This country-specific Q&A provides an overview to real estate laws and regulations that may occur in the United States.
It will cover the most pertinent issues including ownership structures, restrictions, transfers, taxes and environmental contamination.
This Q&A is part of the global guide to Real Estate. For a full list of jurisdictional Q&As visit http://www.inhouselawyer.co.uk/index.php/practice-areas/real-estate
The U.S. Constitution sets forth a system of federalism where governmental power is divided between the national (or federal) government and the governments of individual states. Each state also has its own constitution, which further divides governmental power between the state and local governments. For this reason, legislation affecting the acquisition, disposition, use, financing, and taxation of real estate can be found at each of the national, state, and local levels of government.
Each state in the U.S., other than Louisiana (which employs a civil law system), follows a common law regime which evolves through both case law (e.g., court decisions) and legislation, and laws can vary greatly from state to state. In following the common law tradition, U.S. courts generally allow parties engaging in transactions relating to commercial real estate the freedom to set the terms of those transactions by contract, subject to regulations relating to the public interest (e.g., environmental, tax, counter-terrorism).
How is ownership of real estate proved?
There is no uniform land registration system across the entire U.S. to verify ownership of real property. Instead, recording systems have been adopted on a state-by-state basis, and each county (or "parishes" or "boroughs" in Louisiana and Alaska, respectively) within each state has its own recorder's office for evidencing ownership and other interests in real property. While there are similarities among the rules of each such recording system and recorder's office, such rules vary by county and it is therefore important to ensure that any instruments that are intended to be recorded comply with the rules of the applicable recorder's office.
In order to confirm ownership of real property in the U.S., it is therefore necessary to perform a title search of the real estate records in the county where the applicable property is located. Electronic availability of such records varies by county and, if available, such records are typically only available from a certain date, and therefore, a search of the physical records of the applicable recorder's office is almost always necessary. It is important to note, however, that with few exceptions, a search of a county's real estate records does not guarantee that the owner appearing of record in such search is actually the owner of the property.
As such, prospective purchasers or lenders in U.S. real estate transactions routinely engage a title insurance company to perform a title search on their behalf and, at the time of closing, purchase insurance from a title insurance company to cover the ownership of the property and the state of title thereof. Once engaged, the title insurance company will examine the real estate and other records and produce a title report which discloses, among other things, the record owner, as well as any interests to which such record owner's title is subject, such as leaseholds, security interests, easements, restrictive covenants, and other liens and encumbrances.
It is important to note, however, that a title report by itself is not an insurance policy and therefore cannot be relied on in a legal sense; it merely provides an indication as to what the title insurance company believes is the state of title. As such, prospective purchasers and lenders in U.S. real estate transactions almost always purchase title insurance (the cost of which is paid for once, at the time of the closing and, in the case of a loan, is paid for by the borrower), which insures that title to the property is in the name of the insured, and provides coverage against, among other things, any defects, liens or encumbrances on title, other than those noted in the policy. The principal benefit of purchasing a title insurance policy is to cover claims that arise after closing and which threaten or impair the insured's interest in the real property and, in such instance, the title insurance company will pay or dispose of the claim in accordance with the terms of the policy. A title insurance policy also covers against the risk of forged documents and, in most jurisdictions, matters that arise between the date of closing and the date that the applicable instrument is recorded in the real estate records. The premium for title insurance is based on the insured amount (along with the cost of additional coverage, as applicable), is negotiable in some states and is fixed by statute in other states.
Are there any restrictions on who can own real estate?
There are very few restrictions on who can own real estate or interests therein.
The federal government (specifically the Committee on Foreign Investment in the United States) has the authority to review transactions (including real estate transactions) that could result in control of U.S. real estate by a foreign person and may cancel or rescind a transaction if it determines that doing so is in the best interest of U.S. national security.
At the state level, many states have no additional restrictions, though there a handful of states that restrict the right of a non-U.S. person to buy, own, and sell large parcels of land.
What types of proprietary interests in real estate can be created?
The main proprietary interests in real estate that can be created are:
- Fee Estate: where the owner owns the real property, typically in perpetuity. The fee estate commonly includes the land, the development rights relating to airspace above the land, and any buildings or other improvements on that land, but the parties are free to agree to other arrangements. For example, a fee estate could include only land and airspace with certain defined limits or could only include an interest in land or airspace.
- Leasehold Estate: where the tenant is granted a lease of an agreed area for a fixed term. With very few exceptions, there is no minimum or maximum term and the lease can include renewal rights. In some cases, a lease is granted in the entirety of the fee owner's estate, often referred to as a ground lease. Ground leases are typically for significantly longer terms than leases of designated space at a property. The tenant under a ground lease will typically seek to record a memorandum of the ground lease in order to put all interested parties on notice with respect to the tenant's interest in the property, and protect its interest from being subordinated to the rights and interests of subsequent purchasers of the property or interests therein. Subject to the terms of the lease, the tenant can, in turn, grant a lease of all or a portion of its leased premises (for a period not to exceed the term of its lease), which is referred to as a sublease.
- Tenancies in Common: where a property is owned by more than one person (referred to as a "co-tenant"), with each co-tenant having an undivided interest in the entire property. A co-tenant's ownership interest in the property is reflected as a percentage and the ownership percentage among co-tenants need not be equal. Each co-tenant, however, has the same right to possess the property as the other co-tenants, regardless of ownership percentage. The parties to such arrangement often enter into a "tenancy in common agreement" which outlines their respective rights and responsibilities to each other with respect to the applicable property.
- Condominium Ownership: a type of fee estate where land and improvements are split into a number of units. Each unit is a distinct property and includes an undivided interest in the overall property's common elements. The condominium regime allows multiple owners to own and use distinct portions of a property while collectively sharing ownership of the common facilities of the property, for which each unit owner is responsible for paying a proportionate share of expenses (referred to as common charges). Unit owners typically have the right to sell, mortgage, lease or alter their unit, however, such rights may be limited in some way by the documents creating and governing the condominium.
- Cooperative Ownership: where a corporation owns the property, and individual owners own shares of such corporation and are granted a "proprietary lease" leasing a particular unit of the property. The number of shares of the corporation that each owner holds is typically proportionate to the size of the unit leased to the cooperative shareholder. Similar to condominium ownership, cooperative shareholders have shared rights to use the property's common elements, for which each owner is responsible for paying a proportionate share of maintenance expenses. Cooperatives, however, often impose restrictions on the sale of unit (which is effectuated through a sale of shares and an assignment of the proprietary lease) as well as restrictions on the rights of a cooperative shareholder to alter their unit. The use of cooperative ownership structures are most commonly found in the Greater New York metropolitan area and the midwestern region of the U.S.
Is ownership of real estate and the buildings on it separate?
Not unless otherwise agreed. Buildings are treated as part of the land and transfer with it unless otherwise agreed. For example, it is possible to carve out a specified block of airspace and the buildings structures within it from a transfer of a fee estate or the grant of a lease. Doing so is unusual, and potentially problematic, as it can affect the marketability of the property, and where it is necessary to do so, this is typically achieved by granting separate leasehold interests or subjecting the fee interest to a condominium structure.
What are common ownership structures for ownership of commercial real estate?
Commercial real estate is typically owned by corporations, trusts, partnerships, limited liability companies, or limited partnerships. Tax concerns, personal liability of the investors, management concerns, and transferability of ownership interests are all factors to be considered in selecting the appropriate entity through which to own the property.
A corporation is (i) managed by its board of directors, (ii) continues in existence regardless of the death, bankruptcy or sale of interests of any shareholder, with few exceptions for certain tax reasons, and (iii) generally protects shareholders from personal liability for the corporation's obligations. By default, a corporation is treated as a "C" corporation for U.S. federal income tax purposes. Profits of a "C" corporation are taxed at the corporation level and, if dividends are distributed to shareholders, also taxed at the shareholder level, thus limiting its attractiveness to investors. Under certain circumstances, a "C" corporation can elect to convert to an "S" corporation. An "S" corporation is only subject to one level of tax. Among other limitations, however, a shareholder of an "S" corporation may only be an individual who is a U.S. citizen or resident alien, estate or certain types of trusts.
The primary goals shared by investors when selecting a vehicle to own commercial real estate – avoiding double taxation and limiting liability to the amount invested – can be achieved in many cases through the use of a limited partnership or limited liability company, and in certain jurisdictions, a business trust. In most cases, a Delaware limited liability company is used mainly because such an entity achieves both of these objectives, is easy to form and operate, and Delaware's laws are well developed and provide for a lot of flexibility. Another entity that achieves the goal of avoiding double taxation and limitation of liability is a real estate investment trust (a "REIT"). If the proper election is made, a REIT can be in the form of a limited liability company, a partnership, a corporation or a trust. Provided an entity qualifies as a REIT, it generally is not taxed on its otherwise taxable net income and gains to the extent that it distributes such income and gains to its shareholders. Rather, shareholders of a REIT are generally subject to tax on such distributions so that an investment through a REIT is typically subject to a single level of tax and not the double level of tax that generally applies to "C" corporations. In order to qualify as a REIT, an entity must satisfy certain requirements with respect to its ownership, operations, income, and assets. If an entity's status as a REIT is terminated because it fails to meet the applicable REIT requirements and does not satisfy certain relief provisions, the terminated REIT will be taxed in the same manner as a "C" corporation.
What is the usual legal due diligence process that is undertaken when acquiring commercial real estate?
For transactions involving the sale of commercial real estate, the investor's lawyer would typically review, as part of due diligence, and/or assist with commissioning the following:
- the real estate records and other state and city governmental records through a title report prepared by a title insurance company;
- a survey of the land and improvements located thereon;
- a zoning report or zoning letter;
- an environmental report (commonly referred to as a "Phase I" environmental site assessment);
- leases (if the property is subject to leases – though the extent of this review will depend on the nature of the property and why the investor is purchasing the property); and
- any other material contracts relating to the property.
The due diligence process performed by the investor's lawyer can take several weeks (particularly as some of the key searches can take a number of weeks to be produced) and is relatively expensive as most sales are on an "as-is" basis. As such, sellers give limited representations regarding leases, services contracts and some other property related matters but do not generally give purchasers warranties regarding title to the property, the condition of the property or its compliance with laws. In certain cases (such as where the seller is selling complex or numerous properties via a competitive bid process), the seller may decide to assemble many of the relevant due diligence materials in order to speed up the sale process, ensure that all bidders are equally up to speed, and to avoid the same due diligence from being carried out several times (which could disrupt tenants at the property or the seller's employees).
In many cases, the purchase and sale agreement will provide for a due diligence contingency period which is when most of the legal and non-legal due diligence will take place. During that period, the investor has the right to terminate the purchase and sale agreement for any or no reason and, in such event, will receive a return of any deposit monies previously posted. When market conditions favor the seller, however, such periods are shorter or may even be eliminated.
In the case where a property is sold by way of a transfer of the direct or indirect ownership interests of the property owner, additional due diligence is performed in respect of the relevant entities that are to be purchased. In such transactions, the seller would typically give representations and warranties on the constituent entities with much fewer representations or warranties on the property itself.
What legal issues (if any) cannot be covered by usual legal due diligence?
Generally, a purchaser would take title to real property subject to matters of which it is actually aware as well as those for which it is on constructive notice. Constructive notice attributes knowledge to a person or entity of those things that would be known if a search were carried out by a reasonable person even if such person or entity did not in fact have actual knowledge. While in the typical due diligence process lawyers commission and review most of the searches that would otherwise result in constructive notice, there are some searches that are not performed by lawyers. For example, matters that would be apparent from a physical inspection of the property would be imputed on to a purchaser. As lawyers do not generally inspect properties, the purchaser will need to satisfy itself of this issue.
What is the usual process for transfer of commercial real estate?
Letter of Intent ("LOI")
· Hire a broker or self-market the asset for sale.
· Depending on the market and level of interest in the asset, the seller's broker may solicit bids from interested purchasers which may then go through multiple rounds of bidding until a potential purchaser is selected.
· Review LOI from purchaser and negotiate same.
· Prepare and aggregate due diligence materials (title documents and property information, including leases, financial information, service contracts, existing third-party reports) for distribution to potential purchasers. Prior to such distribution, it is common for sellers to require that a potential purchaser execute an agreement to keep such information confidential.
· Prepare and negotiate LOI.
· Review and negotiate confidentiality agreement, if applicable.
· Review any due diligence materials provided by the seller.
· Consider and solicit proposals for financing.
· There is no prescribed form of LOI but there are industry standard terms.
· The LOI is generally not binding except for specifically agreed upon terms such as the existence of a broker, confidentiality and, in some cases, an agreement by the seller to exclusively deal with the purchaser for a specified period.
· In some cases (usually where time is short and the deal is relatively straightforward), the parties dispense with the negotiation of a LOI and proceed "to contract". In such a case, the seller will instruct its lawyer to prepare a draft purchase and sale agreement for review by the purchaser and its lawyer.
· Increasingly, most of the due diligence materials are hosted on a secure website known as "virtual data rooms."
Purchase and Sale Agreement (the "PSA")
· The seller's attorney to prepare drafts of PSA and closing documents.
· Negotiate PSA, deed and other closing documents with the purchaser's lawyer.
· Review and negotiate PSA and closing documents.
· If the purchase is not subject to a due diligence contingency period (see Q7 above), carry out due diligence and commission title report, survey of the property, and other third party reports.
· If the purchase is subject to a due diligence contingency period, then carry out limited due diligence to assist with negotiation of PSA.
· There is no prescribed form of PSA but market standard terms.
· Most states have specific rules on the wording for the type of deed to be used and the items that must be present in order for it to be in recordable form.
Signing to Closing
· Satisfy any seller conditions to closing.
· Obtain any third party consents or approvals, if applicable.
· If the property is subject to financing that is not going to be assumed, then request a payoff letter or arrange for the assignment of the existing mortgage to the new lender, as applicable.
· Prepare closing statement and agree on apportionments.
· At signing, pay deposit into escrow with title insurance company or seller's lawyer.
· Finalize sourcing debt and equity capitalization for payment of purchase price.
· Satisfy any purchaser conditions to closing.
· Review closing statement and agree on apportionments.
· A deposit of not more than 10% of the purchase price (less in larger transactions) is typically paid into escrow on signing which will be forfeited if the purchaser fails to complete the sale (unless failure was due to the seller's fault or if the purchaser has a right to terminate).
· Closing statement deals with the apportionment of real estate taxes, rental income, arrears, service contracts, and other expenses.
· Deeds (and any other documents to be recorded in the real estate records) must be notarized (or if executed outside of the U.S., notarized in a U.S. embassy or consulate office or notarized by a local notary with an apostille).
· Use of purchase price proceeds to pay off any existing debt.
· Delivery of deed and any other closing documents.
· Arrange closing phone call or meeting with escrow agent, lawyers for purchaser, seller's lender, and purchaser's lender for dating of documents and release of funds.
· Pay into escrow balance of purchase price as adjusted by apportionments.
· Satisfy purchaser's lender's loan conditions precedent and execute loan documents.
· Execute closing documents.
· Attend closing phone call or meeting with escrow agent, lawyers for seller, seller's lender and purchaser's lender for dating of documents and release of funds.
· If closing is "in escrow," all closing funds and documents will be sent to escrow agent to be held by them and then distributed upon the satisfaction of specific conditions.
· If not provided at closing, provide purchaser with tenant lease files and any keys to the property.
· Close all utility accounts for the property that are in the name of the seller.
· Remit any rents received by the seller from tenants that relate to the post-closing period.
· If applicable, file any notices required by any government agencies.
· Send notices of sale executed by the seller to tenants, service contractors, and any other applicable third party.
· Transfer (or open new) utility accounts for the property.
· The title insurance company will arrange for recording of the discharge of the seller's mortgage, the deed, and the purchaser's mortgage documents. If it was serving as escrow agent, then it will also arrange for distribution of original sets of closing documents to the purchaser and seller. While the title insurance company may not record the documents on the day of the closing of the transaction, the title insurance company will, in most jurisdictions, insure the purchaser for the gap period between closing and recording.
· In cases where some of the amounts that need to be apportioned cannot be determined at the time of closing, those amounts are typically apportioned based on an estimate and then re-apportioned post-closing once those amounts are able to be determined.
Is it common for commercial real estate transfers to be effected by way of share transfer as well as asset transfer?
It is far more common for real estate transfers to be effected by way of deed (asset transfer) than by way of share transfer. Generally, unless there is a compelling commercial reason to do so, purchasers prefer to purchase the asset rather than to purchase the shares of the property owner because in a share transfer the property owner's liabilities continue after the transfer. In the case where a transaction is to be effected through a share transfer, additional due diligence needs to be carried out in respect of the applicable entity.
On the sale of interests in land does the benefit of any occupational leases and income automatically transfer?
Yes. In the typical case, however, the seller and purchaser will execute a separate instrument assigning all of the leases that affect the property.
What common rights, interests and burdens can be created or attach over real estate and how are these protected?
A wide variety of rights, interests and burdens can be created or attached to real estate, but given the historical nature of real estate law in the U.S. and the adoption of certain vestiges of the arcane laws of England, there are a large number of complex rules that govern them, which can create somewhat arbitrary distinctions around exactly when certain rights, interests or burdens will attach and "run" with the land. Some of these key interests are:
- easements: for example, rights of way over a property;
- restrictive covenants: for example, an agreement not to build more than one house on a plot of land;
- mortgages securing debt obligations; and
- options to purchase, and other rights to purchase, such as rights of first refusal and rights of first offer.
While recording of the foregoing documents is not required in order for the applicable document to be enforceable against the grantor, all of the above rights and interests must be recorded in the real estate records in order to ensure that such rights and interests are not subordinated to subsequent bona fide purchasers for value who record their interest.
Are split legal and beneficial ownership of real estate (i.e. trust structures) recognised
Title to real property may be held in trust, with a trustee holding legal title and the beneficiaries of the trust holding beneficial title. Such a structure is typically implemented for estate planning purposes. In such a case, the trustee, with reference to the trust he, she or it is holding for, would appear as the record owner of the property. In the case of a sale of a property by a trust, the title insurance company will require evidence of the trustee's authority to sell the property. Also, some states permit the use of a nominee structure, whereby a nominee would hold the property on behalf of another and may engage in transactions with respect to the property.
What are the main taxes associated with commercial real estate ownership and transfer of commercial real estate?
Taxes imposed on ownership of commercial real estate are:
Income taxes: U.S. federal income taxes, as well as state and local income taxes in certain states and localities, apply to income arising from the ownership of commercial real estate by both U.S. and non-U.S. tax residents. The rates will vary depending on a number of factors, including the structure through which the real estate is owned (e.g., whether the real estate is owned through a flow-through entity, a "C" corporation or a REIT), whether the direct and indirect owners of the commercial real estate are U.S. tax residents and, if not, the applicability of an income tax treaty with the U.S.
Property taxes (or real estate taxes): In the U.S., the real property tax scheme varies by state and sometimes by local jurisdiction, but generally, local governmental entities are required to comply with the state's tax laws to assess and collect an annual tax (with the rate varying by locality) on the value of land, structures, and improvements. Usually, the tax imposed is calculated by reference to a stated percentage of the fair market value of the real estate. Certain types of property are exempt from real property tax, including properties owned by a not-for-profit organization and properties in specified economic development zones. In addition to real property tax, most state tax schemes provide for the taxation of tangible personal property owned by business entities.
Other taxes: Certain jurisdictions impose a commercial rent tax on tenants of commercial real estate.
Taxes commonly imposed on the transfer of commercial real estate located in the U.S. are:
Income Tax: U.S. and non-U.S. tax residents are generally subject to U.S. federal income tax, as well as state and local income tax in certain states and localities, on capital gains recognized on the disposition of U.S. real estate. The rates vary depending on a number of factors, including the structure through which the real estate is owned. In addition, non-U.S. tax residents disposing of U.S. commercial real estate are generally subject to a withholding tax equal to 15% of the purchase price (including any debt assumed or treated as assumed in connection with the disposition).
Real Estate Transfer Tax: Many U.S. states (and a number of counties and cities) impose a transfer tax on the sale of a property (or the granting of a long term lease) based on the purchase price of the property as finally reflected in the deed and/or accompanying tax forms or affidavits. In addition to direct transfers of property, some states impose a tax on transfers of a controlling interest in an entity that owns property located within the state. Each state and local government sets its own rate of tax and the basis to which that rate is applied.
Mortgage Recording Tax: A number of states and municipalities impose a mortgage recording tax, calculated as a percentage of the face amount of the mortgage (and occasionally varying with the length of the term of the mortgage loan). Mortgage recording tax is typically due at the time the mortgage is recorded and paid by the borrower although the process for the payment of mortgage recording tax and the party responsible for the payment of the same can vary depending on the custom of the applicable state and/or municipality. Some states permit a borrower seeking to refinance a mortgage loan to have the mortgage encumbering its property assigned to its new lender and thus avoid paying mortgage recording tax on the principal then outstanding.
What are common terms of commercial leases and are there regulatory controls on the terms of leases?
Although certain jurisdictions do place restrictions on commercial leases such as limiting the length of their term or prescribing certain required provisions, the terms of commercial leases are primarily established by contract rather than any federal, state or local governmental authority.
Leases must be granted for a fixed period (i.e., they cannot be indefinite). With very few exceptions, there is no legal maximum or minimum duration though it is rare for a lease to be longer than 99 years. In the market, retail leases are often between 5 and 15 years. The duration of offices and industrial leases can be up to 20 years or more.
Tenants under commercial leases do not have a statutory right to renew the term of their lease and such right is entirely determined by contract.
There are no regulations on the amount of rent charged for a commercial space and, as such, the same is determined by contract. The parties to the lease may agree to a fixed rent throughout the term of the lease or they may agree to rent increases which may be based upon a fixed percentage, tied to a referenced index of inflation such as the Consumer Price Index of the U.S. Department of Labor, or be based upon a fair market value determination (or some combination thereof). The longer the term of a lease, the more likely it is that there will be one or more adjustments of the rent based on fair market value of the property (often with a floor to prevent rent from decreasing). In some retail leases, the rent is either wholly or partly based on percentage rent which is calculated by reference to the tenant's revenue at the premises.
It is typical for there to be regulations limiting the use of a property. Leases will also usually restrict a tenant's ability to change the use of the premises.
There are few laws regarding either party's repair obligations in the commercial context. Parties are therefore free to agree who is responsible for each type of repair. Typically, the landlord is responsible for repairs to the structure and roof of the property as well as systems that serve the building at large while the tenant is responsible for repairs to its space and those systems that exclusively serve its premises.
There are no laws in the commercial context as to what expenses may be passed through to a tenant. Parties are free to agree what items are to be included in the calculation. Where the lease is part of a building, the tenant will be required to pay the costs of operating, repairing, maintaining, and insuring the structure of the building in addition to the cost of lighting, heating etc. the common areas (e.g., reception, stairwells). Each tenant's share of operating expenses is usually calculated on a pro-rata floor area basis. Tenants will resist the inclusion of expenses that are capital in nature in the calculation of its obligation to reimburse operating expenses.
There are few laws regulating a tenant's right to assign its interest in a commercial lease. Typically, a commercial lease will prohibit a tenant from assigning its interest in the lease without the landlord's consent. These restrictions would generally extend to direct or indirect transfers of ownership interests in the tenant. Further, leases will often provide a landlord with the right to cancel the lease or "recapture" the premises upon a request from a tenant to assign its interest in the lease. Assignment provisions are the subject of a great deal of negotiation and often a landlord would agree to not unreasonably withhold, condition or delay its consent with respect to a request therefor. As part of its negotiation, tenants will seek to have certain transferees pre-approved and exempt from the recapture right (e.g., transfers to affiliates or in the case of a sale or merger of the parent company). An assignor of a lease is not released from liability thereunder absent an affirmative release from the landlord. It should be noted that in the event of a bankruptcy involving a tenant, the bankruptcy court may order the assignment of a lease even where such assignment would violate some of the assignment provisions of the lease and regardless of whether the landlord has consented to such assignment.
There are few laws regulating a tenant's right to sublease its premises. Similar to the restrictions on assignment, a commercial lease will generally prohibit a tenant from subleasing its premises without the landlord's consent and also provide the landlord with a right of recapture if a request is made therefor. Just as they do in the case of assignment, landlords will often agree to not unreasonably withhold, delay or condition their consent to a tenant's request to sublease. Care should be taken by a tenant to ensure that a sublease should not expire later than the day before the expiration date of the prime lease in order to avoid the sublease from being re-characterized as an assignment of the prime lease.
Each state has laws governing the right of a landlord to terminate a lease and evict a tenant in the case of a default by the tenant of its obligations under a lease. Landlords typically have the right to terminate a commercial lease and evict a tenant through court proceedings if the tenant fails to pay rent and/or other amounts when due or in the case of other breaches by the tenant which remain uncured.
A commercial lease will also usually provide the landlord or tenant with the right to cancel the lease in the case of a material casualty to the premises or a taking of the whole or a material part of the premises by eminent domain.
Though less typical, tenants may have the right to terminate its lease early under certain circumstances or at certain times during the term of the lease. In such a case, the tenant may be required to pay a termination fee and provide ample notice to compensate the landlord for the leasing costs it incurred and allow it sufficient time to re-let the premises. Leases for space in shopping centers often contain termination rights in favor of tenants which are exercisable if occupancy at the shopping center falls below a specified threshold or if a specific tenant is no longer operating at the center.
How are use, planning and zoning restrictions on real estate regulated?
Use, planning, and zoning restrictions are enacted and enforced by each municipality (e.g., city, county or town) through statute. Use, planning and zoning laws affect the use of a property, the standards to which any buildings located on a property must be constructed as well as limits on lot size, building size, height, floor area ratio, number of rooms, parking, and setbacks. If the property is being operated under a permitted use, then such use is considered to be permitted "as of right." Properties which were constructed prior to current use, planning, and zoning restrictions are typically grandfathered into the current code, meaning that they are considered "legal non-conforming" and can remain and, in some cases, be rebuilt to the same extent they were non-conforming following a casualty. An owner of property may apply for a special use permit or variance if compliance "as of right" would cause it undue hardship which, if approved, would allow for additional uses or other non-compliance with applicable regulations.
Although use, planning, and zoning restrictions are primarily shaped by local law, federal law can pre-empt local law.
Use, planning, and zoning restrictions may also be created by contract between owners of interests in real property. These are often found in reciprocal easement agreements and covenants, conditions, and restrictions in connection with planned developments, such as shopping centers and subdivided housing developments where property owners benefit from having the use and characteristics of adjacent properties conform to certain specifications. The agreements "run with the land" and are almost always recorded in the recorder's office. Certain municipalities, such as the city of Houston, Texas have historically relied exclusively on private deed restrictions rather than statute in order to regulate use, planning, and zoning restrictions.
Who can be liable for environmental contamination on real estate?
Federal and state law including the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, commonly known as "CERCLA" or "Superfund", impose liability on parties that own, operate or occupy (or have previously owned, operated or occupied) contaminated property regardless of fault. While parties to a purchase agreement can allocate responsibility for clean up between them, this will not serve to prevent claims from the government under such laws. Purchasers, however, may avoid liability under CERCLA and under most state laws if they satisfy the bona fide prospective purchaser defense. This defense requires that a purchaser conduct "all appropriate inquiry" into the environmental condition of a property prior to its acquisition and exercise "appropriate care" with respect to any environmental condition thereat. To qualify for the defense, the purchaser cannot be affiliated with any other party that is potentially liable for clean-up costs. The standard for "all appropriate inquiry" was promulgated by the U.S. Environmental Protection Agency and generally is the process of evaluating a property's environmental condition and assessing potential liability for any contamination. While there is no one size fits all for "all appropriate inquiry," in the typical case it means commissioning a type of environmental assessment of the property commonly known as a Phase 1 Environmental Site Assessment. "Appropriate care" means that the purchaser took reasonable steps to stop any continuing releases, prevent any threatened future release, and prevent or limit human, environmental or natural resource exposure to any previously released hazardous substance. Most states have comparable defenses under their respective environmental statutes.
Is expropriation of real estate possible?
Yes. Expropriation, known as the power of "eminent domain" or "condemnation" or a "taking," is the power of the federal or state government to take private property for a public purpose in exchange for just compensation. Additionally, private corporations (such as utility companies) may also have eminent domain powers if such powers were delegated by law. Eminent domain can be effected through the taking of a fee interest, easement, leasehold or other real property interest. The Fifth Amendment to the U.S. Constitution requires that any such taking be for a "public purpose" and that the owners thereof receive "just compensation" and, further to that, the Fourteenth Amendment to the U.S. Constitution affords such owners due process rights including the opportunity to be heard in an impartial judicial setting. Appraisals are commissioned in order to assist with determining the amount of compensation to be awarded to a property owner. Other factors that are considered include business losses and, if applicable, the loss in value to the remainder of the property.
Is it possible to create mortgages over real estate and how are these protected and enforced?
Yes, mortgages can be created over real estate (or an interest therein). As a technical matter, however, in some states, the manner in which security is granted over real estate is by deed of trust (rather than a mortgage) where the property owner places the property in trust with a trustee for the benefit of the lender. In the case where the interest to be secured is a leasehold, the terms of the lease must first be reviewed to ascertain if the lease is indeed financeable and to ensure that any requirements prescribed by the lease have been satisfied.
In order to perfect the lender's interest in a mortgage, the mortgage must be recorded in the real estate records in the county where the applicable property is located. Once recorded, a mortgage will generally have priority over any future encumbrances (except for encumbrances that the lender was aware of or should have been aware of). While a mortgage does not need to be recorded in order to be enforceable, the failure to record generally exposes the lender to have its interest subordinated to any subsequent bona fide purchaser for value that records its interest first. Depending on the municipality where the property is located, the method for recordation (i.e., physical delivery vs. electronic recording) and the volume of documents submitted for recording, the actual recordation of a document may take place on the day of closing or days or weeks after the closing of the transaction. Any delay in the recordation of a mortgage is not a practical concern because the lender will have obtained a title insurance policy for its mortgage loan and the title insurance company will insure the lender for the gap period between closing and recording.
A mortgage is a lien which provides the lender with the power to sell the property owned by the borrower at the time the mortgage was granted. In the case of a default, the lender may exercise such power of sale through the foreclosure of the mortgage. There are two types of foreclosure – judicial and non-judicial foreclosure. The remedy of judicial foreclosure is available in all states, and more than half also permit non-judicial foreclosure. The specific remedies available to a lender and the manner in which a foreclosure is carried out is governed by state law with significant variations. Generally, in a judicial foreclosure, the lender must commence a lawsuit against the borrower to initiate the foreclosure process. The entire process is then run through the court and, as a result, takes longer than a non-judicial foreclosure and allows the borrower to raise defenses as part of the proceeding. In a non-judicial foreclosure (typically permitted in states that employ a deed of trust regime), the lender may proceed with the foreclosure outside of court in accordance with state law. Non-judicial foreclosures are naturally less formal and proceed quicker than a judicial foreclosure. In either case, the borrower will have the right to attend and bid at the auction and the lender will have the right to credit bid the amount of its indebtedness. If anyone other than the lender is the winner of the auction, then the lender will receive the proceeds from the sale up to the amount of its indebtedness with any surplus going to junior lienholders or the borrower. If the lender is the winner of the auction, it or its designee becomes the owner of the property. Depending on the state and the terms of the loan, the lender may be able to pursue the borrower or other credit parties for any deficiency.
Are there material costs associated with the creation of mortgages over real estate?
It depends of the location of the property. Some states and municipalities impose a mortgage recording tax which is calculated as a percentage of the face amount of the mortgage and is paid by the borrower (see Q14). In all cases, in addition to its own costs, a borrower will be responsible for the lender's title insurance, legal fees, and due diligence costs as well as a de minimis recording charge.
Is it possible to create a trust structure for mortgage security over real estate?
Yes, except such structures are usually in the form of an agency relationship rather than a trust. Where collateral is pledged or security interests granted to more than one lender it is common to use a collateral agent to hold such collateral and/or security interests as agent for the lenders. Under this structure, the underlying lenders can change without any changes being required to the mortgage or security documentation and the collateral agent would enforce the security on behalf of the lenders. Also, the collateral and security interests held by the collateral agent should not be part of the collateral agent's estate in the event of its insolvency though the lenders would likely need to seek approval from the bankruptcy court to unwind the structure or take other action.
What is the main legislation relating to commercial real estate ownership?
There is no main legislation relating to commercial real estate ownership across the U.S. As explained in Q1 above, the U.S. Constitution sets forth a system of federalism which divides governmental power between the national (or federal) government and the governments of individual states. Each State also has its own constitution which, in turn, divides governmental power between such State and the municipalities located within such State. The laws relating to commercial real estate ownership are generally governed by state law though federal law will also apply as to some aspects.