Saturday, January 28, 2006
Energy and Real Estate
An economic analysis of the impact of ever higher energy costs on real estate.
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The last 150-200 years have been a period of extraordinarily cheap energy. Besides energizing almost all our methods of production, cheap fuels have also seriously distorted our way of living so that most of the middle-class section of the North American population live far away from their places of work. More specifically, cheap fuel and commuting, though expensive in time, meant the coming to reality of social status elements the likes of the ‘American Dream’ – owning a single-family dwelling or the equivalent ‘Canadian Dream’ – owning an interest in land, but distorted to the excess of becoming status symbols. As such, at the bottom of these two elements of economic reality in our social structure lies the fundamental desire on the part of many individuals to obtain some sort of status satisfaction from the social environment in which they live by flaunting their real estate possessions in a rather ostentatious way.
The impact of this attitude has been felt not only on the ever-increasing prices people have been willing to pay throughout the years for the acquisition of real property assets that fulfill and complement their status satisfaction, but also on the very designs and architectures of homes and residential complexes. Thus it is possible to find, nowadays, in many metropolitan centers exceptionally beautiful homes and villas and elaborate constructions, which go well beyond the rather simple conception of the aforesaid dream of owning a home. As cheap energy has fueled this constant social trend in both Canada and the United States these past few decades, if we imagine that energy starts to become steadily more expensive in the coming years then we can reasonably expect that the trend will gradually be reversed and the present separation between home and work will steadily decrease.
Often overlooked, but an important design consideration affecting the total energy used by the home, is the size of the home. Recent statistics compiled by the US Department of Energy show that new homes on average use more energy than older homes, partially due to larger home size, increased use of air-conditioning, and the widespread use of numerous electronics. While home size will likely be determined by factors other than energy efficiency, considerations are now on the drawing board as to whether the same function can be delivered in a smaller package. Smaller homes, because there is less space to heat and cool and less wall area for energy loss, use less energy for heating and cooling than larger homes. For example, in many climates a screened porch can add practical living space without the cost of adding air-conditioned space. Additionally, architects and home designers are coming to grips with the realization that comfort has almost nothing to do with how big a space is but, rather, that it is attained by tailoring our houses to fit the way we really live.
On the economic aspect of things, a recent study undertaken once again on behalf of the US Department of Energy details that home heating costs can be expected to skyrocket in the forthcoming years. For example, the Department of Energy predicts that homes heated with natural gas could see their fuel costs explode by as much as 48 percent by 2007. And the cost of home heating oil could surge by up to 32 percent. As oil becomes scarcer and more expensive there is a high probability that the economic shock waves will hit hard throughout the economy. Petroleum is a basic raw material used in the manufacturing of many products including chemicals, paints, plastics and synthetic textiles. Other industries - steel, aluminum, electric power - use large quantities of oil and oil derivatives in the course of their production. When petroleum supplies become pinched and prices push up, these industries may well be forced to restrict output and raise prices, thus putting even more inflationary pressure on the economy. Scarcely any enterprise is immune to the oil squeeze, as the lessons of the ‘70’s and the ‘80’s have taught, and real estate is definitely no exception.
As shortage of supply is typically followed by price increase in many economic models, there is a general consensus in many circle that the inflationary cycle will start all over again, prompting the Federal Reserve Bank to hike interest rates. This process has begun already, as interest rates are slowly oozing upwards. An increase in the prime rate means typically a subsequent increase in both passive and active banking rates, that is the rates banks charge for mortgages, credit cards and consumer loans as well as the interest they pay on bond, term deposits and certificates of investment. A question arises, therefore, as to whether an energy crunch – not the mythological real estate bubble – could cause a market slow down and how concerned should people be not just about the value of their own homes, but about the economy of the entire country. Afterall, real estate has positioned itself after five years of continuous expansion as the single most ingrained and relevant market in the economic basket of goods.
The answer is to be found in what economists refer to as the wealth effect. Consumers tend to spend more when their net worth increases and less when it decreases. Economists use this rule of thumb: a $1 change in household wealth leads to a roughly 5-cent change in consumer spending. By that measure, a 10 percent decline in real estate prices would knock about half a percent off the gross domestic product. Even more significant for the economy, though, would be a collapse in home equity lending. The industry has been booming as housing prices have soared. But if prices stop rising, new borrowing against home equity will drop, and may disappear. This is important, because home equity lending in Canada amounted to more than $20 billion last year - or nearly 4 percent of the economy. If all that borrowing - which freed up cash that was spent on new furniture, appliances, vacations, cars and the like - simply vanished, the effect could be large enough all by itself to send the economy into recession. But that's not all. The housing sector has even broader effects on the economy, by some estimates accounting for 25 percent of all activity. A decline in property values would most likely lead to declines in other industries, like construction, brokerage, banking and insurance. And these are important for future growth. Construction, for example, amounts to 7 percent to 8 percent of the economy, according to the Economic Council of Canada. Then there is banking. Because of the leverage associated with real estate, a fall in values would affect banks and other lenders. It would probably lead to tightened credit standards, less lending and higher interest rates. If lenders begin to suffer steep losses, there is always the danger of financial contagion, in which problems at one institution ripple out to others it does business with.
In essence energy is so important for real estate and real estate so important for our economy, that the impact of an energy crunch would be felt not only on real estate but would spread and engulf the entire economy and impact our very own way of living.
Luigi Frascati
Real Estate Chronicle
Monday, January 23, 2006
Referential Offers
The thrust of the referential purchase price offer is to piggyback on the next highest bona fide offer that is acceptable to the Seller. The offer contains a clause that reads, in general lines, as follows: “The purchase price is $1,000 above the price offered in the nearest competing bona fide offer acceptable to the Seller to a maximum of $350,000. The Seller agrees to provide a copy of such nearest competing offer on acceptance of this offer”. The referential purchase price offer, therefore, is a clever way by which the Buyer endeavors to establish a purchase price by reference to prices contained in competing offers. As it can be reasonably anticipated, there are many variations in the wording of referential purchase price clauses.
The problem with this kind of offers is that there is a very good chance that neither the Seller nor the Buyer may pursue a legal remedy should either of them default at completion, due to the wording of the referential purchase price clause. The leading case is a 1985 decision of the House of Lords in England, which held that referential offers are invalid. This case has since been adopted at Common Law, at least insofar as it applies to referential bidding. The general principle of law holds than an offer by one bidder which is dependent for its definition on the offers of others is invalid and unacceptable. The rationale is that this type of offers is inconsistent with and potentially destructive of the very tendering process in which it is submitted.
Whether the focus is on the referential purchase price offer or on the bidding tendering process, there are enough similarities for a Seller to be concerned when dealing with referential offers. An approach that could be employed to circumvent problems involved when confronted with referential purchase price offers would be for the Seller to counter with an Addendum, which deletes the referential purchase price clause and inserts a fixed price for an identical amount in its stead. The benefit for the Seller is, of course, that he will not find himself in a position to have to disclose to the Buyer the nearest highest offer, but whether this will be acceptable to the Buyer is an entirely different matter.
What this all means in a multiple offer scenario is that in the eventuality that a referential purchase price offer comes around the Seller will have to assess its legitimacy, the enforceability of the offer and the bona fide of the contract. Unquestionably, therefore, the Seller that accepts such an offer will take an extra risk, the measure of which may very well lie in the offers that the Seller has decided to disregard in favor of the referential purchase price offer. A risk this that ultimately may not be warranted.
Tuesday, January 17, 2006
'Subject To'
Resolving ambiguities in real estate contracts.
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Contracts of Purchase and Sale are typically written in Real Estate using ‘subject to’ clauses, that is conditions that must take place prior to the purchase being finalized. Conditions precedent are the opposite of conditions subsequent, which are conditions that must continue to exist for something else to continue. Since the contract is the instrument that signifies the common intention of the parties to be legally bound by their respective obligations, it is diriment that contracts be written in clear and unambiguous terms. If the parties have not expressed those obligations with sufficient clarity, there is no contract because there does not yet exist the necessary common intention to be bound by definite obligations. It is a requirement at law, therefore, that all of the terms and conditions of the contract be sufficiently clear, the reason being that the law does not enforce arrangements whose essential terms or conditions are uncertain.
The ideal ‘subject to’ clause is one whose criteria are so clear that it is completely obvious whether the criteria for satisfying that clause are met. To determine the certainty of a ‘subject to’ clause the courts often consider whether the criteria for satisfying such ‘subject to’ clause are subjective or objective. A subjective criterion is one that depends on the personal view of the individual who decides it. In contrast, an objective criterion is one that depends on an external event. Therefore, the more subjective the wording of a ‘subject to’ clause, the more likely a court will find the clause to be uncertain. To be absolutely technical, furthermore, in addition to be subjective and objective the courts have recognized that conditions precedent may also be partly subjective and partly objective, and that different results occur depending on the circumstances.
Each ‘condition precedent’ case must be considered on its own facts. Some conditions precedent are so imprecise, or depend so entirely on the subjective state of mind of the Purchaser, that the contract process must still be regarded at the offer stage. An example of a subjective ‘subject to’ clause would be: “This Contract is subject to the approval of the Buyer’s parents”. This means that if a condition precedent is wholly subjective (sometimes called a ‘whim and fancy’ clause), the courts may view the arrangement in law as nothing more than an offer by the Seller that the Buyer may accept by removing the ‘subject to’ clause. In other words, even though there was an initial offer followed by an acceptance, and even though the instrument is called Contract of Purchase and Sale, the arrangement at law is nothing more than an offer until such time as the ‘subject to’ clause is removed (by the Buyer).
On the other hand, when the condition precedent is clear, precise and objective, a contract is completed. Neither party can withdraw, but performance is held in suspense until the parties know whether the objective condition precedent is fulfilled. An example would be "Subject to the Buyer obtaining satisfactory financing” by a certain date. If a ‘subject to’ clause is objective, a contract comes into existence as soon as the offer is accepted. The obligation to carry out the contract to completion is suspended until such time as the condition precedent is removed.
But, as stated before, there is a third class of conditions precedent. Into this class fall the types of conditions that are partly subjective and partly objective. An example would be: “Subject to the Planning Department approval of the attached plan of subdivision”. This clause looks objective but, in fact, it differs from a truly objective condition precedent in that someone has to solicit the approval of the Planning Department. Perhaps some persuasion of the Planning Department will be required. Can the Purchaser prevent the condition from being fulfilled by either refusing to present or otherwise convince the Planning Department not to approve the plan of subdivision? Clearly, the Purchaser must take two steps to fulfill his obligation in this respect: the first step is to submit the plan of subdivision to the Planning Department, and the second is to use his best efforts to make sure the Planning Department approves it.
The law in relations to implying terms in a contract is no different in relation to conditions precedent than it is for other terms of the contract. Contracts must not be permitted to fail over an omission that the parties would immediately have corrected if they had noticed the omission at the time the contract was made. The courts have at their disposal the ‘efficacy test’ and the ‘officious bystander test’ to guide them through their evaluation of contracts. In the example above, the efficacy test would require that someone submit the plan of subdivision to the Planning Department, and the officious bystander test would be met by both parties answering the hypothetical question as to who will present the plan – obviously the Purchaser. In essence, where a condition precedent is partly subjective and partly objective the court must determine whether its features are objective enough to constitute a contract. If, on the other hand, the clause is predominantly subjective, then the arrangement will amount to nothing more than an offer, which the Buyer may accept by removing the ‘subject to’ clause.
Luigi Frascati
Real Estate Chronicle
Thursday, January 12, 2006
Anatomy of Strata Developments
A strata development consists of strata lots, common property and common assets. The part of the property that is individually owned is technically called ‘strata lot’, although we normally refer to it with various terms such as ‘condominium’ , ‘condo’ or ‘strata unit’. Every strata owner owns a proportionate interest in the common property and common assets of the strata corporation. The owner cannot separate his or her interest in the strata lot from the proportionate interest in the common property and common assets, with a few exceptions. In practicality this means that the strata lot owner cannot sell only the proportionate interest in the common property and common assets while retaining the interest in the strata lot.
The owner of a strata property has less autonomy than someone who owns a non-strata interest in real estate. This is so because the individual strata ownership is always subject to the broader community interests of the strata development. The strata corporation is based upon a democratic structure, with by-laws that reflect the strata’s community values. These by-laws govern how owners and tenants may use the strata lots, the common property and common assets. The combined owners of all strata lots make up the strata corporation. Each owner has one vote per strata unit, and eligible voters elect a strata council to carry out the day-to-day work of the strata corporation. Major decisions that affect strata owners or their strata lots must be made by the eligible voters in general meetings.
The same legal principles that apply to a 450-unit residential condominium development apply to a 50-unit industrial warehouse complex and a 20-parcel bare land strata or, for that matter, a two-unit duplex strata. The strata scheme is self-enforcing, in that there is no government body that regulates compliance with strata legislation and there are no ‘strata police’. To enforce the provisions of the law, every owner has the right to file an application into Court for an order requiring the strata corporation to comply with the legislation. In addition, certain disputes among owners or with the strata corporation can be arbitrated.
Tuesday, January 10, 2006
Real Estate Capital Growth
An economic insight on why real estate capital values may slow down but never stop accumulating.
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It is an undisputed fact that market economies, in Capitalism, are moved by the supply and demand for goods and services. Whereas it is natural and obvious to explain and justify demand as a direct and proximate result of the need for goods and services, it is not quite equally so natural and obvious to explain and justify why such goods and services should be available for us to grab in the first place. Demand has to do with the way the intricate thread and connectivity of neurons in the human mind work – or don't work. And since out of six billions or so humans there are six billions or so different minds, it follows that demand is a very subjective variable indeed. Supply, on the other hand, is in direct function and the proximate result of only one economic element: capital growth.
The basis for the real estate market is the demand by households, businesses, governments and institutions for space and shelter to conduct activities. Consequently, as demand changes in direct function of human activities and economic and demographic variables, conditions within the real estate market change. The demand for space, shelter and support for human activities is not for the land itself but, rather, for the use of the land – that is for the services provided by the land. Land that is useful has a value to the user. This value is the real motivating force for the operation of the real estate market.
More specifically, the value of land represents the amount a potential user is willing to pay in exchange for the right to use the land. From another perspective, it is the amount that the holder of the right to grant permission for the use of the land will receive in exchange for granting this right to another party. When there is no exchange, the holder receives value through his own use of the land. For example, a homeowner does not have to pay rent to live on the land. As the benefits from using land may be received long into the future, the value of an interest in land will be the dollar amount invested today that is justified by the anticipated benefits, given risk and current investment conditions. In general, any interest in land that has a value through use will also have a capital value. Value through use of land is possibly the only one precept - in the long and twisted line of thinking and rationalization of the human mind – that is common and shared by Marxism, Socialism, Fascism and Capitalism. The unreconcilable differences among these social doctrines, however, lie in the practical economic applications of the value through use of land as it relates to totalitarian regimes. On the other hand, value through use of land was absent during pre-industrial Mercantilism, as trade, tariffs and monopolies were given precedence over investment, free market and monetarism.
Housing supply is produced using land, labor, and various inputs such as electricity and building materials. The quantity of new supply is determined by the cost of these inputs, the price of the existing stock of houses, and the technology of production. In Economics, the price elasticity of supply measures the responsiveness of the quantity supplied of a good to its price. This responsiveness is measured as the percentage change in supply that occurs in response to a percentage change in price. As real estate is a fixed and durable commodity and the land underneath is practically indestructible, real estate markets are modeled as a stock-over-flow market. About 98 percent of supply consists of the stock of existing houses, while about 2 percent consists of the flow of new development. The stock of real estate supply in any period is determined by the existing stock in the previous period, the rate of deterioration of the existing stock, the rate of renovation of the existing stock, and the flow of new development in the current period.
Essentially, the production of real estate output depends on the accumulation of capital. This is so because the propensity to invest in production (construction of new inventories) depends a lot on expectations of furure profitability and on the present perceptions of market risk. If production stops being perceived as profitable, or if the present perception of market risk increases sharply, capital will exit more and more from the sphere of real estate production. What drives the accumulation process, therefore, is the perpetual search for more surplus-value, that is the amount of the increase in the value of capital upon investment, i.e. the yield regardless of source or form. This requires a constant supply of a labor force which can conserve and add value to inputs and capital assets, and thus create a higher value. The rationale behind this is that labor adds value by satisfying demand through production, since when people acquire income they tend to invest it, and the more people that acquire income the more people that tend to invest it. Therefore, there is a correlation between capital and unemployment in real estate or, if you will, between income and labor. An increase in levels of consumption sets forth an increase in prices caused by a corresponding increase in demand, in itself generated by a commensurate increase in the income-employment factor. It follows, therefore, that growth is derived by the equilibrium of capital and investment with labor and employment. And since, furthermore, production is in direct function of consumer spending which increases as unemployment falls, it follows that capital accumulation inreases as employment rises and capital accumulation decreases as employment falls.
As capital accumulation in real estate is driven by surplus value as explained above, and because of the fact that it is not possible for employment to ever reach a ‘zero value’ in any economy (otherwise there is no economy), real estate capital growth will never stop accumulating and, therefore, demand for real estate outputs will always be there – even in the worst possible market. Real estate, therefore, is unique in this respect and quite unlike other markets that are not anchored on the relationship between capital and labor. These other markets are far more speculative in nature, in that future capital accumulation is fueled only by present capital consumption. As one thing undercuts the other, therefore, these speculative markets are more unstable, unsafe and prone to crash. What happened to the stock market on Black Monday - October 19, 1987 - when it lost twenty-two percent in value in eight hours is primary proof of it.
Luigi Frascati
Real Estate Chronicle
Saturday, January 07, 2006
Privacy Issues in Real Estate
Realtors in Canada cannot wiretap anybody …
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Canada has two federal privacy laws, the Privacy Act and the Personal Information Protection and Electronic Documents Act (PIPEDA). The Privacy Act imposes obligations on some 150 federal government departments and agencies to respect privacy rights by limiting the collection, use and disclosure of personal information. Individuals are also protected by the PIPEDA that sets out ground rules for how private sector organizations may collect, use or disclose personal information in the course of commercial activities. Initially, PIPEDA applied only to personal information about customers or employees that was collected, used or disclosed in the course of commercial activities by the federally regulated private sector, organizations such as banks, airlines, and telecommunications companies. The Act now applies to personal information collected, used or disclosed by the retail sector, publishing companies, the service industry, manufacturers and other provincially regulated organizations. Real estate is, of course, one sector of the service industry.
Of all the Provinces in Canada, British Columbia is possibly the strictest when it comes to enforcing consumers’ privacy rights. The Personal Information Protection Act of British Columbia came into force and effect on January 1, 2004 and applies to all consumers and service industries in the Province, including real estate, banking and mortgaging. Specifically as it relates to real estate, the Act protects all personal information that is collected, used or disclosed, including information regarding a person’s race, age, marital status, religion, employment history, home address and telephone number(s) including cellular telephone number, finances including the purchase or sale of real property, credit history, banking qualifications and political opinions.
The provincial legislation imposes significant obligations on real estate brokerage firms and individual professionals, pretty much in line with the fiduciary duties and obligation contemplated in agency relationships. Below is a synopsis of the most important obligations:
[ ] Designation of a ‘Privacy Compliance Person’ – Since companies are simply legal entities and cannot enforce compliance with the Act, each brokerage firm must designate an individual who is personally accountable for the firm’s compliance with privacy regulation. This individual needs not be a real estate licensee. A non-practising, non-licensed owner or shareholder, for instance, can serve as a Privacy Compliance Person. This individual must be proficient with all facets of the Act and is in charge of educating staff and manage inquiries and complaints.
[ ] Identification of Purposes – Whether in the process of introducing a Listing Contract or drafting an Offer To Purchase, the real estate professional has an obligation to clearly identify and explain to each individual why and how there is a need to collect and use that individual’s personal information. Furthermore, the real estate professional has an obligation to explain why, how and to whom he may wish to disclose such information.
[ ] Limitation of Collection, Use and Disclosure – The real estate professional must not collect, use and disclose more information than what is reasonably necessary under the circumstances. Moreover, there is an obligation imposed on the Realtor not to collect, use and disclose personal information for any purpose unless the individual has consented to that purpose.
[ ] Destroy Information – Personal information must be destroyed once it is no longer needed for the purpose for which it was collected. One notable exception is Contracts of Purchase and Sale, which must be stored for two years but only for review purposes by pertinent real estate licensing authorities.
[ ] Provide Access – Individuals are guaranteed access to their own personal information for purposes of review and amendment thereof.
[ ] Provide Recourse – Procedures must be implemented to receive and respond to complaints and inquiries.
When it comes to enforcement, the Legislation establishes a procedure that empowers the British Columbia Information and Privacy Commissioner to investigate – including auditing – an organization. The Commissioner has the power to issue orders which are binding on firms. Failure to comply with the Legislation can result in penalties up to CAD $100,000 as well as civil damages and criminal charges.
Privacy is an issue taken very, very seriously in British Columbia.
Luigi Frascati
Real Estate Chronicle
Tuesday, January 03, 2006
Enhancing Homes Sex Appeal
Smart Sellers use Evolutionary Economics to increase sex appeal (of their homes, that is)
The marketing power of sex appeal is not a new concept. It is no coincidence that sex innuendo and the ubiquitous use of the erotic and exotic has been used for several years in commerce and trade, from the so-called satiric pornography of Calvin Klein ads to the muscle men and women hawking Evian water, to the sensual allure used in graphic and advertising design in music, art, film, packaging, and publishing. Artistic flare and technological innovation are unquestionably the basis of the recent partnership of Dolce & Gabbana with Motorola for the marketing of one-thousand gold Motorola RAZR V3i phones, and the marketing itself is based on the tenets and principles of Evolutionary Economics.
Evolutionary Economics theorize that change is based on repetition of technology and routines. If change occurs constantly in the economy, then a mechanism is in act that replicates the Darwinian sequences of evolution that provide selection, generate variation and establish self-replication – a process that is otherwise known as ‘progress’. The theory postulates that markets act as the major selection vehicles. The variety of competing firms is both in their products and practices that are matched against markets. Both products and practices are determined by routines that firms use: standardized patterns of actions implemented constantly. By imitating these routines, firms propagate them and thus establish inheritance of successful practices.
The link between sex appeal and marketing is established by one of the tenets of Evolutionary Economics, in that consumers love novelties and, what’s more, can create novelties. Evolutionary Economics does not view consumers as mere passive recipients of goods and services but, rather, active producers as well. The reason is that at the basis of production and consumption there is human imagination and desire for novelty. Furthermore, when people actually ‘own’ novelties in the form of goods they set about to convince others that the possession of such novelties shows that they have achieved a higher status, and that if others were clever enough to do what they did or to possess the same things that they have, then the others too could achieve high status and enjoy all the things that come from it, including the best sex (if a male) or the highest economic security (if a female) that they could possibly desire. As Aristotle Onassis once said "The only point in being rich is to have as much sex as you want with as many beautiful women as you want".
As unorthodox and bizarre as this particular marketing concept may sound, it has revealed itself to be deadly effective in commerce and trade. Taken as individual goods, high-fashion couture and cellular phone have absolutely nothing in common and, on the other hand, if Motorola itself were to set about selling gold cellular phones the marketing would likely be catastrophic. But by combining Motorola’s technology with Dolce & Gabbana’s fashion sex appeal and exotic innuendo the match is perfect. This concept is about to enter finance and real estate as well.. Think about it carefully: the home is the place where the two genders meet, it is the perfect status symbol and the purchase and sale of a home is the quintessential novelty for the Seller (the producer) and the Buyer (the consumer). A question, therefore, arises as to how Sellers can improve the odds by enhancing home marketing through sex appeal. The answer lies in making homes as much comfortable (for the men) and reassuring (for the women) as possible.
Architectural styles of new constructions are changing already, with the ever increasing round looks of exteriors reminiscent of feminine sensuality and the use of glazed windows and conspicuous steel beams – male machismo at its best, while on the inside, comfort and reassurance are perhaps best signified by the increasing use of home elevators. The bathroom is certainly one of the most frequently-used rooms in the house, and just a few subtle changes in color can make the difference between a cold, sterile environment and a warm, welcoming one. The same effect can be expanded throughout the home by painting a few rooms, hang no-sew window treatments an even by merely adding throw pillows here and there, or new bed linens. The skillful blend of colors, woods and home design elements promotes feminine harmony, warmth and balance with char green, sand, white, red, black, dark brown and all colors of nature at the top of the line and, if contemplating a hardwood floor, mahogany is the wood of choice since it enriches the environment rendering a sense of abundance, and slate flooring and polished concrete walls help create a natural masculine feeling, especially if combined and contrasted with the glacial looks of stainless steel appliances.
