REAL PROPERTY LAW. Chapter 6. Ellen Szymanski 1 and Roberto O. Soto INTRODUCTION

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1 Chapter 6 REAL PROPERTY LAW Ellen Szymanski 1 and Roberto O. Soto INTRODUCTION The Washington State economy provides foreign investors with many opportunities to invest in the real estate market, including office, retail, commercial, industrial, agricultural and residential properties, just to name a few. The body of laws regarding real property is among the oldest and most well established in Washington State. Many of the basic concepts are similar to those established in other countries. However, real property law concerns the property in a particular location, which means there can be differences even between the various counties in the state. Real property law also has unique terminology that may be different than other legal terms with which foreign investors may be acquainted. Whether real estate is the primary aspect of your business in Washington, or merely a collateral consideration for your investment plans, you should seek expert legal advice. This chapter provides a basic overview of purchasing and leasing real property in Washington State Definition of Real Property The term real property generally means land and improvements permanently affixed to the land, though each real estate contract will provide its own definition. Personal property encompasses everything else, such as automobiles and furniture. Different laws govern the ownership, sale and leasing of personal property. This article only discusses real property, which will be referred to as real property or property interchangeably Laws and Regulations of the Real Estate Industry The real estate industry is subject to numerous state statutes (codified law), case law (a court s interpretation of the law) and local regulations. Americans have a long history of private ownership of real property and therefore have a cultural fascination with owning real estate. There are separate statutes for types of property such as timeshares, condominiums, mobile homes, agricultural lands, Indian lands, public lands, and forest land. Statutes also govern the type of interest in property such as easements, fee ownership, licenses, and leases. Case law interprets these statutes and regulations. Case law changes over time so it is important to seek 1 Ellen Szymanski is a real estate attorney with the Seattle office of Graham and Dunn, PC. Ms. Szymanski wrote the 2003 version of this chapter. 2 Roberto O. Soto is a real estate attorney with the Seattle office of Williams Kastner & Gibbs, PLLC. He is a graduate of the University of Washington (B.A. and J.D.). Mr. Soto wrote the 2010 update to this chapter. 49

2 DOING BUSINESS IN WASHINGTON the counsel of attorneys specializing in real estate who keep abreast of changes in statutes, regulations and case law Real Estate Agents Most commercial property is purchased, sold, or leased with the help of a state-licensed real estate broker. The duties and responsibilities of real estate brokers are governed by statutes, case law and the particular contract between an agent and principal. See, e.g. RCW Although not technically needed for a transaction, a broker will be employed by most parties to market their property or search for property. Real estate brokers (also called agents) have access to the Multiple Listing Service, a central database where the majority of properties in the country are listed for sale. There are buyers agents and sellers agents (also known as the listing agent). In some circumstances, parties will choose one agent to serve both parties (also known as a dual agent ). However, using a dual agent is not recommended for transactions between unrelated parties. Each real estate agent (the seller s agent and the buyer s agent) is paid a commission from 2 to 3 percent of the purchase price of the property for a total of 4 to 6 percent of the purchase price. The seller typically pays real estate broker commissions at closing. 6.2 PURCHASING REAL PROPERTY Once you find the property you wish to purchase, you must negotiate the terms of the sale. Each transaction is different. An experienced attorney will draft an agreement that meets the needs of your transaction. It is imperative that the agreement provide the terms you want, as resolving later disputes may rest entirely on the contents of the agreement Real Estate Contracts Industry Standards Although parties are free to negotiate any terms they want, there are industry standard provisions that appear in most contracts. Deviations from the industry standards should be a point of negotiation between the parties. There are common law and statutory restrictions that govern interpretations of these agreements. However, when courts adjudicate contractual disputes of real estate transactions, their overriding purpose is to determine the intent of the parties and decide each dispute on this basis. The lesson to keep in mind is to say what you mean in your real estate contract in case you do not have an opportunity to explain to a judge what you intended to say in the contract Specific Performance Purchaser s Remedy The purchaser of real estate will want the purchase and sale agreement to have a provision for specific performance as a remedy if the seller defaults. Specific performance allows the court to order the seller to complete the sale as opposed to ordering the seller to pay monetary damages to the purchaser. Importantly, specific performance is not available as a remedy in every type of contractual dispute. But it is available for purchasers of real property because the courts consider real property unique and irreplaceable. Thus, monetary damages do not adequately compensate a buyer when the seller breaches the purchase and sale agreement. One of the primary purposes of the purchase and sale agreement is to tie up the property to 50

3 REAL PROPERTY LAW prevent the seller from accepting a higher offer from a third party. This is accomplished by allowing the remedy of specific performance. Without it, the seller would be free to accept a higher offer as long as the higher offer covered a possible monetary damage award of the original purchaser Earnest Money Seller s Remedy On the other hand, if the buyer breaches a purchase and sale agreement, the seller s remedy is usually contractually restricted to a monetary award of the purchaser s earnest money. Earnest money is a deposit either in cash or in the form of a promissory note to be paid by the purchaser and deposited into escrow when the parties sign the purchase and sale agreement. The buyer forfeits it if he defaults on the agreement and fails to close on the property. Under current Washington law, the seller can only keep 5 percent of the purchase price if the buyer defaults even if the buyer put down more earnest money than that. The seller must give the remainder back to the buyer Due Diligence Once you find property that you wish to purchase, you must determine whether it is suitable for your purposes through a process called due diligence. The parties enter into a purchase and sale agreement (a contract) that provides for a due diligence period before the purchase is contractually obligated to close. Due diligence is the review of all material aspects of the property in light of the intended use including review of (a) title; (b) boundary and surveys; (c) environmental inspection or testing; and (d) zoning, subdivision and permitting. Title Insurance. The concept of title insurance is not common in countries whose legal systems are not derived from the English common law. In most countries the purchase and sale of real property is generally conducted through a government officer like a notary or a civil registrar whose participation serves as an approval of the transaction. In the United States, however, most real property transactions are conducted without much government intervention. While Washington law requires the conveyances of real property to be by deed, which must be recorded in the county where the property is located in order to be effective against the interests of third parties, the government does not make a determination regarding the validity of transactions. The title insurance industry was developed to provide purchasers of real property with the assurance that they were obtaining legally enforceable rights to property. Title insurance therefore lends to the stability of the real estate market in the United States and is an integral part of all types of real property transactions. As a condition to closing, the title insurance company must be willing to issue an owner s title policy. The title insurer will review the public records of the county where the property is located to confirm that the seller owns the property and whether there are any encumbrances. The title insurance company will issue a preliminary commitment, which indentifies the property s owner, and provide copies of all liens, easements or other encumbrances recorded in the public records. As part of buyer s due diligence review, the buyer reviews the preliminary commitment and documentation. The buyer will notify the seller which encumbrances on title will need to be removed prior to closing. Traditionally, the seller must remove all financial 51

4 DOING BUSINESS IN WASHINGTON encumbrances before closing, including mortgages, unpaid taxes and assessments, mechanics liens and judgments liens. The buyer should be aware that although prior owners may have caused a financial encumbrance, the encumbrance can attach to the property and become the obligation of the property s new owner. The public records give notice to the purchaser and subjects the purchaser and the property to such restrictions. The buyer should also review all easements of record. An easement is the right to use all or a part of another s property. For example, an access easement may allow your neighbor to use your driveway or vice versa. An easement for the city may allow it to install sewer pipes or other public utilities through privately-owned property. The buyer should carefully inspect the preliminary title commitment to determine if such easements conflict with its intended use. The purchase and sale agreement must allow the purchaser to refuse to close without forfeiting the earnest money if the title is not acceptable to the purchaser at closing. A purchaser can opt for a standard title insurance policy or an extended title insurance policy. Typically, the seller will pay for standard title insurance premium and the purchaser will pay the additional amount for the extended title insurance policy. Extended coverage will provide additional protection for the purchaser. Your attorney can provide you with the exact differences in the policies and advise you, after a review of the property, which insurance should be obtained. Title insurance companies will not issue an extended policy without a survey of the property. A survey maps the existing improvements, locates the property boundaries, and identifies any visible encroachments, recorded easements or other recorded physical encumbrances. There are also title endorsements for insurance policies offered by title companies to protect the purchaser for specific items that the purchaser would like to insure. The title company can provide a list of such endorsements and your attorney can review your options with you. Legal Descriptions and Boundary. When you purchase or lease property, the agreements between the parties must accurately identify and locate the property with a legal description. The street address or the tax identification number for the property is not adequate. Legal descriptions in Washington are either (a) based on a federal survey completed in 1851 dividing the state into sections, townships or ranges; (b) a metes and bounds description; or (c) a lot number or recorded plat. The county where the property is located records the transfers of property rights in a filing system based on the legal description. Without a proper legal description, you will not have an enforceable purchase agreement or lease agreement. But even if you have a correct legal description, there may still be problems with the boundary lines. When purchasing property, it is imperative that you physically inspect the actual boundaries. If the property is substantial, it may be prudent to obtain a survey of the boundary lines. It is possible to lose property to or gain property from an encroaching neighbor based on a claim for adverse possession. Extended coverage title insurance policies require a survey and will usually cover claims of adverse possession. Environmental Review. When you buy real property, you may unwittingly buy environmental liability, too. Various federal and state statutes require property owners to clean 52

5 REAL PROPERTY LAW up a site even if prior owners caused the contamination at issue. As a purchaser you may inherit environmental liability which prior owners caused. Therefore, buyers should conduct an environmental inspection. A Phase One Environmental Assessment is the initial step in evaluating the property. It consists of a walk-through of the property, and a review of the property s history through historical documents and regulatory agency records. If Phase One identifies issues that may need further review, buyers then conduct a Phase Two Environmental Assessment. Phase Two involves searching for hazardous substances through soil, water and other testing and identifying any necessary remediation, reporting or monitoring. For example, Phase One may identify the likelihood of underground oil tanks common in Washington. Phase Two would test the soil surrounding the area to determine if any tanks have leaked. In addition, if the property contains wetlands, shore lands or a watershed, other federal and local regulations may apply. Water rights may also be an issue, especially for property in arid regions of Eastern Washington Closing Deeds. The term Closing refers to the completion of the transfer of the title to the property. Real Property is transferred when the seller executes a deed. There are four types of deeds: the quit claim deed, bargain and sale deed, statutory warranty deed, and special warranty deed. The type of deed used determines the warranties which the seller gives to the purchaser. These may include: (a) Warranty of Seisin (grantor warrants that he or she owns the property being transferred); (b) Warranty of Right to Convey (grantor has power and authorization to convey the property); (c) Warranty Against Encumbrances (grantor warrants against unrecorded easements, restrictive covenants, financial encumbrances or other encumbrances affecting use and ownership to the property); (d) Warranty of Quiet Enjoyment (grantees possession and use will not be disturbed by a third party); or (e) Warranty to Defend (grantors will defend grantees title against third party claims). Each type of deed is best suited for a specific type of transaction. For example, when transferring between related entities, a company may not need warranties between the entities and may choose a quit clam deed to transfer the property. When purchasing property from an unrelated third party, a statutory warranty deed is preferred because it carries the most warranties and therefore offers more protection to the purchaser. Escrow Agent. Buyers and sellers often use escrow agents to act as a depository of funds and documents for closing. Escrow agents also facilitate closing. The escrow agent represents both parties, but that representation is generally limited to following the escrow instructions provided by the parties or as embodied in the purchase and sale agreement. The purchaser deposits earnest money with the escrow agent. Among its various responsibilities, the escrow agent will prepare a closing statement for the purchaser and the seller, prepare and file the excise tax affidavit, and record the deed after all conditions to closing have been met. Closing Costs. At closing, the seller customarily pays the excise tax, title insurance premiums for standard coverage, real estate commissions and half of all escrow and recording fees. In addition to the purchase price, the purchaser usually pays half of the escrow and recording fees and the additional fee for extended title coverage, if selected. Of course, parties 53

6 DOING BUSINESS IN WASHINGTON can contract to allocate the closing fees in a different manner but it is important to know the industry standards for your negotiations. If you deviate from industry standards, you should specifically negotiate the change. At closing, the seller will deliver the executed deed to escrow and the purchaser will deposit the purchase price into escrow. After the escrow agent receives these, he or she will record the deed in the county records. Title is then transferred. 6.3 LEASING PROPERTY Leasing Contracts A lease is an agreement by which a party known as tenant or lessee takes possession of real property to use and enjoy under the terms and conditions contained in the lease for a period of time in exchange for paying rent. The tenant returns the property to the owner ( landlord or lessor ) at the end of the lease term. There is no standard form for a lease, but there are certain requirements for a valid lease and standard provisions found in most leases. For example, the signature of the landlord and tenant must be notarized and the agreement must contain a valid legal description of the leased property. Each lease is different and the parties should carefully review it. Some are very onesided, providing almost all advantages to either landlord or tenant. Such one-sided leases require careful attention by the party reviewing them. Basic statutory rights that should be preserved may be waived by terms of such a lease. For example, residential leases are subject to provisions of Washington State s Residential Landlord Tenant Act, which provides various protections to tenants, not applicable in commercial transactions. You should also be aware of any local laws or ordinances that may affect the rights to real property. For example, many local governments have zoning laws that describe how property may be used and developed. Statutory protections are not necessarily contained in the lease but some may be waived by the terms of the lease. Also, if either landlord or tenant declares bankruptcy, a federal bankruptcy court may rearrange the rights and obligations of the parties. A tenant who occupies a property without a valid lease or after a lease has expired is considered a month-to-month tenant. A month-to-month tenancy is a precarious position for a tenant who desires a long-term solution to property needs. A month-to-month tenancy can be terminated with only a 30-day notice. The rent is set at the sole discretion of the landlord and may be increased each month Letter of Intent Lease negotiations usually conclude with the parties executing a letter of intent that details the business terms of the lease. The parties should carefully draft these letters to prevent them from becoming binding before the parties execute a formal lease. An attorney will then use the letter s terms to draft the lease Subleasing 54

7 REAL PROPERTY LAW When the tenant leases a portion of the property to a third party ( subtenant or sublessee ) the agreement is know as a sublease. A sublease agreement resembles a lease and usually incorporates terms of the original lease ( Master Lease ). Usually, the sublease will require approval by the original landlord according to the assignment and sublease provisions in the Master Lease for procedures for approval of a sublease. An important distinction between a sublease and a lease is that the rights of a subtenant are derivative to the tenant; therefore, if the Master Lease is terminated for any reason, the sublease also terminates. The subtenant thereafter has no right to occupy the premises and must sign a new lease with the master landlord to stay or pay on a month-to-month basis at a rental rate set by the landlord. It is paramount to remember that even though a property may be subleased, the original tenant is usually responsible for ensuring that the responsibilities under the Master Lease are met. 6.4 CONCLUSION Basic to real estate law in the United States is the principal that real property should be used in the stream of commerce and not laid to waste by disuse. Therefore, the motivation behind what can be a confusing web of state statutes, local regulations and over a century of case law is to make the use and purchase of real estate a safe and reliable investment. Whether you are taking advantage of the local knowledge of a real estate broker, the expertise of a licensed appraiser or surveyor or the legal consultation of a real estate attorney, there is a long tradition of professionalism in such fields. We advise you consider investing in Washington s State real property resources and take advantage of its professional consultants. 55