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CHAPTER BASIC REAL ESTATE CONCEPTS 1 KEY TERMS appurtenance indestructibility REALTOR® bill of sale land use controls realty chattel...

CHAPTER BASIC REAL ESTATE CONCEPTS 1 KEY TERMS appurtenance indestructibility REALTOR® bill of sale land use controls realty chattel land scarcity deed nonhomogeneity situs hereditaments personal property specific performance highest and best use personalty tenements immobility real estate improvements real property LEARNING OBJECTIVES At the conclusion of this chapter, you should be able to: 1. Describe the characteristics of real estate, including classes of property, physical characteristics of land, and economic characteristics of land. 2. Describe the concepts of land use and investment, including highest and best use, land use controls, investment objectives, scope of the real estate business, and the real estate market. IN THIS CHAPTER This text is designed to help you master the fundamentals of real estate by introducing information in a step-by-step format that requires no real estate background. This chapter provides an overview of the entire real estate business. Each topic introduced in this chapter is discussed in more detail in the following chapters. You should use this chapter to become familiar with the format of the book, including objectives, summary of important points, and questions. Each of these sections is designed to help you study the 1 2 CHAPTER 1 Basic Real Estate Concepts material efficiently to master this information. Finally, this text offers advice on preparation for the North Carolina Real Estate Licensing Examination. BASIC REAL ESTATE CONCEPTS Real property has certain physical and economic characteristics that set it apart from other marketable commodities. These characteristics are so interrelated that they have a definite effect on one another and are sometimes difficult to separate in a practical sense. This chapter discusses these characteristics and their effects on real property value. Basic Terminology and Definitions Real estate, real property, realty, and land—These terms often are used inter- changeably to describe the combination of land, improvements, and rights and privileges. Title (ownership) is conveyed by deed. Personal property, personalty, or chattel—Anything that is not considered to be real property. Title is conveyed by bill of sale. The first thing students will have to master in this course is the concept that all property is either real or personal. The concept of real property is made up of three components: land, improvements, and rights and privileges. (These compo- nents are addressed in more detail in the forthcoming chapters, but the following gives a brief introduction.) Land—The surface of the earth with the boundaries extending downward to the middle of the earth extended back upward to the highest heavens. Land consists of three components: surface, subsurface, and airspace. This concept shows us that much of what is considered “land” is, in fact, made up of air. In common usage, the term “land” often is used in much the same way as the terms real estate, real property, and realty. Improvements—Anything used to better or “improve” the use of the land. These are artificially attached items and are considered to be real property and not personal. Appurtenance—Any right or privilege that is considered to run with the land. Not all rights and privileges are considered to run with the land and may be “personal” in nature. The concept of runs with the land is that the right or privi- lege is an integral part of the property, much like structures or other improve- ments, and are conveyed as a normal part of the deed transferring title to the real property. For example, municipal water and sewer lines are an example of a right or privilege the government has to place the pipes to provide utility service to the property and likely others. When the title is conveyed to a subsequent owner, that © OnCourse Learning.  Basic Real Estate Concepts 3 right remains intact. The same would apply if a property owner has the right to cross over adjoining property to access theirs. Most likely, this would be a perma- nent right that would convey upon transfer. Tenements—Ownership interest in anything immobile and is considered part of the real property. Hereditaments—Any rights capable of being inherited. Economic Characteristics of Land Scarcity An important economic characteristic of real property (Figure 1.1) is its availabil- ity or scarcity. Land is a commodity that has a fixed supply base. No additional physical supply of land is being produced to keep pace with the ever-increasing population. The problems created by an ever-increasing demand for the limited supply of land, however, have been eased substantially by an increase in the eco- nomic supply of land. This increase has come about as a result of the greater utili- zation of the existing physical supply of land. Farmers are continuing to increase the use of land in the agricultural area. Greater crop yields per acre are being achieved as a result of scientific and technological advances. Today, the agricul- tural industry is producing more cattle per acre and more bushels of crops per acre than it did just a few years ago. In urban areas, land is being utilized to a greater extent through high- density development. Advances in science and technology result in the creation of high-rise office buildings, apartment complexes, and multilevel shopping cent- ers. Consequently, 1 acre of land serves many times the number of people who could use the land in the absence of these improvements. Modification by improvement is another factor that has increased the economic supply of land. These modifications can include the construction of highways, bridges, water reservoirs, purification plants, and public utilities. The improve- ments and expansions of public air and land transportation systems also make a significant contribution in this regard. These accomplishments in the fields of 1. Scarcity 2. Permanence of investment 3. Location FIGURE 1.1 Economic characteristics of real property. Source: © 2019 OnCourse Learning © OnCourse Learning. 4 CHAPTER 1 Basic Real Estate Concepts construction and transportation have converted land that had not been acces- sible and useful in a practical sense into land that can now be used. A substantial increase in the economic supply of land has resulted from these improvements to the land (rather than improvements on the land). Permanence of Investment Because of the physical characteristics of immobility and indestructibility of land, the investment of capital and labor to create improvements to the land and improvements on the land is a long-term investment. It takes many years to recoup the investment made to improve the value and quality of land. If a developer mis- judges the demand for land-specific improvements or if economic conditions, including real estate market conditions, change dramatically, the developer may never recoup his full investment. Location (Situs) The location of land, or situs, is an extremely important economic (or more pre- cisely, socioeconomic) characteristic of land, and it is the characteristic that has the greatest effect on property value. The physical characteristic of immobility dictates that the location of a parcel of land is permanent. Therefore, if the land is located in an area where demand is high, the land will have a substantially increasing value. Conversely, if the land is inaccessible from a practical stand- point or is located in an area with little or no demand, its economic value will be depressed. Although the location of land cannot be changed, the value of the location (and consequently, the value of the land) can be increased by improvements to access and other modifications. Additionally, the value of the location can change as the result of the changes in preferences of people. In the 1950s there was a great flight from the urban centers to the suburbs. This resulted in property value reductions in urban areas. This trend has moderated in recent years. People are rediscovering the inner cities, rehabilitating older properties, and restoring lost urban property values. Physical Characteristics of Land Immobility An essential physical characteristic of land (Figure 1.2) is its immobility. That land cannot be relocated from one place to another is an obvious feature of land as a commodity and is the primary distinguishing feature between land and personal property. The physical characteristic of immobility is the reason the economic characteristic of location significantly affects land value, thus making the market for land a strictly local market. This requires brokers and agents to have specific © OnCourse Learning.  Basic Real Estate Concepts 5 1. Immobility 2. Permanence 3. Uniqueness FIGURE 1.2 Physical characteristics of land. Source: © 2019 OnCourse Learning knowledge of their local real estate market to serve buyers and sellers in their respective market areas. Permanence (Indestructibility) Another unique feature of land is its physical characteristic of indestructibility. “Other textbook Land is a permanent commodity, and it cannot be destroyed. It may be altered sub- resources list four economic charac- stantially in its topography or other aspects of its appearance, but its geographic teristics of land: coordinates remain. Land values can change positively or negatively as a result of scarcity, location, changing conditions in the surrounding area and are said to suffer from economic improvements, and obsolescence when such changes adversely affect the value of land. For example, permanence and three physical character- the construction of an interstate highway can radically affect land values. Do not istics: immobility, confuse economic obsolescence with physical depreciation, which is a loss in value indestructibility, and from deterioration of the improvements on the property itself (see Chapter 13). uniqueness.” The permanence or indestructibility of land makes it attractive as a long-term —Tim Terry, DREI investment, but an investor should be alert to changing conditions that can affect the value of the investment. Uniqueness (Nonhomogeneity) An important feature of the land is that no two parcels are identical, in either a physical or a legal sense. For example, two tracts of land are quite different from two cars that come off an assembly line. Two cars may be nearly identical, and one could be substituted for the other; this is clearly not the case with real estate. Even two apparently identical adjoining parcels differ in aspects such as soil, drainage, view, and vegetation, to name a few. This uniqueness, or nonhomogeneity, of each parcel of land gives rise to the concept of specific performance. If a seller contracts to sell her real property, the law does not consider money a substitute for this duty. Thus, if a seller tried to breach the contract and pay financial damages instead, the buyer could refuse to accept the money and insist on taking title to the land as the only acceptable per- formance of the contract. For example, one might sign a purchase agreement for a home in a particular neighborhood because it was next to friends, family, or schools. If the seller changed her mind and offered another, better home on the other side of town, the buyer could hold the seller to specific performance of the original contract for the unique advantages of that property. © OnCourse Learning. 6 CHAPTER 1 Basic Real Estate Concepts GENERAL CONCEPTS OF LAND USE AND INVESTMENT The Highest and Best Use Concept The concept of highest and best use is of extreme importance and considers all the physical and economic factors affecting the land. The highest and best use of land is that use that will provide the property owner the best possible return on an invest- ment over a specified time period, resulting in the highest possible present value of land. Present value is defined as the value at the time of the appraisal; therefore, highest and best use can and does change with time. The use must be legal and must comply with zoning ordinances, government regulations, legally enforce- able private deed restrictions, and restrictive covenants. The highest and best use of land is attained by the intelligent use of capital, labor, and other resources to improve the land and its productivity. The task of coordinating and combining capital, labor, and resources to create an improvement is performed by an expert in real estate. The expert may be an individual developer or may be a general partner in a limited partnership with the other investors providing the capital as limited partners. The expert must determine the use of the land that will provide the necessary income from the land after labor and capital have been paid. For example, the expert will establish the optimum size of a building to be constructed on a particular site. The space should not be overimproved or underimproved. The building must not contain more space than can be rented in the market, nor should it fail to provide the space that the market demands. An overimprovement or an underimprovement does not provide the optimum income to the land, and as a result, the land is not put to its highest and best possible use. A particular parcel of land has only one highest and best use at any particular time. The loss of residual income to the land resulting from failure to employ the land to its highest and best use causes the value of the property to diminish. Public and Private Land Use Restrictions Even though most land in the United States is privately owned, there is a vested public interest in land because the type of property use affects surrounding prop- erty owners and the general public. Because of this interest of the general public and of other property owners, the use of land requires regulation for the benefit of all. The need for land use controls has existed since the country’s founding. This is especially true in areas of extremely dense population, where land uses radically affect a great number of people. Public land use controls exist in the form of city planning and zoning, state and regional planning, building codes, suitability for occupancy requirements, and envi- ronmental control laws. Additionally, there is substantial public control of land use as a result of government ownership. Examples of government ownership include public buildings, public parks, watersheds, streets, and highways. © OnCourse Learning.  General Concepts of Land Use and Investment 7 Regulation of land use in the private sector exists in the form of protective or restrictive covenants established by developers, restrictions in individual deeds (pri- vate deed restrictions) requiring the continuation of a specified land use or prohibit- ing a specified land use, and use restrictions imposed on a lessee in a lease contract. Real Estate Investment Objectives Real estate investors come in many varieties, ranging from the individual who buys one rundown property and fixes it up for resale or rental to the individuals or corporations who buy large commercial complexes such as shopping centers and factories. The primary purpose of any investment is to produce income or profit, bal- ancing the profit the investor desires against the risk he is willing to take. Real estate offers the opportunity to make a profit in three ways: appreciation, positive cash flow, and tax advantage. Appreciation is the increase in market value during the time the investor holds the property. If an investor buys a property for $100,000 and it increases 3% in value annually, and he holds the property for 10 years, the property will have appreciated to a value of $134,391.46. A positive cash flow exists when the gross effective income produced by the property exceeds the total of operating expenses. (See Chapter 13, “Real Property Valuation,” for the discussion of gross effective income and expense.) Tax advantages may result from appreciation or gains being taxed at a capital gain rate lower than the investor’s marginal tax rate when the property is sold and from deductions of property taxes, insurance, and other expenses during the time the investor owns the property. Depreciation may provide an annual tax reduc- tion, postponing the tax on the depreciated amount until the property is sold. While appreciation, positive cash flow, and tax advantage are ways to make money on real estate investments, leverage allows more money to be made on less investment. For a simplified example, suppose an investor buys a $100,000 prop- erty with an initial investment of $10,000 for down payment and closing costs. The property appreciates $3,000 the first year, has a positive before-tax cash flow of $50 a month, and produces a tax savings of $400 for the year. This $4,000 is only 4% of $100,000, which is not a very good return on an investment. However, it is 40% of $10,000, which is an excellent return on an investment. Real estate, like any investment, has risks. The real estate’s market value can decline, the property can deteriorate, or the area surrounding the property can change, adversely affecting the property value. Rent or income may not meet expectations. Plants or military installations nearby can close. An “oil glut” can change to an “oil bust,” leaving an overabundance of office space, homes, and so on. Environmental problems may adversely affect the property. If any of these things occurs, the effect may be compounded by the real estate’s lack of liquidity. The investor most likely cannot sell the property instantly for its full value. © OnCourse Learning. 8 CHAPTER 1 Basic Real Estate Concepts SCOPE OF THE REAL ESTATE BUSINESS The real estate business is extensive in scope and is a complex industry. Usually, when people think of the real estate business, they think only of residential bro- kerage. This is just one of several specializations within the real estate business, however. In fact, within the field of brokerage, there are several specializations, including farm and land brokerage, residential property brokerage, and commercial and investment property brokerage. In addition to brokerage, other specializations in real estate include property management, appraising, financing, construction, property development, real estate education, and government service. Real estate transactions can be traced to early written records from biblical times, but those transactions were between the seller and buyer directly, without the participation of a real estate broker. The business of real estate brokerage is a product of the twentieth century. In the early 1900s, states began enacting licens- ing law legislation, and today all states in the nation require real estate brokers or salespeople to be licensed. North Carolina adopted its Real Estate License Law statute in 1957. The establishment of the National Association of Real Estate Boards in 1908 was a major factor in the development of real estate brokerage. During the 1970s, the name of this trade group was changed to the National Association of REALTORS® (NAR). The term REALTOR® is a registered trademark of NAR, and it identifies licensees who are also members of the local, the state, and the national association. It is important to remember that all licensees are not REALTORS® and that only the active members of these associations may use the term REALTOR® or REALTOR ASSOCIATE®. One of the most important accomplishments of NAR and its predecessor organization was the creation of a Code of Ethics in 1913. This code has contributed significantly to the professional stature of real estate brokerage. Strong parallels exist between licensing laws and this original Code of Ethics. Defining Broker and REALTOR® The general public has a poor understanding of the distinction between a broker and a REALTOR®. The North Carolina Real Estate Commission issues real estate broker licenses and regulates broker’s practices. The term REALTOR® designates a licensee (bro- ker) who is also a member of the local association of REALTORS® at the city or county level, a state association of REALTORS®, such as the North Carolina Association of REALTORS® (NCAR), and NAR. The REALTOR® association is in no way associated with or regulated by the Real Estate Commission, although the two groups work together for the advancement of professionalism in the real estate business. © OnCourse Learning.  Scope of the Real Estate Business 9 Not all licensees are REALTORS®. North Carolina has approximately 94,500 licensees, of whom only roughly about one-third are REALTORS®. In addition to being answerable to the Real Estate Commission and to the civil and crimi- nal courts for wrong-doing or failure of duty, the REALTOR® is also accountable under the Code of Ethics to the local association of REALTORS®. Other significant contributions of NAR include efforts that have resulted in licensing laws being enacted in all states, legislative activity on the federal level to prevent unnecessary and harmful legislation from diminishing rights of private ownership in real property, and excellent programs of continu- ing education for members and nonmembers through NAR and its affiliated organizations. Relocation is a growing part of the real estate business. A vast relocation network exists. Many corporations offer transferring employees generous relo- cation packages, including paying the closing costs for selling old homes and purchasing new homes. Some corporations have in-house relocation depart- ments to assist employees with every aspect of their move. Others contract with third-party relocation companies to provide these services. Many corporations, relocation companies, real estate brokerage firms, appraisers, attorneys, and others who work with relocation belong to the Employees Relocation Coun- cil, which provides networking, research, education, and so on, to its mem- bers. In-depth coverage of relocation is beyond the scope of the text; however, new agents are advised to become familiar with the wants, needs, and expecta- tions of relocating individuals, families, and employers, as well as relocation companies. Real estate brokerage is the bringing together of buyers and sellers or land- lords and tenants for the temporary or permanent transfer of an interest in real property owned by others through purchase, sale, lease, or rental by a real estate broker for compensation. In North Carolina, such brokerage activities require a North Carolina broker’s license. The fact that real estate represents a growing percentage of the wealth in the United States illustrates the extremely broad scope and importance of the real estate business. The complexity of this business requires that agents have con- tinual interaction with people in a variety of other professions. Today’s real estate practitioner needs a basic knowledge of the many functions performed by other members of the real estate and allied professions. Real estate professionals must work with mortgage bankers or brokers to secure financing for their clients; appraisers to validate the value of the property; home inspectors and wood-destroying insect inspectors to determine the condi- tion of the property; developers and contractors when selling new construction; attorneys, surveyors, and insurance agents when closing properties; and govern- mental officials, such as tax assessors, environmental health specialists, and city and county planners when necessary. © OnCourse Learning. 10 CHAPTER 1 Basic Real Estate Concepts Successful real estate practitioners are also counselors and educators who must recognize the limits of their knowledge and guard against giving legal, accounting, or tax advice. The Real Estate Market A free market is one in which the buyer and seller negotiate a purchase and sale without undue pressure, urgency, or outside influence other than the principle of supply and demand. Although government regulations may indirectly affect the price of real estate or the costs of borrowing money to buy real estate, the govern- ment does not set real estate prices. The principle of supply and demand deter- mines real estate prices; thus, the real estate market is an excellent example of the free market concept. Market value, which is discussed in Chapter 13, depends on the free market concept. Special Characteristics The physical characteristics of land create special characteristics of the real estate market that do not exist in other markets. As noted previously, the immobility of real estate causes the market to be local in character, requiring local specialists who are currently familiar with local market conditions, property values, and availability. The nonhomogeneity, or uniqueness, of each parcel of real estate also requires that the market be local. Each parcel of real estate is unique, primarily because of its location. The physical characteristic of immobility also results in a market that is slow to react to changes in supply and demand. When supply substantially exceeds demand, existing properties cannot be withdrawn from a local market area and relocated to an area in which there is a higher demand. Conversely, when the demand exceeds supply, new supplies of housing and business properties cannot be constructed quickly. Therefore, after a recession, it takes many months for the supply to equal or exceed demand in the real estate market. Factors Affecting Supply and Demand Several factors affect supply and demand in the real estate market, on both the local and national levels. Examples of these factors include interest rates; avail- ability of financing for purchase and construction; population migrations; varia- tions in population trends and family formations; government regulations; local and national economic conditions; and the availability and cost of building sites, construction materials, and labor. Historical Trends Just as the economy as a whole is subject to peaks and valleys of activity that have recurred over the years with fairly reasonable regularity, the real estate industry, © OnCourse Learning.  Scope of the Real Estate Business 11 as a part of this economy, is similarly subjected to recurring periods of recession and prosperity. The real estate industry is often the first industry to feel the adverse effects of depressed conditions in the national and local economies. It may take the real estate industry longer than the economy as a whole to climb out of a reces- sion because of the inability of the real estate industry to react quickly to radical changes in supply and demand. But that is not always the case. In recent times, real estate has sometimes remained strong during a recession or led the recovery from an economic downturn. Another characteristic of the real estate cycle is that the real estate industry usually attains a much higher level of activity in prosperous times than does the economy in general. The Real Estate Practitioner North Carolina defines only one real estate license category, broker, since it became an all-broker state on April 1, 2006, eliminating the “salesperson” license category. All individuals or entities who want to engage in real estate broker- age activities in North Carolina must first be licensed as brokers. Many current brokers have received their licenses under previous criteria of either education and experience (criterion one) and the passing of a state examination (criterion two). Some have been licensed based on reciprocal licensing arrangements in other states. Those who met the criteria for and were licensed as brokers before April 1, 2006, can remain brokers with no provisional status attached to their licenses. Those who were licensed as salespersons as of that date were licensed automatically as brokers at that time, although with provisional status. All new brokers licensed after April 1, 2006, were granted licenses on provisional sta- tus. To remove provisional status, all provisional brokers must complete three 30-hour post-licensing courses and pass the course exams. A broker without provisional status is able to practice independently. A broker with attached provisional status is not. She must work under the supervision of a broker who is a broker-in-charge (BIC) until she has completed all post-licensing requirements to remove the provisional status and to practice independently. A provisional broker cannot become a BIC. A BIC must have a minimum of two years’ full-time real estate experience, which may be met as a broker regardless of provisional status or lack thereof; however, provisional status must be removed before becoming a BIC. Although the broker-in-charge is ultimately responsible for all actions of the provisional brokers she supervises, the provisional broker cannot escape responsibility for her duties and actions. Relationships between brokers and clients/customers, as well as relation- ships among brokers, are discussed extensively in Chapter 7. They are men- tioned in this chapter only to clarify the terminology used in this text. The word © OnCourse Learning. 12 CHAPTER 1 Basic Real Estate Concepts broker or agent is used when the text is referring to a broker or a provisional broker when differentiation between the two is not required. The terms broker and provisional broker are used to differentiate the two categories of licensees, when necessary. The successful real estate practitioner is not engaged in applying techniques of the “hard sell.” Rather, he is a counselor or an adviser working diligently to solve the problems of buyers, sellers, and renters of real estate. Everyone who contacts a real estate office has a problem. The problem involves real property— the need to buy, sell, or lease. The real estate practitioner’s ability to solve these problems for the benefit of others results in a successful career. Like any good counselor, the real estate practitioner provides information to, but does not make decisions for, the clients and customers. What information can and cannot be provided depends on several factors, but especially on the law of agency, which is discussed in Chapter 7. A career in real estate can provide the practitioner with satisfaction from serving the needs of people and with accompanying financial rewards. Success in the real estate business is built on knowledge, service to others, and ethical conduct in all dealings. The real estate practitioner must be knowledgeable in a variety of other sub- jects necessary to satisfactorily perform one’s obligations in real estate trans- actions. These other subjects, which are discussed in depth in later chapters, include property ownership and interests, transfer of title to real property, fun- damentals of residential construction, valuation of real estate, land use controls, fair housing laws, property management, insurance, and federal income tax implications of real estate ownership and sale. The real estate practitioner also must understand the meaning of the various real estate and legal terms used in real estate transactions. Finally, the practitioner must have a basic understand- ing of the various arithmetic problems that are common in the activities of real estate brokerage. Summary of Important Points 1. Real property includes the surface of the land, all improvements that are attached to the property, everything beneath the surface, and the airspace above the land. 2. Personal property (also called personalty or chattel) is the opposite of real property—that is, everything that is not real property is considered per- sonal property. Things that are readily movable—that is, not attached to the land—are personal property. 3. Real property has the physical characteristics of immobility, permanence, and uniqueness. © OnCourse Learning.  Summary of Important Points 13 4. Real property has unique economic characteristics based on its physical location (situs). 5. The principle of highest and best use of land is an all-important concept in land use. Failure to make the highest and best use of land results in a lower value. 6. Controls of land use are necessary to protect the vested interests of the gen- eral public as well as the interests of surrounding landowners. Land use controls can be private, such as private deed restrictions and restrictive cov- enants, or public, such as zoning ordinances. 7. The real estate business involves many specialties besides residential bro- kerage and requires knowledge of many fields, including finance, housing codes, government regulations, contract law, and appraisal. 8. A real estate market is local and is an example of the free market concept wherein buyers and sellers have adequate time and information to reach a purchase and sale agreement without undue pressure, and with factual knowledge of all important aspects of the transaction. The physical and eco- nomic characteristics of land create a market that is local and slow to react to fluctuations in supply and demand. 9. The effects of depressed economic conditions are sometimes felt by the real estate industry before other segments of the economy. Traditionally, the real estate industry has been slower to pull out of depressed economic periods, but typically it reaches higher peaks of activity and prosperity during pros- perous times than many other segments of the economy. In recent times, however, the real estate market has remained strong during a recession and sometimes has led the recovery from an economic downturn. 10. The real estate agent acts as an advisor or problem solver for the benefit of one’s clients and customers. Because the purchase of a home involves the seller’s most important financial asset and creates long-term financial obli- gations for the buyer, the agent must be thoroughly knowledgeable, compe- tent, and responsible. 11. Real estate investment offers the opportunity to earn profits through appreciation of the property value, tax advantages, and positive cash flow. Leverage allows an investor to earn a greater return on a smaller initial investment. Some of the risks involved in real estate investments are market value declines, property deterioration, and adverse changes in the surround- ing area. © OnCourse Learning. 14 CHAPTER 1 Basic Real Estate Concepts Review Questions Answers to the review questions are in the Answer Key at the back of the book. 1. All of the following are separable ownerships 6. The employment of the concept of highest in land EXCEPT: and best use: A. surface of the land. A. includes consideration of the physical and B. area below the surface. economic factors affecting land use. C. nonhomogeneity. B. results in the greatest present value of the D. air rights. land. C. must be a use feasible in the near future. 2. The characteristic of land that causes the real D. all of the above. estate market to be essentially a local market is the physical characteristic of: 7. An example of public land use controls is: A. indestructibility. A. restrictive covenants. B. immobility. B. zoning laws. C. availability. C. deed restrictions. D. natural features. D. protective covenants. 3. The nonhomogeneity of land: 8. Real estate investment offers the opportunity A. is the basis for the legal remedy of specific to produce a profit in the following ways performance. EXCEPT: B. results from the uniqueness of every par- A. appreciation. cel of real estate. B. positive cash flow. C. is a physical characteristic of land. C. specific performance. D. all of the above. D. tax advantages. 4. An increase in the economic supply of land 9. The real estate market may be described in all has resulted from: the following ways EXCEPT: A. increased utilization of the physical supply A. a free market. of land. B. a local market. B. modification by improvements to the land. C. a movable market. C. high-density development. D. a market that is slow to react to changes in D. all of the above. supply and demand. 5. The quality of the location of land and, 10. The function of a real estate agent in dealings consequently, the value of the land can be with buyers and sellers in the real estate changed by: market may best be described as which of the A. the principle of nonhomogeneity. following? B. relocation of the land. A. financier C. changes in the national scope of the real B. counselor or advisor estate business. C. contractor D. improvements to the land that result in D. salesperson accessibility not previously available. © OnCourse Learning.  Review Questions 15 11. The real estate agent must have specialized 16. Physical characteristics of land include all of knowledge of a variety of subjects that the following EXCEPT: include all of the following EXCEPT: A. location. A. financing. B. nonhomogeneity. B. contracts. C. permanence. C. legal advice. D. immobility. D. valuation of property. 17. The National Association of REALTORS® is: 12. Economic characteristics of real property A. a government organization. include which of the following? B. a trade group. A. location C. an organization for buyers and sellers of B. immobility commercial real estate. C. indestructibility D. all of the above. D. nonhomogeneity 18. Factors affecting supply and demand in real 13. Which of the following has the greatest effect estate include all of these items EXCEPT: on real property value? A. government regulations. A. tax rates B. interest rates. B. location C. local economic conditions. C. availability D. real estate investment trusts. D. indestructibility 19. Scarcity and location are examples of: 14. Which of the following is an example of the A. physical characteristics of the land. private control of land use? B. highest and best use. A. zoning C. permanence of investment. B. restrictive covenants D. economic characteristics of the land. C. building codes 20. All of the following are public land use D. environmental controls restrictions EXCEPT: 15. The term REALTOR® designates: A. building codes. A. any real estate licensee. B. protective covenants. B. a real estate licensee who is a member of C. zoning. the national, state, and local association of D. regional planning. REALTORS®. C. only licensees who hold broker’s licenses. D. all of the above. © OnCourse Learning.  CHAPTER PROPERTY OWNERSHIP 2 AND INTERESTS KEY TERMS air rights fixture nonfreehold estate alienation foreshore North Carolina Condominium appurtenance freehold estate Act appurtenant easement fruits of industry (fructus partition bundle of rights industriales) party wall condemnation fruits of the soil prescription condominium (fructus naturales) profit or profit à prendre cooperative hereditament pur autre vie co-ownership intestate succession remainderman curtesy joint tenancy reversionary interest declaration of restrictions judgment lien riparian rights defeasible fee land severalty dower lateral support subjacent support easement leasehold estates survivorship easement in gross levy tenancy by the entirety emblements lien tenancy in common eminent domain life estate tenements encroachment life tenant time sharing encumbrance lis pendens townhouse estate littoral rights Uniform Commercial estovers marital life estates Code (UCC) fee simple absolute mineral lease 16 © OnCourse Learning.  The Concept of Property 17 LEARNING OBJECTIVES At the conclusion of this chapter, you should be able to: 1. Define and give examples of real property and personal property. 2. Define and give examples of fixtures, as well as describe tests for determining whether an item is a fixture. 3. Define and list the freehold estates. 4. Define severalty and concurrent property ownership, including condominiums, townhouses, cooperatives, planned unit developments (PUDs), and time-share property. 5. List and define types of lien. 6. List and define types of easement. 7. Define encroachments and appurtenances such as water, air, and subsurface rights. 8. Describe real property taxation and special assessment systems in North Carolina. IN THIS CHAPTER This chapter begins the discussion of the various forms of real property ownership. Real estate is defined by (and is subject to) a complex and unique body of laws. Although you will be exploring a variety of legal terms, you should not give legal advice. Pro- viding legal advice or opinions is defined as the practice of law, which only attorneys are authorized to do. It is, however, the duty of real estate agents to recognize basic concepts of law as they affect clients and customers and to see that they are properly informed of their rights and obligations through appropriate legal counsel. THE CONCEPT OF PROPERTY Property is an individual’s, a group’s, or an entity’s ownership rights, interest, and legal relationship to something, tangible or intangible, to the exclusion of other individuals, groups, and entities. Property, therefore, may be considered a legally created and protected bundle of rights, which an individual, a group, or an entity has in a tangible item or an intangible concept. A bundle of rights includes the “When you purchase right to possession of the property; the right of quiet enjoyment of the property; the a property, you get a bundle of rights. The right to exclude others; the right to dispose of the property by gift, by sale, or by items in the bundle will; and the right to control the use of the property and profits within the limits of can be remembered by the law. The components of the bundle can belong to one owner or can be sepa- the acronym DEEPC: rated with rights or groups of rights belonging to different owners. Examples of Disposition, Enjoy- ment, Exclusivity, Pos- separate ownership of various rights in the bundle abound. For example, Hertz, session, and Control.” a corporate entity, owns cars (tangible property) but rents the right to use those —Terry Wilson, DREI cars (intangible property) to individuals; an owner of an office building leases office space (right to possess and use) to a corporation; and a landowner sells the mineral rights to his property while retaining all other rights. Note that owner- ship and lease rights may coexist within the same property at the same time. © OnCourse Learning. 18 CHAPTER 2 Property Ownership and Interests Property is divided into real property and personal property. Real estate practi- tioners must have a thorough understanding of the differences between real and personal property. Different laws apply to each type of property. Most items of personal property do not require written documentation of transfer of owner- ship, but all transfers of ownership of an interest in real property must be in writ- ing. Personal and real property are taxed differently. Owners’ and creditors’ rights differ depending on whether the property is real or personal. Real Property In Chapter 1, real property, also called real estate and realty, was defined as land and everything permanently attached to the land. A concept of the law of real property is that real property consists of lands, tenements, and hereditaments; therefore, everything included in the following definitions of these terms is a component of the property owner’s bundle of rights. Land is the surface of the earth; the area below the surface to the center of the earth; and the area above the surface, theoretically, to the highest heavens. Plants are either annuals or perennials. Annuals must be planted each year and are considered personal property. Annuals are also called fructus industriales. Perennials do not require annual cultivation and are considered real property unless planted in a moveable container. Perennials are also called fructus naturales. Land includes structures and other improvements (such as fences, swimming pools, flagpoles, and retaining walls) that have been placed there with the inten- tion that they be a permanent part of the land. Tenements and Hereditaments Tenements include all those things that are included in the definition of land and include both corporeal and incorporeal rights in land. Corporeal rights are tangible things—things that can be touched and seen. Incorporeal rights are things that are intangible. Tenements include buildings (corporeal). Tenements also include rights in the property of another, such as an easement (incorporeal). In addition, tenements include intangible rights in the land of another, such as the right to take minerals, soils, timber, fish, or game from that land. This right is called profit à prendre, or simply profit. Hereditament is a term that includes everything in the term land and everything in the term tenements that is capable of being inherited. The land and buildings are © OnCourse Learning.  The Concept of Property 19 capable of being inherited and are therefore hereditaments. Some personal rights in land, such as the right to fish and some easements, may not be inheritable. If these rights are not inheritable, they are not hereditaments. Things that grow in the soil may be included in the definition of real prop- erty. Growing things that do not require planting or cultivation but that grow naturally and are perennial are fruits of the soil (fructus naturales) and are desig- nated in law as real property. Examples include forest trees, native shrubs, and wild berries. Growing things that require planting and cultivation are fruits of industry (fructus industriales) or emblements and are defined as personal prop- erty. These are usually annual crops, and examples include corn, wheat, melons, and soybeans. The term emblements also is used to denote the right of a tenant to reenter the property and harvest the emblements after the termination of the tenancy. Appurtenances An appurtenance is any right or privilege that is said to “run with the land.” Therefore, it transfers with title to the land. Several of the items discussed next are examples of common appurtenances, such as subsurface, air, and riparian (water) rights. These three examples illustrate that an appurtenance cannot exist by itself; that is, the easement must attach to the primary item, the land that it affects. Other examples of appurtenances include appurtenant easements and the benefits of restrictive (protective) covenants (discussed later in this chapter). Subsurface Rights A subsurface right, or mineral right, is an interest in real property that allows the “Mineral, oil, gas and owner to take minerals from the earth. The owner may conduct mining opera- subsurface leases must be in writing in North tions or drilling operations personally or may sell or lease these rights to others Carolina.” on a royalty basis. A mineral lease permits the use of land for mineral exploration —Melea Lemon, DREI and mining operations. (The Statute of Frauds, discussed in Chapter 4, requires that such a lease be in writing to be enforceable.) The lease may be for a definite term or for a period as long as the land is productive. A mineral royalty is income received from leases of mineral land. Air Rights Ownership of land includes ownership of and the rights to the area above the sur- face of the earth (air rights). The right of ownership of the airspace enables the landowner to use that space to construct improvements, to lease, or to sell to others. The right of ownership and control of the airspace is limited, however, by zon- ing ordinances and federal laws. Zoning ordinances often restrict the height of improvements constructed on the land, and federal laws permit the use of the © OnCourse Learning. 20 CHAPTER 2 Property Ownership and Interests airspace by air traffic flying at an altitude specified by the government. As a prac- tical matter, a property owner is entitled to claim only the area above his land that he might reasonably be expected to use. Water Rights The appurtenant rights of an owner of property bordering a flowing body of water “When the river or are riparian rights. Riparian rights attach to the land but cannot exist by stream is navigable, themselves. Generally, property adjacent to a river or watercourse affords the you own to the water’s landowner the right to access and use the water for purposes such as drawing edge. When it is non- navigable, you own to water for personal use and entering the water via a boat pier. Actual owner- the center of the river ship of the water depends on a number of factors. North Carolina recognizes or stream.” the distinction between a navigable and a nonnavigable watercourse. In the —Tim Terry, DREI former, adjacent owners are limited to the banks of the watercourse, whereas the state owns the body of water and the right to use it. If one owner owns all of the land surrounding a nonnavigable body of water, that owner owns all of the land under the water. If more than one owner owns property surrounding a nonnavigable body of water, ownership extends to the center of the water, unless the deed states otherwise. Littoral rights are the rights of landowners whose property borders an ocean or a lake. If the water levels fluctuate, as with ocean tides, the landowner owns to the mean high watermark. The state owns the foreshore, which is the land between the mean high watermark and low watermark. An owner’s riparian property and property rights can be affected by changes in boundaries caused by the natural forces interacting with land and water. Although the geographic coordinates of land do not change, the part of the surface covered by the land and water can and do change over time. The real estate practitioner should understand the following four natural pro- cesses that affect riparian boundaries. 1. Accretion is a gradual process in which the boundary of riparian land is extended by natural forces, usually water from a river, a lake, or an ocean depositing soil, sand, or rock onto areas previously covered by water. This acquired land becomes the property of the riparian property owner. 2. Reliction is also a gradual process and results from the permanent receding of the water that leaves the ground under it dry and exposed. This acquired land becomes the property of the riparian property owner. 3. Erosion, the reverse of accretion, is a natural process in which the flow or movement of water gradually produces a loss of riparian land—for example, beach erosion. The riparian property owner loses title to the land. 4. Avulsion, unlike accretion, reliction, and erosion, is not a gradual process. It is a rapid or sudden change in riparian land, either loss or gain, result- ing from violent natural forces. There is no legal boundary change for land © OnCourse Learning.  The Concept of Property 21 affected by avulsion. The owner can reclaim the lost land. Theoretically, an owner retains title to and can reclaim land lost through avulsion; however, environmental laws may limit or void his right to do so. 5. Doctrine of prior appropriation is based on the theory that the first person to use the water has a continued right to do so and the later owners can make reasonable use of what is left. Lateral and Subjacent Support Land previously was defined as the surface of the earth; the area below the sur- face to the center of the earth; the air above the earth, theoretically, to the high- est heavens; and everything permanently attached to the earth. For purposes of understanding lateral and subjacent support, consider only the solid surface of the earth. The ground is surrounded by more ground or by water. Riparian rights, the rights of landowners whose property borders water, are well defined in law. The solid surface of land can be gained or lost by forces of nature or by man’s activity. What would happen if your neighbor decided to excavate the dirt from her land bordering your property for a project elsewhere? Unless your land is solid rock, the solid surface could shift, perhaps destroying or undermining the support of improvements on your land. Your neighbor cannot remove the dirt because you have a right of lateral support, which means the right of land to be supported in its natural state by adjacent land. Now consider the part of the land that is below the surface of the earth. Sup- pose you sell the mineral rights. The owner of those subsurface rights can mine beneath your surface, but she must support your surface rights from below. She cannot cause the surface of your land to collapse. Subjacent support is the right to have one’s land supported from below. Personal Property Personal property (also referred to as chattel or personalty) is anything that is not real property; therefore, it is not land or anything permanently attached to land. Unlike real property, it is readily, although not necessarily easily, movable. Some personal property can be severed, or removed, from the property (such as crops) and other property becomes a part of the real property by attaching or annexation (such as planting trees obtained from a nursery). Once attached, it becomes part of the real property unless excluded. Factory-built homes are another example of personal property unless steps have been taken to perma- nently affix it to the land including the requisite paperwork needed to convert it to being considered real property. Its “bundle of rights” is not identical to that of real property. Some property can be classified as real or personal property, depending on circumstances. Ownership of personal property is conveyed by a bill of sale. © OnCourse Learning. 22 CHAPTER 2 Property Ownership and Interests Fixtures Intent is the major determinant in deciding if an item is a fixture. A fixture is an item of personal property that is attached to the land or a perma- nent improvement on the land in such a manner that the law deems it to be part of the real property to which it is attached. Fixtures cause many problems because of misunderstandings by the parties involved. Real estate practitioners can avoid problems by thoroughly understanding the criteria for a fixture and paying care- ful attention to detail when listing and selling property. Total circumstance test. This test, composed of four criteria or factors, may be used to determine an item’s identification as a fixture in the absence of a contrac- tual agreement by the parties. 1. Intention: Did the person making the attachment intend to make a perma- nent improvement? Would it be evident to a reasonable, rational person that the annexor’s intention was that the improvement be permanent? For exam- ple, the owner of a property installs a ceiling fan in the family room. This criterion should be used in conjunction with the other criteria. If the owner expressly states her intention that the attachment is permanent, such as the sales contract stating the item is considered a fixture, and all parties involved are aware of the express intention, the express intention will rule without regard to the other three criteria. 2. Relation of the attacher: An owner is presumed to make a permanent improve- ment, whereas a renter may be presumed to make a temporary attachment. However, the real estate agent should not presume anything about the annexor’s ownership but should ask questions if a tenant is involved. If the real property owner has permanently attached personal property to his real property during his ownership, the attached property is usually considered real property. (See the paragraph “Effect of the Uniform Commercial Code” for an exception.) Once the item becomes real property, its ownership passes to the new owner when the present owner sells or otherwise disposes of the property, absent a contract or an agreement to the contrary. Take the exam- ple regarding the ceiling fan. If a tenant instead of the owner of the property were to install the fan, would his intention be that the ceiling fan remain with the property or would he plan to take down the ceiling fan he had pur- chased and replace it with the original fixture? 3. Method: Does the method of attachment mean that removal of the item will damage the property? Answering this question is a bit tricky. What consti- tutes damage? Is a small nail or screw hole damage? What is “permanently attached”? It may not actually need to be attached. This criterion absolutely © OnCourse Learning.  The Concept of Property 23 must be used in conjunction with the other circumstances. A small picture hanger on a wall likely does not constitute substantial or permanent attach- ment, but a pair of thousand-pound statues sitting on custom-made concrete pillars may. 4. Adaptation: How is the item being used? Is the item adapted to the real prop- erty to which it is attached? An example would be blinds custom made to fit nonstandard windows. The more “site specific” an item is the less obviously attached it needs to be in order to be considered an attachment. Courts have not been consistent in their application of the total circumstance test. If the courts cannot agree, buyers, sellers, and real estate agents are unlikely to always agree. Although real estate agents must understand these criteria, they should not give legal advice as to what is or is not a fixture in a given circum- stance. That would be practicing law without a license. They can avoid, how- ever, most problems in this area by using and understanding the North Carolina Bar Association/North Carolina Association of REALTORS® (NCBA/NCAR) Standard Form No. 2-T, Offer to Purchase and Contract, found in Chapter 10, page 276. Familiarizing the seller with this form at the time of listing and the buyer at the initial buyer interview, or at least by the time of the offer, is an excel- lent way to prevent misunderstandings. Test Tip! For an excellent list of fixtures that are important for testing purposes, refer to paragraph 2 of the Offer to Purchase and Contract (Chapter 10, Figure 10.2). The practitioner must ensure that all parties understand all contracts. This can be accomplished by clearly identifying fixtures and personal property in both the list- ing and the sales contracts. Real property can become personal property by contract. For example, a chandelier is personal property until it is installed in the house and then becomes a fixture upon installation. If the contract provides for the chandelier to be replaced with a less expensive one, the original chandelier again becomes per- sonal property upon removal according to the contract, and the new, less expensive chandelier, which is personal property when it is purchased, becomes real property when it is installed according to the contract. If the contract were silent about the chandelier, the buyers could reasonably expect the chandelier to be a fixture and to convey as real property. In some instances, something is considered a fixture simply because the contract states that it is a fixture even though the item does not appear to meet the standards for a fixture listed previously, such as a stove. Simply stated, if the contract says that an item is a fixture, then it is a fixture. © OnCourse Learning. 24 CHAPTER 2 Property Ownership and Interests Trade fixtures. A special category of fixtures is recognized for the items of per- sonal property that are used in the course of a business operating in a leased property. For example, a merchant may rent a store and install shelves to display “At the end of a lease, merchandise. These shelves are a temporary attachment necessary for the opera- trade fixtures remaining after the lease term tion of the business. A more complex situation would arise in the operation of are considered aban- a restaurant in a rented space. Consider all the items required in this operation, doned by the tenant including stoves, ovens, grills, chairs, tables, and so on. Such attachments are rec- and become the ognized as trade fixtures, and they retain their personal property classification real property of the landlord through the such that the restaurant tenant can remove them at the termination of the lease. process of ‘accession.’” The tenant remains liable for any damages caused by the removal of the trade —Tim Terry, DREI fixture at the expiration of the lease. Again, the agent must ensure that all understandings of the parties are sup- ported by terms of a rental contract. Recall, however, that only attorneys can draft contracts. Real estate practitioners would exceed their authority and be entering the prohibited practice of law if they attempted to write legal clauses in a contract. Agricultural fixtures. Agricultural fixtures are those fixtures installed by a prop- erty owner for the purposes of agricultural use. Although historically treated dif- ferently, they are now treated the same as trade fixtures. Effect of the Uniform Commercial Code. A special situation occurs when an owner has financed the purchase of an item installed in her property. The Uni- form Commercial Code provides for the lender to retain a security interest in a chattel (personal property) until the lender is paid in full. An instrument called a security agreement, which is put on the public record by the filing of a notice called a financing statement, creates the security interest. This notice is filed in the office of the Register of Deeds. The filing of the financing statement provides con- structive notice to the world that a security interest exists in the item. As a result, the attached item is not legally classified as a fixture, or a part of the real property, until the security agreement has been satisfied by full payment. It is treated as personal property of the homeowner until such time as it has been paid for in full. Before that time it can be repossessed by the creditor to satisfy repayment. Consequently, the lender can remove the item in the event the buyer/borrower “The application of the UCC to fixtures defaults in payment, even though the item has been attached to real property. keeps these items as Subsequent purchasers, as well as a subsequent lender, are bound by the filing of personal property or the financing statement. Therefore, a purchaser of the home or a lender accept- personalty until the ing the property as security for a mortgage must complete the payments or per- debt has been repaid.” —Tim Terry, DREI mit the removal of the item by the lender in the event the property owner does not satisfy the debt. Improvements Numerous improvements must be made to and on raw land to make it accessible and suitable for the various uses people have for it. An improvement is anything of value that is added to real property or anything that alters real property in © OnCourse Learning.  The Concept of Property 25 such a way as to increase its utility or value; however, these improvements do not include repairs and replacements. The definition has two parts: (1) private improvements, usually done on the land by the property owner; and (2) public improvements such as streets, sewers, water, and sidewalks done to the land by government or quasi-government organizations. From a practical point of view, the agent should make certain that all parties understand the meaning each party intends to convey when using the terms improvements, improvements to the land, improvements on the land, improved land, or improved lot. Improvements on the land done by property owners include structures such as buildings, paved driveways and walkways, tennis courts, fences, walls, and swim- ming pools. They do not include routine maintenance, repairs, or replacements. Improvements to the land done by government or quasi-government entities may include the following: 1. Roads, highways, and bridges built to make the land accessible. 2. Utilities such as electric power, water, sewer, gas lines, and phone lines brought to the site. 3. Modifications or improvements such as clearing, grading, and draining to make it suitable for its intended use. “Improved land” or “improved lot” could mean the land or lot has had improve- ments to it to prepare it for a building, or it could mean that improvements such as buildings have already been constructed on it. The important thing is for the agent to make certain that the meaning is clear when listing, advertising, and negotiating offers to purchase and in all other aspects of the transaction. Test Tip! For the National Exam section, the student should treat an improvement as an appurtance. Factory-Built (Manufactured) Housing Just like many components of a house today that are manufactured in a factory so is the case for entire homes. Although historically these type homes have been viewed as “less desirable” than a stick-built home, the reality is that manufactur- ing tolerances and conditions are superior to that of many site-built structures. The absence of weather-related delays, reduced theft, and the ability to literally work around the clock make this type of construction attractive in many ways. The reference to a “manufactured” home is a modern term for what many peo- ple traditionally have called a mobile home or house trailer. Today’s manufactured home is built according to rigid U.S. Department of Housing and Urban Develop- ment (HUD) standards and will have a HUD certification label affixed to the exte- rior of the structure. This type of housing can be considered either personal or real property depending on the steps taken by the owner. Initially the manufactured © OnCourse Learning. 26 CHAPTER 2 Property Ownership and Interests home is considered personal property and will be titled with the North Carolina Department of Motor Vehicles (DMV) much the same as an automobile is registered. One of the characteristics of the manufactured home is that it will be constructed on a permanent nonremovable steel chassis, although brokers need to be aware that some modular homes may utilize a steel chassis as well. The owner can convert a manufactured home to real property status by remov- ing the wheels, axle, and moving hitch and affixing the structure to a permanent foundation owned by the homeowner. Once this work has been completed, the owner can file an affidavit of conversion that cancels the title with the DMV, which will finalize the conversion from personal to real property. Once this is done, the owner will need to change the tax listing to show the unit is now real property and the bill of sale and lien will need to be changed to a deed and deed of trust as applicable. Unlike many other situations involving attaching personal property so that it may be considered real property, the manufactured home does not auto- matically convey to real property merely upon attachment. Until the appropriate paperwork has been completed and filed, the unit will remain personal property. Many people confuse modular housing as merely a type of manufactured hous- ing. Although both examples are clearly built in a factory, the modular home is built in accordance with state building codes and once constructed on the per- manent foundation will be considered real property. These type of units also will have an identifying label, including a serial number, that typically is affixed next to the electrical panel, under the sink area, or on the back of the unit. Most subdivision protective covenants that prohibit the construction of a man- ufactured home will not affect the ability of the property owner to construct a modular home on the lot. ESTATES IN REAL PROPERTY Definition of Estate An estate in real property is an interest in the property sufficient to give the owner of the estate the right to possession of the property. It is essential to understand the difference between the right of possession and the right of use. The owner of an estate in land has the right of possession of the land in addition to the right to use it. An easement owner, in contrast, has the use of the land but not the right to possess it; therefore, the easement is a nonpossessory interest in land. The Latin translation for the word estate is “status.” This indicates the relationship in which the estate owner stands with reference to rights in the property, and it establishes the degree, quantity, nature, and extent of interest a person has in real property. Types of Estate in Land Estates in land are divided into two groups: estates of freehold and estates of less than freehold (also called leasehold estates and nonfreehold estates). Two estates © OnCourse Learning.  Estates in Real Property 27 can exist simultaneously in land. The owner (lessor) of a property has a freehold estate. If she leases the property, the tenant (lessee) has a leasehold estate. Each of these two major divisions contains various groupings or subheadings. Freehold Estates Freehold is defined as an interest in land of at least a lifetime and therefore gener- “‘Freehold’ means ally is identified with the concept of title or ownership. Freehold estates may be fee that you are ‘free to hold’ the property. simple estates or life estates (see Figure 2.1). Fee simple estates are inheritable; You are the owner of most life estates are not. it. A leasehold estate Freehold estates are divided into two categories: estates of inheritance and is anything less than estates not of inheritance. ownership.” —Jim Hriso I. ESTATES OF INHERITANCE Estates of inheritance last a lifetime and continue after the death of the title- holder as they are passed on to one’s heirs. A. Fee simple estates 1. Fee simple absolute. The estate of fee simple absolute provides the great- est form of ownership available in real property. This estate may be described as fee simple absolute, fee simple, or owner- ship in fee. Ownership in fee simple absolute provides certain legal rights usually described as a bundle of rights. The owner in fee simple absolute may convey a life estate to another, may pledge the property as security for a mortgage debt, may convey a leasehold estate to another, may grant FREEHOLD ESTATES I. Inheritable A. Fee simple estates 1. Absolute 2. Determinable NONFREEHOLD ESTATES 3. Conditional (LEASEHOLD ESTATES) B. Life estate pur autre vie (inheritable during A. Estate for years RIGHTS IN THE LAND measuring lifetime) B. Estate from year to year OF ANOTHER II. Not inheritable C. Estate at will A. Conventional life estate D. Estate at sufferance A. Easements B. Marital life estate Note: Provide possession and B. Profits Note: Freehold estates control, but not title. Note: Provide a right, but not provide title. title or possession. FIGURE 2.1 Estates and rights in real estate property (in descending order of importance). Source: © 2019 OnCourse Learning © OnCourse Learning. 28 CHAPTER 2 Property Ownership and Interests an easement in the land to another, or may give a license to conduct some activity on the property to another. Some of these rights may be removed from the bundle, leaving the other rights intact. For example, if the owner conveyed a lease or an easement to another, the owner’s remaining rights would be a fee simple subject to the lease or easement. Fee simple owner- ship should not be confused with the quality of title. Ownership in fee means that the grantee owns it forever, not that it is free of title defects. Certainly an owner cannot expect to live forever, so the ownership con- sists of two periods of time, from receipt of title until the owner dies, and the period of time after the owner dies. The owner has the rights of owner- ship and use during his lifetime and then the ownership shall convey to his heirs (either by will or by the law of descent.). The word “fee” denotes ownership that is inheritable. Fee simple absolute, also known as fee simple or fee, means ownership forever or for at least a lifetime. Because the ownership is considered “for at least a lifetime” the use of the term “fee” does not mean that owner- ship is free and clear of any liens. It speaks more to the quantity of title (at least a lifetime) than to the quality (free of liens). “Fee simple defeasible, 2. Fee simple determinable. This defeasible fee or qualified fee estate is sometimes known as also an inheritable freehold estate in the form of a fee simple estate; a fee with a condition however, the grantor can terminate the title under certain conditions. subsequent or a fee simple determinable, An example of a fee simple determinable is a situation in which a gran- can be defeated and tor conveys title to a college and in the conveyance stipulates that the taken away.” title is good “so long as” the property is used for scholastic purposes. —Terry Wilson, DREI Title received by the college can be for an infinite period of time. If the property is not used for the purpose specified in the conveyance, how- ever, the title will automatically terminate and revert to the original grantor or the grantor’s heirs. 3. Fee simple subject to a condition subsequent. The fee simple subject to a condition subsequent can continue for an infinite period, as is the case with the fee simple absolute. The fee simple subject to a condition subsequent also can be defeated and, therefore, is a defeasible title. The fee simple subject to a condition subsequent is created by the grantor (the one conveying title), who restricts the future use of the property in some way. For example, a grantor may convey property with the condition that it can never be used as a landfill. As long as the prop- erty is never used for this purpose, the title will continue indefinitely in the name of the initial grantee or any subsequent grantee. Any use of the property for a landfill will violate the covenant in the deed and the original grantor or her heirs may reenter the property and take © OnCourse Learning.  Estates in Real Property 29 possession or go to court and sue to regain possession. By doing so, the titleholder’s estate is terminated. A grantor may want to convey a title this way for several reasons. In the case of the landfill, the owner may be protecting the property he owns that is close to the landfill. In the case of the college, the grantor may be highly committed to education but may not want to give up ownership of the property for any other reason. Notice that in the case of a fee sim- ple determinable, the estate in the grantee automatically terminates in the event the designated use of the property is not continued or a prohibited use is undertaken. This is contrasted with the fee simple subject to a condi- tion subsequent, in which the termination is not automatic. In the latter case, the grantor and/or the heirs must either reenter the property or go to court to obtain possession of the property and to terminate the estate in the grantee. It should be noted that qualified fee or use conditions based on race, color, sex, national origin, familial status, handicap, or religion are void because they are against public policy; therefore, if a qualified fee or use condition based on any of these factors appears as a condition of title, the title is really a fee simple absolute. B. Estates pur autre vie (for the life of another). These estates are measured by the lifetime of a person other than the person receiving the title. They may be willed or inherited by heirs of the life estate grantee if the grantee dies before the person who is the measuring life. These rights should not be confused with the more traditional, and noninheritable, conventional life estates. The pur autre vie is an inheritable right, should the life interest per- son die before the measuring life person deceases. For example, Dad may grant title to his son for as long as Mom (his widow) is still alive. If the son dies before Mom, the title to the life estate pur autre vie would pass to the son’s heirs, such as a grandson or a granddaughter. Therefore, the life estate is not only for the dura- tion of the son’s life, but will last until Mom’s death, as hers is still the measuring life. At Mom’s death, the life estate terminates. II ESTATES NOT OF INHERITANCE Estates not of inheritance are good only for the life of the tenant (free- hold) and do not pass on to his heirs, but rather are disposed of by some other method. In addition to being created by an intentional conveyance, life estates also can be created by operation of law. Life estates created by act of the parties are called conventional life estates, whereas life estates created by operation of law are called marital life estates. A. Conventional life estates (estate for tenant’s own life). A life estate is a non- inheritable freehold estate. It is created only for the life of the named life © OnCourse Learning. 30 CHAPTER 2 Property Ownership and Interests Testator/Grantor Grantee (life tenant) Heirs Upon grantee’s death, title reverts to grantor or testator’s estate when no remaindermen are named. Escheat (if no will and no heirs) FIGURE 2.2 Life estate in reversion. Source: © 2019 OnCourse Learning “Do not memorize tenant; that is, one who holds a life estate. The question arises as to what will that a remainderman happen to the estate at the death of the life tenant. If nothing else is specified means a 3rd party. It is better to remember in the conveyance of the life estate, it will revert to the grantor or to his heirs that any time a life at the death of the life tenant. The grantor or his heirs thus would have a estate ends and the reversionary interest in this case (see Figure 2.2). Alternatively, the convey- reversionary interest ance of the life estate could specify that the estate pass on to someone other does not return to the grantor then a remain- than the grantor or his heirs. This person would be called a remainderman der interest exists.” and has a remainder, or future, interest in the property. After the death of —Len Elder, DREI the life tenant, the remainderman would then have title in fee simple abso- lute (see Figure 2.3). B. Marital life estates. A marital life estate is created in North Carolina by the intestate succession statutes governing the distribution of prop- erty of one who dies intestate, that is, dies without leaving a valid Grantor (in a deed) Grantee Remaindermen or Testator (in a will) Example: Grandfather To son Then to grandson for life (remainderman) (life tenant) in fee simple To heirs if remainderman predeceases life tenant Escheat to the state if no heirs FIGURE 2.3 Life estate in remainder. Source: © 2019 OnCourse Learning © OnCourse Learning.  Estates in Real Property 31 will. This statute allows the surviving spouse to choose a life estate in one-third of the real property owned in severalty (sole ownership) by the deceased spouse at any time during the marriage under certain conditions. If the surviving spouse is entitled to any property of the deceased spouse through a will or intestate succession statutes and the surviving spouse has not joined in the transfer of such property by signing the deed, the surviving spouse must forfeit any interest in the deceased spouse’s property resulting from a will or an inheritance to claim her marital estate. Few surviving spouses elect the marital life estate option because it is seldom advantageous for them to do so. Several important points pertain to marital life estates: A will cannot defeat the marital interest of a surviving spouse. Statutes do not apply to property owned as tenants by the entirety. A surviving spouse has a choice of either marital life estate or property of the deceased spouse willed to the surviving spouse. From these requirements, you can see that it is extremely important for both husband and wife to join in the conveyance of any property owned by either of them while they are married. Otherwise, the grantee’s title could be affected by a marital interest of the surviving spouse. Some states still provide dower and curtesy rights to a surviving spouse. Dower is the wife’s right and curtesy is the husband’s right to a life estate in the property owned by a deceased spouse during the marriage. North Carolina’s intestate suc- cession statutes abolished dower and curtesy rights and provided a substitute, which sets forth the manner in which the property of an intestate (one who has died without leaving a valid will) is distributed to the heirs. Rights and responsibilities of life tenants. A life tenant has the right of alienation. That is, the life tenant can transfer her title to another person or pledge the title as security for a debt. Of course, the individual cannot give a title for a duration longer than her life or the life of the person named in the creation of a life estate to establish its dura- tion. The life tenant also has the right to the net income produced by the property, if any. The life tenant can legally mortgage the life estate. It is unlikely that a lend- ing institution would accept a life estate as security for a mortgage, however, because the estate terminates on the death of the life tenant. If the life tenant were able to do this, however, she would be responsible for the principal and interest on that mortgage note. An outstanding mortgage on the property is the responsibility of the grantor or the remainderman, and the life tenant must pay the interest but not the principal. A life tenant has certain responsibilities. He must not commit waste and must preserve the estate for the benefit of the remainderman or for the person who holds the reversionary interest. Otherwise, the life tenant is not answer- able to the future holder of the estate. The life tenant has a legal right called the right to estovers, which allows him to cut and use a reasonable amount of © OnCourse Learning. 32 CHAPTER 2 Property Ownership and Interests timber from the land to repair buildings or to use it for fuel, but does not allow the tenant to cut and sell the timber for profit. A violation of the right of esto- vers is called an act of waste. A life tenant has an obligation to pay the real property taxes on the property in which he has a life estate. The tenant also has the duty to pay any assessments levied against the property by a county or municipality for improvements to the property. Assessments are levied against land for improvements made to the land, such as paving streets and laying water and sewer lines. The life tenant also has a duty to make repairs to the improvements on the land. He cannot permit the property to deteriorate because of lack of repairs and thus cause depreciation to existing improvements. Many states recognize the primary home as a sort of life estate that can pro- vide some degree of protection from creditors. The North Carolina Home- stead Exemption Law protects an amount of interest, or equity, in the debtor’s personal residence, whether it is real or personal property, from creditors in the event of lawsuits, including bankruptcy filings. The current amount of protection is $35,000, which was increased from $18,500 in December 2009. Additionally, this act increases the amount of protection to a maximum of $60,000 in cases in which the resident is over the age of 65 and the property was previously owned in tenancy by entireties, or in joint tenancy with rights of survivorship, in which one of the former co-owners is now deceased. The property owner is helped by this act in the event of judgment liens obtained against her. The owner still would be obligated to pay property taxes and any mortgage balances due. Homestead exemptions in other states are relatively similar, although many are more extensive than those in North Carolina. Nonfreehold Estates The nonfreehold estates, also known as less-than-freehold or leasehold estates, confer a rental interest in real property. Four estates are recognized: 1. Estate for years is for any fixed period of time and automatically terminates at the end of that period. 2. Estate from year to year is a periodic estate that automatically renews at the end