Well, it seems that with everything you do right, there's always someone else doing it wrong, do it badly, or doing it illegally. Enter Big Brother… the “well-intentioned” legislator who wants to get re-elected by passing a law that protects the innocent from bad people or from their own stupidity. What am I talking about? Several states have passed or are about to pass a rash of laws that will make being a real estate investor a very difficult vocation. While I do understand the need for some guidelines and disclosures from the government to make sure that people are making informed choices and are protected from bad people, these laws are throwing out the baby with the bath water and will likely cause financial harm to the real estate markets in those states. The following is a review of some recent laws and bills that are pending or have passed.
It Is Important That You Read This Even If You Are Not in These States
When it comes to laws like these, it's “monkey see, money do”, resulting in the domino effect. Your state can be next, so pay attention. Visit you state's website and review pending bills. Form a local political action committee. Be involved in the political process. If you are in one of these states, call, fax and email your representatives. Email all your friends and business associates. Picket in from of the state buildings. Contact your local news people. If you sit silent, you have no right to complain!
Texas – Senate Bill 629 – Passed
This bill is an amendment to an earlier law passed in 2001 that regulated installment land contracts. The current law calls these “executory contracts” and requires certain disclosures, most of which are not big deal. However, the penalties for non-compliance are substantial and bear no relationship to the supposed harm the consumers would bear if the disclosures are not followed. It's basically a windfall for buyers who find a good lawyer to hammer a technicality that most investors are not aware of. SB 629 takes it up a notch classifying lease/options as “executory contracts”, the same as land contracts. This is deadly for investors who want to keep the tax benefits ownership when selling on lease/option and taking advantage of capital gains rates. If Texas calls a lease/option an executory contract, it makes it a sale, thus having a negative tax impact on the seller who may want to defer his gains through a 1031 exchange when the tenant exercises his option to purchase.
And, we're just getting started…
The bill further disallows an investor from selling a property by lease/option OR land contract if the seller has an underlying loan on the property without that lender's written permission. Since few, if any, investors have free and clear properties, this would effective eliminate the process of buying a property, financing it, then reselling on a lease/option or land contract. This is bad because it hurts not just investors but anyone who has a house that they want to move. Builders often sell properties on a “rent-to-own” basis, and now will be prohibited from doing so if there is underlying financing on the property. What if you do a fix-and-flip, but are unable to resell the property for cash? Maybe the lease/option would be the solution so you can cover your mortgage payments while still getting a sale? It won't be possible in Texas if this bill passes.
And, it gets Worse!
SB 629 states that you cannot sell a property under an executory contract unless you have title to the property. That means you cannot do a sandwich lease/option in Texas – Period. The bill also has a bunch of disclosures and regulations on lease/options, none of which are objectionable.
North Carolina – House Bill 725 (still pending)
House Bill 725 is a push from the North Carolina Attorney General's office, which has been on the rampage against investors for some time. The AG's office claims to have “hundreds of complaints” from people who were hurt by investors who bought properties “subject to” existing mortgage loans, then defaulted. I find it very hard to believe that more than a few complaints were ever filed. From the way the bill is written it's clear they just don't understand how these transactions work.
This bill is targeted against the investor who buys a property subject to an existing loan, the resells the property by lease/option or land contract to a consumer. The bill requires a number of disclosures to all parties involved, some of which are fine and some of which are absurd and irrelevant. The proposed bill requires the seller to get express written permission from his lender before transferring a property subject to an existing deed of trust, which will never likely happen. And, even if it were possible, the time frame it takes for a seller to get his lender's permission while he is in foreclosure is wholly impractical. This will hurt the seller who is in foreclosure and seeking to simply “dump” his property for whatever he can get. If the investor can cure the seller's back payments and/or negotiate a short sale with the lender, everyone walks away happy. If a seller has no options, he is going to walk away from the property and the bank will have another REO. Everyone loses.
Now, admittedly, some dumb or unscrupulous investors have taken deeds from sellers, promised to pay, then defaulted, leaving the seller with the short end of the stick. The right thing to do is require disclosures so that the seller enters into the deal knowing the risk. Adjustable rate mortgages are very dangerous, too, which is why R.E.S.P.A. requires disclosures. The government didn't go off the deed end and outlaw ARM loans. Curiously, the bill exempts real estate agents from the law, which means a licensed agent could theoretically buy a property subject to an existing deed of trust without lender permission and without the same disclosures as a non-licensed investor would be required to give. The suspicious side of me thinks that the real estate agents are also behind this bill, trying to corner the market on investing or requiring an agent's assistance on these deals so they can profit.
And, the most laughable portion of the bill addressed people like me, requiring all educational seminars to include a copy of the new law in our materials. I suppose the drafters of this bill failed to examine the first amendment, which prohibits the government from restricting the content of free speech.
Maryland – House Bill 1288 (Passed)
House Bill 1288 is aimed at foreclosure investors dealing with sellers in foreclosure.
The bill targets two types of activities, “Foreclosure Consulting” and “Foreclosure Purchasing”. A “consultant” is someone who apparently charges a fee to give advice to the homeowner and/or help him to negotiate with his lender or get a new loan. A consultant must disclose his services in writing and offer a right to cancel that agreement at any time. The consultant cannot buy the property from the homeowner, nor can one of his “associates” (not clearly defined). The foreclosure purchaser must also give certain disclosures in writing, including a ten-day right to cancel the contract. This means you cannot get a deed without giving a homeowner a 10 day “cooling off” period. This is not necessarily a bad idea, but it may prevent a homeowner who is fighting a deadline from doing a last-minute sale. No matter how long the foreclosure process, most homeowners wait until the last week before taking action.
The final part of the bill deals with a foreclosure “reconveyance”, that is, a deal wherein the homeowner stays in the property under a lease, reserving the option to repurchase the property from the buyer at a later date. I don't particularly like these kinds of transactions, because they generally fail and they can sometimes be reclassified by the courts as disguised loans. On the other hand, many homeowners facing foreclosure have no other means to save their property, and in a free market should have the opportunity to engage in a transaction which allows them to try to save their home based on intelligent, informed decisions. This law would require the investor to give the homeowner 82% of the proceeds of the sale if the homeowner cannot repurchase the property, which makes it unfeasible for any investor to even bother trying to help the homeowner. In short, such a law would hurt more homeowners than it purports to protect. The 22 pages of requirements are very technical, so you should review it in detail with a local attorney. House Bill 1288 – Full Text in PDF Format
Colorado Senate Bill 06-071 (Still in Committee)
The Colorado bill is being pushed by the Attorney General and the Colorado Public Trustee's Association (Colorado's foreclosure process involves a public official, the county Public Trustee). This bill is a watered-down version of the Maryland Bill, which will also regulate “foreclosure consultants” and “equity purchasers”. Through lobbying efforts, we have gotten the ear of the AG's office to get some good amendments to the bill that should result in a sensible piece of legislation. Like the Maryland bill, the Colorado bill prohibits a “consultant” or one of his associates from buying a property in foreclosure from the homeowner. The bill, as amended, better defines a “consultant” so as not to confuse such a person with a “purchaser” who will be buying the property, not offering the homeowner “advice for money”. The bill is still in discussion and we are hoping to further refine some of the “reconveyance” provisions to make it fair for investors and protect homeowners from predators. The bill also adds criminal penalties for violation of the law, which is certainly scary for the average investor who does not understand how to comply. If you are in Colorado expect a seminar this Summer to explain all of the nuances!
Illinois Senate Bill 2349 (Still in Committee)
The Illinois law is similar to the Maryland Bill, but takes it up a notch. The proposed bill would also apply to properties “in distress”, that is, homeowners who are 90 days late, but no foreclosure has been filed. This is extremely dangerous because there's no public filing until the foreclosure action has started, thus no way to know who is in default! Also, the Illinois bill would require an investor to pay off the seller's liens before doing a foreclosure reconveyance, that is, you can't take a property subject-to the existing loan and sell it back on a lease/option. However, you are not prohibited from taking subject-to and selling it to a third party.
The Illinois bill also contains the “82% of proceeds to the seller” provision, which effectively kills any intelligent investor from getting involved. Why would you want to buy a property and risk the homeowner defaulting, filing bankruptcy and hauling you into court over 18% gross profit? On the other hand, I can see the argument why it is patently unfair for a homeowner to lose a property with 50% equity for non-payment of one month's rent, but these cases are rare. In any event, a court always has the equitable power to call a contract “unconscionable” where it sees fit. Using an arbitrary number like 82% may not be feasible when the local real estate economy is in the toilet and banks are selling properties at 60% of value or less. In short, the government should leave the free market open for people to make deals that they wish to make, punish those who take unfair advantage, and require mandatory disclosures so people can make informed choices.
I have mixed feelings about these new bills… on the one hand, they are rash responses the side effects of a strong real estate market, discouraging investors from getting involved in deals and resulting in more properties going to the bank. On the other hand, some of these bills provide “safe harbors” for investors that follow the letter of the law. Since there are really few laws that relate to “creative” real estate investing, providing detailed rules make litigation by a disgruntled seller or tenant/buyer more difficult. It's hard to say, “you didn't disclose X, Y & Z” when in fact the law only requires “A, B & C”. If investors in these states make some noise by contacting their state representatives right away, a modified version of these bills may get passed, making everyone happy. And, if something comes up in your own state, get involved in the process before a bad piece of legislation puts you out of business.
I highly recommend doing the following:
1. Get involved early in the process. Find out who is pushing the bill in your state and why. Contact these groups and offer to assist in the legislative process by discussing practical effects of these laws and other alternatives.
2. Get other groups involved in the process. Community leaders, such as real estate investor associations, mortgage brokers associations, title companies, boards of realtors, etc. Remember, the banks do not want these foreclosure properties in their inventory, so they need investors bailing out properties before they go to sale.
3. Speak to your local representatives. State legislators are generally accessible, to call, fax, and even visit their offices. Let them know you are a voter in their district that has concerns.
4. Speak to the Press. The media is pushing stories about how people in foreclosure are losing their homes, but there's two sides to every story. Talk with local newspaper, radio and television personalities. Write letters to the editor of your paper (click here for a good example).
5. Hire a lobbyist. The best way to get access to legislators is the good old fashioned way – money. Lobbyists (also known as “Public Relations Experts”) have connections with different law makers and can get you an audience to hear your issues. They can find out who is for and against particular issues, and who can either amend or “kill” a particular bill being presented. On the national level, the National Association of Responsible Home Rebuilders and Investors (www.NARHRI.org) has been active in about 8 states.
The most important thing is to get involved early in the process.