Real Estate Exam Prep PDF

KEY CONCEPTS TO PASS YOUR REAL ESTATE EXAM PREPAGENT.COM Table of Contents INTRODUCTION..........................................................................................................................................5 DISCLAIMER...............................................................................................................................................5 WHAT IS A LICENSE?.................................................................................................................................5 THE -OR AND -EE RULE............................................................................................................................6 PROPERTY OWNERSHIP...........................................................................................................................7 BASICS......................................................................................................................................................7 Bundle of Rights................................................................................................................................... 7 Real vs. Personal Property..................................................................................................................9 Fixtures.............................................................................................................................................. 10 Trade Fixture...................................................................................................................................... 11 Appurtenance.....................................................................................................................................11 Encroachment....................................................................................................................................12 Emblements.......................................................................................................................................12 Water Rights......................................................................................................................................12 ESTATES..................................................................................................................................................13 Freehold Estates................................................................................................................................13 Fee Simple Absolute....................................................................................................................................... 14 Fee Simple Defeasible....................................................................................................................................14 Life Estate....................................................................................................................................................... 14 LESS THAN FREEHOLD ESTATES............................................................................................................... 15 Estate for Years..................................................................................................................................15 Periodic Tenancy................................................................................................................................15 Estate at Sufferance..........................................................................................................................15 Estate at Will......................................................................................................................................16 Leases...............................................................................................................................................16 Property Management....................................................................................................................................17 Types of Leases................................................................................................................................. 19 Gross Lease................................................................................................................................................... 19 Percentage Lease........................................................................................................................................... 19 Net Lease....................................................................................................................................................... 19 Lease Option..................................................................................................................................................19 EASEMENTS.............................................................................................................................................20 EXPRESS EASEMENTS..............................................................................................................................20 Creating an Express Easement.........................................................................................................20 Express Reservation....................................................................................................................................... 21 EASEMENT BY NECESSITY........................................................................................................................ 21 EASEMENT IN GROSS...............................................................................................................................22 IMPLIED EASEMENT..................................................................................................................................22 PRESCRIPTIVE EASEMENT........................................................................................................................ 23 GOVERNMENT POWER...........................................................................................................................24 4 POWERS OF THE GOVERNMENT.............................................................................................................24 - 1- Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com Police Power......................................................................................................................................25 Eminent Domain................................................................................................................................25 Taxation.............................................................................................................................................. 25 Escheat.............................................................................................................................................. 25 Zoning................................................................................................................................................25 EMINENT DOMAIN..................................................................................................................................... 27 AGENCY....................................................................................................................................................28 BASICS OF THE RELATIONSHIP..................................................................................................................29 AGENCY RELATIONSHIPS..........................................................................................................................30 Dual Agency.......................................................................................................................................30 Universal vs Special...........................................................................................................................32 Principal & Client................................................................................................................................32 Attorney in Fact..................................................................................................................................33 COMMUNICATION....................................................................................................................................34 TYPES OF FRAUD..................................................................................................................................... 34 Actual Fraud.......................................................................................................................................34 Negative Fraud..................................................................................................................................34 Constructive Fraud.............................................................................................................................34 Negligence.........................................................................................................................................35 Puffing................................................................................................................................................35 Stigmatized property..........................................................................................................................35 CONTRACTS.............................................................................................................................................36 BASICS....................................................................................................................................................36 VALID CONTRACT ESSENTIALS..................................................................................................................37 Capable Parties................................................................................................................................. 38 Lawful Object..................................................................................................................................... 38 Consideration..................................................................................................................................... 38 Offer and Acceptance........................................................................................................................ 38 VALID, VOID AND VOIDABLE......................................................................................................................39 VALID.................................................................................................................................................39 VOIDABLE.........................................................................................................................................39 VOID..................................................................................................................................................40 EXECUTED & EXECUTORY........................................................................................................................ 40 BILATERAL VS UNILATERAL........................................................................................................................ 41 TYPES OF CONTRACTS.............................................................................................................................41 Land Contract....................................................................................................................................41 Option Contract..................................................................................................................................41 Implied Contract................................................................................................................................. 42 LISTINGS................................................................................................................................................... 42 TYPES OF LISTINGS..................................................................................................................................45 Exclusive Listing................................................................................................................................45 Exclusive Authorization and Right to Sell Listing............................................................................... 45 Exclusive Agency Listing....................................................................................................................45 - 2- Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com Open Listing.......................................................................................................................................46 Net Listing.......................................................................................................................................... 46 EARNEST MONEY DEPOSIT.......................................................................................................................47 VALUATION & MARKET ANALYSIS........................................................................................................48 DEPRECIATION.........................................................................................................................................48 Types of Depreciation........................................................................................................................ 48 Economic Obsolescence................................................................................................................................48 Functional Obsolescence............................................................................................................................... 49 Physical Deterioration..................................................................................................................................... 50 EFFECTIVE AGE VS ECONOMIC LIFE.......................................................................................................... 52 DETERMINING VALUE................................................................................................................................52 Steps in the appraisal........................................................................................................................ 52 Essential Elements of Value..............................................................................................................53 Assemblage and Plottage..................................................................................................................53 APPRAISAL METHODOLOGY......................................................................................................................54 Gross Rent Multiplier.........................................................................................................................54 Cost (Replacement) Approach...........................................................................................................55 Unit-in-Place Method......................................................................................................................................55 Square Footage Method................................................................................................................................. 55 Quantity Survey Method................................................................................................................................. 55 CAPITALIZATION (INCOME) APPROACH.......................................................................................................56 MARKET DATA APPROACH........................................................................................................................ 57 APPRAISAL THEORY...............................................................................................................................58 PROGRESSION AND REGRESSION..............................................................................................................58 PRINCIPLE OF CONTRIBUTION................................................................................................................... 59 PRINCIPLE OF CONFORMITY......................................................................................................................60 PRINCIPLE OF SUBSTITUTION....................................................................................................................60 PRINCIPLE OF HIGHEST AND BEST USE.....................................................................................................61 Legally Allowable...............................................................................................................................61 Physically Possible............................................................................................................................ 61 Financially Feasible...........................................................................................................................62 Maximum Utility / Profitability.............................................................................................................62 FINANCING................................................................................................................................................63 FINANCING BASICS...................................................................................................................................63 “Assume” vs “Subject to”....................................................................................................................63 Servicing the Loan.............................................................................................................................64 INVESTING................................................................................................................................................64 ADVANTAGES OF INVESTING IN REAL ESTATE............................................................................................. 64 Appreciation.......................................................................................................................................64 Cash Flow.......................................................................................................................................... 64 Leverage............................................................................................................................................64 Equity.................................................................................................................................................65 DISADVANTAGES OF INVESTING IN REAL ESTATE........................................................................................ 65 Knowledge.........................................................................................................................................65 - 3- Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com Long Term Gains (Liquidity)............................................................................................................... 65 Risk....................................................................................................................................................65 INVESTING TERMS....................................................................................................................................65 Pyramiding.........................................................................................................................................65 Arbitrage............................................................................................................................................65 Syndication........................................................................................................................................65 Partnerships.......................................................................................................................................66 LOAN CLAUSES.......................................................................................................................................67 ACCELERATION CLAUSE............................................................................................................................ 67 ALIENATION CLAUSE................................................................................................................................. 67 PREPAYMENT CLAUSE..............................................................................................................................67 LOCK-IN CLAUSE......................................................................................................................................68 SUBORDINATION CLAUSE..........................................................................................................................68 TRUTH IN LENDING..................................................................................................................................68 APR........................................................................................................................................................68 LOAN TERMS............................................................................................................................................69 PRIMARY AND SECONDARY MARKET..................................................................................................72 PRIMARY MARKET....................................................................................................................................72 SECONDARY MARKET...............................................................................................................................73 FHA & VA...............................................................................................................................................75 Federal Housing Administration.........................................................................................................75 VA Loan.............................................................................................................................................. 76 TRUST DEEDS AND MORTGAGES.........................................................................................................77 TRUST DEEDS.......................................................................................................................................... 77 MORTGAGE.............................................................................................................................................. 78 PRACTICE.................................................................................................................................................81 FAIR HOUSING.........................................................................................................................................81 The Americans with Disabilities Act of 1990......................................................................................81 Blockbusting.......................................................................................................................................81 Steering.............................................................................................................................................. 82 SHERMAN ANTI-TRUST LAW......................................................................................................................82 - 4- Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com Introduction If you do not know what is in this book, there is no way you will pass your exam. These are the essentials to passing the exam. It is that simple. We cannot cover everything that may come up, but we want to make sure you know the essentials. That foundation should make you feel much more confident when sitting your exam. We make no claims that reading this book will make you a better agent. However, we do believe that this book should be an integral part of you passing that pesky exam so you can become an agent. At this point, that is our sole focus — getting you past the exam. Let’s get started! DISCLAIMER In your real estate practice and when sitting for the exam, some information in this book may conflict with other information you have been given: You need to also refer to information provided by your state licensing authority and any local pre-licensing courses you may be required to take. This book does not provide legal advice. Real estate sales and related issues are full of topics that many people, including attorneys, that require an attorney’s advice or that are best left up to an attorney. We unequivocally advise you that in any issue involving a legal matter, first and foremost, consult an attorney. Information can be obtained from your state licensing board. This will include a copy of the state license law, an application or a license, information on the content of the exam (if available), plus additional information about obtaining your real estate license. You may be able to get this information online. If you’re new to the field, you should request the “package of information” your state sends out for people who want to become a licensed salesperson. What is a license? A “license” is a personal privilege to use the land of another. A license is not considered a true interest in the land because it can be taken away at any time and does not transfer with title. - 5- Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com Examples of a license would include being able to park your car in a garage or having a ticket to the movie theater. A license can be created with a spoken (or oral) agreement like giving someone permission to fish in your lake. You are now getting your real estate license. Let's not forget why it is called a real estate license. Real refers to real property, and estate has to do with duration of ownership. THE -OR AND -EE rule The suffix "-or" is used for the person who performs an action. The suffix "-ee" is used for the recipient of that action. In real estate, you will hear words like: ▪ Grantor – Grantee ▪ Lessor – Lessee ▪ Vendor – Vendee ▪ Optionor – Optionee ▪ Trustor – Trustee ▪ Mortgagor – Mortgagee ▪ Offeror – Offeree The list goes on. The gist of it is, the -or gives and the -ee receives. A nice sentence to repeat to yourself and help remember this is: “GrantOR, lessOR, optionOR, vendOR makes me the givOR of the propetOR for your pleasOR.” - 6- Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com So if you see words like give, convey, sell — these require an -or. Try saying this phrase out loud: “GrantEE, lessEE, optionEE, vendEE, gives MEE propertEE, which makes me HapEE.” So if you see words like receive, purchase or acquire, you know these are likely to correspond to terms ending in -ee. It may sound silly, but when you are taking your exam and you see a question that you do not understand but you know one party is giving something and the other party is receiving something you can let yourself get a little excited: This is something difficult for some to get their head around, but with practice you should have no trouble with these kinds of issues. For example: A vendor sells to a vendee. The grantor conveys property to a grantee, who receives it. There may be a question which reads: "Who conveys property?" You see an option that says “Grantor” and another option is a “Grantee”. You may not know anything about deeds, but you know the answer is Grantor because -or refers to the conveyor. People often get confused with a mortgagor and mortgagee because they do not understand why the mortgagor is the -or when the borrower is the person receiving the money. What you need to remember is that it all depends on what is being received and what is being borrowed. The buyer is pledging the property, so he or she is mortgaging the property and is known as the mortgagor. The lender receives their pledge, and therefore is the mortgagee. PROPERTY OWNERSHIP BASICS Bundle of Rights The “bundle of rights” are the rights that come with property ownership. There are various rights or interests connected to property ownership. An interest is a privilege and/or legal share. When something is owed to a person by claim or legal guarantee, it is considered a right. - 7- Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com Property ownership is also subject to the rights or interest of others. The bundle of rights includes the right to: ▪ use ▪ give away ▪ sell ▪ mortgage ▪ lease ▪ rent ▪ enter ▪ refuse to exercise any of these rights The bundle of rights is an accepted way to explain what is involved in owning property. Teachers often use this concept as a way to look at difficult information regarding owning property. The bundle of rights is usually taught to explain how many parties can have an interest in the property as owning land is not as simple as buying property and acquiring all the rights to it. Think of it like this: In hockey, you have 6 players on the ice (5 plus a goalie). Each player is like a right. When a player gets a penalty, he must come off the ice. When the player is done serving the penalty, the team returns to full strength; but theoretically if every player was penalized, there would be no team left and it would be game over. - 8- Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com Let’s relate this to real estate: a mechanic's lien is a penalty. You will lose one of your rights just as if you lost a player in the hockey game — until the penalty has been released. Releasing that lien gives you back those rights or "players", and they rejoin the bundle held by the owner. In the United States (and under common law), the fullest possible title to real estate is called "fee simple absolute". But there are always some restrictions (or encumbrance) on property. Even the US federal government's ownership of land is restricted in some ways by state property law. Real vs. Personal Property “Real property” incorporates all things attached to the land and all rights inherent with that land. Real property usually involves things that are immovable such as homes and buildings. This is not always the case as there are examples of things that are movable and considered real property. However, as a general rule to help pass your exam remember: “Real = Immovable.” When you think of real estate, you think of homes and buildings. Remember: The word “real” has to do with things that are immovable, the word “estate” has to do with duration of ownership. That is why you are getting a real estate license. “Personal property” involves things that are generally movable. This can include items like furniture, jewelry, clothing, art, or other household goods. On your exam, you may hear personal property referred to as “chattels” or “personality”. To help you remember this, think of the word cattle. Cattle sounds like chattels. Cows like to “moo”, so chattels are moovable property! It may sound ridiculous, but when chattels come up in your exam, you may be relieved at the thought of those mooing cows! “Severance” is changing an item from real property to personal property by detaching it from the land. “Annexation” is adding to property by attaching an item to the property (so attaching personal property to real property). This creates a fixture. Annexation is can often also mean attaching a smaller piece of land to a larger one. Also, a smaller document may be annexed to a larger one, such as a codicil to a will. Although physical joining is implied, actual contact is not always necessary. In the law of real property, annexation is used to describe the manner in which a chattel is joined to property. For example, a sink becomes a fixture when it is annexed to the plumbing outlet and is therefore real property. - 9- Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com Fixtures One of the ways to remember the difference between personal property and real property is that personal property goes with the person and real property goes with the real estate. A “fixture” is personal property that becomes real property. This means that it was something that went with the person, but for it now goes with the real estate that is being sold. The classic example of a fixture would be a chandelier, as it is an item that was movable but is now attached to the property. Other examples might be a sink or a toilet. To remember this, remember the name “MARIA”. Can anybody say that name without singing the song by Blondie? Why should you be thinking about that song when they ask you about a fixture on your exam? Because MARIA stands for: ▪ Method ▪ Adaptability ▪ Relationship ▪ Intention ▪ Agreement Method of attachment. Is the item permanently affixed to the wall, ceiling or flooring using nails, glue, cement, pipes, wires, or screws? Even if you can easily remove it, the method used to attach it might make it a fixture. For example, ceiling lights, although attached by wires that can be removed the lights are a fixture. Adaptability. If the item becomes an integral part of the home, it cannot be removed. For example, a pool covering is a fixture because that cover goes with that pool, even though it can be easily folded up and put away. - 10 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com Relationship of the parties. If there is a dispute between buyer and seller, the buyer is likely to win. If the dispute is between tenant and landlord, the tenant is likely to win. This comes up in exams when dealing with emblements. These are crops grown on land that is being rented. Intention of party when the item was attached. When the installation took place, was the intention to make a permanent attachment? If so, the item is a fixture. Agreement between the parties. Read your purchase contract. Most contain a clause that expressly defines and agrees on items included in the sale. They often refer to: “All existing fixtures and fittings that are attached to the property.” Remember, what two people agree upon would trump all the other rules about a fixture. Trade Fixture A “trade fixture” is a piece of equipment on or attached to the real estate which is used in a trade or business. Trade fixtures are different from other fixtures because they may be removed from the real estate (making it personal property even if attached) at the end of the business tenancy, while ordinary fixtures attached to the real estate become part of the real estate. The business tenant must compensate the owner for any damages due to removal of trade fixtures or else repair the damage. It is important that you remember trade fixtures remain the tenant’s property, so they are personal property. An example of this might be a display case used by a clothing store or a dentist chair. The dentist’s chair would be a trade fixture as the chair is being used for the dentist’s business. Even though it is attached to the property, the dentist will take that chair with him when he moves to a different location. Appurtenance “Appurtenance” is a term for what belongs to and goes with something else. The appurtenance is always less important than what it belongs to. The word comes from the Latin appertinere: "to appertain." Appurtenance is something which belongs to something else, it an be attached or not; it could be a barn to a house, or an easement to land. The appurtenance is part of the property and passes with it upon sale or other transfer. - 11 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com Encroachment When you think of the word “encroachment” you might think of somebody stepping over a line from their side on to yours. For all of you football fans out there, think of all those times when a defensive team goes over the neutral line before the ball is snapped up. In real estate it is not all that different. An encroachment is when a structure or improvement on one person’s land physically intrudes on the land of another person. Examples might also include a fence or driveway which crosses the property line. Remember: your property line extends upwards to the sky, so a tree hanging over your property is also an encroachment. An encroachment can be found by a survey. Encroachment is a form of trespass, so when an encroachment occurs, you may be able to sue your neighbor for trespass. Emblements “Emblements” are annual crops which have been legally cultivated and belong to the tenant. The tenant has an implied right to its harvest, so emblements are treated as the tenant's property. They are considered personal property. A tenant farmer has the right to his crops even after his lease ends until the end of the growing season. Crops grown on property just before it’s sold are also generally considered the personal property of the seller. Remember that personal property goes with the person. This comes into play in the law of landlord and tenant, or in the foreclosure of mortgages and other legal situations that place the rights of another party in conflict with those of a farmer who has planted a crop which has not yet been harvested. In these situations, the doctrine of emblements operates to guarantee the farmer's right to harvest the fruits of his labor even if he loses title to the land on which they are grown. Water Rights No one has title to water. Property owners whose land is next to bodies of water have a “reasonable” right to the use of the water, but that water is not theirs so there are limits on what you can do with that water. “Riparian rights” allow a property owner to use water from moving water such as a river stream or creek. - 12 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com “Littoral rights” concern properties next to an ocean, sea or lake rather than a river or stream. Littoral rights are usually to do with the use and enjoyment of the shore. An easy to way to remember this is that riparian rights have to do with water that is moving in one direction, littoral rights have to do with water that does not have a direction. Think Riparian = River, Littoral = Lake. Repeat this to yourself and you should remember. “Correlative use” allows a property owner the use of underground water or water from a river for irrigation. In states where water is scarce, the “doctrine of prior appropriation” determines the use of the water. According to this doctrine, the use of the water is determined by the state, not the owner whose property is next to the body of water. “Accretion” happens when soil is brought by the water and increases the size of the property. When water moves back and new land is acquired, this is called “reliction”. “Erosion” is when land or soil is worn away by wind, water, currents, or ice. If natural causes tear away land in a violent way, this is called “avulsion”. A dam breaking or an earthquake is an example of avulsion. ESTATES Freehold Estates A “freehold estate” is an estate where you have exclusive right to enjoy the possession of a property for an indefinite period of time. In contrast, a “less than freehold estate” is for a fixed, defined period. The three types of freehold estates that come up on the real estate exam are: ▪ Fee simple absolute ▪ Fee simple defeasible ▪ Life estate - 13 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com Fee Simple Absolute A “fee simple” (or “fee simple absolute”) is an estate in land. This type of ownership cannot be claimed by the previous owner or the previous owner’s heirs; however, it is not free from encumbrances. Fee simple absolute is the greatest interest in a parcel of land that you can possibly own. Sometimes, it is simply called "Fee". It is the most common way of owning real estate in common law countries, and is usually the most complete ownership interest that can be had in real property (except for absolute title). Fee simple ownership is absolute ownership of real property and is only limited by the four basic government powers of taxation, eminent domain, police power, and escheat. It could also be limited by some encumbrances or a condition in the deed. You do not really need a memory technique to remember this as long as you understand what the word absolute means. It means complete and unrestricted. Fee Simple Defeasible A “defeasible estate” is created when a grantor puts a condition on a fee simple estate (in the deed). This means that if a particular event happens, the estate could be lost. Two types of defeasible estates are the fee simple determinable and the fee simple subject to a condition subsequent. - The grantor may state a specific duration such as: "I grant this to A as long as the land is used for a park." If or when the specified event happens, the estate will automatically end and go back to the grantor or the grantor's estate; this is called a fee simple determinable. - The grantor may state a specific condition such as: "No alcohol to be served." This would be a condition subsequent. You could lose title if you serve alcohol. Life Estate A “life estate” is an interest in real property which lasts the duration of one person’s lifetime. This may be the lifetime of the person holding the estate or it may be the lifetime of another person. For example, Anne can give a property to Dan for the life of Anne. Dan would be the life tenant. A life tenant receives the property and is responsible for maintenance of the property and paying taxes. If a life tenant allows a property to deteriorate, it would be “committing waste” — and a life tenant cannot commit waste. - 14 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com A life tenant cannot leave the property to someone in their will. A life tenant may sell, mortgage, or lease the property for the duration of the estate. So any contracts would end upon the death of the life tenant. For example, if Dan dies and the property were to go back to Anne, Anne would have the estate in reversion. If Anne dies, then the property would not be Dan’s because he had it as long as Anne was alive. On Anne’s death, the property would go to Lisa, and then Lisa would have the estate in remainder. LESS THAN FREEHOLD ESTATES A “less than freehold estate” is an estate held by someone who rents or leases property. It is also known as a “leasehold estate”. The key element of a less than free hold estate is the limitation of time. Lease is a legal estate, so leasehold estate can be bought and sold on the open market. A less-than-freehold estate could be an estate for years, periodic tenancy, estate at will, or an estate at sufferance. Estate for Years An “estate for years” is a leasehold interest in land for a fixed period of time. It is often called a “tenancy for years”. An example of an estate for years would be a summer rental, as it has a definite beginning and end date. There is no need to give notice at the end of the rental. So a lease for six months would be an estate for years, and a lease with a specific beginning and end date would be an estate for years as well. Periodic Tenancy “Periodic tenancy” is also known (confusingly!) as an “estate from years to years”. It is a tenancy that is not bound to a lease with a fixed period — like an estate for years. A periodic tenancy follows a period such as a month-to-month, week-to-week, or year-to-year. To end the lease, proper notice must be given. Estate at Sufferance An “estate in sufferance” happens when the tenant wrongfully holds on to a property after his lease has ended; this is often called a 2tenancy at sufferance”. - 15 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com An example of an estate at sufferance would be a tenant that does not pay rent. In simple terms, the landlord is suffering. This is not a form of trespass as at one point the tenant did have the right to be on the property. The landlord would have to legally evict the tenant in this situation. Estate at Will “Estate at will” means that it can be ended at any time. It all depends on the will of both parties. An estate at will gives the lessee the right to possession until the estate is terminated by either party; the term of this estate is indefinite. This is not allowed in many states. Leases In a lease, the landlord is the lessor and the tenant is the lessee. Oral (or spoken) leases can be binding. Generally, however, leases are written and give exclusive possession of the property to the lessee with a reversionary right to the lessor. A “reversionary right” means the owner has the right to take back possession of the property after the lease has expired. Just like in any other contract, a valid lease must contain mutual agreement, consideration, capable parties, and lawful object. The lessee has the right to “quiet enjoyment” and possession of the property, which means that their possession will not be disturbed by anybody with superior title (the landlord). The lease is a bilateral contract because both the landlord and tenant have obligations. The lease agreement can restrict the way the tenant uses the property and give certain conditions regarding the security deposit and the duration of the rental. Death does not usually end the lease. If one of the parties dies, the responsibilities stated in the agreement could pass on to the heirs of the deceased. Generally, when a property is sold the new owner has to honor the lease, however this isn’t always the case. Leases are personal property as they do not always run with the land. It is a contract with an individual person. Unless the lease forbids it, the tenant has the right to sublet or assign the property. An “assignment” is a transfer of contract rights, unlike a sublet where you rent the property and lease it to another person and still have a responsibility to your landlord under the rental agreement. - 16 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com “Constructive eviction” is a term used in property law to describe a situation where a landlord either does something or fails to do something that he has a legal duty to do. An example might be if the landlord refuses to provide heat or water to the apartment — as a tenant cannot live without water — so the tenant vacates the premise. This would be constructive eviction. Property Management A “property manager” has a fiduciary relationship with the owner. The main goal of the property manager are to generate the highest net income while maintaining the value of the property. A property manager is a general agent of the owner because they are engaged in an ongoing business relationship. Most states recognize property management contracts as personal service contracts that would end upon the death of either party. Most states require property management agreements to be in writing. A property manager may be paid according to the gross or net income the property produces. The duties of a property manager include: ▪ Preparing the budget. ▪ Allocating the money for fixed expenses, operating expenses, and reserve funds. ▪ Selecting quality tenants (which involves being familiar with the market rent versus the contract rent). ▪ Offering concessions to attract tenants. The lease agreement should say when the rent is due. If the lease does not give a date, rent is due the last day of the leasing period. The property manager should maintain good relationships with the tenants. The duties of maintaining the property include hiring contractors or employees and overseeing their work. - 17 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com The property manager must keep funds for capital expenditure like remodeling and renovating the property. A property manager should have knowledge of the following: ▪ Market conditions ▪ Record keeping ▪ Expenses ▪ How to handle environmental hazards ▪ Risk management Risk management involves judging whether insurance is needed to protect the owner and manager from certain risks such as: ▪ Loss of revenue ▪ Liability from injury of anyone on the premise ▪ Loss due to fire ▪ Medical coverage for employees ▪ And casualty losses The four options a property manager has for avoiding risk are: ▪ Avoid the risk by removing the problem. ▪ Deal with the risk by purchasing insurance with a large deductible. ▪ Control the risk by installing protective equipment. ▪ Transfer the risk by obtaining insurance with no deductible. - 18 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com Types of Leases There are different types of leases that come up on your exam. Gross Lease A “gross lease” is a rental agreement where the tenant pays a fixed amount which never changes as a result of changes in the various expenses of the property. The landlord pays for these expenses, which might include repairs, taxes, and operating expenses. It is the opposite of a net lease where these costs are covered by the lessee. Percentage Lease A “percentage lease” is a rental that is based on a percentage of the monthly or annual gross sales made on the premises. Percentage leases are common with large retail stores, especially in shopping centers. A fundamental concept of the percentage lease is that both the landlord and the tenant should share in the advantages of the location. There are many types of percentage leases: the straight percentage of gross income, without minimum (which is uncommon); the fixed minimum rent plus a percentage of the gross; the fixed minimum rent against a percentage of the gross, whichever is the greater amount; and the fixed minimum rent plus a percentage of the gross, with a ceiling to the percentage rental. There are also others. Net Lease A “net lease” is where the lessee has the responsibility to pay taxes, insurance, and maintenance as well as the monthly lease payment. This is often referred to as a “triple net lease”. Lease Option A “lease option” is a rental agreement where the tenant has an option to buy the property during the term or at the end of the lease. Here, the owner of the property would be the optionor, the tenant would be the optionee. “Consideration” is given to the optionor to secure the option for the optionee. The consideration can be monthly payments or it can be money up front towards a down payment on an already established amount. If the optionee exercises the option, title would revert back to the time the contract began, not when the option was exercised. - 19 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com EASEMENTS An “easement” is when one person has the right to use the land of another for a specific purpose (such as access to their property). The easement “runs with” the land, meaning that when the property is sold, the right transfers to the new owner. You will often hear two terms when dealing with easement: “ingress” which means to enter, and “egress” which means to exit. Easements must be in writing. An “appurtenant easement” involves two properties, owned by two different owners. The two properties involved are called “dominant” and “servant”. If you are not sure about who is who, just think about what the two words mean. “Dominant” means they are dominating; so, they are in charge. “Servient” means they are serving; so therefore, the servant is serving another person. So, the dominant tenement is walking all over the servient tenement. This may be confusing sometimes, as the dominant tenement’s property is usually smaller than the servant tenement’s property. But hey, Napoleon was a small guy and he always seems to "dominate". EXPRESS EASEMENTS In many ways, the “express easement” is the best way to create an easement. There are two ways to create an express easement: Creating an Express Easement Express Grant An express easement created by “express grant” is given by the servient estate to the dominant estate. This type of express easement is usually bought and bargained for. For example, one neighbor may want to build a parking pad or basketball court off of their driveway, but may not have enough room on their lot to do so because their driveway already butts up against the property line. This owner may offer to pay her neighbor $500 for his consent to grant an express easement to build a parking pad and basketball court off of her driveway that extends over his land by ten feet. - 20 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com Express Reservation An express easement created by “express reservation” is when the owner of one large piece of land splits the land into two or more pieces. She places an easement on one or more pieces of land to allow access to the other parcels. For example, imagine a farmer who owns 40 acres of land. The eastern side of his land borders the best lake in the state, so he decides that he is ready to give up his rusty old tractor and sell his land to a developer for a hundred million dollars, so he can spend the rest of his days fishing. The only problem is that the farmer’s home, which he spent 10 years building with his own two hands and has every intention of living in until his final days, is on the far west side of the 40- acre property; the only way to get to the lake is by driving over the eastern half of the property. The farmer may expressly reserve an easement, at the time when the property is split into several parts, allowing him to cross the newly established property to the east of his homestead in order to reach the lake. Here, he has created an “express reservation”. EASEMENT BY NECESSITY An “easement by necessity” is similar to an “implied easement”. It is an easement created by the courts. In fact, an easement by necessity is in many ways a type of implied easement. Courts will only create an easement by necessity when the easement is necessary to the use of some piece of property. Most often, easements by necessity occur when a certain piece of land is completely landlocked and would otherwise have no other access to a road. So if your land were completely landlocked, and the only way to get to your land was by crossing over Bill's property, an easement by necessity would exist giving you access to the road over Bill's property. However, if at some time in the future other options come up and the necessity no longer exists, neither will the easement. In other words, an easement by necessity can and will only last for as long as it is necessary to achieve its result. Given our previous example, if at some later time the city buys some land next to you and puts in a new road that now gives you direct access without having to cross anyone else’s property, your previous easement by necessity over Bill's property will disappear because it is no longer necessary. In that case, the easement by necessity would be “extinguished”. - 21 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com EASEMENT IN GROSS An “easement in gross” involves only one property. An example of this would be a utility company which needs to cross the property but they are not trying to get to another. In an easement in gross there is no dominant property. It is a right for a specific person (or legal entity), not a piece of property. So if you have an easement in gross to cross your neighbor’s land on to your land, it means that the easement is for your own personal use, and may not be a right which would be included with your land if you sell your land. An easement in gross does not transfer with the property when it is sold. This is very common for utility companies. They need to cross people’s property but they are not going to another property. IMPLIED EASEMENT An “implied easement” is an unrecorded easement which is legally necessary; it could be for light, air, or access to a land-locked parcel. This is a fancy way of saying that it is an easement that is created by the courts. The idea behind implied easements is that courts understand that people are not always going to do things the “right way.” Shocking, I know! The truth is that sometimes people are not well-informed, sometimes lawyers mess up, and sometimes even the best neighborly relationships go bad. In the end, one property owner may be left without a driveway that he had always used ever since he first bought the property because his neighbor decided that she doesn’t want him driving over her property anymore. So, instead of forcing one owner to figure out a new way to enter and exit his property, the court will step in and create an implied easement. The idea is that despite the fact that no express easement was ever created; both parties had always intended that this easement exist, and this intention is obvious in the way they used the land in question. Often, we see implied easements happen when a property owner divides her property into smaller pieces but didn’t create express easements at the time the property was divided. How do you create an implied easement? - 22 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com You must show that there was unity of ownership of the dominant and servient estates and that the use was: 1. apparent 2. in existence at the time of the grant 3. permanent 4. continuous 5. reasonably necessary to the enjoyment of the premises granted PRESCRIPTIVE EASEMENT A “prescriptive easement” is a bit like taking land from somebody else. At first glance, many people see prescriptive easements as little more than stealing because it is acquired without paying money but rather by just using it without permission. Let’s look a little more closely and see what a prescriptive easement really entails, though. A prescriptive easement is defined as: “an easement created from an open, adverse, and continuous use, hostile to the true owner’s title over a statutory period.” To which your response may be: “huh???” This definition may sound as if it’s written in another language, however it is simply a concise way to describe what a prescriptive easement involves. So now, let’s break it down into something a little easier to digest. If you want to establish a prescriptive easement over someone else’s property, you have to be using the property in the same kind of way you would use a normal easement (so like a pathway, driveway extension, garden, etc.). As an example, assume that you have a driveway on the edge of your property that runs alongside your neighbor’s property. It happens to be built on what you thought was the border, but it turned out to be five feet onto your neighbor’s side. Your use must be “open” and “notorious”. What this means is that you cannot hide your use from everyone, especially the property owner. If you only ever run home across the back of your - 23 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com neighbor’s yard at 2 in the morning, when you know for a fact that the neighbors are on vacation, this would not count as “open” and “notorious”. The above example of the driveway, however, is visible to all. The next important qualification to establish a prescriptive easement is that the use must be “adverse”. What this means is that the use must be done without permission from the owner. So, let’s go back to our above example with the driveway. If your neighbor knows that part of the driveway is on her land and told you it’s okay, she has given you permission — so it is not “adverse”. This does not mean, however, that your neighbor doesn’t know about your use, only that they haven’t given you permission. Finally, the use has to be “continuous” for a statutory period; this period varies depending on what state you are in. Continuous use does not necessarily mean that you use it every day or even every week. Continuous is not the same as constant. Often, it comes down to the court to decide whether or not the land was being used often enough to be considered continuous. In our example of a driveway along your property border with your neighbor, the use would most definitely be continuous — as the driveway is there every minute of every day, and you use it on a relatively regular basis. Thus, if you did accidentally build a driveway on what you thought was your land, and used the driveway for 15 or more years, the odds are that you have gained a prescriptive easement on that portion of your neighbor’s land. GOVERNMENT POWER 4 POWERS OF THE GOVERNMENT To remember the government powers just think of the name PETE: ▪ P for Police Power ▪ E for Eminent Domain ▪ T for Taxation ▪ E for Escheat No ordinary individual has any of these rights. - 24 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com Police Power “Police power” is the state’s right to regulate an individual’s conduct or property to protect the health, safety, welfare, and morals of the community. This comes up a lot on the exam. Unlike the exercise of “eminent domain”, the state does not need to pay compensation for using police power. Common examples of police power are: zoning, building codes, rent control. Eminent Domain “Eminent domain” refers to the power of the state to take property for a public use. In some jurisdictions, the state gives its eminent domain powers to public and private companies (often utilities companies) so they can run telephone, power, water, or gas lines. The owner of any appropriated land is entitled to “reasonable compensation”, usually defined as the fair market value of the property. Taxation A charge on real estate used to pay for services provided by the government. Escheat “Escheat” is where property goes back to the state because an individual has died without a will and without heirs. Escheat ensures that property always has an owner, which is the state or government if nobody claims the property. Escheat is usually done on a revocable basis — which means that ownership of the estate or property would revert to a rightful heir if they eventually come along. There’s no easy way to remember this one other than to imagine the government “cheated” to get the property because they didn’t even know the person who died. We’re not trying to get political here — this is just a way to remember what the word means. Zoning “Zoning” is the regulation of private land use and development by local government. There are no federal zoning laws. Zoning is an essential part of a master plan. This may be a plan for the long-term development of a particular area. Zoning increases the marketability of property. After all, would your house to be next to a gas station? Well, luckily for you, the gas station would not want to be near you either. This is where zoning comes in. - 25 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com Zoning is a police power. Do not think of the men in blue when you think of police power. Remember, the police power is the state’s power to create laws to maintain public health, safety, morals, and general welfare. Zoning for land use is generally divided into: ▪ Residential ▪ Commercial ▪ Agricultural ▪ Industrial ▪ Special use properties Each of these land uses also falls into a specific subdivision. For example, a multi-family unit would be zoned as R-3 where the R stands for Residential. “Special purpose properties” would be for properties that are there to benefit the public such as: ▪ Schools ▪ Hospitals ▪ Police Stations “Zoning ordinances” are a set of laws which control the: ▪ Height of buildings ▪ Setback ▪ Density ▪ Floor area ratios - 26 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com ▪ Buffers ▪ Buffer zones ▪ Variances A setback is the distance from the edge of the road or sidewalk to the structure that was built. It can also be the distance from the center of the road, check with your local zoning to see where the setback line is for you. Density is usually associated with subdivisions and restricts the number of houses that can be built per acre within that subdivision. A floor area ratio is the ratio of square footage to land area. The floor area ratio can be used in zoning to limit the amount of building in a certain area. A buffer is found between two lots, such as a fence, wall, or a row of trees. A buffer zone is a space of land between two use districts such as a park, playground, or a highway. Down-zoning is a change in zoning to permit less intensive developments than are currently permitted. So for example, a zone could go from commercial to residential. A variance is an exception to the zoning rules. A variance is only granted in exceptional situations and if it will not affect the rest of the community. For example, suppose a "low density residential" zone requires every house has a setback of no less than 100 feet. If one particular property was only 100 feet deep, it would be impossible to build a house on the property. A variance could exempt the property from the setback rule and allow a house to be built. Variances are granted lot by lot. EMINENT DOMAIN If you say it fast enough it would sound like you are saying “imminent doom”. Although it is not that scary, it is not that far off! - 27 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com “Eminent domain” is the power of the state to seize a citizen's private property, to expropriate property, or to seize a citizen's property rights. This is what makes it scary. But it is not all bad as you would get monetary compensation. The property can be taken for government use or on behalf of a third party for public or civic use. In some cases, it could be taken for the purposes of economic development. The most common uses of property taken by eminent domain are for public utilities, highways, and railroads. Some jurisdictions require government bodies to offer to purchase the property before resorting to the use of eminent domain. The term “condemnation” is the name for the act itself whereby title is transferred from its private owner to the government. It may not be the entire property; it could also be a smaller part of it or an interest in it, like an easement. In most cases, the only thing that remains to be decided when a condemnation action is filed is the amount of just compensation to be paid (note that is a common question on real estate exams). Do not confuse “condemnation” with a property being “condemned”. That would be when a building has become so dilapidated that it is legally unfit for human habitation. The second type of condemnation of buildings (on grounds of health and safety hazards or gross zoning violation) usually does not take away the owner’s title but does require them to sort out the situation or else the government will do it at the owner's expense. “Inverse condemnation” is where the government takes private property but fails to pay the just compensation. The owner then needs to sue the government to get any compensation. That's right, inverse condemnation is essentially suing the government. An example would be if the city widens a boulevard and thereby takes the entire parking lot of a market. The city offers to pay for the lot, but the market claims it has lost all its business since no one can park and now it wants the value of the entire parcel, including the market building. In this situation they would file for inverse condemnation. AGENCY “Realtor” is a term within the trade, much like the term “Kleenex”. The catch is that many people use the word realtor as a generic term, in the same way as you might ask for a Kleenex when in fact any brand of tissue would be fine. Saying that you are a realtor means you are part - 28 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com of that designated organization known as "the board of realtors". Therefore if you are not a realtor, you cannot say you are a realtor. An “agent” is an individual or corporation who represents another. The other person or corporation is known as the “principal”. A real estate broker does the representing and this relationship is called an “agency”. And three parties are referred to in agency law: a “principal”, an “agency”, and “third persons”. In real estate transactions: ▪ the agency is the real estate broker who represents a client for specific purposes; ▪ the principal is the client (such as a seller, buyer, landlord, tenant, lender, or borrower), who hires a broker to sell or lease property, to locate a buyer or tenant, or to arrange a real estate loan with other persons; ▪ third persons are individuals or associations (corporations, limited partnerships, and limited liability companies) other than the broker’s client. The broker contacts these third persons on behalf of his client. BASICS OF THE RELATIONSHIP The principal asks the agency to do certain things for them. The principal is legally bound by the acts of the agency, as it has been entrusted with carrying out duties on behalf of them. An agency can be created by: 1. express agreement, whether oral or written; 2. implication, based on the custom or practice of the trade; 3. conduct of the principal. Under the legal doctrine of estoppel, the principal must admit to the existence of an agency if it is properly formed. As a real estate agent, the term “fiduciary relationship” comes up on a regular basis. A fiduciary relationship is a legal relationship that creates a position of trust and confidence. The acronym ACOLD will help you remember your duties in a fiduciary relationship. - 29 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com As an agent, you must: ▪ A - be Accountable ▪ C - use Care and skill ▪ O - Obey legal instructions ▪ L - be Loyal to your client ▪ D - Disclose all pertinent information. When we say “loyalty”, what we mean is that the principal’s interest must come before anyone else. It means keeping confidential information confidential — so any information that would affect the bargaining position of the client. An example of this would be to not disclose that the client is going through a divorce. The “law of agency” defines the rights, duties, and responsibilities of all legal parties. An “agency relationship” is a relationship in which an agent is authorized to perform certain acts on behalf of a principal. If the agency relationship changes at any time during the transaction, the change must be disclosed in writing, and the party must give consent to the change. AGENCY RELATIONSHIPS Dual Agency Dual agency! Sounds like something out of a James Bond thriller, doesn’t it? Sadly, it is not that exciting, but the meaning is not far off what you might imagine in the movies. This is a broker working for the good guys and the bad guys. You will often come across this when studying for your real estate exam, and people will often tell you: “You will never use that after you pass!” That is not entirely true. This will come up in your real estate career quite a bit. - 30 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com There are times when a buyer and a seller could enter into a dual real estate agency with their real estate broker. This is not necessarily a bad thing; it all just depends how it is handled by the people involved. This usually happens when potential buyers don’t have an agent. They contact a seller’s agent either at an open house or through an ad. They ask the seller's agent to submit an offer on their behalf. If the agent does this, the agent would be acting as a dual agent. Dual agency in a real estate transaction means the broker represents both the seller and the buyer. Dual agencies can occur with one or two agents. To understand this further you have to remember that the agent is not the one being hired, the broker is. This may seem odd as a client only ever has contact with the agent and may never even see the broker. But the agent works under a broker. Therefore, technically speaking, the agent is always looking for business for the broker, not themselves. When the transaction is completed, the broker is the one who is actually paid the commission. The broker will share the commission with the agent who found this bit of business and who completed the transaction. Understanding this will help you understand how a dual agency can often occur when there are in fact two different agents involved. The buyer’s agent and the seller’s agent may be licensed under the same broker. With dual agencies there is a potential conflict of interest for the buyer and seller and this is why it is not allowed in some states. In states where dual agencies are allowed, the real estate agency must inform both the buyer and seller of a dual agency in writing. Dual agency puts some restrictions on a real estate agent. Have you ever had to mediate an argument between two friends or even a couple? It can be uncomfortable because the two parties are at odds, and you must be looking out for both their interests and can’t take one person’s side. The agent has to treat both buyer and seller with fairness and honesty. The agent has to give full disclosure about the property but cannot reveal confidential personal information to either party. Because you are looking out for both parties’ interests, when it is time to make an offer the real estate agent cannot advise the buyer or seller on the price to offer and/or the price to accept. In short, the agent’s loyalty is now compromised as they cannot try to advance the interests of one party over the other. You have to stay totally neutral. - 31 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com Universal vs Special A “universal agent” is one who has been given full power to act on behalf of a person or business. A “general agent” is authorized by the principal to perform any and all acts in the on-going operation of the job or business. So, a real estate licensee acting as a property manager is a general agent to the owner. A “special agent” is one who has limited authority granted by the principal. The relationship with the principal is not expected to be continuous. The listing contract creates a special agency relationship with the seller. They can only fulfill certain duties written down in the listing contract, and the relationship ends when the terms have been fulfilled. Principal & Client A “principal” is any person involved in a contract, such as a seller, buyer, principal broker, or an owner who has hired an agency as a property manager. A “client” is a party who has signed an agreement with an agency, and this agreement creates a fiduciary relationship. A customer uses the services of a real estate licensee but signs no agreement with an agency. So this could be a person who sees an ad in the paper and calls the agent. Even though there is not a fiduciary relationship with the customer, the licensee must act honestly and fairly with the customer. When you list a property, you are representing the seller. As a licensed real estate professional it is your duty to make sure that the buyer understands that you represent the seller. A seller who enters into a listing contract with a brokerage firm is a client of the listing agent’s company, not of the agent themselves. The brokerage firm and the listing agent must act on behalf of the seller’s interest. When a real estate broker enters into a contract with a buyer, the buyer becomes the client and the seller becomes the customer. A buyer’s broker may be paid by the seller, the buyer, or both. Because of the contractual relationship, the agent is still a buyer’s agent even if the seller pays the commission. - 32 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com Attorney in Fact An “attorney in fact” is a person authorized to sign documents on someone’s behalf. It can mean any person who has been empowered to sign documents for another individual. When an attorney in fact signs a document, the signature should also include the name of the principal. For example, if Bob is signing on behalf of Bill, the signature might read, “Bob, attorney in fact for Bill” or “Bill, signed by Bob, attorney-in-fact.” Attorneys in fact may only be used for acknowledgments. So basically, as far as those documents are concerned, Bob is Bill for that one act of signing. This is essentially what attorney in fact means on its most basic level. You are given the authority to be that person for that one act. Note: Do not confuse this with being a practicing lawyer. - 33 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com COMMUNICATION TYPES OF FRAUD Actual Fraud “Actual fraud” is an intentional misrepresentation or a representation which suppresses or distorts the facts. It can also be making a promise with no intention to follow through. Essentially, you are straight up lying. An example would be telling a buyer that the roof of a property is completely fine when you know full well that it is not okay at all. It would also be actual fraud for the agent to say: "Don’t worry about the roof — if you buy this house, I will personally fix it, you have my word," when they don’t even know how to fix or have no intention of fixing it. Negative Fraud “Negative fraud” is lying through omission. It happens when somebody does not disclose a material fact in order to get somebody to enter into a contract that could put that person in a bad situation regarding money, damage, or even personal harm. An example would be an agent showing a home with roof problems and the client asking, "are there any issues with the structure of the roof?" and the agent replying, "have I shown you the basement?" Constructive Fraud “Constructive fraud” is lying without knowing you are lying. You didn’t necessarily intend to deceive somebody. An example would be an agent showing a home with roof problems and the client asking, "are there any issues with the structure of the roof?" and the agent replying, "yes, its fine — the roof is great," when the roof in fact has problems. The agent thought the roof was fine. When this occurs you may hear the agent say, "Whoops, my bad." - 34 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com Negligence “Negligence” is failing to perform a duty or exercise a reasonable level of care in a certain situation. Negligence is typically due to a lack of time, forgetfulness, or just plain laziness. For example, if an agent is listing a property and there is a question regarding the zoning, the agent should contact the zoning office. Usually, this can be determined by a phone call or checking the website. If the agent knew that there was a question regarding the zoning of a property and did nothing, the agent could be found guilty of negligence. Fraud may take the form of either misrepresentation or negligence. In either case, the agent may be liable for damages incurred by the buyer because of the misrepresentation or the agent may face disciplinary action and lose their license. The owner may also be liable for damages because of the agent’s misrepresentations even if the owner was not the source of the misinformation conveyed to the buyer. Puffing “Puffing” is an exaggeration of a fact. Many agents are guilty of puffing when showing a house. We have all heard agents say, “MAN!! This is enormous!!” It’s not lying, but it’s close. Who knows, maybe it is the biggest house the agent has ever seen, but more than likely the agent is exaggerating to create a sale. Puffing is usually an exaggeration made by a salesperson or found in an ad regarding the quality of the property or the service on offer. It is really more of an opinion than a fact, which is why it is usually not considered binding. Puffing is legal as long as the statements themselves are not fraudulent. Stigmatized property “Stigmatized property” means that a property may be undesirable for reasons unrelated to its physical condition or features. These can include murder or suicide or even a belief that a house may be haunted. - 35 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com It is the seller's responsibility to disclose any such past history of the property. CONTRACTS BASICS An agent must have a working knowledge of contract law, because every aspect of the business deals with the contract. A contract is an oral or written agreement to do or not do a certain thing. Many oral (spoken) contracts are valid and enforceable. However, most contracts involving real estate must be in writing to be enforceable. The statute of frauds says that documents that must be in writing to be enforceable. In most states, real estate documents such as sale contracts, deeds, and mortgages must all be in writing. Some states allow an oral listing for less than one year. But to receive compensation, a broker needs an employment contract in writing. So it is in an agent’s best interest to have a written listing agreement. Many real estate contracts contain a “time for performance”. For example, a listing contract has an expiration date. An offer has a time period. And a sales contract has a date by which the buyers must inspect the property, secure a mortgage commitment, and a close the sale. If a time period is not specified, the law allows a reasonable time to complete the contract. When the phrase “time is of the essence” is written in the contract, it means that everything must be done within a specific time. If the requirements are not met, the promisor will have breached the contract and the promisee can cancel the contract. An “as is clause” in a contract means the buyer is buying the property as he sees it, with all existing conditions. The seller is still bound to disclose property defects, but not to make repairs. An “assignment” is the transfer of contract rights from one party to another. This could be the transfer of a right, title, or interest in a property. A contract is assignable unless the contract or state law forbids it. Personal service contracts are usually not assignable. The party transferring the contract is called the assignor; the party receiving the transferring contract is called the assignee. - 36 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com So for example, let’s say two years ago you entered into a five-year lease agreement and opened your business. Today, a party wants to buy your business. If you sell your business, and assignment is permitted, you may assign your lease to the new owner. If the lease is assigned, you are the assignor and the new owner is the assignee. The landlord would now expect the lease payment from the new owner. An assignment does not relieve the assignor from liability unless “novation” has been granted. Novation is the substitution of one contract for new one and it takes away liability. Just remember “Nova” is Latin for “New”, hence Novation — a new contract. A “liquidated damage clause” is a provision in a contract for damages if a party breaks the agreement. In a sales contract, the earnest money may be considered liquidated damages if the parties agree. That is, if the buyer breaches the agreement, the seller may keep the earnest money. “Specific performance” is a court action to force a contract to be carried out. For example, if all the requirements of a contract have been met, but the seller refuses to sell the property, the buyer may sue for specific performance. Brokers do not sue for specific performance. A contract is cancelled when there is an agreement between the contracting parties to waive all remaining duties and to terminate the contract. This means returning the parties to the same legal position they were in before entering into the contract. It is called a “rescission”. VALID CONTRACT ESSENTIALS The essentials of a valid contract are: ▪ Capable parties ▪ Lawful object ▪ Consideration - 37 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com ▪ Offer and acceptance Capable Parties To be a “capable party”, the person must have the legal capacity to contract. Typically, this means the person must be at least 18 years old and of sound mind. Other competent parties would include: ▪ A person given authority to enter into contracts on behalf of a corporation. ▪ A person with a proper power of attorney. ▪ A fiduciary given the authority to contract. ▪ An “emancipated minor” - somebody under 18 who is legally allowed to act on their own behalf because they got married, served in the military, or through court action divorced their parents. Lawful Object A contract must be entered into for a legal purpose. For example, when you see in the movies a contract to kill, that is not really a contract because it’s not lawful. A contract like this with an illegal purpose is void. A contract must also be entered into freely, without duress, threats, blackmail, misrepresentation, or fraud. Consideration Normally, when we think of consideration we think of money, but consideration can be anything of value. It is bargained for and received. Consideration can even be love and affection. Offer and Acceptance “Offer and acceptance” is also called mutual consent or a meeting of the minds. An offer must contain the exact terms and conditions, and the offer must be accepted without changes. The offer must be clear in character, the property must be accurately described to identify it, and you must give an exact price. - 38 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com You cannot offer to buy a house for “a whole lot of money”. You must say one million dollars or whatever the exact amount is you are offering. Don’t forget the "or -ee" rule! The offeror is the party giving the offer; and the offeree is the party receiving the offer. In real estate, the offer is usually made by the buyer and received by the seller. An offer must be accepted without change by the offeree or the offeree’s authorized agent. Before accepting, an offer or counteroffer can always be refused. An offer is terminated by death or insanity of the offeror or offeree. Destruction of the property; or a material change can also be cause of termination. A counteroffer occurs when the seller changes any of the terms made by the offeror. This reverses the legal position of the parties and the offeror becomes the offeree, and the offeree becomes the offeror. This means the counteroffer is a brand new contract. VALID, VOID AND VOIDABLE A contract can be classified as “valid”, “void”, or “voidable”. VALID A “valid” contract is one that meets all the basic elements of contract law. For example, you sign to buy a blue house, the house is blue, thus the contract is valid. VOIDABLE A “voidable” contract allows the option to rescind to either party. When the contract is written, it is valid but it could be voided in the future. Most sales contracts are voidable contracts because they contain contingency clauses. For example, remember that blue house you wanted to buy? Well, you signed a contract for a blue house but now you show up and the house is green! This is voidable not void! That is because the violation of the contract should not stop you from being able to buy the house. You signed for a blue house, but maybe you also like the color green? That is why you have the option to continue with the contract making it voidable not void. - 39 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com A “contingency” is where things depend on a specific event that must occur before a contract is binding, so: providing for a blue house when you sign for a blue house. If a contingency provision cannot be met, the contract can be legally voided such as in the example given. Contracts that are entered into under duress, misrepresentation or fraud are voidable. If you are put under duress, that makes a contract voidable not void. For example, if a gun is put to your head with a person saying, "Sign the contract or else I will shoot!" that is being put under duress in its most intense form. But even that does not make the contract void. It is voidable because that person pointing the gun at your head should not take away your ability to purchase the property. What if you actually like the property? Well, now you can still buy it, even though you were put under duress as the contract is voidable, not void. VOID A “void” contract has no legal force. It is missing an essential element; thus it is not a contract. A contract to kill, for example, would be void, because it has an illegal purpose. You do not have the option to kill somebody! A more common example is if one of the parties involved is legally deemed mentally incompetent. If that is true, the contract is void as it violates one of the four essential elements of a valid contract. Which are — mutual consent, lawful object, capable parties, and consideration. EXECUTED & EXECUTORY An “executed” contract is when all parties have fulfilled their promises. For example, a sales contract is complete when the transaction closes. Do not confuse an executed contract with the act of signing a document, which is execution of the document. An “executory” contract is where one or both parties still have obligations yet to be performed. For example, a sales contract is an executory contract until the buyer gets financing, and the seller proves they have a clear and marketable title. - 40 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com BILATERAL VS UNILATERAL A “bilateral” contract is one where there is a promise for promise. Sales contracts and listings are examples of bilateral contracts. In a listing contract, the seller promises to pay if the agent finds a buyer. A “unilateral” contract is a one-sided agreement, that is, only one party makes a promise to do something. A lease option is a unilateral contract until the option is exercised. Another example of a unilateral contract is a lost dog sign, you find the dog, you get paid, but you are not promising to go and look for the dog. TYPES OF CONTRACTS Land Contract A “land contract” is a financial agreement between a vendor and a vendee. Generally, title is held by the seller until final payment is made. The land acts as a security device. Usually, the seller is responsible for paying taxes and insurance because the seller holds legal title to the property. A land contract is also known as a “contract for deed”, “an agreement to purchase and sell”, or a “land installment contract”. In a land contract, the seller is the vendor, and the buyer is the vendee. The buyer has an “equitable interest”, which means a beneficial interest in the property and gives the holder the right to acquire legal title in the future. Option Contract In an “option contract”, the seller is the optionor and the buyer is the optionee. It is a unilateral contract because the seller must sell, but the buyer has the option to buy. When created, an option contract is a unilateral contract. But when the buyer uses the option, it becomes a bilateral contract. The option is assignable to another party unless the contract forbids it. In a “lease option”, the lessee agrees to lease the property with an option to buy the property. - 41 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com The option is usually given in exchange for consideration; this could be money up front or added to the rent. The lessee would be the optionee and the lessor would be the optionor as they are giving the option to purchase at a designated time. Implied Contract An “implied contract” is a contract that is not in writing and is lawful because of the actions of the parties and the circumstances they are in. How does that happen? An old saying comes to mind: “If it walks like a duck, smells like a duck, and sounds like a duck, then it must be a duck.” If it looks like a contract, then it probably is! LISTINGS A “listing” is an employment contract between principal and broker where the broker is being employed to find a buyer and accept a deposit. It is the most essential element of a broker- principal relationship. A listing hires a broker to find a buyer, not to sell a house. This is an important distinction. Another important distinction: Remember the seller hires the broker to find a buyer, not the agent. People think they are hiring the agent because for all practical purposes they are, as that is who solicited the business and will be conducting the transaction. But in actuality, the agent is working on behalf of the broker, therefore when the house sells and the seller pays a commission, that commission is going to the broker, not the agent. The broker will then share the commission with the agent as per their agreement. The next big question people have is, "If you are telling me that the broker is hired to find a buyer, then what does the agent of the buyer do?" Think of it like this; The broker of the seller says to all the other brokers and their agents “I’ve been hired to find a buyer for Mr. Smith’s property on Oak tree Lane! If you have a buyer and they buy this property, I will share my commission with you for helping fulfill my contract with Mr. Smith.” The amount that is going to be shared must be disclosed to the seller. Now, in real life they do not stand on a house and use a megaphone, but that is the gist of how it works. The more commonly accepted way is to put the property on the MLS. - 42 - Pass your exam with interactive practice exams, videos, webinars and more at PrepAgent.com MLS stands for Multiple Listing

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