Shared Ownership of Real Property.
We have all read and heard about the decline of real estate prices and sales. Over 20% of American real estate owners have property that is worth less than the outstanding debt on the property. In the meantime, the lending industry has become increasingly stringent, and fewer people qualify for loans, especially in our area. Unless you occupy real estate as your residence, a foreclosure or short sale will result in the lender sending you a 1099 form reporting the amount of the debt that was written off. You must include that debt forgiveness as part of your income for which you must pay income tax. All in all, this is a tough climate for investors.
Challenging times call for innovative solutions to real estate investments. Sellers may need to offer taking back a second trust deed, or propose lease options to potential buyers. Older owners may consider selling a remainder interest in the family home, that is keeping a life estate that allows them to continue to occupy the property so long as they choose. While marketing efforts are underway, the monthly payments are still due on time. What else might an owner consider to save their investment, and reduce the risk and costs associated with foreclosure? A viable strategy in the times of a faltering economy is the shared or co-ownership agreement. We increasingly see arrangements between parents and children, unmarried couples, or owners and investors who pool money to either buy or hold real estate. Using shared ownership arrangements lessens the likelihood of default by allocating the burdens and responsibilities among multiple owners, while using real estate to generate cash flow.
It is important to not only record a deed to reflect the shares of each owner, but also to prepare and sign a written co-ownership agreement. A written co-ownership agreement maximizes the odds of a successful relationship. It does so in two ways. First, it accurately documents the parties’ understanding. The best time to decide what each person gives and receives, and when, is before any disagreements arise. Secondly, creating the agreement means that the parties must think about and resolve issues they otherwise might not consider. What will we do if things do not turn out as we expected? Resolution is much easier before one has a stake in the outcome.
Issues that should be dealt with in a co-ownership agreement include:
- Contributions: How much will each party contribute to acquire the property, and to pay the on-going expenses? Since expenses include not only the mortgage, taxes, and insurance, but also maintenance and repairs, they will likely include unexpected outlays. Although expenses are usually shared based on ownership percentages, problems often arise over who decides when expenses are incurred and for what purpose. What is the consequence if a party doesn’t pay their share?
- Percentage Ownership: Parties often assume that they are acquiring equal interests, regardless of how much each contributes. The interests are equal only if the owners so agree. A written agreement will clarify all parties’ intentions before the money is spent.
- Sale or Transfer: Owners assume that they will only be dealing with each other, people that they know and trust. Unless the parties restrict the right to sell or transfer an interest, any owner has the right to sell their interest to a stranger or demand sale of the entire property.
- Management: Typically the touchiest issue is the making of decisions about the ownership, use and operation of the property. Without a pre-arranged management structure, the simplest problems can lead to discord. The usual mechanisms to solve management issues include granting one owner the authority to make decisions in his or her best judgment, or reaching consensus by a majority of owners.
- Possession: Does one owner have exclusive use of the property? If co-owners occupy the property at the same time, how is the space allocated? Most importantly, does the agreement give an owner the right to allow third parties to use the property, e.g., friends, roommates?
- Liability: The parties should agree that an innocent owner will be indemnified by a negligent owner for wrongful acts. This gives protection in the event of third party claims or lawsuits. Without such a provision, the innocent suffer with the wrongdoers.
- Termination/Sale: The most important issue is the “exit strategy,”i.e. how to end the relationship and dispose of the property. This issue can be addressed with right of first refusal, sale upon predetermined events, such as a certain date, and buy out upon death. Without an agreement, the alternative is costly litigation.
The best arrangement is one which is thoughtful and comprehensive. By addressing all possible contingencies before they come up, the parties can easily structure a neutral approach – one which meets each person’s needs. Putting the agreement in writing adds permanency to the arrangement, surviving the passage of time or substitution of parties. I don’t know about you, but I find that documentation is more reliable than my memory!
We must increasingly rely upon new solutions to the economy. For those of us invested in real estate, the shared ownership agreement can serve to reduce exposure while participating in the income and appreciation available in real estate in a down economy. If you trust each other enough to invest together, do it the right way with a well-crafted written agreement.
By Christopher C. Jones © September 2008