If you’re a real estate investor or involved in real estate wholesaling in Arizona you’ll want to be informed about new legislation soon to be enacted.
What is HB 2747 (Wholesale real estate buyers; disclosure)?
House Bill 2747 (“HB 2747”) is a bi-partisan bill in the Arizona Legislature that will likely be signed into law by the Governor. HB 2747 places disclosure requirements on buyers who enter into residential purchase agreements/contracts in the real estate market and then assign the contracts (i.e., “wholesalers”).
What property is subject to HB 2747’s disclosure requirements?
The disclosure requirements found in HB 2747 will apply to “residential real property,” which is defined as “real property with fewer than five (5) dwelling units.” This means that any residential property up to a four-plex will fall within the law’s requirements.
Residential vs Commercial Property
An apartment complex with five (5) or more units will not be subject to the law. And it appears commercial property will not be subject to the law. However, a strict reading of the definition of “residential real property” could lead to a different conclusion.
Technically, commercial property is “real property with fewer than five dwelling units” as commercial property contains no dwelling units. This strict reading will likely not control as HB 2747 uses the term “residential” so any reasonable interpretation will exclude commercial property.
The same cannot be said of vacant land that is zoned for residential use. Vacant land is normally treated differently than real property containing an actual residential structure. The sale of vacant land generally requires a different contract, disclosures, and due diligence. In practice, it is not considered residential property. It is considered vacant land.
Unfortunately, the simple and vague definition of “residential real property” found in HB 2747 appears to encompass vacant land that is zoned for residential use as it would be residential real property with less than five dwelling units.
Who is subject to HB 2747’s disclosure requirements?
HB 2747 applies to a “Wholesale Buyer” and “Wholesale Seller.”
Wholesale Buyer vs Wholesale Seller
A “Wholesale Buyer” is defined as “a person or entity that enters into a purchase contract for residential real property as the buyer and assigns that same contract to another person or entity.”
A “Wholesale Seller” is defined as “a person or entity that enters into a purchase contract for residential real property as the seller that does not hold legal title to that real property and that assigns that same contract to another person or entity.”
Basically, the “Wholesale Buyer” and “Wholesale Seller” are the same. The term “Wholesale Seller” and its definition is confusing and vague. Essentially, the “Wholesale Seller” is the assignor of a residential purchase contract.
In a true wholesale transaction (as opposed to a double escrow), a “Wholesale Buyer” never enters into a “purchase contract for residential real property as the seller.” Instead, an assignment is executed with the “Wholesale Buyer” as the assignor. This is a completely different document than a purchase contract. Now, in a double escrow transaction, the buyer under the original contract will enter into a purchase contract for the same property as the seller with a third-party buyer.
Change of Sides in a Transaction
However, the buyer who is now the seller under the purchase contract with a third-party buyer for the purpose of a double escrow will likely never then assign that same contract to another person or entity.
Basically, a strict reading of the definition of “Wholesale Seller” does not require any disclosures from an assignor of a residential real estate contract as such person or entity is “not entering into a purchase contract for residential real property as the seller” nor would it require disclosures from a buyer who is attempting a double escrow as such buyer (who is now the seller under the second contract) will not be assigning the purchase contract with the third-party buyer.
Weakness of Language
While the language for “Wholesale Seller” is not well crafted and clearly written by someone who has no actual knowledge of how real estate wholesale transactions work, I recommend that the disclosures required by HB 2747 be followed by an assignor of a residential real estate contract or a buyer who is entering into a purchase contract with a third-party buyer for the purpose of a double escrow.
I do not believe the requirements of HB 2747 apply to novations as the seller and buyer are entering into a direct contract that simply replaces the original contract. There is no assignment of the original contract and no contract between the original buyer and the third-party or end buyer.
What are HB 2747’s disclosure requirements?
A “Wholesale Buyer” must “disclose in writing to the seller that the buyer is a wholesale buyer.” This honestly is not much of a requirement and will not require any significant change to the purchase contract.
Most wholesale purchase contracts contain an assignment clause that allows the buyer to assign the contract. As such, the only revision will be to add the statement “Buyer is a Wholesale Buyer” at the beginning of the assignment clause.
A sample assignment clause with the disclosure may read “Buyer is a Wholesale Buyer and may assign this Contract or any of its rights hereunder to any person, partnership, corporation or other entity without notice to Seller or Seller’s consent.”
A “Wholesale Seller” must “disclose in writing to the buyer that the seller is a wholesale seller that holds an equitable interest in the real property and that the wholesale seller may not be able to convey title to the property.”
The assignment of a real estate purchase contract in and of itself is likely a disclosure of this nature. However, when a statute prescribes specific disclosure language, I recommend that the actual language as shown in the statute be used.
Inserting this language in the assignment should not be problematic as the assignee is generally aware of the fact that the assignor does not hold legal title to the property. Inserting this language in a purchase contract with a third-party buyer for a double escrow may be a little more problematic.
End buyers in a double escrow transaction tend to be less experienced with these types of transactions and may be concerned with the insertion of the disclosure language in the contract. To ease these concerns, HB 2747’s disclosure language could be followed by a statement explaining why the seller may not be able to convey title (i.e., because it is contingent upon the current owner conveying free and clear title to the seller, etc.).
What are the consequences of a violation of HB 2747?
If a “Wholesale Buyer” fails to make the disclosures required by HB 2747, “the seller may cancel the contract for sale at any time prior to the close of escrow without penalty and may retain any earnest money paid by the Wholesale Buyer.”
Essentially, the seller may cancel the purchase contract and retain the earnest money. The language “at any time prior to the close of escrow” is important. If the transaction closes with a contract that does not have HB 2747’s disclosure language, the seller cannot later come back and set aside such a transaction.
Basically, “no harm no foul” if a transaction closes without HB 2747’s disclosure language.
If a “Wholesale Seller” fails to make the disclosures required by HB 2747, “the buyer may cancel the contract for sale at any time prior to the close of escrow without penalty and shall be refunded all earnest money paid by the buyer.”
This allows the assignee or end buyer to terminate the assignment (or purchase contract in a double escrow) and receive a return of the earnest money even if it is designated as non-refundable. Similar to the failure of a Wholesale Buyer to make the requisite disclosures, there is “no harm no foul” if a Wholesale Seller fails to make the HB 2747 disclosures to an assignee or end buyer and the transaction closes.
Presently, HB 2747 does not contain any fines, penalties, or civil liability for its violation. The only consequence is the cancellation of the transaction prior to closing and loss of the Wholesale Buyer’s earnest money or the refund of the earnest money to an assignee or end buyer.
Is HB 2747 now a law?
No. It will only become law when signed by the Governor. As it is a bi-partisan bill, it will likely be signed. Even though HB 2747 is not presently the law, it is recommended that wholesale real estate investors/wholesalers begin the process of updating their contract documents so as to comply with HB 2747 so that they are in a position to comply if and when HB 2747 becomes the wholesale real estate law so as to avoid a disruption in their business and affect their real estate license.
I will continue to monitor the status of HB 2747 and will provide an update as to if and when it becomes law or will become effective.
DISCLAIMER: This is for informational purposes only. It is not legal advice and does not create an attorney-client relationship. None of the information contained herein should be acted upon without seeking specific legal advice. Anyone receiving and reviewing this information should seek specific legal advice from an attorney regarding their specific situation.