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When is it Time to Throw in the Towel on Financed Land?

Apr 13

Posted by Mike Fitzgerald in Bank-owned, Foreclosure, Legal Issues, Loan Workout, REO | No Comments

NOTE:  I am not an attorney and this article merely relates different strategies I have seen friends and customers try when faced with land that is worth less than the amount borrowed against it.  Please visit our Professional Resources  page to find an attorney that knows far more about these issues than I do.  The goal of this article is to give landowners some frame of reference to engage in dialogue with their lender before the situation becomes desperate.

I hear the same story all too often about land developers and builders who hold on until the very end trying to make payments on raw land or developed subdivisions until all their money is gone.  Land speculation and development is very different from other forms of real estate investment because there is no possibility of income until the very end of the investment cycle when the property is sold.  Unlike houses, apartments, office buildings, warehouses, or retail stores, it is next to impossible to derive lease income from land and lots.  When the market for land evaporates as it has done in the last 12-18 months in Metro Atlanta, the land owners have no way to generate cash from their holdings.  Many have tried to find work, but there aren’t many vacancies in the two industries hit hardest by the Great Recession in Atlanta:  Construction and Real Estate.  To complicate matters, the loan payments must still be paid on a regular schedule.

So what is a land owner to do in this current environment?  One option is to continue making loan payments until all resources are depleted and then turn over the property by a process known as deed-in-lieu foreclosure and file bankruptcy.  Another option is to stop making loan payments, lose the property by foreclosure and then defend a lawsuit filed by the bank for their loss on the deal.  Neither of these options seems very attractive to the land owner.  Relocating to Belize might be somewhat more attractive.

A third option is a short sale – yes these work for land too.  A short sale is when the bank agrees to release the lien on the real estate for a payment that is “short” of the amount due on the loan.  There are two types of short sales – recourse and non-recourse.  In a recourse short sale the bank does not forgive the remaining debt and may pursue the borrower to collect that debt just as if the bank foreclosed on the property.  There are two benefits to a recourse short sale: 1) the borrower won’t have a foreclosure on his record and 2) the borrower has some control over the selling price of the land.  In a foreclosure situation, the bank takes the property back in at their most current appraised amount and that’s the number they use as a basis for the deficiency lawsuit.

The non-recourse short sale is the best option for the land owner – in this arrangement, the lender and land owner work together to market and sell the property at a price they can both live with.  The borrower then agrees to pay some portion (or in some cases none) of the deficiency between the selling price and the loan balance.  The bank in turn agrees to forgive the unpaid balance and will not pursue the borrower for this amount in the future.  There are two disadvantages to the borrower however:  1) The bank will send the borrower a 1099 for the forgiven debt and the borrower may have to pay income tax and 2) the borrower may have a notation on his credit report that says that the loan was satisfied for less than the amount owed.

What is a Right of First Refusal?

Nov 27

Posted by Mike Fitzgerald in Contract Questions, How-to, Legal Issues | 4 Comments

Sometimes also referred to as a First Right of Refusal is a right granted by the owner of the property to another entity (the Holder).  The Holder has the right to purchase the property in question in the event the owner receives an acceptable offer to buy.

Some common situations where you find Rights of First Refusal include:

  • Landlords may grant one to a tenant who wants to buy the property when the landlord is not ready to sell immediately.
  • When a property owner sells a portion of his property and retains the rest, he may grant a right of first refusal to the buyer on the seller’s remainder tract.
  • In partnerships, each partner may grant a right of first refusal to all other partners requiring him to offer his partners the right to buy his interest in the partnership before allowing some new entity to buy in.  (Also see “Shotgun Clause” on wikipedia for a more interesting arrangement.)

In the event the property owner receives an offer that he plans to accept, he must notify the Holder usually by delivering a copy of the purchase offer.  Certified Mail Return Receipt Requested is what I’ve used in the past to create proof of delivery along with a letter for the Holder to sign acknowledging notification.  The Holder then has a period of time (defined when the right of first refusal is granted) to elect to purchase the property under the exact same terms as the written offer or release the right of first refusal.  Sometimes a this release requires a Quit Claim deed and sometimes the expiration of the time limit on the right is sufficient depending on the requirements of the title company and the parties involved in the transaction.

The response period is usually 30-60 days and can make any property with a right of first refusal very difficult to market because a potential buyer has to wait for a month or two without any certainty that they will actually get the property.  Sometimes rights of first refusal specify a price trigger such that the seller only has to contact the right holder if the offer to purchase is below a specific price.  Sometimes the right expires for example a right may expire at the end of lease if granted by a landlord to a tenant.

The correct way to do a right of first refusal is to record the right on the title of the property in question.  This protects the holder of the right because anyone trying to buy the property would most likely do a title search and discover the right of first refusal.  In practice, the right is written directly into the lease.

What happens if the owner sells property bound by a right of first refusal without notifying the Holder.  That’s probably where an several attorneys could rack up fees trying to sort the matter out.  My advice is to always have a real estate attorney’s help in creating or exercising a right of first refusal.

Footnote:  Rights of First Refusal are one of the best reasons for Brokers not to accept Open Listings.