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2154TX Marketing I: Building a Real Estate Practicecompany. Usually, companies will purchase additional insurance (worker’s compensation, errors and omissions, and liability insurance) and employ the services of an accountant and lawyer. A lawsuit can potentially bankrupt the company and ruin its image; therefore, companies should always prepare for these types of events. By thinking ahead, the company is protecting its image and its future.Field Applications of Building a Successful BusinessPlease consider the following case studies. After reading the situations, decide on how one can resolve the dilemma or complication. Case Study 1Broker A has just opened his own real estate brokerage firm and hired four salespeople to work under him. Broker A has decided to employ the laissez-faire management style becauseit is his first managerial position, and he is afraid of offending and discouraging his salespeople. Two months later, the real estate brokerage company is unorganized, and the employees will not listen to the broker. What should Broker A do? AnswerBefore selecting the laissez-faire management style, Broker A should have done some research to see the advantages and disadvantages to the style. Although the laissez-faire style allows employees to actively participate in the company, it does not provide structure and standards for the employees. Managers who select the laissez-faire approach usually are passive and indecisive and want others to make the decisions for them. To succeed, brokers must know which type of management style will best fit the structure of the company. The laissez-faire approach can oftentimes backfire because it questions the broker’s ability to manage, lead, and make decisions. Employees who do not see their managers/brokers as leaders will not respect them.
3155TX Marketing I: Building a Real Estate PracticeIn this case, BrokerA should create a new policies and procedures manual and strictly enforce it. This may require the broker to create a new training program that will familiarize the employees with the new standards. Broker A may also want to gradually move the company toward a different style of managing; he should do this by making changes gradually so that the employees are not overwhelmed by the changes. Case Study 2Broker A has just opened up his real estate brokerage firm and wants to hire some experienced salespeople. He wants his company to be successful and believes that hiring women or non-whitesalespeople will hinder his company’s success. Broker A thinks that women and non-whitesalespeople do not do as well in the real estate industry. Broker A says that he is not sexist or racist, but he is only looking out for his company’s future and that should not be a crime. Is he correct in his views? AnswerBroker A is entitled to his opinion, but he is NOT entitled to discriminate against individuals based on their race, sex, nationality, color, religion, familial status, or handicap when it comes to employment. There are several employment laws that protect individuals from discrimination in any part of the employment process—this includes hiring, firing, providing compensation, and giving promotions. Title VII of the Civil Rights Act of 1964, the Americans with Disabilities Act and the Age Discrimination in Employment Act all protect individuals from job discrimination; these laws work together in order to promote equal employment opportunities. Case Study 3Seller A has decided to use the listing services of Broker B. Seller A explains to Broker B that her neighborhood has extremely stringent standards as to who they want to move
4156TX Marketing I: Building a Real Estate Practiceinto the community. Seller A stresses that her neighborhood does not want any racially or ethnically diverse families to move into her home. Therefore, she does not want her property shown to any minorities. Broker B explains to Seller A that he cannot promise her anything but says that he will try. What did Broker B do wrong in this situation?AnswerThe Fair Housing Act specifically says that it is unlawful to not offer an individual housing based on his or her race, color, nationality, gender, familial status, religion, or handicap. The purpose of the act is to ensure that everyone has an equal chance of obtaining housing. Though Broker B was trying to act in the best interest of the client, Broker B’s main obligation is to ensure that the real estate industry (and his company) upholds a positive public image and federal fair housing laws. By disregarding the Fair Housing Act, the broker is not respecting the rights of able and qualified consumers and endangering hiscompany. Case Study 4Seller A has decided to use Broker B’s listing services. Broker B walks through the property with Seller A and takes note of the property’s layout, amenities, and conditions. Broker B notices that the dining room and living room both have hardwood floors, but the rest of the property is carpeted. She asks Seller A if the rest of the home has hardwood flooring underneath the carpet. She notices Seller A has an uncertain look on his face, but he still answers yes to the question. Broker B dismisses her suspicions and lists the property as having wall-to-wall hardwood flooring. Three weeks later, the property is sold, and soon thereafter, Buyer C contacts Broker B and claims that Broker B misrepresented the property. The home did not have hardwood flooring throughout the property. What should Broker Bhave done?
5157TX Marketing I: Building a Real Estate PracticeAnswerOften, licensees will take the word of the seller and not investigate the situation themselves, even if they have a doubt or suspicion. In order to protect herself from liability and misrepresentation, Broker B should have checked underneath the carpet herself to see if there was hardwood flooring. Since brokers are not specialists in environmental conditions and property value, brokers should encourage their clients to have their homes inspected and appraised. Because Broker B doubted Seller A’s response, Broker B should have looked into the issue. If a broker has any doubt or suspicion regarding a property’s condition, then he or she should employ the services of a home inspector or appraiser; this will protect the broker from liability, fraud, misrepresentation, and negligence.Case Study 5Broker A wants to open up a residential brokerage office in the Northwest part of the city. He knows that there are many real estate brokerage firms in that area, but he believes that with his reputation and quality of service, he will be able to take over a large market share. After hearing this, his colleague, Broker B, says that Broker A should not be overly confident and perform a market analysis in order to determine whether or not there is enough demand and business in that area for Broker A to thrive. Broker A tells Broker B that he has never performed a market analysis and does not need to. Broker A explains that he opened his current office under similar situations and can assume that he will remain successful. Who is correct in this situation? AnswerAlthough Broker A has just reasons to believe that he will be successful, he should follow Broker B’s advice. Broker B’s advice allows Broker A to make safe and carefully thought out choices. Broker A, being a businessman, should opt for being safe rather than being sorry.
6158TX Marketing I: Building a Real Estate PracticeA market analysis allows Broker A to evaluate his potential in the market by studying recent sales information and the types of properties that have been sold. He needs to collect information regarding the total value of properties sold in the area, the number of properties sold, and the number of transactions at each brokerage firm in the area. By obtaining this information, the broker can determine how much of the market each brokerage firm possesses. He can then determine if there is enough demand in that market for him to enter it. Case Study 6After a year of mediocre sales, three of Broker A’s salespeople have decided to work for another firm. The firm’s lackluster performance was a result of poor marketing strategies, and Broker A frantically realizes that she has not taken the necessary precautions in order to prepare for this situation. She calls Broker B for advice. What advice should Broker B give?AnswerBroker B should tell Broker A to come up with a new marketing plan and hire new salespeople. Although it might seem too late to create a new marketing plan, Broker B should explain to Broker A that she should not continue using an ineffective marketing plan.It is better to create a new one that will utilize the company’s financial resources efficiently. Before creating a new marketing plan, Broker A should research her area to determine which marketing techniques would work the best. She should decide whether this market area prefers to read the newspaper, watch television, listen to the radio or surf the Internet. By determining which medium her audience tends towards, the broker can maximize her advertising efforts.
7159TX Marketing I: Building a Real Estate PracticeSince the broker has a shortage of employees, she needs to determine a way to attract salespeople to her firm. She can do this by holding career seminars, sending out recruiting brochures to competing firms, or placing an ad in the classifieds. In the future, the broker should track the turnover in her company over a period of time. From this information, she can determine how many people need to be hired each year. Case Study 7Broker A has just hired Salesperson B, who is in a wheelchair. When Salesperson B gets to the office on the first day, he realizes that he cannot maneuver his wheelchair around the office. He asks Broker A if he can rearrange the furniture around the office in order to accommodate his wheelchair. Broker A does not want to disturb the workspaces of the other salespeople in the office so Broker A says that he does not have to make accommodations for the handicap. He promptly tells Salesperson B that if he cannot work under the current conditions than he can quit. Salesperson B tells Broker A that it ishis duty under theAmericans with Disabilities Act to provide him with reasonable working conditions; however, Broker A says that the ADA is only applicable if the other employees in the office are not inconvenienced. Who is correct? AnswerThe Americans with DisabilitiesAct defines making reasonable accommodations as making existing facilities readily usable to disabled employees; this includes restructuring job descriptions, modifying work schedules, and acquiring the necessary equipment to accommodate a disabled person’s needs (hearing aids, translation software, etc.). An employer is required to make these accommodations if the company does not experience an undue hardship, which is an action that requires a significant difficulty or expense. In this case, the law will consider whether moving desks around will be deemed as an undue hardship on the company, and, most likely, it will rule in the favor of Salesperson B. Although Broker A will have to spend some time moving desks and office equipment around, he will not incur any additional costs. In this case, Broker A would be better off
8160TX Marketing I: Building a Real Estate Practicemaking accommodations for Salesperson B than risking a discrimination lawsuit; therefore, Salesperson B is correct.Case Study 8Broker A has just received her broker’s license, and she now wants to open her own firm. She needs some guidance and advice on opening up a real estate brokerage office so she turns to Broker B. What are some useful suggestions that Broker B could give Broker A? AnswerOpening a business requires a lot of planning; therefore, Broker B should definitely recommend that Broker A create a business plan. Not only will the business plan serve as a road map for the company in the future, but Broker A can use the business plan to obtain funding from lenders and investors. The business plan will allow Broker A to establish her company’s goals, identify the strategies she will use to accomplish those goals and determine her company’s ability to succeed. After creating a business plan, Broker B should tell Broker A to make a marketing plan. A marketing plan will allow Broker A to identify her target market and decide how to reach that market. Similar to the business plan, the market plan identifies the company’s marketing goals and strategies; Broker A will use the information in the marketing plan to establish benchmarks that determine whether or not the company is reaching its goals. Lastly, Broker B should also explain to Broker A the importance of hiring qualified and experienced salespeople. Having a capable andexperienced staff will make her job easier and increase the likelihood of financial successes. In order to find experienced salespeople, Broker A should recruit from competing firms and place ads in the classifieds. Broker A should appeal to these salespeople by describing the benefits of working at her company and how her company is better and different from other companies.
9163TX Marketing I: Building a Real Estate Practiceor he wishes to run the organization and how much input the manager wants from employees. Aside from managing employees, managers must also oversee the company’s records and finances. Managers must maintain company records, in order to protect the company from any misunderstandings, complications, and lawsuits. In the case that something happens, brokers will have documentation available to protect their company. There are four types of records that brokers must maintain–transaction, personnel, license, and finances.Lastly, a company’s finances are essential to its success. Therefore, a company should create a general operating budget in order to project its future earnings. This allows the broker to determine whether or not his company will be profitable in the upcoming year. A general operating budget is a company’s outline of its projected income and costs; it is comprised of a company’s gross income and operating expenses. The company’s gross income is the total amount of earnings that the company has made before taxes, and its operating expenses are the total amount of costs the company incurs in order to maintain the business. Please return to the course player to take the Module Quiz.
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129TX Marketing I: Building a Real Estate PracticeReal estate investments come in many different forms, including malls, strip malls, offices, apartments, hotels, golf courses, ski lodges, residential rental property, and warehouses. These investments, however, are not without risks. Good decision making requires an accurate market study and a working knowledge of the principles of economics.It should be noted that the information contained within this lesson may become dated and the student may need to update his or her knowledge on the issues presented here.Cash FlowInvestments in real estate have three main cash flows: from rent, from appreciation, and from an increase in equity. Rent is the price a tenant pays to use the property. In many situations, this is a straightforward charge; but some lessors charge percentage rents, which involve a base rent, rather than a rent per square foot, plus a percentage of the gross sales of the lessee. Real estate investments also pay off through appreciation. Appreciation is the increase in the present value of a property over time. A property can increase in value without appreciating, through inflation. Inflation is a rise in general prices; the future value of a property mustbe adjusted for inflation before its appreciation can be determined. Properties that are well-kept and located in desirable areas will appreciate over time. This can lead to a lower vacancy rate, higher rents, and a higher resale value. One decision of anasset manager is whether to make capital improvements in a property that will increase its value and cause it to appreciate in the future.The final cash flow from real estate is equity build-up. Equity is the amount of a property that the investor hasactually paid for. Investors increase their equity through amortization of the property’s mortgage. Amortization is the decrease in the principal balance on a loan over time.
1310TX Marketing I: Building a Real Estate PracticeDecisionsIn this section, we will consider several decisions asset managers commonly face, including the decision to rent or lease a property, to renew or replace a tenant, to improve or convert a property, to sell or hold one, etc.The Decision to Rent or LeaseThere are different advantages and disadvantages associated with tenant agreements that involve month-to-month rents (periodic tenancy) and those that involve long-term leases. Monthly rent schedules allow the landlord to raise rents with the market. However, the landlord who rents his property is at a greater risk for vacancy, as his tenant’s contract only runs through the month. Property managers must be familiar with the needs and desires of their individual tenants. Generally, long-term leases are offered at lower rates, because tenancy is more or less guaranteed during the term of the lease. This decreases the cost to the landlord of marketing and improving the property. Some long-term leases that allow the tenant to get out of the agreement by giving a 30-day notice have penalty fees to make up lost profits from theseunrealized benefits. The structure of a particular lease will be dependent on each tenant and the prevailing market conditions at the time.The Decision to Renew or ReplaceAt the end of a tenant’s lease, the manager may be faced with the decision to either renew the lease with the current tenant or find a replacement tenant. Current tenants may pressure the manager for lower rents or other benefits. The cost of making changes in the lease must be weighed against the cost of finding a new tenant, including improving and repairing the property to marketable quality, the period of vacancy after the current occupant leaves, and the cost of marketing the property.Risk assessmentis important in such decisions. A manager can only estimate the time it will take to find a replacement tenant, or the terms that will be necessary to reach an agreement.
1411TX Marketing I: Building a Real Estate PracticeThe Decision to Improve or ConvertA manager often has to make improvements to a property. The cost of improvements is typically less for renewing tenants than for new tenants, because renewing tenants face the difficulty of accommodating the improvements during their tenancy, and the difficulty and expense of moving if improvements are not made. New tenants, however, must be enticed to rent or lease the manager’s property over other, competing properties. For this and other reasons, landlords are more likely to charge lower rates to tenants with long-term leases and to provide incentivesfor renewing tenants.Improvements can include such things as new insulation, building extensions, retiling, repainting, etc. The improvements a manager makes can be crucial to a sale. A radio station looking to rent a building may be far more likely to buy one that already has its own broadcasting antenna than one that does not. Of course, the manager must weigh the cost of making any improvements, especially specific ones, against the likelihood that a new tenant will decide to rent or lease the property.A manager should also weigh the cost of improvements against the cost of conversion. Sometimes the purpose a building was designed to execute is not the most profitable use of the space the building occupies. For example, a luxury apartment complex maybe situated in an area with rapidly declining demand for such living. The property might be better off if it were converted to a center containing professional offices for dentists and attorneys. The investor must decide whether the cost of conversion will be made up by the increased occupancy rate it creates. This decision is, of course, constrained by time limits: the time the decreased demand for the building’s current use is expected to continue and the time the investor intends to hold the property. It may be more profitable to sell the building to another investor who is willing to make the required conversions and take on the risk herself or himself.Sometimes it can be more cost efficient to completely demolish a building and construct a replacement. For example, a small office building might be torn down to
1533TX Marketing I: Building a Real Estate PracticeIf our desired rate of return is 10%, we enter the following into cell B5:=NPV (0.1, B1:B4)And the program will return our NPV, $29,161. Essentially, this figure tells us that if we were to invest $29,161 at 10% per annum for four years, we would receive the same amount of money that we received through our first four years of operations.Most investment calculations for real estate are based on a 10-year holding period, but for the sake of simplicity, let us suppose we plan to sell property A after four years. If the purchase price is $86,500 and we estimate an average of 3% appreciation per year, we expect to sell the property for: $86,500 + $86,500 x 0.03 x 4 = $96,880We can calculate the NPV by adding $96,880 to our fourth year operations figure in the spreadsheet. Our new NPV is $95,331.94. Suppose our alternative to investing in property A is investing in the stock market at an expected rate of 5%. The NPV to receive the same amount of returns from the stock market at this rate is $112,412.27. The required stock purchase well exceeds the cost of buying property A for $86,500, so property A is the better alternative.Internal Rate of ReturnThe internal rate of return (IRR) of an investment is the yield of the investment within itself, i.e., when all the cash inflows and outflows to the investment have been discounted to zero. The IRR can be used to make asset allocation decisions. Investors consider a decision to be a good one if the IRR is greater than the opportunity cost of the capital required to implement it.IRR can be difficult to calculate. We have to use our formula for NPVand estimate rates. The formula, as above, is:
1634TX Marketing I: Building a Real Estate PracticenNPV = ∑[(Cash Flow at i) ÷ (1 + IRR)t(i)]i = 0Since the NPV is the discounted value of all cash flows, and IRR is the rate of return independent of all cash flows, we have to find the value for IRR that makes NPV = 0. Unfortunately, there is no mathematical formula we can use to do this for us. We have to estimate a value for IRR and see how close our NPV is to 0, and then use that knowledge to estimate a closer value, etc. Software is available that does this for us, and by far the most prevalent is Microsoft’s Excel spreadsheet software that is included with many people’s computers. If you have Excel, you can use the formula: =IRR (values, guess)To calculate IRR, record the payments as negative values and the income as positive values in the order paid or received in a column. Suppose the values you enter are in column B, cells 2 through 37 and your estimated IRR is 10%. You would write in cell B 38 the following formula:=IRR (B2:B37, 0.1)The software would then give you an IRR figure. Your estimated rate of return does not have to be too close to the original; if you do not enter a figure, Excel will use a 10% initial estimate and work from there.To use the Internal Rate of Return, simply compare it to the other investment opportunities available. If the interest rate for fixed-rate securities is 8%, the typical return on stock market portfolios is 9%, and the IRR of a different investment opportunity is 8.5%, stick withthe 10% IRR. With the aid of software, this method is simple, though not foolproof.
1735TX Marketing I: Building a Real Estate PracticeModified Rate of ReturnThe Internal Rate of Return can be inaccurate because it neglects to consider the actual rate that cash flows from the investment will be reinvested at. To compensate for this, some investors use the Modified IRR, or MIRR, which calculates a rate of returnon the basis of the finance rate (determined from the cost of the investment) and the rate the investor expects to receive on reinvestment. The formula for MIRR is too complex to consider here, but it, like the IRR, can be calculated with Excel, or other investment programs.Lesson SummaryIn order to make informed decisions about asset allocation, a manager must be able to use the available valuation techniques for real estate, including both financial ratio methods and the discounted cash flow (DCF) analysis. Two financial ratios often used in valuation are the price to earnings ratio (P/E) and the capitalization or cap rate. P/E ratios are widely used in valuing stocks and have some merit in the valuation of Real Estate Investment Trusts (REITs). Cap rates are by far the most widely used method of valuing real estate investments. The cap rate is equal to the Net Operating Income (NOI) divided by the Net Present Value (NPV) of the property. So, to determine the NPV of an income-producing property, an investor must simply divide the NOI by her or his projected cap rate. Another method of valuation, which is gaining ground in the market today, is the DCF analysis. These analyses use pro forma projections—future financial statements incorporating certain assumptions and hypotheses—to determine an alternative’s cash flows. These cash flows are then discounted to an NPV using a complex equation that many software programs, such as MS Excel, can perform. The investor or manager then compares the difference between the discounted present value and the cost of several alternatives, to determine the best asset allocation strategy. This type of NPV analysis is closely related to the Internal Rate of Return (IRR). This rate can be compared with other available rates, such as stock market returns or
1851TX Marketing I: Building a Real Estate Practicediscounted cash flow analysis, on the other hand, uses a discount to find a comparable net present value for an investment.5. For which of the following reasons might a borrower NOT want an adjustable rate mortgage (ARM)?A. ARM rates can increase to levels well above the market interest rates for conventional loans. Though these loans have payment caps, they often do not have rate caps and there is a chance for the borrower torealize negative amortization, or an increase in the principal balance of the loan.B. ARMs typically have initial interest rates that are 1-3 points higher than the market interest rates for conventional loans. Though these rates may decrease in the future, they may remain the same or increase, causing even greater payments. The rate for the loan is tied to an index, which varies at the lender’s discretion, and may move in a direction unfavorable to the borrower.Feedback:A is correct. ARMs are attractive because they have initial interest rates lower than those for conventional loans (typically 1-3 points lower). However, these loans are tied to an independent economic index, which can fluctuate upward, causing higher payments and, in some cases, negative amortization.Tax-Favorable Real Estate TransactionsQ: What is a 1031 Exchange? A: Section 1031 exchanges are available for real and personal property held for investment or used in a trade or business. The exchange of property under Section 1031 of the Internal Revenue Code allows the exchanger (i.e., the taxpayer) to avoid the depletion of equity that can result from paying taxes on the sale of her or his property. 1031 exchanges are basedon the principle of continuity of investment, under which the
1952TX Marketing I: Building a Real Estate Practiceexchanger’s investment in the replacement property is seen to be substantially a continuation of his or her investment in the relinquished property. Thus, the exchanger may invest the entire equity accrued in her or his investment property in the replacement property.Q: What are the requirements of a fully deferred exchange? A: The general rule is that a fully deferred exchange requires that the exchanger’s replacement property must amount to a trade for equal or greater equity and for equal or greater fair market value. One important effect of this rule is that the exchanger must use the entire net proceeds from the relinquished property as a down payment on the replacement property. Also, the exchanger must replace any mortgage paid off at the sale of the relinquished property with an equal or greater mortgage on the replacement property.Q: What is “boot?”A: “Boot” is a term that describes anything of value that a taxpayer receives in an exchange other than a replacement property. When parties make a like-kind exchange, sometimes it is necessary to include cash (cash boot) or other dissimilar assets (such as a reduction of debt through the exchange [mortgage boot]) in the transaction to balance the value of the exchange. The party receiving these dissimilar assets is taxed for their value. If the exchanger fails to purchase a replacement property of equal or greater value than the relinquished property, then there is a strong possibility that tax law will judge that he or she has received mortgage boot. An exchanger can also receive other property which will be deemed boot. For example, if an exchanger receives an automobile, art work, or any other thing of value as part of an exchange, then this non-like-kind property will be deemed boot and taxed on the fair market value of the property received.
2053TX Marketing I: Building a Real Estate PracticeQ: Can the exchanger take cash out of a 1031 Exchange? A: You cannot take cash out of an exchange without creating a taxable event. If an exchanger elects to take some of the equity out of the sale proceeds in the way of cash or a note, then this is called “cash boot” and is taxable. To avoid taxable boot, an exchanger should opt to refinance after the exchange transaction is completed, rather than taking cash out of the sale proceeds. Q: What are the basic rules for determining whether one parcel of real estate is of like kind to another? A: In the case of real estate, all property is considered to be of like kind to all other real estate. For example, farm land can be exchanged for an office building, and a condominium can be exchanged for a trailer park. Certain other tangible personal property can be exchanged, like airplanes and equipment. Whether one piece of personal property is of like kind to another is usually determined by evaluating whether they fall within the same General Asset Class or Product Class.Q: What does Section 1031 tell us about when replacement properties should be identified? A: Section 1031 tells us that replacement properties must be identified within 45 days after the sale or transfer of the relinquished property. This requirement is strictly enforced, even if the 45th day falls on a holiday. This identification must be put in writing; it must be signed and dated by the exchanger; and it must be received by the qualified intermediary no later than 45 days after the sale of the relinquished property. Replacement property must be identified unambiguously. Usually a legal description or a mailing address is sufficient to clearly indicate the chosen property. The identified replacement property must be purchased within 180 days of the date that the relinquished property was sold, or the due date of the exchanger’s tax return, which occurs first.
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238TX Marketing I: Building a Real Estate PracticeQualified Exchange Accommodation Arrangement (QEAA):A contract between an exchanger and an EAT (exchange accommodation titleholder) which is required to conduct a safe harbor reverse exchange under Revenue Procedure 2000-37. This contract creates the relationship under which the replacement property is parked with the EAT until the exchanger is prepared to go through with the exchange transaction.Qualified Intermediary:An entity that (or individual who) facilitates a 1031 exchange between a buyer and a seller by acting as a disinterested third-party representative for the exchanger. Qualified Product:A product (generally an investment or retirement account) that meets the IRS guidelines thatwould allow it to qualify for various tax benefits or advantages. Generally, a qualified product allows a taxpayer to accumulate money for retirement on a pre-tax basis. Relinquished Property:The property being sold by an individual making a 1031 exchange, sometimes also called “Phase I property.”Replacement Property:The property being acquired by an individual making a 1031 exchange, sometimes also called “Phase II property.”Revenue Procedure 2000-37:A procedure developed by the IRS providing for a safe harbor in which no gain or loss is recognized for exchangers conducting reverse exchanges. Reverse Exchange: (Also sometimes called a “reverse Starker exchange”) A type of 1031 exchange in which the exchanger purchases a replacement property before he or she sells the property to be relinquished. Often, but not always, conducted under the guidelines of Revenue Procedure 2000-37.
2412TX Marketing I: Building a Real Estate PracticeLesson Learning ObjectivesBy the end of this lesson, you should be able to:Identify motivated buying and selling clients.Outline the attributes of qualified and non-qualified products and how they can be of benefit to the sales process.Explain how money can be accumulated using pre-tax dollars, accumulating interest on a tax-deferred basis, and creating litigation protection.Explain how the market affects the appeal of qualified and non-qualified products.Explain how tax laws affect the viability of these investments.IntroductionThe Employee Retirement Income Security Act of 1974 (ERISA) revolutionized the way that Americans fund their retirement. This Act, under the administration of the U.S. Department of Labor and the Internal Revenue Service, sets forth certain standards thatemployee retirement plans must meet. Benefit pension plans, which provided predictable, secure lifetime benefits for 42 million workers and retirees, traditionally played a fundamental role in the nation’s retirement system, especially for older workers in large organizations. However, these plans generally pay the greatest benefits to those who put in 20 or 30 years with the same employer, and are thus of less value to the majority of Americans who tend to change jobs more frequently. Prior to ERISA, pensions and Social Security were the largest contributors to retirement funding. However, many Americans now have what are known as “qualified products,” i.e., retirement accounts such as 401(k)s and individual IRAs,whichmeet specific IRS guidelines that allow the accounts to qualify for tax advantages. Funds are paid into these accounts before taxes are deducted from an employee’s paycheck; these funds are then allowed to accrue tax-free interest in the account until
2513TX Marketing I: Building a Real Estate Practicethe time of disbursement. Instituting pre-tax credits for retirement saving allows the power of compound interest to create large cash deposits for retirees.The 2004 Retirement Confidence Survey reveals that 68 percent of Americans had at least some moneyearmarked for retirement in accounts set up in their names. Thirteen percent of workers over age 54 reported their total savings and investments at $100,000 or more (including employer contributions); five percent had saved less than $50,000, but more than $25,000; and 29 percent had set aside less than $ 25,000. A $100,000 nest egg would buy an annuity that would provide $10,627 a year in retirement income. A $50,000 retirement fund would provide an annuity that would pay $5,313 a year, and $25,000 would provide an annuity worth $2,656 a year. 2004 Retirement Confidence Survey here.Those who own retirement accounts should be made aware of their opportunities to increase the amount and yield of their holdings by purchasing real estate. Real property can be purchased through such an account with pre-tax monies and accumulate capital tax-free until disbursement. This lesson concerns the methods and strategies behind tax-favorable transactions that use retirement accounts. Real estate professionals who are aware of these strategies can make money while guiding their clients toward building a profitable estate.It should be noted that the information contained within this lesson may become dated and the student may need to update his or her knowledge on the issues presented here.Qualified ProductsQualified products are generally defined as retirement vehicles purchased using pre-tax dollars. The most familiar qualified products are 401(k)s, SIMPLEs, SEP IRAs, and individual IRAs.
2614TX Marketing I: Building a Real Estate PracticeThere are currently billions of dollars earning interest in each of these products, funds that will be distributed when the account holders turn 65 (the generally accepted retirement age). We should note, though, that these funds can often be distributed to an investor as early as the age of 59½ without the account holder having to pay a tax penalty. All of these accounts require that account holders take a minimum distribution at age 70—that is to say, at age70 accounts holders must be accepting some income from (and thus paying taxes on) the funds in their retirement accounts. The age at which minimum distribution must begin is based on mortality tables.Attributes of Qualified ProductsLet us examine some of the attributes that these products have and how they can be of benefit to the sales process. Our goal here is only to acquaint ourselves with the appropriate terminology and concepts; because we are not trying to gain in-depth knowledge at this point, we will only treat these topics briefly.All of the information provided about these various accounts is current as of 2015 and drawn from IRS publications. However, the monetary figures associated with the accounts (e.g., the limits on annual contributions) do change regularly and students should consult the most recent IRS publications (or speak with a tax attorney) to find current figures.401(k)A 401(k) plan is a qualified retirement account established by the Internal Revenue Code of 1978. At the time of this writing, an employee can place up to $18,000 in pre-tax dollars into her or his 401(k) account; this figure changes year-to-year. Any matching contributions made by an employer are understood by the IRS to be in addition to this limit—in 2015, $18,000 is the limit that an individual can put in on his or her own, but an employee’s employer may choose to match that amount, and their combined annual contribution ($36,000) would still fall within the legal contribution limits.
2715TX Marketing I: Building a Real Estate PracticeSIMPLE“SIMPLE” is anacronym which stands for “savings incentive match plan for employees.” This employer-sponsored plan is typically used in small companies as an alternative to a 401(k) –in fact, it is often called the “savings incentive match plan for employees of small employers.” An employer’s matching contributions to a SIMPLE account cannot equal more than three percent of an employee’s salary. Employee contributions are called “salary reduction contributions;” these are employee-chosen contributions or elective deferrals, which are made by an employer on the employee’s behalf with funds taken from an employee’s pre-tax income. Employee contributions are limited to $9,000 for 2004 and to $10,000 for 2005.SEP IRA“SEP” is an acronym thatstands for “simplified employeepension”—a low-cost pension plan useful for small businesses. A SEP IRA allows an employer to contribute up to 25 percent of an employee’s compensation or $40,000 (indexed), whichever is less, based on the first $200,000 of compensation.IRA“IRA” is an acronym for “Individual Retirement Account.” These are individual retirement plans; they are like 401(k)s in that interest accrued in them is non-taxable. However, not all contributions to an IRA are from gross income (i.e., pre-tax), whereas all 401(k) contributions are made from pre-tax income. The general limits imposed on contributions to traditional IRAs in 2004 were $3,000 ($3,500 if the contributor is over 50); in 2005, these limits were $4,000 ($4,500 if the contributor is over 50). The maximum contribution as of 2015 is $5,500.00. One’s income and age often affect the amount one is permitted to put into an IRA each year. The amount that one can contribute on a pre-tax basis is limited, i.e., one generally cannot make the entire annual maximum contribution from pre-tax income. Even though the contribution basis is small, huge amounts are transferred (in what is known as a “rollover”) from 401(k)s and other corporate retirement plans every year when employees move to different jobs.
2816TX Marketing I: Building a Real Estate PracticeYour opportunity to offer real estate to individuals with retirement accounts lies mostly in the IRA market; those with corporate pension plans can also be receptive if the plan document and investment statement allow such assets into the plan. A secure, mutually productive relationship with a financial advisor can be extremely valuable to you in making these determinations.Non-Qualified ProductsNon-qualified products are generally defined as financial products purchased with after-tax dollars. Interest is accumulated ona tax-deferred basis and generally must satisfy the same distribution rules that apply to qualified products. Attributes of Non-Qualified ProductsThe most familiar non-qualified products are annuities. Although other products can offer the same tax accumulation, they may or may not offer the application attributes that will allow the prudent real estate professional to help the product holders take advantage of the opportunities presented by the real estate market.In this lesson, the non-qualified product applications that we will be discussing are the charitable gift annuity (CGA) and the Roth IRA. A Roth IRA is a retirement account funded by after-tax monies (thus making it a non-qualified product),which allows those monies to collect interest tax-free. When money is paid out of the Roth IRA, these payments are tax-free as well because taxes were paid on it already. The holder of a Roth IRA may not purchase property for his or her own use through the account, though she or he may invest in property.AnnuitiesAn annuity is an obligation to pay a specific sum (generally monthly or annually) to a particular recipient. For our purposes, an annuity can be thought of as a contract (generally made with an insurance company) for a lump sum or scheduled premiums that are paid out on specific, pre-determined dates. The annuity issuer guarantees an
2917TX Marketing I: Building a Real Estate Practiceincome for a certain period or for the remainder of the purchaser’s life. These annuities can be traded for real property, as a tax-favorable alternative to other methods of purchasing them. In all cases, annuities accumulate value or interest on a tax-deferred basis. An annuity confers a right to a periodic payment derived from a principal sum; the individual upon whom this right is conferred is called an “annuitant.” This right may be obtained by bequest, donation, or purchase. The types of annuities that can be bought through insurance companies include simple (or straight) and refunding annuities. The main difference between these two types is that a simple annuity stops payment when the annuitant dies, regardless of whether the principal fund plus interest has been paid. A refund annuity refunds any unpaid sum to the annuitant’s estate when he or she dies. An annuity must be created by a specific annuity contract. Given this fact, we should note that general contract principles and defenses apply to annuity contracts, including the requirement that the annuity contract involve consideration. In legal terms, consideration is something of value, such as money or apromise, which is given to show acceptance or acknowledgement of a contract. Consideration is what distinguishes something given according to the terms of a contract from something given as a gift. Generally, an annuity contract does not fail for lack of consideration, even if the annuity is a gift to a third party. Consideration for an annuity contract is derived by using a mortality table. The purchaser of an annuity (i.e., the annuitant) fills out a TDA Proposal to obtain the annuity. A Tax-DeductibleAnnuity Proposal Worksheet is included here for you to review.
3018TX Marketing I: Building a Real Estate PracticeAn insurance policy that entitles the beneficiary of the policy to receive installment payments is not an annuity unless a separate annuity contract is drafted by the insurer.
3152TX Marketing I: Building a Real Estate PracticeProperty that combines a principal residence and a business may be transferred in this sort of exchange, and the appropriate value assigned to the business portion of the property. Second HomesA second home does not qualify as an investment property. A second home might be rented out, and, thus, could qualify as a rental property. However, if the owner uses it for personal purposes for more than 14 days a year or for more than 10 percent of the days it is actually rented, then it will not be treated as an investment or rental property for that tax year. It will be treated as a second personal residence. Partnership InterestsIndividual partnership interests may not be transferred in a 1031 exchange. Many small investment or business properties are owned by partners; if title to the property is held in the name of the partnership, thenthe entire partnership must participate in the exchange. Individual partners may not exchange their individual partnership interests, but business organizations can participate in 1031 exchanges as exchangers. This rule is in place because the majority of partners actually have an interest in the partnership itself and not merely in the real estate being exchanged. However, the IRS will not permit exchanges of individual ownership interests even if the only assets of the partnership are real estate. Insome cases, a partner may be able to convert her or his partnership interest into interest in real property and exchange that, under the applicable laws. Partnership taxation law is highly complicated, and the 1031 restrictions on exchanging partnership interests are similarly complex. If partnership property is to be involved in an exchange, this transaction needs to be planned far in advance and will likely require the assistance of other financial professionals.
3253TX Marketing I: Building a Real Estate PracticeProperties Held for ResaleProperty that is held for resale—also known as “inventory” or “dealer property”—is not exchangeable under Section 1031, which requires exchange property to be acquired with the intent to hold it for investment. There is, however, no minimum holding period sufficientto prove that a property was held for investment. The burden of proof lies on the taxpayer and is supported by facts and circumstances that are unique to each exchange. It is nonetheless practical to use the two-year test as a conservative measure—that isto say, if the exchanged property is held for two years this is likely to indicate that it was not intentionally acquired for resale purposes.Properties Held by a Related PartySpecial rules govern exchanges of property among related parties. Related parties include members of a family (i.e., brothers and sisters, spouses, ancestors, and lineal descendants); this concept is defined in Section 267(c)(4) of the Revenue Code (i.e., in Section 267(c)(4) of Title 26 of the U.S. Code) as follows: “The family of an individual shall include only his brothers and sisters (whether by the whole or half-blood), spouse, ancestors, and lineal descendants.” Exchangers should, in general, avoid purchasing the replacement property from a related party because this relationship can create unnecessary complications in the transaction. However, direct exchanges between related parties and the transfer of relinquished property to a related party can be valid, tax-deferred transactions if the exchanged property is held for two years following the exchange. The most common scenarios involving the related party rules are: The exchanger sells to a related partyThe exchanger acquires property from a related party. Taxpayers should always have their legal counselors and tax advisors review purchases of replacement properties from related parties. In Private Revenue Ruling 9748006, the IRS disallowed tax deferral to a taxpayer who had purchased his mother’s propertyThe related parties directly swap their properties witheach other
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354TX Marketing I: Building a Real Estate PracticeDescribe the history and purpose of the Deceptive Trade Practices Act (DTPA).Explain whythe existence of and adherence to the NARCode of Ethics is good for the real estate profession.Key TermsBroker:A real estate professional who brings parties together for specific purposesand negotiates deals. Client:The person(s) or entity(ies) with whom a real estate broker or a real estate broker’s firm has an agency or legally recognized non-agency relationship.Customer:A party to a real estate transaction who receives information, services, or benefits but has no contractual relationship with the realestate professional or the real estate professional’s firm.Ethics:The study of standards of conduct and moral judgment, which includes the system or code of morals of a particular person, religion, group, professional, etc. It is also the required conduct (to act otherwise would be unlawful) of real estate professionalsas outlined in the National Association of REALTORS®Code of Ethics.National Association of REALTORS®(NAR):The industry association for brokers, salespeople, appraisers, and other real estate professionals. NARrequires its members to adhere to a strict code of ethics, which forces its members to operate at a higher standard. NARCode of Ethics:A code designed to establish a public and professional consensus against which the practice and conduct of REALTORS®and REALTOR-ASSOCIATES®may be judged.
366TX Marketing I: Building a Real Estate PracticeLesson 1: Ethics,Morals, and Approaches to Ethical DecisionsLesson TopicsThis lesson focuses on the following topics:Ethics and MoralsThe 4 Approaches to Making Ethical DecisionsEnd-Result EthicsRules and Laws EthicsSocial Contract EthicsIndividual Conscience EthicsA Model for Ethical Decision Making......................................................................................................................................................................20
377TX Marketing I: Building a Real Estate PracticeLesson Learning ObjectivesBy the end of this lesson, you should beable to:Define ethics as used in this module.Describe the difference between ethics and morals.Briefly describe the four business ethics approaches used in this module.Illustrate how ethical decision-making is conducted.Explain social contract ethicsand individual conscience ethicsEthics and MoralsThe Definition of EthicsFrom the Second College Edition of the American Heritage Dictionary, copyright 1982 by Houghton Mifflin Company, Boston, Massachusetts:Ethics:The study of the general nature of morals and of specific moral choices to be made by the individual inhis relationship with others. The rules or standards governing the conduct of members of a profession (page 467).The Definition of MoralsFrom the Second College Edition of The American Heritage Dictionary, copyright 1982 by Houghton Mifflin Company, Boston, Massachusetts:Moral:Of or concerned with the judgment principles of right and wrong in relation to human action and character. Synonym: Ethical-approaches behavior from a philosophical standpoint; it stresses more objectively defined, but essentially idealistic, standards of right and wrong such as those applicable to the practices of lawyers, doctors, and [businesspeople]. (pages 813-814)
388TX Marketing I: Building a Real Estate PracticeMorals vs. EthicsEthics are morals that society has converted into laws and principles, whereas morals are the ideas of right and wrong that are inherent in each individual. The two terms are oftentimes used interchangeably, but they do not mean the same thing. No one is perfect, and all of us are faced with difficult choices every day. The study of ethics would be easy if there was always a clear right and wrong answer in every situation. However, in many situations it just is not that easy and there seems to be one version of right contrasted with another version of right.Case Study AA broker with ABC Real Estate goes out on a listing appointment. During the course of her discussion with the sellers, the broker discovers that the sellers are selling their home because they just cannot live next door to their neighbors any more. According to the sellers, although the neighbors maintain their yard, the neighbors have very loud arguments at all hours of the night. The neighbors are known to abuse alcohol, which contributes to the arguments. The sellers are tired of being awakened by the arguments of their neighbors and the occasional visits from police. Is the noise from the neighbors something that should be disclosed to potential buyers? Perhaps only to buyers that the broker thinks would be bothered by the noise? Should the broker keep quiet because she owes her fiduciary duty to the sellers and knowledge about the neighbors might lower the price that the sellers would receive for the house? Is there another solution?Due to difficult situations like these, there needs to be a system that helps professionals make ethical decisions. The Code of Ethics plays a large role in setting guidelines for
399TX Marketing I: Building a Real Estate Practiceagents to follow; it is up to the agent to follow the Code as she or he deems morally appropriate. Of course,when there is legislation, court precedents and/or commonlaw pertaining to specific situations, then the decision may be much easier. On the other hand, there are situations where two laws are involved, and legal counsel is needed to determine how to proceed because following one law may appear to violate the second law. Note:This course is not intended as a substitute for legal counsel.The 4 Approaches to Making Ethical DecisionsWe will now discuss four approaches to making ethical decisions and the model for applying these approaches. The student will be asked to apply these approaches and the model for ethical decision making in Lesson Four. The four approaches are similar to those in a book written by Deborah H. Long entitled Doing the Right Thing: A Real Estate Practitioner’s Guide to Ethical Decision Making, Second Edition. The four approaches we will use in this course will be based on:1.End-Result Ethics2.Rules and Laws Ethics3.Social Contract Ethics4.Individual Conscience Ethics. End-Result EthicsA person who approaches an ethical decision using End-Result Ethics may draw up a list of advantages and disadvantages of a potential decision; whichever list has the most items determines if the proposed decision is appropriate. This is a pragmatic approach and has appeal in the real estate industry since agents are concerned with public opinion, making people happy,and closing transactions.
4010TX Marketing I: Building a Real Estate PracticeA downside of this approach is that obeying the law is only one item on the list, and there are consequencessuch as lawsuits, potential loss of real estate licensure, and potential loss of NARmembership for disobeying the law. Essentially this approach tries to find the solution that makes the most people happy.In some cases, there are no laws involved, onlypersonal feelings and preferences. What causes one person to be happy may cause another person pain.A paraphrased case study fromDoing the RightThing (DRT, p. 28) to illustrate how this approach may be applied is given in the next scene.Case Study BA real estate office is considering a ban on smoking within the office based on health concerns. Perhaps 80% of the office does not smoke, but the 20% who do smoke bring up concerns about potential decreased sales because without cigarettes the smokers become irritable and unproductive. The agents are also concerned about clients whosmoke and whether or not smoking clients may go to a competitor who allows them to smoke. A no smoking policy has the potential to make 80% of the office happy, but at the expense of making 20% of the office unhappy in addition to a potential loss of clients. An advantage of the End-Result approach to ethics is that it is a common sense approach that considers all the stakeholders within the decision process. A disadvantage is that this approach fails to define “happiness” in a consistent manner and cannot be applied to every situation. Therefore, other approaches may be necessary to reach the best potential decision.
4114TX Marketing I: Building a Real Estate Practicethe dispute advise the local board in writing that they choose not to arbitrate before the board, they may not have to arbitrate.A weakness to the social contract approach is that sometimes change is difficult because of an established community belief system. For example, buyer brokers may attempt to establish themselvesin a market, but in many cases, the established real estate community will try not to cooperate with them. The established real estate community believes in the traditional way of doing business; therefore, they will be fearful and skeptical of new practices presented by buyer brokers. Another potentially large disadvantage to the social contract way of thinking is that some people who adopt this theory believe that the supreme authority is the state. If the state or community adopts an approach that is immoral, then all persons in the state could be at risk.Individual Conscience EthicsIndividual Conscience Ethics uses individual and personal beliefs in order to establish a standard for decision-making. Most other philosophies are primarily concerned with focusing on the outer world such as laws and societal consequences for guidance andaction. Individual Conscience Ethics “focuses on what lies within each person: conscience. A conscience can be defined as the [voice within]” (DRT, p. 35). Martin Luther King, Jr. and Mahatma Gandhi are persons who practiced this approach even though it involved great personal risk.A limitation to Individual Conscience Ethics is that it is individualized; therefore, it is hard to apply this approach when managing an office where each individual in the office has his or her own personal ethical code and, on some issues, those codes may clash (DTRT, p. 36). A paraphrased case study fromDoing the RightThing(DRT, p. 37) to illustrate how this approach may be applied.
4215TX Marketing I: Building a Real Estate PracticeCase Study EYou are the listing broker of a home in a well-kept neighborhood of mediumpriced homes. The home you are listing is not along the power lines, but there is an elementary school in the neighborhood that is located on land purchased from the power company with a close proximity to a power substation and high-voltage lines. When the school was being constructed, there were protests from parents who cited several studies that showed that children who were constantly exposed to electromagnetic fields (EMFs) developed childhood leukemia and other diseases. As a result of the parental concerns, the school board agreed to periodically test the EMF levels throughout the year, and no significant results were discovered. However, the school board voted to allow parents to move their children to another school within the district if they were still concerned about the potential effects of EMFs. The owners of your listing have asked you not to mention anything about the EMF issue. You have read the results from several studies on the effects of EMFs and the results seemed conflicting and confusing. In your state, there is no law compelling you to disclose the EMF issue. You have seen evidence that the homes that are along the power lines sell for less than comparable neighborhood homes without power lines. If you disclose that children who attend the neighborhood elementary school may be exposed to a potential environmental risk, your listing will probably sell for less.How would you handle this situation?A Model forEthicalDecision MakingConsider the following decision-making model.In order to use this model, it is helpful to define facts, assumptions, persons affected, resources, trial decisions, and final decisions.
4316TX Marketing I: Building a Real Estate PracticeDefining the ProblemFactsFact: Astatement or assertion of verified information about something that is the case or has happened.Examples of facts in Case Study E:The sellers would like to sell their home (subject property).Their home is not close to the high voltage power lines.Making a Final DecisionEvaluating a Final DecisionDefining the ProblemDetermine:•Facts•Assumptions•Affected persons•ResourcesApplying an Ethical System•End results approach•Rules and laws approach•Social contract approach•Individual conscience approachMaking a Trial Decision for Testing
4417TX Marketing I: Building a Real Estate PracticeTheneighborhood elementary school is located in close proximity to a power substation and high voltage lines.Some parents are concerned about potential long-term affects to children who are chronically exposed to electromagnetic fields (EMF) and those parents protested the construction of the school on the site purchased from the power company.The school board has agreed that parents who are concerned about EMFs may move their children to another school within the district.The EMF readings at the school have been periodically tested and none of the readings have been reported as significant thus far.Homes located along high voltage power lines have sold for less than comparable homes that are not near power lines.The sellers have requested that the listing broker not mention the EMF issue while marketing the home.AssumptionsAssumption: According to the person facing the decision, anything related to the situation that is assumed to be true and from which a conclusion can be drawn.Examples of assumptions in Case Study E:There is not a clear scientific conclusion that EMFs are harmful.Since homes next to high voltage lines have sold for less than other comparable homes and there has been a lot of publicity over the EMF issue in relation to the construction of the elementary school, it is possible that the subject property may sell for less rather now or later.Persons AffectedPersons affected: All persons that will probably be affected by whatever decision is reached.Examples of affected persons in Case Study E:
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483TX MarketingI: Building a Real Estate PracticeInitially, this module will introduce the federal Fair Housing Act, explaining the groups of people whom it covers and the various wrongs against which the law is meant to protect. In addition, we will discuss the meaning of discrimination and the existence of certain exemptions to the law. After detailing the Fair Housing Act, this modulewill move on to other relevant statutes, such as the federal Equal Credit Opportunity Act and the Americans with Disabilities Act.This module concludes with a real estate practice lesson that will present you with various case studies. Using the information you have gained from this module, this final lesson provides you with an opportunity to decide how to handle the common predicaments that oftenface those providing brokerage services. Module Learning ObjectivesUpon completion of this module, you should be able to:Explain the purpose of the federal fair housing laws Identify the protected classes covered by the Fair Housing Act.Name the seven activities considered illegal underfair housing laws.Identify the five exemptions from the federal fair housing laws for property owners.Recognize discrimination in real estate practice.List acts considered discriminatory under the Fair Housing Act of 1968 as amended in 1972 and 1988.Discussthe purpose of the federal Equal Credit Opportunity Act (ECOA) and list the classes it protects.Describe the purpose of the Americans with Disabilities Act (ADA).Outline how the ADA affects real estate practice.Explainhow fair housing complaints are handled.List the penalties for non-compliance with fair housing laws.Identifyvarious ways a broker might incorporate business practices designed to prevent discriminatory practices.Explain the purpose of the HUD/NAR Partnership and why it is important.
494TX MarketingI: Building a Real Estate PracticeState the basic principle that should guide licensees in following HUD’s Advertising Guidelines.Identify acceptable and unacceptable words and phrases for use in advertisements.Describe how to apply the practices that help a licensee show that he or she does not discriminate.Key TermsAmericans with Disabilities Act (ADA):This Act prohibits discrimination against individuals with disabilities. Specifically, it guarantees them access to employment, public services, telecommunications, public accommodations, and commercial facilities. Blockbusting:Inducing the panic selling of homes at below market value, generally by raising fears that an influx of individuals belonging to a particular minority group will decrease property values in a neighborhood and otherwise affect the area negatively.Civil Rights Acts of 1866 and 1870:These Acts stipulate that all persons, regardless of their race, color, or previous position of servitude, have the same legal right to make and enforce contracts. Similarly, these Acts entitle all people to the full and equal benefit of laws and proceedings for the security of persons and property.Civil Rights Act of 1964:A federal Act that includes a prohibition against discrimination by housing programs that receive any federal funding.Civil Rights Act of 1968:This federal Act prohibits discrimination in the sale or rental of property on the basis of race, color, religion, or national origin. Later amendments added prohibitions against discrimination on the bases of sex, handicap, and familial status.Disability:The federal government defines a disabled individual as a person who has a physical or mental impairment that substantially limits one or more of that individual’s major life activities. This legal definition also includes any individual who has a record of having suffered from such impairment.
505TX MarketingI: Building a Real Estate PracticeDiscrimination:Unfavorable or unfair treatment of a person or class of persons based on race, sex, color, religion, national origin, familial status, or disability.The relative favorability or fairness of treatment is judged by comparing it to the way theindividual or institution accused of discrimination interacts with people who are not members of the class.Dwelling:The Fair Housing Act defines a dwelling as any building, structure, or portion of a building that is occupied as—or designed or intendedfor occupancy as—a residence by one or more families. This definition also includes any vacant land offered for sale or lease for the construction of a building, structure, or portion of a building that is intended to be occupied as a residence.Equal Credit Opportunity Act (ECOA):A federal Act prohibiting discrimination in lending on the basis of race, color, religion, national origin, sex, marital status, age (provided the applicant is of legal age), or on the basis of the applicant’s receipt of incomefrom a public assistance program.Fair Housing Act:A federal law prohibiting discrimination in the sale or rental of housing on the basis ofrace, color, religion, sex, handicap, familial status, or national origin. This Act makes up Title VIII of the Civil Rights Act of 1968. Familial Status:“Familial status” is a term meant to capture the idea of having a family with minor-aged children. An act or practice is considered discrimination on the basis of familial status if it is unfavorable or unfair to anyone who is pregnant or planning to adopt, or to families with children under 18 who reside with a parent or other legal custodian. Housing for Older Persons:Senior citizen or adult communities that are exempt from the federal laws prohibiting discrimination against families with children.Redlining:A refusal to finance housing for people living in a certain area, or a restriction on the number of loans granted in a certain area. Redlining is illegal under fair housing
5110TX MarketingI: Building a Real Estate PracticeGenderFamilial statusReligionDisabilityIt is a violation of federal law to discriminate against someone in the sale or letting of residential real estate on the basis ofher or his membership in one of these seven protected classes. Some individual states and local jurisdictions, such as counties and cities, have introduced legislation to protect additional classes. It is, therefore, necessary for licensees to review state laws and local ordinances regarding housing discrimination to ensure that their conduct satisfies any additional requirements. All of the protected classes listed earlier were established by the Civil Rights Act of 1968 except sex, familial status, anddisability. Sex was added in 1974 by the Housing and Community Development Act. A 1988 amendment to the federal Fair Housing Act itself added familial status and handicap.Advising the Real Estate ConsumerA licensee should advise any seller, buyer, landlord, or tenant of the protected classes under the law at the inception of the relationship with any of these parties.An example of how a licensee might do this is:“Mr./Ms. Prosect, by both state and federal law I am prohibited from providing services to anyone based on their race, color, religion, national origin, sex, familial status or disability.What this means is that I am not able to discuss with you such issues as the ethnicity of a neighborhood or whether anyone living on the property has had orhas HIV/AIDS.I will not and cannot discuss these issues with you.”
5211TX MarketingI: Building a Real Estate PracticeThe reasons that a licensee may wish to do this are:It is good business, as Texas is now one of the most diverse states in the nation and ranks number two (behind California) in numbers of transactions that involve foreign parties.It will help expand the opportunities for the licensee.It’s the “right thing to do” and is included in Article 10 of the REALTOR® Code of Ethics.It’s the law –both state and federal.As will be discussed later, HUD and the State of Texas utilize undercover buyers, sellers, landlords, and/or tenants whose mission is to get a housing provider to commit a violation. These undercover operatives are called “testers” or “shoppers” and they are targeting real estate agents.By advising every prospect of the intent to comply with the law, a licensee will probably be able to avoid a lot of frustration and wasted time.A licensee, who is a member of the National Association of REALTORS® should keep in mind that the REALTOR®Code of Ethics does have two additional protected classes over and above the seven under state and federal law. They are sexual orientation and gender identity. Also, some cities and counties may also have additional protected classes that the licensee may want to be aware of that could include:age, marital status, ancestry, source of income (or public assistance).It will be up to the licensee to be aware of these.Definition of DisabilityWhile some of these classes may seem self-explanatory, the definitions of “disability” and “familial status” may be a little less clear. For example, a disability does not necessarily mean a physical disability. The next few pages will define the terms “disability” and “familial status.”The law states that a disabilityis any physical or mental impairment that limits one or more of a person’s major life activities, such as walking, talking, hearing, seeing, breathing, learning, performing manual tasks, and caring for oneself. This definition thus includes a variety of conditions, such as being infected with HIV or having AIDS, being an alcoholic,
5312TX MarketingI: Building a Real Estate Practiceand having a learning disability. It is worth noting here that while alcoholism is considered a disability, being addicted to illegal drugs is not.A disability can be actual or perceived. This means that if a real estate professional believes that a prospect may have a disability of any kind, and, as a result, refuses to rent, offer services, show housing, etc., then that professional has violated the federal Fair Housing Act. This is true regardless of whether or not the person is actually disabled. Real estate professionals and lessors must make reasonable accommodations for people with disabilities. A landlord or real estate professional mustmake any accommodation that helps a disabled person acquire and enjoy his or her dwelling, though the parties providing accommodation(s) are not required to suffer undue hardship in doing so. For brokerages, this could mean providing Braille versions of pamphlets and handouts. For a lessor, this could mean allowing a person with an assistive animal to keep that animal indoors, even if tenants are generally forbidden to keep pets.Although you may not discriminate against people because of a disability, itis not illegal to refuse housing to prospective tenants, or to evict current tenants, who have a physical or mental impairment that poses a direct threat to other tenants. For example, it would not be illegal to refuse to rent an apartment to an unmedicated schizophrenic with a history of violence against others, even though the person has a documented mental impairment. In cases like these, it is important that real estate professionals, landlords, prospective sellers, and other people bound by the FairHousing Act show that an actual and direct threat exists. For example, a tenant with Tourette’s syndrome who cannot help making loud noises throughout the night may pose an indirect threat to other tenants through the long-term effects of sleep loss, but does not pose any immediate, direct threat. The courts have ruled that a landlord must also show that no reasonable accommodation could eliminate the direct threat posed by a tenant.
5475TX MarketingI: Building a Real Estate Practicehas written an advertisement; the licensee publishes this advertisement in the local paper. It reads as follows:2-1 duplex on quiet street. Suitable tenant will be non-smoking; straight, male preferred; no pets.Landlord Z is now waiting for responses to the advertisement and for his real estate representative to produce prospective tenants.Has the landlord done anything that violates the federal Fair Housing Act? Has the real estate licensee representing him violated the Fair Housing Act?Case Study 5 ResponseThis is a complex example, the nuances of which require professional legal interpretation. However, on the surface, we can identify a number of problematic issues. It is more than likely that Z and the real estate licensee (as well as the publishing entity, i.e., the local paper) have violated federal fair housing laws, and perhaps state and local fair housing laws, as well. As the student may recall, the exemption to the federal Fair Housing Act reads that a sale or rental of a single-family residence isexempt, provided that the owner:Does not own, or own an interest in, more than three single-family residencesWas the previous occupant of the dwelling being sold, or—if the owner was not the most recent resident—the owner has not made another sale or rental exempt from the fair housing laws in the past 24 monthsDoes not use the facilities or services of a real estate licensee, broker, or salesmanDoes not use any discriminatory advertisingThe first problem here is that Z owns more than three dwellings. He is not the most recent resident of the property, but neither has he made any exempt sales or rentals in the last 24 months. If he owned three or fewer dwellings, this fact might help him qualify for an exemption, but because he owns more than three properties this fact is not relevant to whether this transaction is exempt.
5576TX MarketingI: Building a Real Estate PracticeIn addition, as soon as Landlord Z hired a real estate professional and published the discriminatory advertisement, he created further problems for himself by failing to satisfy the last two requirements for an exempt transaction. Federal housing law picks out this advertisement as discriminatory because Landlord Z’s request for a male tenant indicates a preference based on gender. While sexual preference is not currently a protected class under the federal Fair Housing Act, it is in many state and local jurisdictions. Somestates, cities, and counties have more stringent laws thatwould make the author of this advertisement guilty of other sorts of discriminationas well. Sexualorientation, gender identity, and age are among the common groupings that local and state jurisdictions protect. It is possible (depending on where Landlord Z lives) that he violated other statutes, in addition to the federal Fair Housing Act.It is worth noting that the newspaper that published the ad may be held liable as well. As the student may recall from earlier lessons, HUD decided that publications incur liability for discriminatory advertisements.Remember:Fair housing laws protect all of us from unethical, unwarranted, and inappropriate discrimination. Financially, it is a poor business practice to turn away qualified prospects, or to run advertisements that focus on eliminating potential tenants rather than describing the property. Lost prospects may not translate into financial hardship, but discriminatory practices are not a good way to build up clientele, earn referrals, or develop a respectable reputation. Ethically, we should all strive to prevent unfair treatment and do our best to treat others fairly and respectfully, thereby upholding both the letter and the spirit of fair housing legislation.
5677TX MarketingI: Building a Real Estate PracticeLesson SummaryThis lesson outlined ways that real estate licensees can adhere to both the letter and spirit of federal fair housing legislation. In particular, it focused on ways that licensees can avoid discriminatory advertisements and demonstrate their dedication to fair housing to their potential clients and customers. In general, developing a standard way of addressing, meeting, and greeting all potential clients and customers—both in person and on the phone—will help you avoid accidental discrimination. Similarly, it is important to develop a standard battery of questions thatare asked of all buyers and lessors (or all sellers and landlords) to help identify their needs and goals. This is a good idea because it will help ensure that the licensee’s assumptions are not mistaken for facts about the client and that these assumptions do not lead the licensee into accidental discrimination. In addition, a generalized approach helps a licensee to provide the same degree and quality of customer service to all clients.One way that a real estate licensee can evidence non-discrimination is by joining a professional organization that works to promote fair housing. One such organization is the National Association of REALTORS®. In fact, the National Association of REALTORS®and the U.S. Department of Housing and Urban Development (HUD) have entered into a partnership, with the goal of making fair housing more accessible. Together, HUD and NAR hope to share the responsibilities associated with fair housing compliance, to identify fair housing issues and concerns, to develop strategies for addressing these issues and concerns and to evaluate the success of these endeavors. Brokers must be especially careful in their advertisements. In addition to discriminatory statements, HUD will also prosecute those persons who exploit language barriers, models, or particular media to illustrate an unethical and unfair preference. If a discriminatory ad is published, then both the writer and the publisher (for example, the newspaper or magazine) can be held responsible. Avoiding discriminatory advertising is easy! Just remember: Describe the property, not the people.
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5910TX Marketing I: Building a Real Estate Practicelicenses. For the Certified Residentiallicense levelthere are six options now acceptable for college credit requirements.The Licensed Residential Real Property Appraiser classification requires completion of 150 creditable class hours as specified in the Required Core Curriculum. The prerequisites for taking the AQB-approved Certified Residentialexamination are completion of 200 creditable class hours as specified in the Required Core Curriculum. Qualifying experience is also required for residential appraisal licenses and certifications.Field ExperienceProfessional, academic,and technical education programs usually require some period of apprenticeship or internship and real estate appraisal is no exception. Most aspiring appraisers work under the direct supervision of an experienced appraiser, sometimes for years, prior to starting their own professional careers. It takes a lot of experience before a newly certified or licensed appraiser commands the professional esteem that gives his or her appraisal report its merit. Some universities, as well as some states, require an internship before graduation. For those students searching for an internship on their own, many appraisal companies will hire interns for research and field assistance. ObjectivityAn appraiser should be as objective as possible. Any personal interest she or he has in a particular property must be disclosed to all relevant parties. Those appraisers known for professional objectivity tend to reap the most monetary benefits of their profession and the respect from both fellow licensees and the public.Appraisers should avoid those circumstances that are contrary to maintaining their objectivity, such as:Having personal or family relationships with a party involved with atransactionOwning property or being related to someone owning property close to or adjacent to a subject property
6011TX Marketing I: Building a Real Estate PracticeHaving an appraisal fee based upon a percentage of a property’s valueIf an appraiser accepts an assignment with any such personal interest, then the final value estimate’s credibility is lessened. USPAP and the ethics of most appraisal organizations requires that any bias or interest in a property be identified in the appraisal report, although such a disclosure will not necessarily validatean appraisal with a conflict of interest. In fact, banking regulators and federal legislation will not allow banks to accept appraisals if the appraiser has any type of interest, even if disclosed. For the sake of practicality, appraisers should simply avoid any project in which they have personal interest. In particular, it is extremely important that an appraiser's compensation is never contingent upon his or her final value estimate.CompetencyA value estimate is directly related to the competency of the appraiser. An appraiser can prove and improve her or his competency by:Belonging to an organization that requires mandatory continuing educationContinually improving his or her skills, even when not required by lawEstablishing relationships with other well-respected professionals, such as bankers, brokers, and lawyersHaving or obtaining experience with specific property typesHaving no interest in the property and not having a relationship with anyone involved in a transactionObtaining an appropriate license or certificationNever making compensation contingent upon a report's resultsForeseeing possible complications and preventing them
6112TX Marketing I: Building a Real Estate PracticeQualifications of an AppraiserAlthough there are state licensing and certification programs, the actual qualifications of individual appraisers will vary. Often, appraisers join independent appraisal organizations to prove qualification and dedication to continuing education.Professional DesignationsUntil licensing and/or certification, professional designation was the primary benchmark for assessing an appraiser's qualifications. Professional appraisal associations have been in existence for many years. Some of these associations helped establish the industry standards we now take for granted. A good, professional appraisal organization: Promotes ethical standards in appraisingIncreases competencyGains recognition for their members as qualified appraisersMost organizations require candidates or applicants to:Prove their actual appraisal field experiencePass at least one written examinationProve their ability to complete an appraisal report by submitting a demonstration report or samples of their work productA good way to judge the validity of an association membership is to weigh it againststate and federal standards. If an organization has more stringent qualification requirements and ethical standards than state and federal legislation and agencies (covered in subsequent scenes) require, then it is probably a reliable association. For example, obtaining a designation from the National Association of Independent Fee Appraisers (NAIFA) requires that candidates prove their ethical character and field competency beyond the average state and federal requisites. Before the federal government mandated licensing, the public often confused designations given by professional associations with a state license or some other type of
6213TX Marketing I: Building a Real Estate Practicegovernment permit. The public often referred to appraisers as certified even though no certification process existed. Professional SocietiesTaking a membership in an appraisal society helps one maintain his or her professional credentials and keep up to date in the appraisal field. These societies have gatherings, meetings, courses, and seminars. The prerequisites for membership vary widely; some are more rigorous than others. Most appraisal organizations require extra education and proof of experience to join. Below is a list of appraisal-related societies. In general, a good, professional organization will set membership requirements in excess of the Appraisal Foundation's minimum requirements. Please keep in mind that one should carefully weigh the professional benefits of joining any one of these organizations. Accredited Review Appraisers Council•Publisher of The Review Appraiser•Member designation: AAR (Accredited in Appraisal Review)American Association of Certified Appraisers, Inc., Cincinnati, OhioMember designations: •Non-certified: Affiliate and R-1 (Residential-First Level);•Certified: CA-R (Certified Appraiser-Residential), •CA-S(Certified Appraiser-Senior), and CA-C (Certified Appraiser-Consultant)American Society of Appraisers•www.appraisers.org •Publisher of Technical Valuation, a professional journal, and the Appraisal and Valuation Manual •Member designations: ASA (Senior Member), ASR (Senior Residential Member) and FASA (Fellow)American Society of Farm Managers and Rural Appraisers, Inc., Denver,
6314TX Marketing I: Building a Real Estate PracticeColo. •www.asfmra.org •Member designations: AFM (Accredited Farm Manager) and ARA(Accredited Rural Appraiser)American Society of Professional Appraisers, Atlanta, Ga.•Member designations: •CRRA (Certified Residential Real Estate Appraiser) •CCRA (Certified Commercial Real Estate Appraiser)American Society of Real Estate Appraisers, Atlanta, Ga.•Member designations: oRSA (Residential Senior Appraiser) oCSA(Commercial Senior Appraiser)Appraisal Institute•www.appraisalinstitute.org •Publisher of The Appraisal Journal and Valuation Insights and Perspectives,as well as a number of special reports and books•Member designations: MA1 (Member of the Appraisal Institute) and SRA(Senior Residential Appraiser)The Appraisal Institute was created in 1990 by the merger of theAmerican Institute of Real Estate Appraisers and the Society of Real EstateAppraisers. Appraisal Institute members who were members of one of the earlier organizations also may have one of the following designations, although these are no longer issued by the Appraisal Institute: RM (Residential Member), SRPA (Senior Real Property Appraiser), and SREA (Senior Real Estate Analyst).Appraisal Institute of Canada•www.aicanada.org
6417TX Marketing I: Building a Real Estate PracticeAppraisal Employment and Job FunctionsA professional real estate appraiser evaluates the worth of a property. Anybody may request an appraisal (an individual or a company) and it may be sought for any reason, such as determining a loan value or for insurance coverage. An appraiser submits his or her evaluation in the form of an appraisal report, for which she or he must conduct a thorough study of the property. An appraiser will take on many roles as he or she prepares the report: broker, surveyor, economist, and possibly even accountant. However, an appraiser should not engage in any activities, either expressly or implied that they do not possess education, license, or certification to practice. Employment OpportunitiesMany appraisers choose to join pre-existing organizations and companies. The following is a brief list of those employment opportunities of which many appraisers take advantage. Federal AgenciesAll agencies involved in road conservation or construction hire appraisers. In addition, the Department of Veteran’s Administration (VA) and the Federal Housing Administration (FHA) appraise properties before insuring or mortgaging. There are many opportunities within both agencies.Large Businesses and CorporationsLarge corporations and businesses commonly employ appraisers to weigh various development plans. When considering a proposed or possible expansion site, office location, project or investment, such organizations may use appraisers to evaluate a number of financial feasibility principles, including the highest and best use (discussed at length in coming lessons). In addition, investment and commercial properties pose complex value calculations. An experienced appraiser often needs to gather the necessary data and complete necessary computations before submitting a valuation.
6518TX Marketing I: Building a Real Estate PracticeAppraisal CompaniesThere are many appraisal companies networked from coast to coast that employ hundreds of appraisers within their offices. While not all appraisal companies are this big, larger appraisal companies require many licensed and certified persons to get through their daily workload. Individuals and businesses may contact such companies, or smaller, local businesses, to contract an appraiser for a particular job. Self-employmentMany single-family appraisers are self-employed. Usually, homeowners call upon this type of appraiser for single-family, residential homes.CompensationAppraisers evaluating single-family homes, most frequently on behalf of the buyer or the buyer’s lender, receive an appraiser's fee. These fees vary according to a job's complexity. The more time allocated to an appraisal,the higher the fee. This fee is open to negotiation because outside factors, such as incurred cost and market competition, influence it. The most important thing to remember when establishing compensation is that it should not be contingent on the final value of the property in question, as this would lead to a directconflict of interest.Federal Regulations & National AgenciesThe 1980s struggled with high inflation and instability in the real estate market. Idle or soft monitoring of the savings and loan industry, over estimations in the real estate market, and loose bank insurance policies contributed heavily to this economic upheaval. Federal appraisal legislation is one way that the federal government offset the 1980s’ economic troubles. This lesson explains the biggest components that formed the legislation we now use: the Appraisal Foundation, FIRREA, and USPAP. These three components work together to regulate the appraisal profession. As you complete this lesson, pay close attention to how the three overlap.
6619TX Marketing I: Building a Real Estate PracticeThe Appraisal FoundationThe Appraisal Foundation is not a government agency. It is a national, non-profit organization founded in 1987; however, FIRREA (an act passed by Congress in 1989 and discussed on subsequent scenes within this lesson) provides that states must adhere to the standards developed by the Appraisal Foundation. More information can be found at the agency's website.Two boards make up the Appraisal Foundation: the Appraisal Standards Board, or ASB, and the Appraiser Qualifications Board, or AQB. The Appraisal Standards Board (ASB)The Appraisal Standards Board (ASB) is responsible for establishing the rules for completing an appraisal and compiling its report. In addition, the ASB enforces the Uniform Standards of Professional Appraisal Practice (USPAP),which outlines the ethical and professional standards of real estate appraisal. Coming scenes present more information on USPAP.The Appraiser Qualifications Board (AQB)The Appraiser Qualifications Board (AQB) develops the minimum standards for state agencies to use in their respective licensing and certification laws for real estate appraisers. The AQB establishesthe minimum qualifications for licensing, certification and recertification of appraisers nationwide.FIRREAWhile economic cycles are complex and typically not due to a change in one economic indicator or single event, a noticeable downturn in the 1980soccurred with the deregulation of the savings and loan industry. Once deregulated, savings and loan institutions immediately involved themselves in the purchase and construction of private developments. Because these powerful institutions had a direct interest in the value of property developments, they began urging the unregulated appraisers to hit certain
6720TX Marketing I: Building a Real Estate Practicevalues. These appraisers were not subject to state or federal regulation, so many responded to the institutions' pressures by submitting false or exaggerated value reports. This singular problem coupled with the overall weak 1980s economy signaled to Congress the need for action. Congress responded to the problems with the Financial Institutions Reform, Recovery and Enforcement Act, or FIRREA. FIRREA changed more than just the appraisal industry; however, for our purposes, the provisions of FIRREA were aimed at protecting federally insured banks from fraudulent or incompetent appraisals and preventing dishonest industry pressure. FIRREA requires:That the states develop and maintain a system of licensure and certification for appraisers That the bank regulators adopt policies regarding the performance and utilization of appraisalsThat federal bank regulators instituted individual regulations by August 1990. (These regulations are commonly known as the final rule by lenders and appraisers.)That appraisers for bank use must be either certified or licensedThat a national list of all licensed and certified appraisers is available to lending institutionsLicensing vs. CertificationOne aspect of FIRREA designates the difference between a licensed and certified appraiser and the professional qualifications of both:Certified appraiser: May value one to four residential units without regard to value or complexity. Licensed appraiser:May value one-to four-unit residential structures with a value below $1,000,000, and complexbuildings with acontract price no more than$250,000
6840TX Marketing I: Building a Real Estate PracticeThe principle of substitution, particularly important to the sales comparison approach to real estate appraisal, states that a buyer only pays as much as he or she would have to pay for a comparable house in a comparable area. For example, if two houses that are very similar to the subject house sell for $120,000, then it is likely the home in question will sell for around the same amount. If two houses are alike in almost every way, then a potential buyer will purchase theless expensive home.
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7117TXMarketingI: Building a Real Estate PracticeTheprimaryconcernofthelenderisdeterminingthedegreeofrisk.MostlendersuseFNMA/FHLMCunderwritingstandards(discussedlater)forconventionalloansandFHAandVAstandardsforFHA/VAloans.Withthisinmind,wewillfirstturntoqualifyingthebuyer.Therearefivemajorareasofconcernwhenqualifyingthebuyer,allofwhichmustbeverifiedbythelender:IncomeCreditNetworthSourceoffundsDebtsIncomeThethreetestsoftheborrower’sincomearequantity,quality,anddurability:howmuch,howwell,andhowlongincomecanbeexpectedtolast.QuantityTheapplicant'sincomemustbesufficienttorepayboththemortgageloanandallotherrecurringinstallmentdebts.Part-timeincome,overtimeincome,pensions,retirementbenefits,andincomefromsecondjobscanbeconsidered.Militaryallowancesarecountedprovidedtheycanbeverified.Incomefromrentalpropertyisalsoconsidered.Thelenderusuallyrequirescopiesofsignedleases,andonlyapercentageofanynetincomecountstowardsqualifyingbecauseofpossiblefuturevacancies.Alimonyand/orchildsupportiscountedprovideditiscourt-orderedandahistoryofpaymentscanbeverified.Onlyapercentageofthisincomeiscounteddependingonthelengthoftimeitisexpectedtocontinue.Anynegativecashflow,suchascarpaymentsorlossesonrentalproperty,iscountedaslong-termdebtandsubtractedfromnetincome.
7218TXMarketingI: Building a Real Estate PracticeQualityAllincomereportedbytheapplicantisverifiedbythelender.Iftheborrowerisanemployee,thenthelendersendsaVerificationofEmploymentFormtotheemployerrequestinginformationregardingthelengthofemployment,grosssalary,andotherincomeandthelikelihoodofcontinuedemployment.Iftheapplicant'ssoleincomeisintheformofcommissions,thenitmustbeverifiedbythepasttwo-year'staxreturns.Ifonlypartofthetotalincomeiscommissions,W-2formsandaverificationofemploymentarealsoconsideredasproofofsuchincome.Atwo-yearhistoryisusuallyrequirediftheincomeistobecounted.Iftheborrowerapplicantisself-employed,thelenderusuallywantstoreview:federalincometaxreturnsfortheprevioustwoorthreeyears,profitandlossstatements,businesscreditreports,businessplansandtheborrower’scurrentfinancialstatement.DurabilityIncomeisconsideredsufficientifconsistentworkingpatternsareestablishedandthereisareasonableexpectationtheincomewillcontinue.Asageneralrule,atwo-yearjobhistorymustbeverified.CreditThecredithistoryoftheapplicantisprovidedthroughacreditreportfromareputablecreditreportingservice,whichindicatesa10-yearrecordofpastandcurrentcreditaccounts,theamountofcreditinvolved,andthepatternofrepayment.Lettersofexplanationmaybesubmittedwithregardtocreditproblems.Theseshouldbesubmittedtothelenderatthetimeofapplicationtoavoidanymisunderstandingsfurtherintotheunderwritingprocess.NetWorthTheapplicant'scurrentassets,includingthesourceoffundsbeingusedforanydownpaymentandsettlementcosts,willbeverified.Also,aborrower'snetworthoftentimes
7319TXMarketingI: Building a Real Estate Practicehasanimportanteffectonthelender'sfinalloandecision.Alendercountsonlydemonstrablenetworthonotherrealestateownedbytheborrower.SourceofFundsVerificationofthesourceoftheborrower'sdownpaymentandsettlementcostsismadethroughtheRequestforVerificationofDepositForm.Thetwoprimaryfiguresonthisformthattheunderwriterlooksatare:Currentbalanceondeposit.Averagebalancefortheprevioustwomonths,althoughthisvariesbylender.DebtsAlldebts,regardlessofthenumberofpaymentsremaining,mustbeincludedontheloanapplication.Forconventionalloans,installmentdebtsthatcannotbepaidoffbypayingtheminimumpaymentsin12monthsorlesswillbeincludedintheapplicant'stotallong-termdebtratio.ForFHAandVAloans,debtswithsixormorepaymentsremainingwillbeincludedintheapplicant'stotallong-termdebtratio.Thesearesimplyguidelines;lendersmayimposetheirownstandards,whichmayactuallybemorestringent.Thiscouldincludecountingalldebtswithoutregardtothenumberofpaymentsremainingorevenfactoringinthemaximumpossiblepaymentsoncreditcardsorotherlinesofcreditthatdonotcurrentlyhavebalances.LoanApplicationChecklistQuickturnaroundtimebeginswithacompleteloanapplication.Althoughthistopicwillbedealtwithlaterwithmoredetail,abriefoverviewisessentialforallrealestatelicensees.Essentialloanapplicationinformationthatborrowersshouldhavereadyincludes:Nameandphonenumberofalllandlordsforthepasttwoyears.Copiesof30days’worthofmostrecentpaystubs(ororiginalpaystubsonVAloans).PrevioustwoyearsofW-2s(or1099sifself-employed).
7420TXMarketingI: Building a Real Estate PracticeAllBondProgramsrequirethreeyearsoftaxreturns,W-2sandresidencyinformation.Mostrecenttwomonths’bankandinvestmentstatementsforallaccounts.Thesewillneedupdatingthroughapproval.Copyofrecordeddivorcedecree(allpages)(ifapplicable).Settlementstatementsfromallrealestatesoldinthepasttwoyears.Copiesofleaseagreementsonanyrentalpropertyownedandproofofrentalincomeforthepasttwoyears.CopyofDD214,StatementofServiceorCertificateofEligibility(VAloansonly).Copiesofcartitlestoanyvehicle(s)ownedfreeandclearandlessthanfouryearsold.Warrantydeedsonanyfreeandclearrealproperty.Next,weturntoabriefoverviewofunderwritingguidelinesandtheunderwritingprocesssothatyouwillunderstandfurtherwhatisinvolvedinobtainingrealestatefinancing.UnderwritingGuidelinesandProcessWhatFactorsdoUnderwritersConsider?Underwritersapproveordenyamortgageloanapplicationbasedonanevaluationofthefollowing:Incomeandassets,whichhelpdeterminetheborrower'sabilitytopayaloan.Credit,whichshowstheborrower'scurrentcredituse,showshowtheborrowertreatedobligationsinthepast,andhelpsdeterminetheborrower'screditworthinessandwillingnesstorepayaloan.Property,whichdetermineswhetherornotthepropertyisadequatecollateralfortheloan.Underwritersbasetheirdecisiononacombinationorlayeringofthesethreefactors.
7521TXMarketingI: Building a Real Estate PracticeHowdoLayersofRiskAffectHomeownership?Thepresenceofindividualriskfactorsdoesnotnecessarilythreatenaborrower’sabilitytomaintainhomeownership.However,whenlayersofrisk—anumberofinterrelatedhigh-riskcharacteristics—arepresentwithoutsufficientoffset,theircumulativeeffectdramaticallyincreasesthelikelihoodofdefaultandforeclosure.Tohelpborrowersmaintainlong-termhomeownership,underwritersworktounderstandborrowers’needsandtomanagethepresentrisksintheirloans.IncomeAnalysisOncealenderdetermineshowmuchstableincometheloanapplicanthas,heorshemustdecidewhetherornottheamountofstableincomeisadequatetocovertheproposedmonthlymortgagepayment.Thelendermustalsoconsideratthistimetheincomeratiosincludedinthepurchaser’sdebt.Inadditiontolenderratios,apurchaser’screditscoreaffectstheabilitytoobtainaloan.Realestateprofessionalsshouldbeabletoqualifyprospectivebuyersbeforeshowingthemhomes.Qualifyingprospectsupfrontgivesthemanideaofthemaximummonthlymortgagepaymenttheirincomewillsupportandhelpstodeterminewhichpropertiestoshowthem.Oncethemaximummonthlypaymentisestablished,therealestatelicenseecandeterminethemaximumsalepricethebuyercanafford.Andinasimilarmanner,ifalicenseeknowswhatthemonthlypaymentonaparticularpropertyis,sheorhecandeterminethemonthlyincomenecessarytoqualifyfortheloan.HousingExpense-to-IncomeRatioThehousingexpense-to-incomeratioisthepercentofnetincomethatgoestowardpayingfortheproperty.Highpercentagesareariskfactor,andlendersusuallysetlimitsontheratio.Forexample,forconventionalloans,theproposedhousingexpense(principal,interest,taxes,andinsurance)shouldnotexceed28percentoftheborrower’s
7622TXMarketingI: Building a Real Estate Practicestablemonthlyincome.Lendersonconventionalloanswillconsidercompensatingfactorsinthequalifyingprocess.Someofthesefactorsinclude:AlargedownpaymentCashreserveUpwardmobilityMilitarybenefitsCompanybenefitsTemporaryincomeNominalincreaseinhousingexpensesTotalDebtServiceRatioConventionallendersconsideraborrower’sincomeadequateforaloanifthetotaldebtservice—i.e.,theproposedtotalhousingexpense(includingprincipal,interest,taxes,hazardinsurance,andmortgageinsurance,ifapplicable)plusanyotherrecurringliabilities—doesnotexceed36percentoftheborrower’sstablemonthlyincome.Aborrower’srecurringliabilitiescanbebrokendownintothreecategories:installment,revolving,andother.Installmentdebtshaveafixedbeginningandendingdate.Anexamplewouldbeacarloan.Aninstallmentdebtwillbeincludedinthetotaldebtratioiftherearemorethansixmonthsremaining.Revolvingdebtsinvolveanopen-endlineofcreditwithminimummonthlypayments.Exampleswouldbecreditcardsanddepartmentchargecards.Thelenderusesthemostrecentrequiredminimummonthlypaymentintheirdebtcalculation.The“other”categoryincludesalimony,childsupport,andothersimilarongoingobligations.Atthecurrenttime,neitherFNMAnorFHLMCtakeintoaccountchildcareexpensesasarecurringliability.
7725TXMarketingI: Building a Real Estate PracticeTofilloutourconventionalloananalysis,wetakeourpreviouslycalculatedPITI=$982.60,anddivideitbytheborrower’sstablemonthlyincomeof$4,500tofindthehousingexpenseratio.Since21.84percentislessthanthemaximumratioof28percent,thisisahousingexpensetheborrowercanbeexpectedtohandle.Tocalculatethetotaldebtserviceratio,weaddthemonthlylong-termdebtpaymenttothePITIpayment:$982.60+$325=$1307.60anddividethisnumberbytheborrower’sstablemonthlyincome.Thisratio,too,isbelowthemaximumamount,andtheborrowershouldqualifyforaconventionalloan.ConventionalLoanAnalysis1stRatio=$982.60/$4500=21.84%ShouldNotExceed28%2ndRatio=($982.60+$325)/$4500=29.06%ShouldNotExceed36%LessonSummaryTopurchaseresidentialrealestate,individualsusuallytakeoutloans.Mostloansarefullyamortized,meaningtheyarepaidoffinequalmonthlyinstallmentsreducingtheprincipalovertime.Theprocessbywhichborrowersareconsideredforloansand,ifqualified,receivethemiscalledunderwriting.Underwritersconsiderthequality,quantity,anddurabilityofaborrower’sincome,andhisorhercredit,networth,sourceoffunds,anddebt.Borrowersqualifyforloansonthebasisoftworatios:thehousingexpense-to-incomeratioandthetotaldebtserviceratio.
7826TXMarketingI: Building a Real Estate PracticeLesson2:ConventionalLoansLessonTopicsThislessonfocusesonthefollowingtopics:IntroductionConventionalFinancingPrimary Lenders The Secondary MarketConventionalLoanGuidelinesFNMA/FHLMCUnderwritingGuidelinesLessonLearningObjectivesBytheendofthislesson,youshouldbeableto:List theadvantagesanddisadvantagesofconventionalloans.Showhowtouseconventionalqualifyingratios.Explainhowthesecondarymortgagemarketworks.
7979TXMarketingI: Building a Real Estate PracticeThepaymentincreasesannuallybyapre-determinedamountwithalloftheincreasebeingappliedtoprincipalreduction.ThiscausesaGEMloantobepaidoffinanaverageof12to17years,dependingontheamountofincreaseofthepayments,whicharetypically3percent,5percent,or7.5percentperyear.AdvantagesofaGEMLoanAGEMismuchlikeafixed-rateloanthattheborrowerself-accelerates,butwithtwodifferences:thereisneverapre-paymentpenalty(asGEM“prepayments”arejusttheregular,increasedmonthlypayments)andthestructureoftheloanmakesaccelerationmandatory,ratherthanoptional.Italsohasthefollowingbenefits:1.Lowerinitialinterestrate2.Simplicityoftheloan3.Known/predictablepayments4.Equitybuildsupquickly5.Reducedinterestcosts6.NochanceofnegativeamortizationDisadvantagesofaGEMLoanThemonthlypaymentincreasesovertime.Theborrowermustdetermineupfrontifsheorhewillbeabletomakethepaymentsastheyincreaseovertheyears.PermanentBuydownAnothernameforapermanentbuydownissimplydiscountpoint,orsometimesjustpoint.Pointsarewhatlenderschargeborrowersforprovidingaloan.Becausealenderwillwanttochargemoreformakinghigherloansandbecausewhenapotentialborrowerfirstapproachesalendertheexactamountofthepotentialloanisunknown,lendersexpresstheirloanchargesinpercentages—thatis,points—ratherthanabsolutedollarfigures.Onepointisonepercentofaloanamount.Forexample,ifaloanamountis$100,000,thenadiscountpointwouldbe$1,000.Whenapotentialborrowerfirstapproachesalender,heorshewillbetoldupfronttheamountofdiscountpointsthatalendercharges.
8080TXMarketingI: Building a Real Estate PracticeTherearetwodifferentperspectivesthataprofessionalrealestatepersonshouldbefamiliarwithwhenitcomestodiscountpoints.Thereisthecashatclosingside,withwhichmostbrokersarealreadyfamiliar,aswellastheincreasedyieldtotheinvestorsideofdiscountpoints.Ifabrokerisfamiliarwiththeyieldsideofpoints,thenthebrokerisbetterabletonegotiatetransactionsforbuyersandsellersthanhisorhercompetition.Sincewearemostoftenworkingwith30-yearloans,theruleofthumbwearedealingwithismostoftencalledtheRuleofEights:eightpointsincreasestheinvestor’syieldbyonepercent.Inotherwords,foreverypointthelendercharges,sheorheisincreasinghisorherprofitbyone-eighthofapercentoftheloan.Ifthelenderweretochargefourpoints,then,theyieldwouldbeincreasedbyfour-eighthsorone-halfofapercent.TemporaryBuydownTheseloansareanalternativetotheadjustableratemortgageand/orgraduatedpaymentmortgage.Theyprovidetheborrowerwiththetemporaryhelpsheorheneedswithoutanychanceofnegativeamortizationandwithapredictablepaymentstructure.Thedisadvantageisthatthereisahigherloanfeeforthistypeofloan.Underabuydownplanthesubsidizingparty—theborrower,seller,builder,etc.—establishesabuydownfund,whichiscollectedincashatclosing.Therequiredportionofthepaymenteverypaymentperiodispaidfromthebuydownfund.Theborrowerthenmakespaymentsattheboughtdowneffectiverate,whicharelowerthanattheactuallendingrate.Whenthetemporarybuydownperiodisover,thelendingratereturnstonormal.