Transfer Fees: How to Make Money in Real Estate (and Render Your Purchaser's Title Unmarketable) Without Really Trying
The Basics of the Program 1
Several companies, particularly in Texas and Florida, have recently developed and copyrighted innovative new programs whereby developers, individual homeowners, and realtors can derive future income from residential properties that they sell today. These programs provide the seller with proprietary documentation that enables the seller to impose a covenant on the title at the time of conveyance to a third-party purchaser. The covenant requires the payment of a “transfer fee” to the seller each time the property is thereafter sold, and imposes a lien in favor of the seller to secure the obligation to pay that fee. The covenant is then recorded in the land records, where it will be picked up in later title searches. By purporting to impose a lien on the property, the covenant forces the title company to either take exception to the lien, or require payment of the fee at closing. The program companies selling these programs then collect the fees and forward the payments, less a commission, to the seller.
A “No-Lose” Situation for the Seller (?)
The program appears very attractive to sellers. When a property owned by a seller participating in the program is sold, the seller does not collect any transfer fee at the time the covenant is created/imposed. The seller has no upfront costs, and no costs of administration, but does have the promise of a potentially huge profit in the future. Because of the promise of future profit, the seller can reduce its sales price, making the sale more attractive to purchasers, and yet still have the prospect to make more money from (an indeterminate) future transfer fee income stream. All of this adds up to provide the seller with a sales advantage.
The program company also markets the product to realtors, who are allowed to share in the payment of the future transfer fees, as both an incentive to sell the product, and, as stated in the marketing materials, a way to derive larger commissions.
According to marketing information of the first known company to market this scheme, the program company gets 30 percent, the seller gets 60 percent, and the realtor gets 10 percent of each future transfer fee payment.
At least one of the program companies has sought to patent its “unique business method” to protect its program from being copied and its prices undercut by competitors.
Effect of the Covenant on the Title
Most of the transfer fee programs have a 99-year term, with a suggested transfer fee of 1 percent to 3 percent per transfer. Because statistically the typical residential property is resold every seven years, the transfer fee collection opportunity is quite attractive. If a seller (not a future owner of the encumbered real estate) is pressured to release the covenant because of a potential lost sale, it is free to do so. However, according to the marketing materials, a 1 percent additional fee on the purchase price generally is not enough to cause a purchaser to “back down” or, on the other side of the deal, to cause a future title-holder to sue to release the covenant.
In some cases, the covenant provides for a one-time “buy out” of the transfer fee, for a payment of 5 percent of the current sales price. Because for this seller and buyer it is cheaper to pay the one-time fee of 1 percent, there is little incentive to pay 5 percent to buy out the covenant, and it remains in place to generate future income.
One of the first of these programs was created by Freehold Licensing. Their program is based on a type of “note” given by Freehold to the seller, whereby Freehold agrees to pay to the seller a sum certain, but with no payment schedule. Instead, payments are made as future transfer fees are collected. The only party coming away from the original closing table with extra money is the realtor, who generally receives an immediate payment of approximately $1,000, supposedly for getting the seller to participate in the program.
What Is the Potential Income to the Seller?
For a residential developer, theoretically, the potential income is significant. Quoting from the Freehold Licensing marketing materials:
- Developer buys 250 acres, plats it into 1,000 lots, and files the Covenant with a 2% Transfer Fee. Homebuilder buys the lots and builds $200,000.00 homes on each lot. Sales through 2010 are exempt.
After 2010, when the subdivision turns over once (meaning each home sells just one time), Developer earns an estimated $3.5 million dollars (avg. $500,000/year). The next time the homes turn over they have presumably increased in value again, earning Developer an estimated $4.5 million dollars (avg. $650,000/year). This trend continues for 99 years. 2
The Title Industry’s Response
When title companies first encountered these covenants, they were unsure how to handle them. For example, several years ago title companies encountered another type of scheme where homeowners were filing “common law” liens against their own properties. Title companies felt it was safe to ignore these liens, on the basis that they were based on faulty law, and lacked consideration. However, on their face, these new “future transfer” liens appear to be supported by some sort of consideration (reduced purchase price), and could be valid under state law. They also are not so large as to be voided as an unreasonable restraint on alienation. In fact, informal industry assessment suggests that several large developers report no resistance to the imposition of the fee on their properties. Therefore, title companies are unable to simply ignore them.
In Texas, where it appears that these schemes started, the title companies are prohibited from insuring over recorded liens against the property without some kind of surety bond or funded escrow. Because it appears that the program company occasionally tracks the records of properties subject to their covenants, the risk of having an action filed to foreclose the lien arising from the nonpayment of the transfer fee is real. Therefore, for the time being, title companies cannot ignore these liens, and must require that these transfer fees be paid, or an exception will be taken in the title policy.
It’s hard to know what challenges, legislative or otherwise, might be mounted against the program, but practitioners should be aware of the subject. And it is probably a good idea to ask yourself if you'd be willing to help a client who wanted to implement one.
Janice E. Carpi is senior vice president and senior underwriting counsel for LandAmerica Financial Group in Glen Ellen, Virginia.
© Copyright 2008, American Bar Association.