern, if the buyer is an investor. When this is your business, you want to limit the ability of a third party to go after your personal assets because of a business liability.
If the buyer is not buying the home to live in but, instead, wants to fix the home and sell or rent it, they should strongly consider buying the home in a business entity such as a Sub Chapter S Corporation or a Limited Liability Company. Both provide liability protect for the owners of the business entity so that if someone gets hurt on the property, they cannot go after the individual owners assets. Both allow the profits and losses to pass through to the individual owners so that they do not have to pay double taxes (these companies do not pay taxes).
Potential Solution to the Second Legal Consideration
The other advantage of forming a business entity when there are more than one owner is that it forces the owners to reduce their agreement between themselves into writing which lessens the risk of a future misunderstanding and, if there is a dispute, a written agreement as to how to resolve the dispute.
Forming a business entity can be done extremely quickly but it must be done right or the owners will live to regret their haste. The entity should be formed before the purchase agreement is signed. The buyer must make sure that the forming of the business entity does not effect their financing.
While there are many self-help legal packages that are around to create your own business entity, they often lead to trouble because the buyer does not know which business entity is the correct one for their situation, they do not properly address the legal issues that their situation presents and they do not consider the tax implications that are present. Often the buyer will create an Articles of Incorporation, file it with the Secretary of States Office, obtain an Employers Identification Number and nothing more. This is not sufficient to create a proper business entity and will inevitably lead to trouble.
When we create a business entity for a client we first determine what type of business entity bests serves their legal needs. We advise our clients they should also consult with their tax advisor and we will work with their tax advisor to determine the best business entity after balancing their legal and tax needs.
Conclusion
There is no question that buying a REO involves numerous risks that aren't as prevalent in the traditional house purchase. These truly are "as-is" deals so the buyer must protect themselves prior to closing or they are taking a tremendous risks. A buyer must understand the risks, must take steps to protect against the risks and determine whether the potential gain is worth the "managed" risk. Too many buyers are treating these purchasers as a traditional purchase with no thought as the the risk they are taking and without doing what they can to manage the risks. Unfortunately, by the time they realize the risk that took, it is often too late - the risk has come to the forefront and they quickly learn that that seller and title company are off the hook leaving them with a financial disaster.