- Buying a Building Lot: How to Avoid Risks
Buying a Building Lot:
What You Don't Know... Can Hurt You
By: Raymond J. Bowie, Esq.
In the Naples real estate market, an unusually high ratio of home buyers opt to purchase a vacant building lot first and then contract with a builder to build a home on the lot afterwards. While it may certainly be more rewarding to buy a desired lot and custom-design the home to fit the lot, there are unique risks involved in buying the lot first. It is truly a case of: what you don't know, can truly hurt you.
The first step for any prudent buyer is to assemble a team of professionals experienced in building lot transactions to advise and assist the buyer, including a real estate agent, real estate attorney and various property inspectors as needed.
To locate potentially suitable lots that are available for purchase in the buyer's price range, the buyer must take care to select a real estate agent experienced in and knowledgeable of the local building lot market to represent the buyer. A buyer can only receive true representation, loyalty, confidentiality, unvarnished advice and full disclosure from a "buyer's agent" – a real estate agent who works exclusively for the buyer's best interests. That should be the first qualification a buyer should insist upon.
Before retaining any agent, the buyer should also inquire how familiar the agent is with vacant land transactions, how experienced the agent is in the local building lot market, and how knowledgeable the agent is of area builders and communities.
The buyer's agreement with his real estate agent should spell out the duties of the agent and how the agent is to be compensated for working for the buyer. It is, of course, commonplace in the real estate industry for the seller to pay at closing a commission to the listing broker who has agreed to split it with the buyer's broker. There is nothing wrong with this or any other compensation arrangement as long as the parties understand it in advance. Since a buyer's agent owes complete fiduciary loyalty to the buyer, full disclosure of compensation is another advantage buyers should expect from employing a buyer's agent.
Unfortunately, misunderstandings as to broker compensation arise frequently in the brokerage of building lots. Buyers usually understand that their agents are getting paid a commission upon the buyer's closing on the lot based upon the purchase price of the lot. But often brokers may also be separately compensated after closing by the builder ultimately selected by the buyer, either by a referral fee or a commission based upon the costs of the construction.
For example, if a buyer buys a lot priced at $300,000, his agent may be compensated with a 5% commission, or $15,000.00, paid by the seller. If the buyer thereafter decides to build using a builder referred by his agent, the builder may have an agreement with the agent to pay a further commission based upon the cost of the home's construction. If the construction costs $400,000 and the agreed commission is 3%, the agent would receive another $12,000 from the builder, which sum is added to the construction costs and ultimately paid by the buyer. Again, there is nothing illegal or improper about this as long as the agent and the buyer understand and agree upon it.
Builders and brokers claim that such payments are not kickbacks for business referrals but rather are "marketing expenses" commonly paid by local builders to real estate agents for marketing their homes. Indeed, paying commissions to brokers based upon builder contracts is almost a universal practice in most gated planned communities which utilize a central sales center and a stable of "preferred builders." Any buyer buying a lot in such a community is obligated to select one of the preferred builders, and each preferred builder has agreed to pay the developer's broker and buyer's broker a commission based on the amount of the buyer's construction contract. The builders, in turn, pass the costs of the commission on to the buyer. Developers do generally make sure that the original lot buyers receive proper advance disclosure of these builder contract commissions.
Problems often arise, however, when the original lot buyer re-sells his lot and the subsequent lot buyer gets no disclosure of these builder commission arrangements. Before the buyer agrees to buy the resale lot, the real estate agents should disclose the buyer's obligation to pay a further commission upon the costs of the eventual construction. Without such disclosure, it is illegal in Florida for any real estate broker to be compensated for referring or placing business in connection with a buyer's transaction.
In buying a vacant lot, the buyer's biggest challenges are to determine the suitability of the lot for the buyer's intended use, any hidden disadvantages or liabilities relating to the lot, and the feasibility of building what the buyer desires to build. Since these investigations take time and cost money, a buyer would be foolish to proceed with them before first having secured the property. The prudent buyer, therefore, secures the property through either a sales contract or an option agreement obligating the seller to sell at an agreed price and terms, while allowing the buyer an "out" if subsequent investigations show the lot is unsuitable to the buyer.
At this stage, the buyer's real estate attorney should be engaged to draft or approve any sales contract to ensure that the contract contains proper seller disclosures and is made contingent upon the buyer's satisfaction with the suitability of the lot. This contingency should allow at least a thirty-day "due diligence period" in which the buyer is given access to the lot to do any kind of studies, inspections, tests or evaluations the buyer wishes to determine the property's suitability for the intended construction.
Some of the matters an astute buyer must evaluate, with proper professional assistance, include building restrictions, lot surveys and elevations, physical access and utilities, environmental conditions, soil and grade quality, and availability of building permits. To do this, it is critical for the buyer to utilize not just the services of his real estate attorney, but also the services of a surveyor, specialized property inspectors and, if the buyer has retained them, the buyer's architect or engineer. If the buyer has selected his desired builder, the builder can also during this period advise on the feasibility and costs of constructing on the lot the desired model or the architect's plan. If the buyer is dissatisfied for any reason with the lot, the buyer can cancel the contract without penalty at any time during this "due diligence" contingency period.
The buyer should also use this contingency period to secure and review, with his attorney's assistance, any easements, covenants and restrictions that might govern use of the lot. Any lot located in a planned community will be governed by a homeowners' association declaration of covenants, conditions and restrictions, which are often quite restrictive as to what can be built upon any lot and how the lot can be used. Even if not governed by any association, there may exist private easements and restrictions placed upon the lot with the agreement of prior owners, favoring adjacent lot owners, utilities or local government. Care must be taken that these easements and restrictions, often called "private zoning", do not unduly impair the buyer's desired use of the lot.
When a buyer buys a building lot in a planned community, there are many other important matters about the community's governance and mandatory assessments that may not be disclosed to the buyer, particularly if the buyer buys the lot from a private seller rather than the developer. Unlike in a number of other states, Florida has no law requiring that a buyer of property governed by a homeowners' association receive a copy of the community's covenants, conditions and restrictions. Those who buy their building lots originally from the developer at least have the benefit of receiving these disclosures from the developer. But a buyer who buys a lot from a resale seller often does not receive any such disclosures. This can lead to a lot of unwelcome surprises for the unwary lot buyer.
For instance, in many contemporary planned communities, the buyer must pay mandatory maintenance assessments not just to one homeowners' association, but also sometimes to three or four different associations. Further, the community may also be part of a "community development district" set up by the developer, where the costs of developing the community are passed through to the buyers, including roads, landscaping and the community's amenities. Where that is done, each lot may be subject to a special assessment of as much as $30,000 or more, to be paid off over 20 or 30 years.
Even more unwelcome may be substantial fees sometimes charged to buyers by homeowners' associations every time a lot is transferred. Some communities charge buyers a "resale capital contribution", ranging as high as $1,500, upon every closing. In at least one community, Mediterra, covenants also require all buyers to pay to the association a "transfer fee" of as much as 1% of the property selling price – and allow the association freedom to use the funds for almost anything it sees fit.
Astute lot buyers in planned communities should, therefore, carefully calculate the impact upon their budgets of transfer fees, required memberships and regular maintenance assessments before committing to the purchase.
Lot buyers in planned communities may also be surprised to learn of covenants that require construction to begin on all lots within two years of the initial developer sale of the lots. For example, if a buyer buys a resale lot from a private seller who has held the lot for 18 months, the new buyer would have only 6 months to secure a builder and begin construction on the lot. Of even bigger surprise to a buyer might be the consequence of failing to begin building on time: Under the covenants, the developer may have to right to repurchase the lot from the buyer at a bargain price less than what the developer originally sold it for.
Clearly, a buyer's investigation of any building lot should entail evaluation of all applicable covenants, conditions and restrictions together with any community's fees and assessments, as well as the physical features and building feasibility of the lot.
Buying a vacant lot first and then building subsequently is not a venture for either the faint of heart or light of pocketbook. But with assistance of qualified professionals such a good buyer's agent, real estate attorney and appropriate property inspectors, the rewards of being able to build a dream home on the ideal lot may well be worth it.