Transfer Fees: How to Make Money in Real Estate (and Render Your Purchaser's Title Unmarketable) Without Really Trying
By Janice E. Carpi
The Basics of the Program1
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.
Be Aware
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.
