May 1, 2024 – High interest rates and inflated construction costs are affecting both the residential and commercial real estate markets, posing diverse challenges for transactional real estate attorneys.

“The conversations in commercial are still around interest rates because it affects the movement of deals,” said Jacqueline Hrovat, a shareholder at Mallery S.C. in Milwaukee.

Hrovat, who’s been practicing real estate law for 23 years, said she expects commercial construction to pick up in the second half of this year as costs come down.

For would-be buyers of existing commercial properties, Hrovat counsels caution in doing due diligence.

Because it’s a sellers’ market, Hrovat said, sellers are unloading properties "as is" and inking deals without making standard representations and warranties about things like property condition, zoning, and permits.

“If you really want to purchase a commercial property, you’ll end up not having as many contingencies,” Hrovat said.

Extra Costs for Buyers

Sellers are also shrinking the due diligence period from 180 days to 90 or even 60 days, Hrovat said. That’s forcing buyers to incur extra costs by hiring consultants to eyeball properties before closing.

Buyers are responding by asking for provisions specifying that if the seller terminates the deal in the diligence period, the seller will reimburse the buyer for some of the diligence costs.

“You have to be careful, because the buyer wants to put in all this effort to make sure that the property’s OK and you have to make sure with your seller that you have a solid deal,” Hrovat said. “It’s kind of a catch-22.”

Dissing DocuSign

Another issue buyers face is the unwillingness of commercial lenders to use DocuSign, software that allows buyers to sign deal documents electronically.

“Commercial lenders won’t approve DocuSign on bigger deals unless you’re using LaserPro, which uses bank-generated form documents,” Hrovat said. “If it’s an attorney-generated set, most lenders will take DocuSign but not for a loan agreement or a mortgage.”

“The borrowers and developers would love to have the option of DocuSign, because it would make things a lot faster,” Hrovat said. “It would save us a lot of time, but original signatures are still the way.”

“If you really want to purchase a commercial property, you’ll end up not having as many contingencies.” – Jacqueline Hrovat, a shareholder at Mallery S.C. in Milwaukee.

Elephant in the Room

Transactional real estate attorneys are also laboring to bring their clients into compliance with the Corporate Transparency Act (CTA).

Enacted by Congress in 2021, the CTA requires anyone who directly or indirectly owns a significant ownership in a company to file a report with the U.S. Department of the Treasury. The report must list the owner’s name, address, birth date, and driver's license and passport numbers.

The CTA aims to make it harder for corrupt organizations and terrorists to launder money. It went into effect on January 1 of this year but was recently ruled unconstitutional by a federal court in Alabama.

Banks, credit unions, insurance companies, public utilities, government authorities, large operating companies, and nonprofits, among others, are exempt from the CTA.

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Juscha E.M. Robinson, a partner at Pines Bach LLP in Madison, said that complying with the act could be onerous for small businesses – for instance, a married couple who forms an LLC to manage a handful of rental properties.

“I’m worried about it from a data security standpoint,” Robinson said. “Not everybody’s going to have an in-house IT person.”

Robinson, who’s practiced real estate law since 2006, said enforcement of the CTA is another issue.

“We’re scratching our heads about enforceability,” Robinson said. “How do you enforce this on mom-and-pop operations?”

Inventory Problem

The real estate market is even hotter on the residential side, due to interest rates.

Homeowners sitting on mortgages with 3% interest rates are reluctant to sell, given that they’d have to take on a 6% mortgage to buy a replacement property.

That means a dwindling inventory of single-family homes for sale.

“I feel really badly for first-time home buyers right now,” Robinson said.

Many buyers have had to waive inspections and real estate condition reports to get into a house. That’s led to an increase in post-closing property condition claims under Wis. Stat. section 100.18, said Attorney Jason Greller.

“These are attractive claims for buyers because they typically allow fee-shifting,” Greller said.

The lack of an inspection and real estate condition report – both essentially risk-shifting vehicles – may grease the skids for a quick sale.

But it leaves a seller open to misrepresentation claims, Greller said, because the seller can’t point to a document that informed the buyer of problems with the property.

“I don’t recommend that sellers allow buyers to have an inspection,” Greller said. “I just let them know that this is a risk.”

‘I Was Just Astonished’

But there’s another side to the high-interest-rate coin: so many buyers are hamstrung by high-interest rates that some lenders are resurrecting long-moribund provisions to help sellers move properties.

Assumption of mortgage is one example, said Greller.

Most mortgages contain a due-on-sale clause, which requires the seller to pay off the loan when he or she sells the property.

But, Greller said, he’s been getting calls lately to draft assumption of mortgage provisions, which allow a buyer to succeed to the seller’s mortgage. Greller said it’s an acknowledgment that many buyers can’t afford a mortgage at today’s interest rates.

It’s common in divorce cases, Greller said.

A divorce settlement gives the house to one spouse and requires that spouse to re-finance the mortgage – something that’s impossible because of the higher interest rate that would apply to the new mortgage.

Recently, a small local bank called Greller, who has practiced real estate law for 29 years, about an assumption of mortgage.

“I was just astonished at that,” Greller said. “They didn’t have one because they’d never done that.”

He said the trend has now spread to larger lenders.

“It’s great for borrowers,” Greller said. “It means they have a better chance of keeping the property.”

“I don’t recommend that sellers allow buyers to have an inspection. I just let them know that this is a risk.” – Attorney Jason Greller

‘You Have to Go Local’

Regarding lenders, Robinson recommends that buyers look to community lenders whenever possible.

“Local institutions can offer a lot more flexibility in their loan terms,” Robinson said.

Robinson said that smaller lenders tend to keep the loans they make as portfolio loans while larger institutions usually sell the loans to another lender, which requires the loans to meet more stringent secondary market standards.

She advises buyers to be wary of online mortgage lenders and said that closing costs are typically cheaper with local lenders.

“I can’t say enough about being able to walk into a lender and look somebody in the eye,” Robinson said. “Anybody who needs more creative financing and they want to be able to talk to somebody, you have to go local.”

The End of Buyer Agent Commissions?

A pending settlement in an antitrust lawsuit filed by the U.S. Department of Justice against the National Association of Realtors (NAR) threatens to alter the residential real estate market as profoundly as interest rate fluctuations have.

Under the settlement, which was approved last month by Judge Stephen Bough, with the U.S. District Court for the Western District of Missouri, the NAR would pay $418 million.

The terms of the settlement may also end the traditional 3% commission that residential real estate buyer agents earn for the sale of a property by making buyer agent commissions more competitive.

Under the current system, the realtors control who can show properties listed on the Multiple Listing Service (MLS), the database of properties for sale. Listing brokers submit offers of buyer agent compensation for each property listed on the MLS, with the offers traditionally being 3% of the purchase price.

The seller traditionally pays both the listing broker’s 3% commission and the buyer agent’s 3% commission, with nearly all the buyer agent’s 3% commission then being folded into the buyer’s mortgage.

Under the proposed settlement, Greller said, “listing brokers are not going to be able to publish offers of compensation.”

“Anybody who needs more creative financing and they want to be able to talk to somebody, you have to go local.” – Juscha Robinson, a partner at Pines Bach LLP in Madison.

Wh​at Effect?

How that will affect buyer agent commissions is up to sellers, Greller said.

For instance, a seller could offer a concession to the buyer in an amount equal to 3% of the purchase price, in effect simply reinstating the buyer agent’s commission.

“That’s one reason why some people think that the Department of Justice has inserted itself in another one of these cases,” Greller said. “The Department of Justice may have concerns about workarounds on offers of compensation.”

An alternative scenario is one where more sellers pay a flat fee to list properties on the MLS and leave buyers and buyer agents to work out among themselves how the buyer agents get paid.

But Greller said that that scenario would remove the option of, in effect, financing the buyer agent’s commission, and leave buyers without the cash to pay the commission out in the cold.

“Moving forward, if these things are not in​cluded in the purchase price, will lenders allow the buyers to include a buyer agent commission as a closing cost?” Greller said.

“We don’t know. This is going to be problem. Even if the buyer is willing to pay it, can they afford it? It’s going to have to be part of the cost.”

Same As It Ever Was?

Greller also pointed out that the proposed settlement, which should be finalized in July, sunsets after seven years.

“If the industry can preserve its existing model by getting sellers on board by offering concessions, well then in seven years they can kind of go back and nobody’s going to notice it,” Greller said.

According to Greller, the settlement’s announcement amid a hot real estate market is bad news for buyer agents – and their attorneys.

“Money and powerful interests always seem to figure out how to get around these types of problems,” Greller said. “It seems to me that the more likely result is that the value of buyer agency ends up being diminished, which I’m not sure is a good thing for lawyers.”