In a former Newsletter, I (J.ROBERT ECKLEY) noted the increasing turn to seller-carried finance in residential, commercial & business sales. I predicted that the use of it would solidly increase as conventional lending became ever more deleveraged, inflexible, complex and adverse as sellers (now getting a 1/4 point on their savings accounts) saw the benefit of collecting comparatively generous interest on seller-carries (now running between 6% and 8%, many even higher). That prediction has certainly proven to be accurate.
Seller-carries are now a significant part of most markets and they are growing monthly, everywhere. By way of a growth example, for residential sales, in 2009, the various MLS systems and private escrow reports (a lot of seller-carries are not reported in MLS for various reasons) in the southwestern U.S. reported a seller-carry median average percentage of the reported “sold” of less than 0.5%; markets “sold” on seller-carries in the same areas are this year reported as just under 15% of the marketplace and growing. San Diego, which closed 0.5% of the reported sales on seller-carries in 2009, went to 2.3% in late December, 2010 and was at 12% in mid-2015. Phoenix went from almost zero in 2009 to a little under a current 17%. Seller-carried commercial sales (sale-buybacks, sale-leasebacks, lease/options, stock or equity swaps, 1031 exchanges and other creative transactions involving no or little conventional finance) are running 22% of all “sold” in the same areas. Sales of business opportunities using seller-carries are between 65% and 70% and seller-carries compose almost 80% for bare land and private sale farms and ranches. This is still below the historical levels of residential and residential development sales during the last downturn (1982-1988) which ranged closer to a third of all deals across the board. What this translates into is millions and millions of dollars of deals done and commissions paid that otherwise could not or would not necessarily have happened under conventional lending and deal models! That’s not chump change any time, let alone in these ruptured times.
But there is a problem. The transactional community-all of the way from the real estate broker, to the mortgage brokers, to escrow closers and title insurers-is not ready for this seller-carry onslaught, either practically or legally. Not only are there few basic real estate licensure schools that still even teach seller-carries to future brokers (they did away with those classes as “obsolete” when the country went through that period when conventional lenders would finance anyone buying anything at any price) but there are also few escrow officers left who are old enough to have learned how to set up and close them, in the 80’s, when seller finance was SOP in the industry. They retired.
Yet the problem is even greater than lack of understanding and experience. It’s the legal side – the Dodd-Frank Act, the SAFE Act, the Home Owners Equity Protection Act and the myriad of complex rules of the Consumer Financial Protection Bureau – with standards that all must be met to the letter, which confounds the job of lawfully creating and closing the seller-financed consumer/residential sales transaction, as 80% of the daily real estate sales market tends to be. All of those laws and rules now also apply to seller finance for the average residential property being purchased by an owner-occupier and some of these standards and legal requirements, if violated, can mete out not just licensure loss and liability to clients, not just stiff public fines and publishing in the CFPB’s national online “Hall of Shame,” but even some serious jail time. In the 80’s, these rules and the harsh penalties – all 24,000 pages of them to date – did not exist. With these rules, it just got more complex to write lawful seller-carries. It did not, by a far cry, make them non-viable, unpopular, or obsolete, as the doubling and tripling of their use in today’s market by those “in the know” more than can attest.
Is stiffer regulation the progressive end, though, of the explosively growing seller-carry market? Nope. But it is the end of any patience for ignorance about how to do seller financing under the new rules – and the current legal ignorance, if not obstinance – is shockingly rife and across the board. A lot of horror stories about what it cost some poor broker or title company for doing it wrong under the new rules, above, can be told, but this does not teach anything that is constructive (other than not to “mess with the Feds,” but does anyone really need to reminded of that eternal principle?) And it chases away a lot of good deals and good marketing people that could, with the right information and a hook-up with the right compliance support services, put people in properties, raise the market and allow many more attorneys, brokers and escrow officers to become “seller-finance masters” to the immense profit of themselves, their brokerages and firms, their clients and customers in this new marketplace. Ignorance has never been bliss. It is usually just a poverty-paved road to fatality.
To identify one resource for mastering the seller-carry market, some terrific classes on the “how-tos” of seller-finance are now developed and out there. Old seller-finance lawyers, like the author of this article, have been brought back to the forefronts they once enjoyed before they were unseated when the Banks lost their minds (and forgot a novel concept called “safe and sound banking practices”) for that decade or so until the Feds intervened with these new rules. When lenders were willing to shovel trillions of dollars into the Black Hole of Underwriting Abstinence, any competition from seller-carries was derailed and with it those who taught it. All of those great transactional techniques and forms developed from the experiences of those millions of seller-carry transactions done across the U.S. in the 80’s went to a dusty closet, until now. Those instructors and their magnificent forms are back in full force… and, well…finally out of the closet, so to speak! (P.S. One serious criterion to use in selecting which instructors, lead brokers, lawyers, escrow officers or other mentors to learn from or which can provide a capable support service is to seek those people out in your line of business who were there and did them in the 80’s-don’t just look for anyone old enough to have done them, but find those who were in the trenches making steady money marketing, writing and closing seller-carries. In an era which almost religiously worships youth, it is risky to say this but the fact is: Find and ally with the “Gray Hairs” in this transactional area and The Force will almost always be with you! It really is an art that starts with focusing the mind well before sharpening the pencil.
The professionals for the “Seller-Carry Team” need to be carefully selected for their competence and their complete compliance with the rules. Note the point that they must be “rule compliant.” That is entirely different than those holding themselves out as having a “system” or “technique” to AVOID the rules. That’s the Devil whispering. There are no “secret back doors” or “shortcuts for insiders” to by-pass these dense and very well-written rules. At least none that do not involve handcuffs at some point. The contentions that there are some “tricks” and “loopholes” came from a range of ignoramuses, charlatans and outright crooks. And compliance is not that hard or expensive when compared with the alternative of checking into Sing Sing. Here is the usual cast of professional players in a typical seller-carry now and what they can and cannot do:
One needs a lawyer who knows seller-carry dynamics AND those new consumer and licensure rules above to draft the core transactional documents. Not necessarily to draft the initial purchase commitment which the real estate broker typically first drafts to get the parties initially together (though it is smart to have a lawyer help even with that for the few couple of times to assure the initial deal is stated right so as to avoid the unsettling and embarrassing need to change a “done deal” later because it crashed into an adverse rule). The lawyer should ALWAYS draft the final core financing documents that come thereafter at closing. And that lawyer should be specifically working as the direct attorney for at least one the parties, typically the seller in seller-carries (where seller is in that scenario “the Bank” and has a solid right to fashion the paperwork on which his money will be lent). That attorney should not also do work for the same brokerage or for the title or escrow company who profits only from a closing-that is a clear conflict of interest. The same attorney should not work for a mortgage broker (though they can help with SAFE Act questions, truth-in-lending and other loan disclosure documents when the deal requires). And, good grief, they should be a REAL attorney and not “that guy at the front desk at the dry cleaners who did these once before in the 80s before he lost his license and went into bankruptcy. And the transactional documents should definitely not come from forms (probably drafted by that same guy at the dry cleaners or someone like him) found on the internet!
Next, a licensed Mortgage Loan Originator (“MLO”) will likely be required both as a matter of offloading the high-risk position of evaluating the borrower’s current credit and likely future loan performance, but also to comply with the new consumer protection laws which in some cases make use of the MLO mandatory in seller-carries. MLOs are the professionals now officially mandated by the SAFE Act to determine the creditworthiness of the buyer for the benefit of the seller’s final decision to make the loan represented by a seller-carry. The CFPB and drafters of the federal SAFE Act rightly believe that the seller needs professional-level underwriting input to competently make the decision to grant or deny a loan to the buyer and the buyer needs protection against rip-off, predatory loan terms (usually unlawful under HOEPA). Real estate brokers and escrow officers or attorneys for them are NOT authorized to act as MLOs nor are they permitted to make the same credit evaluations or engage in the same underwriting acts without an actual MLO license. MLOs take the buyer’s credit application, do balance and employment verifications, run FICOs, tri-merges, apply credit models and finally rate the buyer for the benefit of the seller. Yes, there are some deals where an MLO is not required by the SAFE Act to meet the seller-carry law, such as non-consumer transactions or consumer transactions involving a single seller-financed sale in any 12 month period (backward in time and forward in time) or sales of bare land with no residential building intentions but even for the exempt deals, is there EVER a time when an honest, knowledgeable, bright lawyer, real estate broker, title or escrow company wants to take the liability of certifying to the seller the buyers creditworthiness for years to come and without having a license for that and also doing so without having done any of the standard loan due diligence underwriters do? Want to be a free guarantor for the buyer’s perfect performance for years into the future? One word on that: Dumb. And if that single word did not make the point well enough, here’s another few to balance it out: Welcome to your Chapter 7. Obviously, this does not even cover the point that it is a severe conflict of interest for any of these professionals to both advise the seller that the buyer has the financial horsepower to do the deal AND make money from that deal only because the seller took that advice and did not cancel the deal when-in retrospect some day when it blows up–he should have.
Now to the title and escrow companies. Do not avoid the use of title insurance, closing and collection escrows, even in seller-carries and especially because it is a seller-carry. Seller-carries need the same closing and collection mechanisms as conventionals. They need a competent closer to get prorates and recordation properly done. They need title insurance to assure seller’s title status and an account servicer to be set up to count the beans correctly and assure that the interest paid and interest received statements that are given to IRS by each party each year actually match. They can and should hold final transactional fulfillment conveyance or lien release instruments for buyers’ safety and they can hold and pay reserves where needed. They are essential to a well-conducted deal. But lately, maybe because these vendors are hungry in this tight economy, some are running amok across all of the above consumer rules, exposing themselves and all of the other professionals, let alone the other transactional parties, to atrocious and devastating liabilities. More on that.
Some very misinformed title companies, escrows and agencies are drafting the preliminary and even the final seller-carry transactional documents putting the deal together and apparently “approving” the buyer to the seller and closing the loan without any participation of outside counsel at least for the seller, any lawyer at all in some cases, and all without a licensed MLO. Worse, these rogue entities are even contending that they CAN lawfully do that. That’s the Devil’s whispering, again. They CANNOT do those things or play those roles without engaging in the unauthorized practice of law (see ** below after this article), without, even if they do have their own lawyer, a very serious conflict of interest, without engaging in unlicensed real estate brokerage and unlicensed MLO activity, all violating the SAFE Act and the CFPB and their own and other licensure rules. These wrongful acts seed the transaction with huge state and federal defects that have unbearable, non-dischargeable penalties (up to $1 million a day for all concerned which penetrates any entity to reach the principles). Moreover, the above consumer protection rules may require a number of technical and complex side-paperwork, phrases and broker disclosures to be in the transactional forms and the author of this article has yet to see a single form from title and escrow entities or their attorneys that comply with those. Who ran the APOR for the HOEPA interest test? Who underwrote the ATR and what convention was used? Where are the written SAFE Act seller and buyer personal exemption-statuses or exempt collateral verifications? Who determined that the buying or selling entity qualifies under the SAFE Act under the “Ladder Doctrine” (a rule in which a series of transactions which are substantively allied by a common entity or person inside the entity are all counted towards determining a SAFE Act transactional number or exemption)? The answer observed from most all of the escrow forms out there when asked these questions is:.. Huh?
As noted, above, the transaction may be one in which the use of an MLO is mandatory under the federal SAFE Act and companion state laws and these title and escrow entities are NOT MLO’s nor should they close anything unless they have an outside attorneys’ transactional documents in place, or an outside MLO’s Underwriting Certificate indicating that status or that it is non-exempt and the MLO has found the buyer to have the requisite ATR and “passed’ the deal OR that the deal is not subject to mandatory MLO review and may go forward without an ATR finding. Doing or purporting to do what ONLY a licensed MLO can do-just setting up and closing the deal without any of the rest, is courting disaster for all concerned and in some cases a crime by the perpetrator. And is generates a hell of a lot of civil liability, as it makes the loan defective and, for instance, then gives the buyer a right to rescind, demand all of his money back and WALK on the transaction for up to 2 years after closing! That has the added enjoyment of then getting ALL of the participating professionals-all of whom “should have known better”-sued as “aiders and abettors”, regardless of knowledge or intent! “Thank you for using Acme Title & Escrow, where causing the indictment and collapse of ourselves and all our trade partners by flagrant disregard of consumer protection laws is our motto!” This is surely not what title and escrow management wants to see in the company promo brochures or on CNN. And their trade partners – to whom they have been hard-selling “integrity and capability” – sure as heck don’t want to, either. There are a lot of Captain Ahabs out there. Stay off their ships.
THE CONCLUSION: Above all, do learn and use seller-carry finance! It can be the silver bullet that conquers a local market made flat by out-of-reach conventional finance, low appraisals and the bags of bad credit inherited by potential buyers from the financial calamities of the last decade. Just don’t do seller-carries on your own or at least not the first 10 or so. Use the existing education resources, classes and network of professionals to help you stay right, safe, legal and on-track to double or triple your income by learning the seller-financing art. Associate as your trade partners in this some good attorneys, several MLOs with SAFE Act experience, and title and escrow companies that will gladly stick to the business they are licensed to do which is to assure all mandatory documentation is assembled, to close and to collect on deals put together by preceding professionals. Look in all of this lineup for those who have truly “been there and done that”-those gray-haired ones mentioned who can help you do a truckload of lawful, no-hassle deals which leave your less-enlightened competition far, far behind.
‘Nuff said. From the J. Robert Eckley Newsletter
J. Robert Eckley, Real Estate & Banking Attorney
** See for examples of Bar’s opinion on non-lawyers like brokers and escrow officers drafting unique legal documents: Arizona, see Rules of the Supreme Court of Arizona, Sec. V., Regulation of the Practice of Law, Rule 31 A. (1) which provides in pertinent part that the act of “…preparing any document in any medium intended to affect or secure any rights of a specific person or entity..” is the practice of law needing a valid state license for law practice by the drafter. California: In California see the long-followed, definitive People v. Sipper, 61 Cal. App 2d Supp 844 (1943) [and a long list of consistent cases thereafter] in which the Court held that “law practice” needing licensure included “…legal advice and counsel and the preparation of legal instruments and contracts by which legal rights are secured…”