The real estate market throughout Colorado is very hot to say the least. In “Hot Markets” mistakes happen more frequently. These “mistakes” can cost purchasers of residential and commercial property thousands. In Denver County hundreds of purchasers unknowingly bought income restricted properties that specify not only who can live/own the properties but also cap the amount of appreciation. This is not an isolated problem in Denver, various purchasers are finding out after the fact that the commercial or residential property they bought has restrictions/covenants. What free and easy steps must you take to protect yourself?
What happened?
A young couple purchased a house in Green Valley Ranch (Denver County) and have owned the house for about a year. They recently received notice that they were in violation of a covenant and would have to sell the house and vacate the premises. Unbeknownst to the buyer (and supposedly the seller) the property was part of Denver’s affordable housing initiative and had a covenant that limited who could buy the property and how much the buyers could make. Essentially the property was restricted to lower income buyers and must be sold below market. This is not an isolated incident, supposedly in Denver county there are over 300 homes that could have the same issues)
In this case, the buyers were unaware of the covenant and bought the house for more than prescribed amount in the covenant. According to the covenant the owners will need to sell the house to a person that meets the qualifications and the price will be less than what was just paid for the house.
Many of these buyers will be forced to sell the property at a huge loss to comply with the market cap that is set in the covenants (see 9news article ). If I had to guess this was disclosed in the title commitment since this was a recorded. The buyers failed to notice this item.
Is this limited to Residential or Commercial Properties?
This same issue is not limited to residential properties. Covenants/restrictions on use, ownership, etc… can also be found on all types of properties including farms/ranches, commercial properties, etc.… It is imperative that you know this prior to closing.
What steps must you take to protect yourself?
It is an unfortunate situation that the buyers are in, but this is an easily preventable situation. On any residential or commercial property buyers need to request title insurance and actually read the policy. There is a section on every policy that outlines exceptions. In the exceptions, general covenants, restrictions, easements, HOA covenants, etc… are listed. Most title policies have a link to the actual document where you can see the details as well. You need to click on this link to ensure you understand the restrictions.
These exceptions could be right of ways, income restrictions, disclosures of flight paths, restrictions on who can own the property, access / lack of access, if there are income restrictions, Caps on sales price etc… All of these items can have a huge impact on the value of the property.
If you are purchasing a commercial or residential property. The exceptions are items that excluded from coverage. For example, I was looking at a property and saw via the title policy that access was through a forest service easement. This easement was valid for 3 years and not a permanent easement. After the 3 years the owner may or may not have a right to access the road. The title company refused to insure the property for access. The owner of this property had paid cash and hadn’t bothered to read the title exceptions. He basically bought a landlocked piece of property that was worthless without insured access.
What should a lender do? As a private lender, we have made a process that requires one of the partners review and sign off on title exceptions. This is a critical piece in underwriting since a title exception can drastically alter the value of the property like in the case above.
Who will take a loss? With the deed restriction on market price, the property is worth substantially less than the appraised value. If the homeowner is forced to sell the property for less than their purchase price, they could easily be underwater on their mortgage. For example a lender made an 80% loan to value loan assuming the price was 300k, if the deed restricted sales price is capped at 200k, the borrower is underwater by 40k and the lender could take a 40k hit. I can guarantee that someone will get sued.
Who will get sued?
At the end of the day, a property owner is going to lose substantial money due to the unknow deed restriction. I can guarantee someone will get sued.
- The title company: I find it highly unlikely the title company would miss a deed restriction that has been properly recorded. In over 20 years in real estate lending, I have never seen a title company miss something like this. Since the title company is likely off the hook who is next?
- The realtor: The listing realtor is a likely prospect for a lawsuit. The covenant required that the listing advertise that the property was deed restricted. I would assume the realtor got a copy of the title as well and either didn’t read it or failed to act properly.
- The appraiser: The value of the property is substantially less than the appraised value. Should the appraiser have known about the deed restriction?
- The selling homeowner: If the selling homeowner knew about the restriction (or should have known) they definitely should have disclosed this info.
Know before you buy
It will be important to watch how this case in Denver unfolds and who gets sued along the way. It is much easier and cost efficient to notice an issue before a sale is consummated. Litigation after the fact is lengthy and expensive. The Denver case is a good wake up call to anyone in real estate including lenders, buyers, sellers, realtors, and appraisers. In fast moving markets it is easy to miss/ overlook exceptions. You need to make looking at understanding the exceptions a priority whenever you are purchasing a property to ensure you know what you are getting and are making a sound investment.
Resources/Additional Reading
- http://www.9news.com/article/news/local/next/people-in-denver-forced-to-sell-affordable-housing-they-didnt-know-they-bought/73-530761758
- http://www.9news.com/mobile/article/entertainment/television/programs/next-with-kyle-clark/denvers-safeguards-failed-to-protect-homeowners/73-533005437
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
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