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Real estate law 8th edition aalberts

03/12/2021 Client: muhammad11 Deadline: 2 Day

Eleventh EDITION

REAL ESTATE PRINCIPLES

CHARLES F. FLOYD and MARCUS T. ALLEN

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This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional advice. If legal advice or other expert assistance is required, the services of a competent professional should be sought.

President: Dr. Andrew Temte Chief Learning Officer: Dr. Tim Smaby Executive Director, Real Estate Education: Melissa Kleeman-Moy Development Editor: Julia Marti

Printed in the United States of America ISBN: 978-1-4754-2173-6 / 1-4754-2173-7 PPN: 1515-0111

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DEDICATION

This book is dedicated to R. W. Barber

a man of the land and

C. O. Floyd a man of business. —Charles F. Floyd

This book is dedicated to Rhonda, Melanie, and Issabella.

—Marcus T. Allen

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c o n t e n t s

p r e fa c e xi i i r e a l e s tat e t o d ay f e at u r e s xvi i

c h a p t e r 1

Why Study Real Estate? xx Chapter Preview 1

The Role of Real Estate Studies in Business Education 2

Personal and Business-Related Real Estate Decisions 2

Organization of This Book 3

Special Characteristics of Real Estate 4

The Economic Importance of Real Estate 9

The Real Estate Industry: Career Opportunities 10

Chapter Review 13

Key Terms 14

p a r t o n e

Real Estate Legal Analysis 15

c h a p t e r 2

Property Rights and Legal Descriptions 16 Chapter Preview 17

Real versus Personal Property 18

Fixtures 18

Mineral and Air Rights 20

Water Rights 20

Estates in Land 23

Concurrent Estates 29

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vi Contents

Condominium Ownership 31

Cooperative Ownership 32

Time-Shares 32

Legal Descriptions 32

Chapter Review 43

Key Terms 45

Study Exercises 46

Further Reading 412

g l o s s a ry 413 a p p e n d i x 431

i n d e x 437 c r e d i t s a n d a c k n o w l e d g m e n t s 447

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xiii

p r e f a c e

Welcome to the eleventh edition of Real Estate Principles! As one of the most popular and well-respected texts in college-level real estate education, this book has served as the framework for a practical and rigorous learning experience for intro- ductory real estate students at schools across the nation since its first edition was published in 1981. This edition continues that tradition by incorporating the latest industry advances and education technologies into a comprehensive, student-friendly presentation of the real estate “body of knowledge.” We are absolutely convinced that students who master the material presented in this text will become better-informed real estate market participants whether their primary real estate interests lie in con- sumption, investment, brokerage, appraisal, law, property and asset management, or any combination of these aspects of real estate.

| pedagogical devices ______________________________________

For students, the book contains the following pedagogical devices designed to enhance their learning experience:

■■ Each chapter begins with a Chapter Preview that clearly sets forth the learning objectives.

■■ The Key Terms discussed in each chapter appear in boldface for emphasis. These terms are succinctly defined in the end-of-book Glossary.

■■ Many tables, figures, and photographs are provided throughout the text to help readers visualize the topics and incorporate them in their knowledge base.

■■ Each chapter ends with a Chapter Review that concisely summarizes the key concepts.

■■ Thought-provoking review exercises are provided at the end of each chapter.

■■ Suggested reading lists for each chapter are included to direct students who wish to learn more about specific concepts to additional sources of information, including books, academic journals, practitioner journals, newspapers, magazines, and internet sites.

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xiv Preface

| instructor support _____________________________________

For instructors, we have developed an extensive collection of support materials that can be easily downloaded (with the proper password) from the publisher’s web- site at www.dearborn.com. The materials include

■■ detailed lecture notes in Microsoft PowerPoint and Microsoft Word format for each chapter (for use with a computer display projector or as transparency slides);

■■ assignment exercises for each chapter (with answers); and

■■ multiple-choice, true-false, and short-answer questions by chapter.

Readers familiar with previous editions of this text will be pleased to find that this edition continues to incorporate many of the special features from previous edi- tions that enhance the students’ learning experiences. Close-Ups, Legal Highlights, People Profiles, and Case Studies are liberally sprinkled throughout the book to dem- onstrate how real estate principles can be observed and applied in the “real world.”

| flexible pathways through the text ______________________

Because real estate is such a dynamic and diverse discipline, we have purpose- fully designed Real Estate Principles in such a way that instructors who wish to approach the material from their own preferred direction can do so with relative ease. Each chapter can be treated as a stand-alone learning module within the real estate body of knowledge. While we recommend presenting the material in the chapter order provided for general business students, an instructor who wishes to focus on finance and investment analysis issues can easily shift Chapters 16 through 20 to the beginning of the semester (after Chapter 1) to allow adequate time for in-depth cov- erage. Or an instructor who wishes to focus on real estate economics might consider following the first chapter with Chapters 11 through 15. We would be pleased to get feedback from instructors describing how they choose to sequence the chapters in their courses.

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Preface xv

| acknowledgments _______________________________________

No project of the magnitude of this book can be accomplished without a spirit of teamwork and mutual respect between all the parties involved. We wish to sincerely thank all of the people who provided comments, suggestions, and other invaluable forms of support in the research, writing, and production process, especially Jeffrey J. Rymaszewski, senior lecturer, University of Wisconsin at Milwaukee, Frank T. Cook, and Ron Williams.

In addition, special thanks are due to the students in our classrooms who served as guinea pigs for the new material.

Finally, we hope that everyone who reads this book will be able to use the lessons contained herein to improve their real estate decision-making skills and, ultimately, to enrich their lives with respect to real estate resources.

Charles F. Floyd, PhD University of Georgia

Marcus T. Allen, PhD Florida Gulf Coast University

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xvii

c h a p t e r 1

Case Study: The Importance of Location Case Study: The Gestation of Park Springs

c h a p t e r 2

Close-Up: Water Wars Legal Highlight: Who Can Use the Shore?

Close-Up: The Empire State Building Legal Highlight: How Did an Acre Get to Be an Acre?

c h a p t e r 3

Close-Up: Meadow Brook Ranch Use Covenants Legal Highlight: Validity of Restrictive Covenants

Legal Highlight: Restrictive Covenant Disputes Legal Highlight: A Cautionary Tale on Mechanics’ Liens

Legal Highlight: Prescriptive Easement Legal Highlight: The Case of the Landlocked Parcel

Close-Up: Use of Conservation Easements Legal Highlight: Adverse Possession

c h a p t e r 4

Legal Highlight: What Constitutes “Public Use”? Legal Highlight: Inverse Condemnation

Close-Up: The Smart Growth Controversy Legal Highlight: The Strange Case of the Incredible Shrinking Building

Legal Highlight: The Case of the Costly Permit Legal Highlight: The Takings Issue

c h a p t e r 5

Close-Up: Sleuthing for Transaction Price Legal Highlight: Title Examination through the Grantor and Grantee Indexes

r e a l e s t a t e t o d a y f e a t u r e s

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xviii Real Estate Today Features

c h a p t e r 6

Legal Highlight: Validity of an Oral Contract Legal Highlight: Necessity to Meet “Concurrent Conditions” by Date of Closing

c h a p t e r 7

Legal Highlight: Landlord’s Liability for Failure to Provide Adequate Maintenance Legal Highlight: Liability of Landlords for Injuries to Guests of Tenants

c h a p t e r 8

Legal Highlight: The Seller’s Agent’s Obligations to the Buyer Legal Highlight: Fair Housing

c h a p t e r 10

Close-Up: Green Acres Shopping Center—A Property Management Success Story

c h a p t e r 11

Close-Up: Civita: An Urban Green Village Close-Up: If You Build It Green, Will They Come? Yes!

Close-Up: Five Historic New Towns: Savannah, Riverside, Radburn, Levittown, and Reston Close-Up: Highlands Falls Country Club

Case Study: Milford Hills Saga

c h a p t e r 12

Close-Up: Atlantic Station: A Successful Brownfields Redevelopment Project Close-Up: The First Suburban Shopping Center: Country Club Plaza

Case Study: Birkdale Village Case Study: The Trump Building: 40 Wall Street Case Study: The Interstate North Industrial Park

Case Study: The Boiler Room Office Building: A Unique Adaptive Use

c h a p t e r 14

Close-Up: The Rise of the “Location-Neutral” Urban Migrant Case Study: A Tale of Two Cities: Flint and West Point

Case Study: Neighborhood Revitalization

c h a p t e r 15

Close-Up: Prequalified vs. Preapproved Case Study: The House That Came Off the Mountain

c h a p t e r 16

Close-Up: What Is Credit Scoring?

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Why Study Real Estate?

1c h a p t e r

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case study The Importance

of Location

case study The Gestation of Park Springs

r e a l e s t a t e t o d a y

c h a p t e r p r e v i e w

Why study real estate? Why is it important? What are the characteristics that make real estate different from other types of assets? Fundamentally, people must have places to live and businesses must have locations for their activities. As a result, real estate is a vital resource that touches the economic lives of all people. A thorough understanding of the complexities of real estate resources and the markets in which they are traded enables us to make informed choices regarding real estate for either personal or business use. The objective of this book is to present the general principles necessary for effective real estate deci- sion making. The text also serves as a starting point for more advanced study of the concepts and issues facing real estate market participants.

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2 R E A L E STAT E P R I N C I P L E S

| the role of real estate studies in business education _____

When you first learned that your college or university offers a real estate prin- ciples course as part of its business school curriculum, you may have thought that the focus of the course would be to prepare for a career as a real estate broker. While real estate brokerage is an excellent career choice for many people, this book does not assume that a career in brokerage is your motivation for studying real estate issues. Instead, we present the principles of real estate from the perspective of the user of real estate resources. These principles provide a foundation for effective real estate decision making, whether you intend to make a career in the real estate industry or simply to become more knowledgeable about your personal real estate transactions.

In most universities and colleges, real estate is regarded as a specialty area under the general umbrella of business studies. As such, a real estate principles course cov- ers issues and topics unique to the real estate discipline that are much too specific for adequate coverage in other areas of academic study. Because of the special- ized knowledge required for effective real estate decision making, real estate issues deserve independent attention in a business school curriculum. The intricacies of real estate resources and markets can baffle the ill-prepared decision maker, but a solid foundation in real estate principles will help you make effective personal and business real estate decisions throughout your life and career. In addition, the topics covered in this text will serve as a springboard for those students who wish to pursue a more detailed study of real estate in subsequent courses.

| personal and business-related real estate decisions ______

A thorough understanding of real estate principles is extremely important for real estate decision making in both personal and business-related venues. As indi- viduals, all of us will probably face the following questions several times over the years:

■■ Should I buy a house or a condo or should I lease an apartment for my personal residence?

■■ In what neighborhood do I want to live?

■■ What type of financing should I use, and how do I arrange it?

■■ Should I use a broker to sell my property or try to sell it myself?

■■ How should I structure the sales contract to get the best deal?

■■ How do I decide which property I should invest in?

The same issues that face us as individuals also apply in the business environ- ment. Consider a company that requires additional office space to expand its opera- tions and compete effectively in its product market. Such a company faces many questions that can be addressed only with the knowledge of real estate principles. The following are examples:

■■ Should the company buy or lease additional space? If the company leases space, how should it structure the details of the lease agreement to best serve its objectives?

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C H A P T E R 1 Why Study Real Estate? 3

■■ If the company decides to buy more real estate, should it build a new property or purchase an existing one?

■■ How should the company finance the purchase or development?

■■ Should the company acquire a larger building than it currently requires and lease the additional spaced to tenants until the company needs it?

■■ Should the company consider relocating the corporate headquarters to a different location, either in its current city or in another city altogether?

Appropriate answers to these and other important questions require familiarity with the overall operation of real estate markets, as well as specific knowledge of legal issues, transaction details, and the financial framework of real estate resources. For this reason, real estate principles are a fundamental component of undergraduate business education, regardless of your chosen field of study.

| organization of this book ________________________________

Our goal is to present some of the basic principles of real estate in such a manner that you will be well prepared to anticipate and evaluate changing market conditions and make real estate decisions that best serve your personal and business objectives. We have divided the topics considered in the text into four categories:

1. Part One, Real Estate Legal Analysis (Chapters 2–7) consid- ers issues related to the legal concept of real estate ownership. We define various ownership interests one can obtain in real estate, deed and legal description methods, and private and public limitations on ownership.

2. Part Two, Real Estate Service Industries (Chapters 8–10) discusses the real estate services industry, including brokerage, property man- agement, and appraisal.

3. Part Three, Real Estate Market Analysis (Chapters 11–15) consid- ers the dynamics of real estate markets as a result of national, regional, and local influences on property values and uses. In addition, we review the classic models of urban growth and discuss various aspects of the land development process. We also examine the residential, commercial, and industrial development process.

4. Part Four, Real Estate Finance and Investment Analysis (Chapters 16–19) examines the financing of real estate investment and owner- ship, and real estate investment analysis.

The remainder of this introductory chapter sets the stage for the topics to be addressed throughout this text by describing the special economic characteristics of real estate, the economic importance of real estate, and various career opportunities in the real estate industry.

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4 R E A L E STAT E P R I N C I P L E S

| special characteristics of real estate ___________________

What is real estate? Simply defined, real estate is land and things attached to it such as buildings and other improvements to the land. Real property consists of the legal interests associated with ownership of the physical real estate. In practice, how- ever, the two terms are often used synonymously. All other movable property such as automobiles, furniture, boats, and clothing is known as personal property. As an economic resource, real estate has some distinct characteristics that distinguish it from other types of resources. These characteristics are

■■ fixed location;

■■ uniqueness;

■■ interdependence of land uses;

■■ long life;

■■ long-term commitments;

■■ large transactions; and

■■ long gestation period.

Fixed Location

The characteristic of real estate that distinguishes it from all other types of eco- nomic resources is its fixed location. If there is an oversupply of wheat in Kansas, or of automobiles in Michigan, they can be moved to areas of relative scarcity. This is not true of real estate resources. If there is an oversupply of condominiums in Miami, office space in Manhattan, or shopping centers in Minneapolis, they cannot be trans- ported to other communities where the demand is stronger. A tract of land, of course, cannot be moved a few feet up the street to help meet demand for space at that site. Thus, the success of real estate acquisition, development, and investment decisions is directly affected by the forces of supply and demand in a local area.

Uniqueness

Because real estate is fixed in location, every parcel is unique or, to use a fancy term, heterogeneous. Even subdivision lots located side by side are not perfect sub- stitutes for each other because of differences in such factors as topography, tree cover, and view. These factors often create large differences in property values. For example, lots fronting on a lake will probably sell for much more than lots just across the street; lots with a spectacular mountain view may sell for many times more than nearby ones without the view.

Interdependence of Land Uses

Real estate’s fixed location leads to another economic characteristic: interde- pendence of land uses. The use of real property depends greatly on the provision of

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C H A P T E R 1 Why Study Real Estate? 5

public services, the uses made of nearby land, and the general economic vitality of the neighborhood and community.

It is extremely difficult to use land to its full economic potential, particularly in an urban setting, unless adequate public services are provided and neighboring land is used in complementary ways. Even agricultural lands need to be served by roads, and such basic utilities as electricity and telephone service are necessary for prac- tical homestead use. As we move to denser residential development, public water and sewerage systems are essential as are such governmental services as education, police and fire protection, and various social services. Land must be converted to public use for parks, schools, and other governmental services, particularly trans- portation facilities. If adequate governmental services and public land uses are not available, it will be difficult or even impossible to develop land for residential, com- mercial, or industrial use.

The use of land is also affected greatly by nearby land use. If a large tract of vacant land is located near areas of expanding residential and commercial develop- ment, this location should increase both the land’s potential use and its value in the marketplace. Conversely, the value of land may be affected adversely by its proxim- ity to “undesirable” uses. It would probably be difficult, for example, to develop a single-family housing development next to a chemical plant or slaughterhouse. Such uses, however, particularly if served by transportation facilities and other public ser- vices, may make nearby land valuable for industrial purposes.

The economic vitality of a neighborhood, community, or region greatly affects the demand for real property and its value. If the economy of the area is expanding,

r e a l e s t a t e t o d a y

c a s e s t u d y

The Importance of Location

How important is location to the value of real estate? Very important in the case of a 77-square-foot “studio apart- ment” in the exclusive Knights-

bridge neighborhood of London. The former storage closet, originally conceived as a maid’s room, is only slightly larger than a prison cell, but is priced at $335,000, or about $4,500 per square foot. Moreover, the room has no electricity or heat, which would cost an additional $59,000 to make it habitable. Rather pricey, but the tiny apartment is

located in one of the wealthiest neighborhoods in the world and is within walking distance to exclu- sive stores such as Harrod’s and the city’s iconic Hyde Park.

Almost unbelievably, other ultra high-end Lon- don properties have been selling for even higher prices, sometimes as much as $6,000 per square foot. By comparison, the closet-sized apartment is a bargain. The old real estate axiom that the three most important factors in real estate are location, location, and location certainly applies in this case.

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6 R E A L E STAT E P R I N C I P L E S

the population also will increase, bringing about a corresponding increase in the demand for residential, commercial, and industrial land. Conversely, if the economy of the area is in temporary or long-term decline, the demand for real estate and real estate value also will tend to decline.

It is the interdependence of land uses that leads to the existence of both private and public land-use controls, topics we will study in Chapters 3 and 4. The use of land affects the owners of other land more than the use of almost any other type of private property and may create costs to the public at large. For example, the fill- ing of floodplain lands (the low-lying land near streams) to make them suitable for high-density residential use may cause other owners of land on the floodplain to be affected adversely in periods of heavy rainfall. If other landowners also fill in their portion of the floodplain, a flood hazard may be created that will require large public expenditures to alleviate.

Long Life

Although its ability to generate income may change over time, land is virtu- ally indestructible. Additionally, real estate improvements—that is, buildings on the land—generally have very long lives. For example, a family would expect a new home to last as long as they wanted to live there and beyond, and many houses last for a century or more when maintained properly. Apartment houses, shopping cen- ters, and other types of income-producing property also have very long lives.

Long-Term Commitments

The long lives of real estate improvements mean that investment decisions are, by their very nature, long-term commitments. Although the immediate prospects for the production of income are very important in real estate investment analysis, the factors that influence income generation over the long term are equally critical. For example, the proximity of a hotel to a heavily traveled highway is a predominant fac- tor in the financial success of the hotel. If the hotel is built in a location that soon will be bypassed by a new freeway, it probably will not be a successful investment during much of its life. Conversely, shopping centers are often built somewhat ahead of the market to gain advantageous location in advance of expected population growth.

The characteristics of long life and long-term commitments force the real estate investor and developer to establish realistic, long-term outlooks if they want to make successful investment decisions. The real estate investor who merely assumes that favorable economic trends will continue will probably be unsuccessful. For exam- ple, most of the problems that arose during the recent decline in real estate prices occurred because investors and financial institutions regarded the future with unbri- dled optimism. Investors should analyze carefully the factors that have caused eco- nomic trends to be favorable in the past and try to ascertain what will happen to these factors for some years into the future.

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C H A P T E R 1 Why Study Real Estate? 7

Large Transactions

Another important economic characteristic is the relatively large size of real estate transactions. Because they involve large expenditures, real estate transactions are not entered into either lightly or frequently. A home is by far the average family’s largest single purchase. Investment in income-producing real estate requires even larger outlays.

The large size of real estate transactions means that buyers usually have to rely at least partially on some type of outside financing. This economic characteristic has led to the rise of the real estate finance industry. Both buyers and sellers generally need assistance to analyze the marketplace, evaluate long-term investment decisions, arrange financing and, in general, deal with the complexities of these transactions.

Long Gestation Period

A final economic characteristic of real estate is the long gestation period of real estate development projects. The time between the conception of a development project and its actual completion and subsequent entry into the available supply may be several years. Suppose a group of investors decides to develop an apartment com- plex. To complete this project, they first must acquire the land, then have engineer- ing and architectural plans drawn for the site and buildings, secure zoning and other regulatory approvals, arrange financing, and construct the improvements.

Long delays may occur at any of these steps. For example, it may be difficult to secure approval from the zoning board, or it may be necessary to wait several months for the completion of a new sewer line, or bad weather may delay construction.

The long gestation period makes the supply of real estate slow to respond to increases or decreases in demand. Because the supply cannot be increased quickly, increases in demand often result in rapid upward price movements unless an excess supply exists. Conversely, demand may decline during a project’s gestation period, making it less valuable upon completion than originally anticipated. This is yet another reason the real estate developer must analyze factors affecting future demand and supply. There may be a strong market for, say, office space in a certain area at present. This does not necessarily mean that the strong demand will continue. Many investors have discovered, to their immense sorrow, that by the time the project was completed, demand for the products had declined. Or they may not have fully considered the impact of other projects that were being built at the same time. Suc- cessful real estate investment requires a thorough, long-term economic perspective.

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8 R E A L E STAT E P R I N C I P L E S

r e a l e s t a t e t o d a y

c a s e s t u d y

The Gestation of Park Springs

The development history of the Park Springs continuing care retirement community provides an excellent example of the long gestation period for real estate

development: 10 years from conception to generat- ing income.

In 1994, developers Andy and Kevin Isakson bought a 110-acre former private airport site that straddled two county lines in suburban Atlanta in order to obtain the two acres needed to complete the assemblage for a Super Target shopping center site. They then sold part of the remainder for a parking lot for the 1996 Atlanta Olympics but were left with 54 acres that had limited access and no utilities. In order to make the tract suitable for development they worked with the two counties involved and the state department of transportation to relocate an adjoining road to make the site more accessible. This also meant that the site would be surrounded on three sides by 3,500-acre Stone Mountain State Park. In order to gain utilities they had obtain water from one county and sewerage from the other. Finally, after four years of effort the site was ready for development. Now came the need to obtain zoning.

The plan was for a mixed-use development including apartments and retail space. This pro- posal was met with considerable community oppo- sition based on a fear of an influx of school children and an increase of traffic in the already congested area. Thus, the initial zoning proposal failed. Then one of the community leaders suggested an age- restricted senior retirement community. This was attractive to the community because there wouldn’t be additional local school children and the retired

residents would generate little traffic, particularly at busy hours. The developers responded with a proposal that included 398 residences restricted to persons 65 years of age and older. This proposal gained overwhelming community support and was approved after two more years of effort. This brings us to the year 2000, six years after purchase, with nothing but expense and no income from the property.

The developers saw the potential for success for a continuing care retirement community, one where seniors could purchase the right to occupy an independent living residence with the option of moving to assisted living or skilled care nursing facilities on the same site as their health needs changed. They offered a variety of units, ranging from an 800-square-foot one-bedroom apartment for $135,000 to a 2,400-square-foot detached two- to three-bedroom home for $600,000. For this entry fee the purchaser obtained the right to occupy the unit for his or her lifetime and the use of the development’s facilities, including a fitness center, library, woodworking shop, pottery shop, and three restaurants. A monthly fee covered all utilities, biweekly cleaning, all maintenance, and taxes. At owners’ death, 90% of the entry fee would be refunded to their estate.

The concept met with great market accep- tance, and finally in 2004, 10 years after the property was purchased, the first units were sold and the project began generating a cash flow—not yet a profit, but at least a cash flow. By 2007, all but 16 of the units had been sold, and entry fees had risen by 45%, generating a healthy profit for the developers upon resale of these units. Even

(continued)

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C H A P T E R 1 Why Study Real Estate? 9

| the economic importance of real estate ___________________

Real estate is a vital component of the national economy and constitutes a large portion of national wealth. As of the first quarter of 2014, land and structures com- prise about 21% of the total assets of households and about 33% of the total assets of businesses in the United States (the remainder consists of equipment and inven- tories). Real estate accounts for about 5% of the nation’s gross domestic product and about 36% of gross private domestic investment. In addition to tangible assets, individuals and businesses frequently borrow against real estate assets, which creates financial assets in the form of mortgages and mortgage-backed securities. In early 2014, the total outstanding mortgage debt in the United States was more than $13.3 trillion.

The economy of the United States is especially sensitive to changes in owner- occu pied residential real estate (housing) values. The most recent example was the overall negative economic impact the decrease in housing values in the 2000s had on the economy of the United States as well as impacts throughout the world. The shocking declines in overvalued housing stemmed from aggressive investment in mortgage-backed securities, which led to relaxed loan qualification standards and a variety of alternative mortgage loan products. These relaxed standards and so-called subprime loans enabled many people to obtain loans for which they would not have otherwise qualified. In some cases, borrowers did not have to provide any proof of their income or other assets (so-called liar loans). Some loan products allowed

r e a l e s t a t e t o d a y

c a s e s t u d y

The Gestation of Park Springs

so, the development didn’t begin to really show an overall profit until 2009. Park Springs has been a resounding success, but only with developers who were able to surmount the many obstacles inherent in the site and absorb the large development costs during the more than 10-year gestation period.

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10 R E A L E STAT E P R I N C I P L E S

borrowers to pay only the interest due on the loan (instead of interest and princi- pal amortization, as in traditional loans) for the first few years of the loan. Some loans had reduced initial interest rates (so-called teaser rates) that lowered the initial monthly payments but required higher interest rates (and higher payments) after the first few years. Some loans allowed borrowers to borrow more than the value of the house being pledged as collateral for the loans.

Easy access to mortgages increased demand for housing and resulted in rapidly increasing housing values. According to the S&P/Case-Shiller Home Price Index, housing values increased by more than 47% between 2000 and 2006. By mid-2006, however, many subprime borrowers realized they could not afford their loan pay- ments (especially those with required interest rate adjustments), and the number of delinquent subprime loans started to rise dramatically. By the first quarter of 2007, more than 17% of subprime loans were delinquent, and foreclosures were rapidly increasing. Investor demand for mortgage-backed securities that relied on payments from subprime borrowers for their cash flows dried up very quickly. Lenders quickly instituted more prudent borrower qualification standards and returned to more tradi- tional types of mortgages.

With less mortgage capital available, the demand for housing quickly began to erode. Nationally, home values fell by 32% between mid-2006 and the end of 2009. Some areas experienced even more dramatic declines over this time period: Las Vegas, 55%; Phoenix, 51%; and Miami, 47%. Likewise, the value of mortgage- backed securities plummeted, severely affecting many major financial concerns that held these securities as investment assets. The general economic decline that fol- lowed has proven to be the worst economic crisis since the Great Depression of the 1930s. As of late 2014, housing prices in many markets around the nation are recov- ering but have still not reached the record highs of the mid-2000s.

| the real estate industry: career opportunities ___________

The real estate industry is diverse, offering many career opportunities. To some students a career in real estate means selling homes, and, indeed, this is a significant part of the real estate brokerage industry. But many other fascinating careers in real estate exist, and one of the purposes of this book is to introduce these career oppor- tunities, as well as to provide the basic knowledge needed to become a part of the real estate industry.

Real Estate Brokerage

In 2014, the largest real estate brokerage trade association, the National Associa- tion of REALTORS®, had over 1 million members, including brokers, salespersons, and other real estate professionals. The compensation earned by participants in the brokerage industry fluctuates with the ups and downs of the real estate market, but the U.S. Bureau of Labor Statistics estimated that in 2012 real estate brokers earned an annual average of $82,380, and salespersons $53,200.

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C H A P T E R 1 Why Study Real Estate? 11

Five principal classifications of real estate exist in the private marketplace: owner-occupied residential, renter-occupied residential, commercial, industrial, and farm and other open land. Because it is difficult to be an expert in all aspects of the real estate market, most brokers specialize in certain types of property. The extent of specialization depends on a number of factors, particularly the size of the local market. The real estate broker in a small city may deal in several or all types of prop- erties. In larger cities, brokers may sell one type of real estate or properties located in only one part of a city. Quite commonly, some brokers and salespersons sell only owner-occupied houses, while others deal only in the sale or leasing of income- producing properties.

Property Management

Many people who invest in income-producing real estate, such as apartments and shopping centers, have neither the inclination nor the expertise to personally handle the properties’ day-to-day operating activities, such as leasing, rent collection, build- ing repairs, and building services. These tasks—and, indeed, the general objective of maximizing the value of a property—are delegated to the property manager. Some brokerage firms manage real estate as a supplementary activity, while many larger firms have a separate property management department. Still other property man- agers may be hired directly by the firm that owns the properties. If the property manager does a good job, this function can add considerable value to a property. It can also earn a good income for the property manager. The average annual wage for property managers in 2009 was $52,610.

Real Estate Finance

Several characteristics of real property, principally the long-term nature of real estate investment and the consequent need for large amounts of money over a long period of time, make mortgage credit both necessary for most purchasers and attrac- tive to many lenders. In turn, this has given rise to the real estate finance industry.

Real estate loans are made by many types of institutions and even by individu- als, and major employment opportunities are found in savings associations, savings banks, commercial banks, mortgage banking firms, and life insurance companies. Savings associations and savings banks specialize in residential loans and do most of their lending locally. Commercial banks also lend money on real estate, particularly for relatively short-term construction loans, and they also purchase many mortgages for mortgage bankers.

The mortgage banking and mortgage brokerage industries also play large roles in the financing of real estate. Mortgage bankers do not collect deposits from savers and have only a small amount of their own capital to lend. After originating loans to borrowers, mortgage bankers sell the loans in the secondary mortgage market, but they often continue to service (collect payments, mail late notices, etc.) the loans for a fee. Mortgage brokers do not originate loans with their own funds but instead bring lenders and borrowers together in exchange for one-time fees. Both mortgage

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12 R E A L E STAT E P R I N C I P L E S

bankers and brokers are essential parts of the financial mechanism that makes debt capital available to real estate owners.

Appraisal

Estimates of value are needed in almost every aspect of real estate and develop- ment. Sellers need to know what their potential purchases are worth in comparison with other properties in the market. Mortgage lenders need estimates of value, an appraisal, before they make lending decisions. Appraisals also are essential for tax assessors, insurance adjusters, and right-of-way agents. Accordingly, some apprais- ers are employed by financial institutions, other private firms, and government orga- nizations, while many others work as independent fee appraisers—that is, they offer their services to the public for a fee. The average annual wage of appraisers was $57,040 in 2012.

Consulting

Closely related to real estate appraisal is real estate consulting. The real estate appraiser makes estimates of value, while the real estate consultant advises indi- viduals and firms regarding their real estate investments. Though the two specialties require similar kinds of knowledge, the consultant must have even more extensive knowledge than the appraiser of all phases of real estate, tax laws, and other aspects of investment.

Development and Construction

Real estate development certainly is one of the most fascinating aspects of real estate and one that offers greater potential return—and greater potential risk—than perhaps any other field within the industry. Real estate development involves the acquisition and subdivision of land, designing and planning the project, and the construction of improvements, such as roads, utilities, and buildings ranging from single-family homes to multi-million-dollar office building and shopping centers. Development is often described as the process of creating value by improving real estate for more productive use.

Corporate Asset Management

Although real estate makes up a large portion of corporate assets, most cor- porations have not placed adequate emphasis on managing these assets efficiently. Increasingly, however, firms are establishing corporate real estate departments, and this has led to many new opportunities in the real estate field. As might be expected, utilities and other firms with very large percentages of their assets in real estate have been leaders in the field, and other companies as well are realizing that efficient man- agement of their real estate can add significantly to corporate profits.

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C H A P T E R 1 Why Study Real Estate? 13

Legal Experts

The legal complexity of real estate transactions and development projects often requires the expertise of attorneys and other legal professionals. Many attorneys spe- cialize in real estate law and provide important services for real estate market par- ticipants such as title examination, contract drafting, and litigation. These attorneys often hire paralegals to assist them.

Land Planners

Land-use planning has grown in importance with the increase in both urbaniza- tion and concern for the environment. Planners are employed by local government planning agencies, regional planning districts, and state development offices.

| chapter review __________________________________________

■■ The five broad categories that comprise the real estate “body of knowl- edge” considered in this text include real estate market analysis, the legal framework of real estate, real estate services, the real estate transaction process, and investment analysis.

■■ Simply defined, real estate is land and things attached to it.

■■ The special economic characteristics of real estate are (1) fixed location, (2) uniqueness, (3) interdependence of land uses, (4) long life, (5) long- term commitments, (6) large transactions, and (7) long gestation period.

■■ The characteristic of real estate that distinguishes it from all other types of economic resources is its fixed location. Fixity of location means that every parcel of real estate is unique, and this factor can create large differ- ence in property values.

■■ Land is indestructible, and real estate improvements generally have long lives. Thus, investment decisions are by their very nature long-term decisions.

■■ Because real estate purchases involve large expenditures committed for long periods of time, outside financing is essential for most transactions.

■■ The use of land depends greatly on (1) the provision of public services, (2) nearby land uses, and (3) the general economic vitality of the neighbor- hood and community.

■■ The gestation period for real estate improvements—that is, the time between conception of a real estate project and its actual completion and subsequent entry into the available supply—may be several years. This long gestation period makes the supply of real estate slow to respond to increases in demand.

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14 R E A L E STAT E P R I N C I P L E S

p a r t o n e

■■ Five principal classifications of real estate exist in the private marketplace: (1) owner-occupied residential, (2) renter-occupied residential, (3) com- mercial, (4) industrial, and (5) farm and other open land.

■■ The general objective of the real estate property manager is to maximize the income flowing to the owners from income-producing property.

■■ Mortgage loans now total about $14.1 trillion and have led to the devel- opment of a major sector of the real estate and finance industries. Major employment opportunities related to real estate are found in savings banks, commercial banks, mortgage banking and mortgage brokerage firms, and life insurance companies.

■■ Real estate appraisers estimate the value of real property. Their services are used by buyers and sellers, financial institutions, tax assessors, and many others.

■■ Real estate counselors advise individuals and firms about their real estate investments. They must have extensive knowledge of all aspects of real estate, tax law, and investment.

■■ Real estate development offers greater potential return and greater poten- tial risk than perhaps any other field within the real estate industry.

■■ Land-use planners are engaged in physical design, economic and invest- ment aspects of development, and land-use policies and regulations.

■■ Many real estate specialists are employed at various levels of government in property acquisition, tax administration, land-use planning, and other operations of government.

| key terms _______________________________________________

appraisal

gestation period

personal property

real estate

real property

00RePrinciples_BOOK.indb 14 11/25/2014 8:03:26 AM

p a r t o n e

Real Estate Legal Analysis

00RePrinciples_BOOK.indb 15 11/25/2014 8:03:26 AM

2c h a p t e r Property Rights and Legal

Descriptions

00RePrinciples_BOOK.indb 16 11/25/2014 8:03:26 AM

c h a p t e r p r e v i e w

Perhaps you own or lease some real estate. What exactly are the rights that come with owning or leasing this property? These can be difficult questions because real property rights associated with real estate can be quite complex. Real property rights can be divided in many ways. For example, one party may own the right to use the surface of the land, another may own the right to sub- surface minerals, gas, or oil, and yet another party may own the right to use the water that flows across or under the land. Or two or more owners may jointly own unique and specific rights to the same parcel of real estate. This chapter examines these and other property rights issues that every market participant should understand to ensure effective real estate decisions.

After reading this chapter, you should be familiar with how property rights are divided among various claimholders. The objectives of this chapter are to

■■ define the concepts of real property and personal property;

■■ demonstrate how property rights are physically divided;

■■ consider how property rights are bundled into “estates in land”;

■■ describe how properties can be jointly owned by two or more owners; and

■■ examine the three methods for legally and uniquely identifying individ- ual parcels of real estate.

close-up Water Wars

close-up The Empire State

Building

legal highlight How Did an Acre

Get to Be an Acre?

r e a l e s t a t e t o d a y

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18 PA RT O N E Real Estate Legal Analysis

| real versus personal property ___________________________

In the previous chapter, we defined real estate as land and things attached to the land. Another important term real estate market participants need to understand is property. Although the term property can be used in several ways, we gener- ally think of property as any objects that can be owned or possessed—real estate, vehicles, books, clothing, furniture, stocks, or bonds, for example. Legally, the con- cept of property can be divided into two broad classes: real property and personal property. Real property consists of legal interests in land and things attached to the land. Personal property includes legal interests in all other types of property. Stated more simply, real property refers to rights to real estate—land and things attached to that land—while personal property refers to rights to movable property such as automobiles, furniture, clothing, and business equipment. Personal property is also called chattel.

Generally speaking, the requirements to transfer real property from one owner to another are much more complex than are those for personal property. To buy a book at a store, for example, the purchaser simply tenders the funds and receives the book and perhaps (but not always) a written receipt or “bill of sale.” But when real property is transferred, a written document must be prepared with language that uniquely identifies the property being transferred, the specific rights and interests being transferred, the parties to the transfer, and any other important details involved in the transfer. There are a few exceptions to the rule requiring a written document as evidence of real property transfers (such as a lease for less than one year in some states), but it is always a good idea to specify the details of transactions involving real property in written form to prevent misunderstandings and disputes even if such a document is not absolutely required.

When ownership rights to real property (often called title) are transferred, the document normally used to convey the rights from one party to another is called a deed. When a tenant acquires property rights to leased property, the document used to convey the rights from the property owner to the tenant is called a lease. Leases convey the rights of use and possession of real property under the agreed-on terms, but leases do not transfer ownership rights to the property. Both deeds and leases are considered in detail later in this book.

| fixtures _________________________________________________

Whether a particular item of property is considered real or personal property cannot always be readily determined. For example, a central air-conditioning unit clearly is movable personal property at the time it is purchased. However, when it becomes attached to land as part of a building, it is treated as part of the real estate and considered real property. Personal property that becomes part of the real property when it is attached to the land or a building is termed a fixture.

For example, the antique chandelier you inherited from Aunt Matilda and hung in your dining room is a fixture and part of your house. Unless it is specifically excluded when the house is sold, the new buyer becomes the proud owner of the

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C H A P T E R 2 Property Rights and Legal Descriptions 19

chandelier along with the rest of the real estate. Other items generally considered fixtures include landscaping, automatic garage door openers, water heating or filter- ing systems, window treatments (such as blinds and drapes), and appliances installed in the house (such as built-in dishwashers and central air conditioners). It is impor- tant to remember that if you are selling a home and want to retain ownership of Aunt Matilda’s chandelier or your prized rose bushes, you must specifically exclude them from the transaction. Likewise, if you are purchasing a property, you should be careful to specify what items are to be included when negotiating the terms of the transaction.

Tests for Fixture Status

Whether an item of personal property has become a fixture can be critically important in determining (l) the value of real property, (2) whether a real estate transaction includes the item, (3) whether the item is part of the security given to the mortgagee (lender), and (4) whether the item remains with the landlord or can be removed by the tenant when the lease terminates. These issues are often resolved by through litigation when there are disputes over the status of the item in question.

Intent of the Parties

The most crucial test used to determine whether something is a fixture or per- sonal property is the test of intent of the parties. The best way to indicate intent, of course, is by a written agreement that states clearly which items are to be con- sidered part of the real estate and which are to be considered personal property. For instance, a sales contract for a house might specify that the range and refrigerator may be removed by the seller. Or a lease agreement for a factory or warehouse build- ing might state that the tenant may attach trade fixtures (personal property used in a trade or business) such as machinery, office equipment, and office cubicles to the building without losing the right to remove these items at the termination of the lease. (Notice that trade fixtures are, by definition, personal property, not real prop- erty.) As long as the intent of the parties is made clear, there should be no confusion about whether the item in question is considered a fixture or personal property.

Other Tests of Fixture Status

Unfortunately, the intent of the parties often is unclear, so other tests of fixture status are applied by courts in the event of disputes. If an item of personal property becomes attached to the real estate, it usually is considered a fixture, and the damage caused to the land or building by the item’s removal is a crucial element in the test of attachment. For example, while a portable window air conditioner would likely be considered personal property, a central air-conditioning system would be consid- ered a fixture because the building would be damaged if the system was removed. Another method for determining whether an item is a fixture is the test of adapt- ability. Under this test, items that have been specifically adapted to the real estate are

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20 PA RT O N E Real Estate Legal Analysis

generally considered fixtures. The issue considered in this test is whether removal of the item would substantially alter the usefulness of the remaining real estate. For example, kitchen cabinets and a built-in entertainment center would probably be considered fixtures, while free-standing, noncustom cabinets would be classified as personal property.

Because these last two tests for fixtures do not necessarily provide clear-cut distinctions between real and personal property, the parties involved always should indicate their clear intent by a written agreement. This, of course, helps avoid dis- putes in all business matters.

| mineral and air rights ___________________________________

Real property rights are not limited to the surface of the earth; they also include the space above the earth’s surface (air rights) and minerals or other useful materials that exist below the surface (collectively called mineral rights). Historically, a land- owner’s real property interests have been conceptualized as pie-shaped, beginning at the earth’s center and extending through the surface indefinitely into outer space. In modern thought, the property rights associated with the surface of the land, miner- als, or other useful material that may exist under the surface of the land and airspace above the land are often separated among several different owners. Similarly, the rights to water that may flow over the land or be adjacent to the land are sometimes owned separately from the land itself.

Ownership of airspace is limited to a reasonable distance above the earth’s sur- face. Obviously, an airplane flying over a property at an altitude of several thousand feet rarely interferes with the owner’s use or enjoyment of the land. But when aircraft fly so low that a reasonable use of the land is prevented (for example, near a length- ened airport runway), the owner of the land may be entitled to compensation on the basis that the plane is interfering with the owner’s property rights.

Mineral rights and air rights may be owned by someone other than the owner of the surface of the land. It is common, for example, for a surface owner to sell to a third party the rights to any oil, gas, coal, and other materials that may be located below the surface. The air rights, likewise, may be transferred to persons other than the owner of the surface. For example, office buildings and parking decks have been constructed over the tracks of railroads, with the owner of the building owning only the air rights.

| water rights ____________________________________________

Water rights—who has the right to withdraw water from the land—is a question of considerable importance, particularly in the more arid western states, and increas- ingly in the eastern states. These rights vary from state to state and depend primarily on what type of water the land touches.

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