PrepAgent ExamPrep Ebook

KEY CONCEPTS TO PASS YOUR
REAL ESTATE EXAM
PREPAGENT.COM
Table of Contents
INTRODUCTION ..........................................................................................................................................5
DISCLAIMER ...............................................................................................................................................5
WHAT IS A LICENSE?.................................................................................................................................5
THE -OR AND -EE RULE ............................................................................................................................6
PROPERTY OWNERSHIP ...........................................................................................................................7
BASICS ......................................................................................................................................................7
Bundle of Rights................................................................................................................................... 7
Real vs. Personal Property ..................................................................................................................9
Fixtures .............................................................................................................................................. 10
Trade Fixture ...................................................................................................................................... 11
Appurtenance .....................................................................................................................................11
Encroachment ....................................................................................................................................12
Emblements .......................................................................................................................................12
Water Rights ......................................................................................................................................12
ESTATES ..................................................................................................................................................13
Freehold Estates ................................................................................................................................13
Fee Simple Absolute ....................................................................................................................................... 14
Fee Simple Defeasible ....................................................................................................................................14
Life Estate ....................................................................................................................................................... 14
LESS THAN FREEHOLD ESTATES ............................................................................................................... 15
Estate for Years ..................................................................................................................................15
Periodic Tenancy................................................................................................................................15
Estate at Sufferance ..........................................................................................................................15
Estate at Will ......................................................................................................................................16
Leases ...............................................................................................................................................16
Property Management ....................................................................................................................................17
Types of Leases................................................................................................................................. 19
Gross Lease ................................................................................................................................................... 19
Percentage Lease........................................................................................................................................... 19
Net Lease ....................................................................................................................................................... 19
Lease Option ..................................................................................................................................................19
EASEMENTS .............................................................................................................................................20
EXPRESS EASEMENTS ..............................................................................................................................20

Creating an Express Easement .........................................................................................................20
Express Reservation....................................................................................................................................... 21
EASEMENT BY NECESSITY ........................................................................................................................ 21
EASEMENT IN GROSS ...............................................................................................................................22
IMPLIED EASEMENT ..................................................................................................................................22
PRESCRIPTIVE EASEMENT ........................................................................................................................ 23
GOVERNMENT POWER ...........................................................................................................................24
4 POWERS OF THE GOVERNMENT .............................................................................................................24
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Police Power ......................................................................................................................................25
Eminent Domain ................................................................................................................................25
Taxation.............................................................................................................................................. 25
Escheat .............................................................................................................................................. 25
Zoning ................................................................................................................................................25
EMINENT DOMAIN ..................................................................................................................................... 27
AGENCY ....................................................................................................................................................28
BASICS OF THE RELATIONSHIP ..................................................................................................................29
AGENCY RELATIONSHIPS ..........................................................................................................................30
Dual Agency .......................................................................................................................................30
Universal vs Special...........................................................................................................................32
Principal & Client................................................................................................................................32
Attorney in Fact ..................................................................................................................................33
COMMUNICATION ....................................................................................................................................34
TYPES OF FRAUD ..................................................................................................................................... 34

Actual Fraud .......................................................................................................................................34
Negative Fraud ..................................................................................................................................34
Constructive Fraud .............................................................................................................................34
Negligence .........................................................................................................................................35
Puffing ................................................................................................................................................35
Stigmatized property ..........................................................................................................................35
CONTRACTS .............................................................................................................................................36
BASICS ....................................................................................................................................................36
VALID CONTRACT ESSENTIALS ..................................................................................................................37
Capable Parties ................................................................................................................................. 38
Lawful Object ..................................................................................................................................... 38
Consideration..................................................................................................................................... 38
Offer and Acceptance ........................................................................................................................ 38
VALID, VOID AND VOIDABLE ......................................................................................................................39
VALID .................................................................................................................................................39
VOIDABLE .........................................................................................................................................39
VOID ..................................................................................................................................................40
EXECUTED & EXECUTORY ........................................................................................................................ 40
BILATERAL VS UNILATERAL........................................................................................................................ 41
TYPES OF CONTRACTS .............................................................................................................................41
Land Contract ....................................................................................................................................41
Option Contract ..................................................................................................................................41
Implied Contract................................................................................................................................. 42
LISTINGS ................................................................................................................................................... 42
TYPES OF LISTINGS ..................................................................................................................................45

Exclusive Listing ................................................................................................................................45
Exclusive Authorization and Right to Sell Listing ............................................................................... 45
Exclusive Agency Listing ....................................................................................................................45
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Open Listing .......................................................................................................................................46
Net Listing .......................................................................................................................................... 46
EARNEST MONEY DEPOSIT .......................................................................................................................47
VALUATION & MARKET ANALYSIS ........................................................................................................48
DEPRECIATION .........................................................................................................................................48
Types of Depreciation ........................................................................................................................ 48
Economic Obsolescence ................................................................................................................................48
Functional Obsolescence ............................................................................................................................... 49
Physical Deterioration ..................................................................................................................................... 50
EFFECTIVE AGE VS ECONOMIC LIFE .......................................................................................................... 52
DETERMINING VALUE................................................................................................................................52
Steps in the appraisal ........................................................................................................................ 52
Essential Elements of Value ..............................................................................................................53
Assemblage and Plottage ..................................................................................................................53
APPRAISAL METHODOLOGY ......................................................................................................................54
Gross Rent Multiplier .........................................................................................................................54
Cost (Replacement) Approach ...........................................................................................................55
Unit-in-Place Method ......................................................................................................................................55
Square Footage Method ................................................................................................................................. 55
Quantity Survey Method ................................................................................................................................. 55
CAPITALIZATION (INCOME) APPROACH .......................................................................................................56
MARKET DATA APPROACH ........................................................................................................................ 57
APPRAISAL THEORY ...............................................................................................................................58
PROGRESSION AND REGRESSION..............................................................................................................58

PRINCIPLE OF CONTRIBUTION ................................................................................................................... 59
PRINCIPLE OF CONFORMITY ......................................................................................................................60
PRINCIPLE OF SUBSTITUTION ....................................................................................................................60
PRINCIPLE OF HIGHEST AND BEST USE .....................................................................................................61
Legally Allowable ...............................................................................................................................61
Physically Possible ............................................................................................................................ 61
Financially Feasible ...........................................................................................................................62
Maximum Utility / Profitability .............................................................................................................62
FINANCING ................................................................................................................................................63
FINANCING BASICS ...................................................................................................................................63

“Assume” vs “Subject to” ....................................................................................................................63
Servicing the Loan .............................................................................................................................64
INVESTING ................................................................................................................................................64
ADVANTAGES OF INVESTING IN REAL ESTATE............................................................................................. 64
Appreciation .......................................................................................................................................64
Cash Flow .......................................................................................................................................... 64
Leverage ............................................................................................................................................64
Equity .................................................................................................................................................65
DISADVANTAGES OF INVESTING IN REAL ESTATE ........................................................................................ 65
Knowledge .........................................................................................................................................65
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Long Term Gains (Liquidity) ............................................................................................................... 65
Risk ....................................................................................................................................................65
INVESTING TERMS ....................................................................................................................................65
Pyramiding .........................................................................................................................................65
Arbitrage ............................................................................................................................................65
Syndication ........................................................................................................................................65
Partnerships .......................................................................................................................................66
LOAN CLAUSES .......................................................................................................................................67
ACCELERATION CLAUSE............................................................................................................................ 67
ALIENATION CLAUSE ................................................................................................................................. 67
PREPAYMENT CLAUSE ..............................................................................................................................67
LOCK-IN CLAUSE ......................................................................................................................................68
SUBORDINATION CLAUSE ..........................................................................................................................68
TRUTH IN LENDING ..................................................................................................................................68
APR ........................................................................................................................................................68
LOAN TERMS............................................................................................................................................69
PRIMARY AND SECONDARY MARKET ..................................................................................................72

PRIMARY MARKET ....................................................................................................................................72
SECONDARY MARKET ...............................................................................................................................73
FHA & VA ...............................................................................................................................................75
Federal Housing Administration .........................................................................................................75
VA Loan.............................................................................................................................................. 76
TRUST DEEDS AND MORTGAGES .........................................................................................................77
TRUST DEEDS .......................................................................................................................................... 77

MORTGAGE .............................................................................................................................................. 78
PRACTICE .................................................................................................................................................81
FAIR HOUSING .........................................................................................................................................81

The Americans with Disabilities Act of 1990 ......................................................................................81
Blockbusting.......................................................................................................................................81
Steering.............................................................................................................................................. 82
SHERMAN ANTI-TRUST LAW ......................................................................................................................82
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Introduction
If you do not know what is in this book, there is no way you will pass your exam. These are the
essentials to passing the exam. It is that simple. We cannot cover everything that may come up,
but we want to make sure you know the essentials. That foundation should make you feel much
more confident when sitting your exam. We make no claims that reading this book will make you
a better agent. However, we do believe that this book should be an integral part of you passing
that pesky exam so you can become an agent. At this point, that is our sole focus — getting you
past the exam.
Let’s get started!
DISCLAIMER
In your real estate practice and when sitting for the exam, some information in this book may
conflict with other information you have been given: You need to also refer to information
provided by your state licensing authority and any local pre-licensing courses you may be
required to take.
This book does not provide legal advice. Real estate sales and related issues are full of topics that
many people, including attorneys, that require an attorney’s advice or that are best left up to an
attorney. We unequivocally advise you that in any issue involving a legal matter, first and
foremost, consult an attorney.
Information can be obtained from your state licensing board. This will include a copy of the state
license law, an application or a license, information on the content of the exam (if available),
plus additional information about obtaining your real estate license. You may be able to get this
information online. If you’re new to the field, you should request the “package of information”
your state sends out for people who want to become a licensed salesperson.
What is a license?
A “license” is a personal privilege to use the land of another. A license is not considered a true
interest in the land because it can be taken away at any time and does not transfer with title.
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Examples of a license would include being able to park your car in a garage or having a ticket to
the movie theater.
A license can be created with a spoken (or oral) agreement like giving someone permission to
fish in your lake.
You are now getting your real estate license. Let's not forget why it is called a real estate license.
Real refers to real property, and estate has to do with duration of ownership.
THE -OR AND -EE rule
The suffix "-or" is used for the person who performs an action.
The suffix "-ee" is used for the recipient of that action.
In real estate, you will hear words like:
▪ Grantor – Grantee
▪ Lessor – Lessee
▪ Vendor – Vendee
▪ Optionor – Optionee
▪ Trustor – Trustee
▪ Mortgagor – Mortgagee
▪ Offeror – Offeree
The list goes on. The gist of it is, the -or gives and the -ee receives.
A nice sentence to repeat to yourself and help remember this is: “GrantOR, lessOR, optionOR,
vendOR makes me the givOR of the propetOR for your pleasOR.”
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So if you see words like give, convey, sell — these require an -or. Try saying this phrase out
loud: “GrantEE, lessEE, optionEE, vendEE, gives MEE propertEE, which makes me HapEE.”
So if you see words like receive, purchase or acquire, you know these are likely to correspond to
terms ending in -ee.
It may sound silly, but when you are taking your exam and you see a question that you do not
understand but you know one party is giving something and the other party is receiving
something you can let yourself get a little excited: This is something difficult for some to get
their head around, but with practice you should have no trouble with these kinds of issues.
For example:
A vendor sells to a vendee.
The grantor conveys property to a grantee, who receives it.
There may be a question which reads: "Who conveys property?"
You see an option that says “Grantor” and another option is a “Grantee”.
You may not know anything about deeds, but you know the answer is Grantor because -or refers
to the conveyor.
People often get confused with a mortgagor and mortgagee because they do not understand why
the mortgagor is the -or when the borrower is the person receiving the money. What you need to
remember is that it all depends on what is being received and what is being borrowed. The buyer
is pledging the property, so he or she is mortgaging the property and is known as the mortgagor.
The lender receives their pledge, and therefore is the mortgagee.
PROPERTY OWNERSHIP
BASICS
Bundle of Rights
The “bundle of rights” are the rights that come with property ownership. There are various rights
or interests connected to property ownership. An interest is a privilege and/or legal share.
When something is owed to a person by claim or legal guarantee, it is considered a right.
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Property ownership is also subject to the rights or interest of others.
The bundle of rights includes the right to:
▪ use
▪ give away
▪ sell
▪ mortgage
▪ lease
▪ rent
▪ enter
▪ refuse to exercise any of these rights
The bundle of rights is an accepted way to explain what is involved in owning property.
Teachers often use this concept as a way to look at difficult information regarding owning
property.
The bundle of rights is usually taught to explain how many parties can have an interest in the
property as owning land is not as simple as buying property and acquiring all the rights to it.
Think of it like this:
In hockey, you have 6 players on the ice (5 plus a goalie). Each player is like a right. When a
player gets a penalty, he must come off the ice. When the player is done serving the penalty, the
team returns to full strength; but theoretically if every player was penalized, there would be no
team left and it would be game over.
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Let’s relate this to real estate: a mechanic's lien is a penalty. You will lose one of your rights just
as if you lost a player in the hockey game — until the penalty has been released. Releasing that
lien gives you back those rights or "players", and they rejoin the bundle held by the owner.
In the United States (and under common law), the fullest possible title to real estate is called "fee
simple absolute". But there are always some restrictions (or encumbrance) on property. Even the
US federal government's ownership of land is restricted in some ways by state property law.
Real vs. Personal Property

“Real property” incorporates all things attached to the land and all rights inherent with that land.
Real property usually involves things that are immovable such as homes and buildings.
This is not always the case as there are examples of things that are movable and considered real
property. However, as a general rule to help pass your exam remember: “Real = Immovable.”
When you think of real estate, you think of homes and buildings. Remember: The word “real”
has to do with things that are immovable, the word “estate” has to do with duration of ownership.
That is why you are getting a real estate license.
“Personal property” involves things that are generally movable. This can include items like
furniture, jewelry, clothing, art, or other household goods.
On your exam, you may hear personal property referred to as “chattels” or “personality”. To help
you remember this, think of the word cattle. Cattle sounds like chattels. Cows like to “moo”, so
chattels are moovable property! It may sound ridiculous, but when chattels come up in your
exam, you may be relieved at the thought of those mooing cows!
“Severance” is changing an item from real property to personal property by detaching it from the
land.
“Annexation” is adding to property by attaching an item to the property (so attaching personal
property to real property). This creates a fixture. Annexation is can often also mean attaching a
smaller piece of land to a larger one. Also, a smaller document may be annexed to a larger one,
such as a codicil to a will. Although physical joining is implied, actual contact is not always
necessary. In the law of real property, annexation is used to describe the manner in which a
chattel is joined to property. For example, a sink becomes a fixture when it is annexed to the
plumbing outlet and is therefore real property.
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Fixtures
One of the ways to remember the difference between personal property and real property is that
personal property goes with the person and real property goes with the real estate.
A “fixture” is personal property that becomes real property. This means that it was something
that went with the person, but for it now goes with the real estate that is being sold.
The classic example of a fixture would be a chandelier, as it is an item that was movable but is
now attached to the property. Other examples might be a sink or a toilet.
To remember this, remember the name “MARIA”. Can anybody say that name without singing
the song by Blondie?
Why should you be thinking about that song when they ask you about a fixture on your exam?
Because MARIA stands for:
▪ Method
▪ Adaptability
▪ Relationship
▪ Intention
▪ Agreement
Method of attachment. Is the item permanently affixed to the wall, ceiling or flooring using
nails, glue, cement, pipes, wires, or screws? Even if you can easily remove it, the method used to
attach it might make it a fixture. For example, ceiling lights, although attached by wires that can
be removed the lights are a fixture.
Adaptability. If the item becomes an integral part of the home, it cannot be removed. For
example, a pool covering is a fixture because that cover goes with that pool, even though it can
be easily folded up and put away.
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Relationship of the parties. If there is a dispute between buyer and seller, the buyer is likely to
win. If the dispute is between tenant and landlord, the tenant is likely to win. This comes up in
exams when dealing with emblements. These are crops grown on land that is being rented.
Intention of party when the item was attached. When the installation took place, was the
intention to make a permanent attachment? If so, the item is a fixture.
Agreement between the parties. Read your purchase contract. Most contain a clause that
expressly defines and agrees on items included in the sale. They often refer to: “All existing
fixtures and fittings that are attached to the property.” Remember, what two people agree upon
would trump all the other rules about a fixture.
Trade Fixture
A “trade fixture” is a piece of equipment on or attached to the real estate which is used in a trade
or business. Trade fixtures are different from other fixtures because they may be removed from
the real estate (making it personal property even if attached) at the end of the business tenancy,
while ordinary fixtures attached to the real estate become part of the real estate. The business
tenant must compensate the owner for any damages due to removal of trade fixtures or else
repair the damage. It is important that you remember trade fixtures remain the tenant’s property,
so they are personal property.
An example of this might be a display case used by a clothing store or a dentist chair. The
dentist’s chair would be a trade fixture as the chair is being used for the dentist’s business. Even
though it is attached to the property, the dentist will take that chair with him when he moves to a
different location.
Appurtenance
“Appurtenance” is a term for what belongs to and goes with something else. The appurtenance is
always less important than what it belongs to.
The word comes from the Latin appertinere: "to appertain."
Appurtenance is something which belongs to something else, it an be attached or not; it could be

a barn to a house, or an easement to land.
The appurtenance is part of the property and passes with it upon sale or other transfer.
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Encroachment
When you think of the word “encroachment” you might think of somebody stepping over a line
from their side on to yours. For all of you football fans out there, think of all those times when a
defensive team goes over the neutral line before the ball is snapped up.
In real estate it is not all that different. An encroachment is when a structure or improvement on
one person’s land physically intrudes on the land of another person. Examples might also include
a fence or driveway which crosses the property line.
Remember: your property line extends upwards to the sky, so a tree hanging over your property
is also an encroachment.
An encroachment can be found by a survey. Encroachment is a form of trespass, so when an

encroachment occurs, you may be able to sue your neighbor for trespass.
Emblements
“Emblements” are annual crops which have been legally cultivated and belong to the tenant. The
tenant has an implied right to its harvest, so emblements are treated as the tenant's property.
They are considered personal property. A tenant farmer has the right to his crops even after his
lease ends until the end of the growing season. Crops grown on property just before it’s sold are
also generally considered the personal property of the seller. Remember that personal property
goes with the person.
This comes into play in the law of landlord and tenant, or in the foreclosure of mortgages and
other legal situations that place the rights of another party in conflict with those of a farmer who
has planted a crop which has not yet been harvested. In these situations, the doctrine of
emblements operates to guarantee the farmer's right to harvest the fruits of his labor even if he
loses title to the land on which they are grown.
Water Rights
No one has title to water. Property owners whose land is next to bodies of water have a
“reasonable” right to the use of the water, but that water is not theirs so there are limits on what
you can do with that water.
“Riparian rights” allow a property owner to use water from moving water such as a river stream
or creek.
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“Littoral rights” concern properties next to an ocean, sea or lake rather than a river or stream.
Littoral rights are usually to do with the use and enjoyment of the shore.
An easy to way to remember this is that riparian rights have to do with water that is moving in
one direction, littoral rights have to do with water that does not have a direction.
Think Riparian = River, Littoral = Lake. Repeat this to yourself and you should remember.
“Correlative use” allows a property owner the use of underground water or water from a river for
irrigation.
In states where water is scarce, the “doctrine of prior appropriation” determines the use of the
water. According to this doctrine, the use of the water is determined by the state, not the owner
whose property is next to the body of water.
“Accretion” happens when soil is brought by the water and increases the size of the property.
When water moves back and new land is acquired, this is called “reliction”.
“Erosion” is when land or soil is worn away by wind, water, currents, or ice. If natural causes
tear away land in a violent way, this is called “avulsion”. A dam breaking or an earthquake is an
example of avulsion.
ESTATES
Freehold Estates
A “freehold estate” is an estate where you have exclusive right to enjoy the possession of a
property for an indefinite period of time. In contrast, a “less than freehold estate” is for a fixed,
defined period.
The three types of freehold estates that come up on the real estate exam are:
▪ Fee simple absolute
▪ Fee simple defeasible
▪ Life estate
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Fee Simple Absolute
A “fee simple” (or “fee simple absolute”) is an estate in land. This type of ownership cannot be
claimed by the previous owner or the previous owner’s heirs; however, it is not free from
encumbrances. Fee simple absolute is the greatest interest in a parcel of land that you can
possibly own. Sometimes, it is simply called "Fee". It is the most common way of owning real
estate in common law countries, and is usually the most complete ownership interest that can be
had in real property (except for absolute title).
Fee simple ownership is absolute ownership of real property and is only limited by the four basic
government powers of taxation, eminent domain, police power, and escheat. It could also be
limited by some encumbrances or a condition in the deed.
You do not really need a memory technique to remember this as long as you understand what the
word absolute means. It means complete and unrestricted.
Fee Simple Defeasible

A “defeasible estate” is created when a grantor puts a condition on a fee simple estate (in the
deed). This means that if a particular event happens, the estate could be lost. Two types of
defeasible estates are the fee simple determinable and the fee simple subject to a condition
subsequent.
- The grantor may state a specific duration such as: "I grant this to A as long as the land is used
for a park." If or when the specified event happens, the estate will automatically end and go back
to the grantor or the grantor's estate; this is called a fee simple determinable.
- The grantor may state a specific condition such as: "No alcohol to be served." This would be a
condition subsequent. You could lose title if you serve alcohol.
Life Estate
A “life estate” is an interest in real property which lasts the duration of one person’s lifetime.
This may be the lifetime of the person holding the estate or it may be the lifetime of another
person.
For example, Anne can give a property to Dan for the life of Anne. Dan would be the life tenant.
A life tenant receives the property and is responsible for maintenance of the property and paying
taxes. If a life tenant allows a property to deteriorate, it would be “committing waste” — and a
life tenant cannot commit waste.
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A life tenant cannot leave the property to someone in their will. A life tenant may sell, mortgage,
or lease the property for the duration of the estate. So any contracts would end upon the death of
the life tenant.
For example, if Dan dies and the property were to go back to Anne, Anne would have the estate
in reversion. If Anne dies, then the property would not be Dan’s because he had it as long as
Anne was alive. On Anne’s death, the property would go to Lisa, and then Lisa would have the
estate in remainder.
LESS THAN FREEHOLD ESTATES
A “less than freehold estate” is an estate held by someone who rents or leases property.
It is also known as a “leasehold estate”. The key element of a less than free hold estate is the
limitation of time. Lease is a legal estate, so leasehold estate can be bought and sold on the open
market.
A less-than-freehold estate could be an estate for years, periodic tenancy, estate at will, or an
estate at sufferance.
Estate for Years

An “estate for years” is a leasehold interest in land for a fixed period of time. It is often called a
“tenancy for years”. An example of an estate for years would be a summer rental, as it has a
definite beginning and end date. There is no need to give notice at the end of the rental. So a
lease for six months would be an estate for years, and a lease with a specific beginning and end
date would be an estate for years as well.
Periodic Tenancy
“Periodic tenancy” is also known (confusingly!) as an “estate from years to years”. It is a
tenancy that is not bound to a lease with a fixed period — like an estate for years. A periodic
tenancy follows a period such as a month-to-month, week-to-week, or year-to-year. To end the
lease, proper notice must be given.
Estate at Sufferance
An “estate in sufferance” happens when the tenant wrongfully holds on to a property after his
lease has ended; this is often called a 2tenancy at sufferance”.
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An example of an estate at sufferance would be a tenant that does not pay rent. In simple terms,
the landlord is suffering. This is not a form of trespass as at one point the tenant did have the
right to be on the property. The landlord would have to legally evict the tenant in this situation.
Estate at Will
“Estate at will” means that it can be ended at any time. It all depends on the will of both parties.
An estate at will gives the lessee the right to possession until the estate is terminated by either
party; the term of this estate is indefinite. This is not allowed in many states.
Leases
In a lease, the landlord is the lessor and the tenant is the lessee. Oral (or spoken) leases can be
binding. Generally, however, leases are written and give exclusive possession of the property to
the lessee with a reversionary right to the lessor.
A “reversionary right” means the owner has the right to take back possession of the property
after the lease has expired. Just like in any other contract, a valid lease must contain mutual
agreement, consideration, capable parties, and lawful object.
The lessee has the right to “quiet enjoyment” and possession of the property, which means that
their possession will not be disturbed by anybody with superior title (the landlord).
The lease is a bilateral contract because both the landlord and tenant have obligations. The lease
agreement can restrict the way the tenant uses the property and give certain conditions regarding
the security deposit and the duration of the rental.
Death does not usually end the lease. If one of the parties dies, the responsibilities stated in the
agreement could pass on to the heirs of the deceased.
Generally, when a property is sold the new owner has to honor the lease, however this isn’t
always the case. Leases are personal property as they do not always run with the land. It is a
contract with an individual person.
Unless the lease forbids it, the tenant has the right to sublet or assign the property. An
“assignment” is a transfer of contract rights, unlike a sublet where you rent the property and
lease it to another person and still have a responsibility to your landlord under the rental
agreement.
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“Constructive eviction” is a term used in property law to describe a situation where a landlord
either does something or fails to do something that he has a legal duty to do.
An example might be if the landlord refuses to provide heat or water to the apartment — as a
tenant cannot live without water — so the tenant vacates the premise. This would be constructive
eviction.
Property Management
A “property manager” has a fiduciary relationship with the owner.
The main goal of the property manager are to generate the highest net income while maintaining
the value of the property.
A property manager is a general agent of the owner because they are engaged in an ongoing
business relationship.
Most states recognize property management contracts as personal service contracts that would
end upon the death of either party.
Most states require property management agreements to be in writing. A property manager may
be paid according to the gross or net income the property produces.
The duties of a property manager include:
▪ Preparing the budget.
▪ Allocating the money for fixed expenses, operating expenses, and reserve funds.
▪ Selecting quality tenants (which involves being familiar with the market rent versus the
contract rent).
▪ Offering concessions to attract tenants.
The lease agreement should say when the rent is due. If the lease does not give a date, rent is due
the last day of the leasing period.
The property manager should maintain good relationships with the tenants. The duties of
maintaining the property include hiring contractors or employees and overseeing their work.
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The property manager must keep funds for capital expenditure like remodeling and renovating
the property.
A property manager should have knowledge of the following:
▪ Market conditions
▪ Record keeping
▪ Expenses
▪ How to handle environmental hazards
▪ Risk management
Risk management involves judging whether insurance is needed to protect the owner and
manager from certain risks such as:
▪ Loss of revenue
▪ Liability from injury of anyone on the premise
▪ Loss due to fire
▪ Medical coverage for employees
▪ And casualty losses
The four options a property manager has for avoiding risk are:
▪ Avoid the risk by removing the problem.
▪ Deal with the risk by purchasing insurance with a large deductible.
▪ Control the risk by installing protective equipment.
▪ Transfer the risk by obtaining insurance with no deductible.
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Types of Leases
There are different types of leases that come up on your exam.
Gross Lease
A “gross lease” is a rental agreement where the tenant pays a fixed amount which never changes
as a result of changes in the various expenses of the property. The landlord pays for these
expenses, which might include repairs, taxes, and operating expenses. It is the opposite of a net
lease where these costs are covered by the lessee.
Percentage Lease
A “percentage lease” is a rental that is based on a percentage of the monthly or annual gross
sales made on the premises. Percentage leases are common with large retail stores, especially in
shopping centers. A fundamental concept of the percentage lease is that both the landlord and the
tenant should share in the advantages of the location. There are many types of percentage leases:
the straight percentage of gross income, without minimum (which is uncommon); the fixed
minimum rent plus a percentage of the gross; the fixed minimum rent against a percentage of the
gross, whichever is the greater amount; and the fixed minimum rent plus a percentage of the
gross, with a ceiling to the percentage rental. There are also others.
Net Lease
A “net lease” is where the lessee has the responsibility to pay taxes, insurance, and maintenance
as well as the monthly lease payment. This is often referred to as a “triple net lease”.
Lease Option
A “lease option” is a rental agreement where the tenant has an option to buy the property during
the term or at the end of the lease. Here, the owner of the property would be the optionor, the
tenant would be the optionee.
“Consideration” is given to the optionor to secure the option for the optionee. The consideration
can be monthly payments or it can be money up front towards a down payment on an already
established amount.
If the optionee exercises the option, title would revert back to the time the contract began, not
when the option was exercised.
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EASEMENTS
An “easement” is when one person has the right to use the land of another for a specific purpose
(such as access to their property). The easement “runs with” the land, meaning that when the
property is sold, the right transfers to the new owner. You will often hear two terms when
dealing with easement: “ingress” which means to enter, and “egress” which means to exit.
Easements must be in writing.
An “appurtenant easement” involves two properties, owned by two different owners. The two
properties involved are called “dominant” and “servant”. If you are not sure about who is who,
just think about what the two words mean. “Dominant” means they are dominating; so, they are
in charge. “Servient” means they are serving; so therefore, the servant is serving another person.
So, the dominant tenement is walking all over the servient tenement.
This may be confusing sometimes, as the dominant tenement’s property is usually smaller than
the servant tenement’s property. But hey, Napoleon was a small guy and he always seems to
"dominate".
EXPRESS EASEMENTS
In many ways, the “express easement” is the best way to create an easement. There are two ways
to create an express easement:
Creating an Express Easement

Express Grant
An express easement created by “express grant” is given by the servient estate to the dominant
estate. This type of express easement is usually bought and bargained for. For example, one
neighbor may want to build a parking pad or basketball court off of their driveway, but may not
have enough room on their lot to do so because their driveway already butts up against the
property line. This owner may offer to pay her neighbor $500 for his consent to grant an express
easement to build a parking pad and basketball court off of her driveway that extends over his
land by ten feet.
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Express Reservation
An express easement created by “express reservation” is when the owner of one large piece of
land splits the land into two or more pieces. She places an easement on one or more pieces of
land to allow access to the other parcels.
For example, imagine a farmer who owns 40 acres of land. The eastern side of his land borders
the best lake in the state, so he decides that he is ready to give up his rusty old tractor and sell his
land to a developer for a hundred million dollars, so he can spend the rest of his days fishing. The
only problem is that the farmer’s home, which he spent 10 years building with his own two
hands and has every intention of living in until his final days, is on the far west side of the 40-
acre property; the only way to get to the lake is by driving over the eastern half of the property.
The farmer may expressly reserve an easement, at the time when the property is split into several
parts, allowing him to cross the newly established property to the east of his homestead in order
to reach the lake. Here, he has created an “express reservation”.
EASEMENT BY NECESSITY
An “easement by necessity” is similar to an “implied easement”. It is an easement created by the

courts. In fact, an easement by necessity is in many ways a type of implied easement. Courts will
only create an easement by necessity when the easement is necessary to the use of some piece of
property.
Most often, easements by necessity occur when a certain piece of land is completely landlocked
and would otherwise have no other access to a road. So if your land were completely landlocked,
and the only way to get to your land was by crossing over Bill's property, an easement by
necessity would exist giving you access to the road over Bill's property.
However, if at some time in the future other options come up and the necessity no longer exists,
neither will the easement. In other words, an easement by necessity can and will only last for as
long as it is necessary to achieve its result. Given our previous example, if at some later time the
city buys some land next to you and puts in a new road that now gives you direct access without
having to cross anyone else’s property, your previous easement by necessity over Bill's property
will disappear because it is no longer necessary. In that case, the easement by necessity would be
“extinguished”.
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EASEMENT IN GROSS
An “easement in gross” involves only one property. An example of this would be a utility
company which needs to cross the property but they are not trying to get to another. In an
easement in gross there is no dominant property.
It is a right for a specific person (or legal entity), not a piece of property. So if you have an
easement in gross to cross your neighbor’s land on to your land, it means that the easement is for
your own personal use, and may not be a right which would be included with your land if you
sell your land. An easement in gross does not transfer with the property when it is sold.
This is very common for utility companies. They need to cross people’s property but they are not
going to another property.
IMPLIED EASEMENT
An “implied easement” is an unrecorded easement which is legally necessary; it could be for

light, air, or access to a land-locked parcel. This is a fancy way of saying that it is an easement
that is created by the courts.
The idea behind implied easements is that courts understand that people are not always going to
do things the “right way.” Shocking, I know!
The truth is that sometimes people are not well-informed, sometimes lawyers mess up, and
sometimes even the best neighborly relationships go bad. In the end, one property owner may be
left without a driveway that he had always used ever since he first bought the property because
his neighbor decided that she doesn’t want him driving over her property anymore. So, instead of
forcing one owner to figure out a new way to enter and exit his property, the court will step in
and create an implied easement.
The idea is that despite the fact that no express easement was ever created; both parties had
always intended that this easement exist, and this intention is obvious in the way they used the
land in question. Often, we see implied easements happen when a property owner divides her
property into smaller pieces but didn’t create express easements at the time the property was
divided.
How do you create an implied easement?
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You must show that there was unity of ownership of the dominant and servient estates and that
the use was:
1. apparent
2. in existence at the time of the grant
3. permanent
4. continuous
5. reasonably necessary to the enjoyment of the premises granted
PRESCRIPTIVE EASEMENT
A “prescriptive easement” is a bit like taking land from somebody else. At first glance, many
people see prescriptive easements as little more than stealing because it is acquired without
paying money but rather by just using it without permission. Let’s look a little more closely and
see what a prescriptive easement really entails, though.
A prescriptive easement is defined as: “an easement created from an open, adverse, and
continuous use, hostile to the true owner’s title over a statutory period.” To which your response
may be: “huh???” This definition may sound as if it’s written in another language, however it is
simply a concise way to describe what a prescriptive easement involves. So now, let’s break it
down into something a little easier to digest.
If you want to establish a prescriptive easement over someone else’s property, you have to be
using the property in the same kind of way you would use a normal easement (so like a pathway,
driveway extension, garden, etc.).
As an example, assume that you have a driveway on the edge of your property that runs
alongside your neighbor’s property. It happens to be built on what you thought was the border,
but it turned out to be five feet onto your neighbor’s side.
Your use must be “open” and “notorious”. What this means is that you cannot hide your use from
everyone, especially the property owner. If you only ever run home across the back of your
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neighbor’s yard at 2 in the morning, when you know for a fact that the neighbors are on vacation,
this would not count as “open” and “notorious”. The above example of the driveway, however, is
visible to all.
The next important qualification to establish a prescriptive easement is that the use must be
“adverse”. What this means is that the use must be done without permission from the owner. So,
let’s go back to our above example with the driveway. If your neighbor knows that part of the
driveway is on her land and told you it’s okay, she has given you permission — so it is not
“adverse”. This does not mean, however, that your neighbor doesn’t know about your use, only
that they haven’t given you permission.
Finally, the use has to be “continuous” for a statutory period; this period varies depending on
what state you are in. Continuous use does not necessarily mean that you use it every day or even
every week. Continuous is not the same as constant. Often, it comes down to the court to decide
whether or not the land was being used often enough to be considered continuous. In our
example of a driveway along your property border with your neighbor, the use would most
definitely be continuous — as the driveway is there every minute of every day, and you use it on
a relatively regular basis. Thus, if you did accidentally build a driveway on what you thought
was your land, and used the driveway for 15 or more years, the odds are that you have gained a
prescriptive easement on that portion of your neighbor’s land.
GOVERNMENT POWER
4 POWERS OF THE GOVERNMENT
To remember the government powers just think of the name PETE:
▪ P for Police Power
▪ E for Eminent Domain
▪ T for Taxation
▪ E for Escheat
No ordinary individual has any of these rights.
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Police Power
“Police power” is the state’s right to regulate an individual’s conduct or property to protect the
health, safety, welfare, and morals of the community. This comes up a lot on the exam. Unlike
the exercise of “eminent domain”, the state does not need to pay compensation for using police
power. Common examples of police power are: zoning, building codes, rent control.
Eminent Domain
“Eminent domain” refers to the power of the state to take property for a public use. In some
jurisdictions, the state gives its eminent domain powers to public and private companies (often
utilities companies) so they can run telephone, power, water, or gas lines. The owner of any
appropriated land is entitled to “reasonable compensation”, usually defined as the fair market
value of the property.
Taxation
A charge on real estate used to pay for services provided by the government.
Escheat
“Escheat” is where property goes back to the state because an individual has died without a will
and without heirs. Escheat ensures that property always has an owner, which is the state or
government if nobody claims the property. Escheat is usually done on a revocable basis — which
means that ownership of the estate or property would revert to a rightful heir if they eventually
come along.
There’s no easy way to remember this one other than to imagine the government “cheated” to get
the property because they didn’t even know the person who died. We’re not trying to get political
here — this is just a way to remember what the word means.
Zoning
“Zoning” is the regulation of private land use and development by local government. There are
no federal zoning laws.
Zoning is an essential part of a master plan. This may be a plan for the long-term development of
a particular area.
Zoning increases the marketability of property. After all, would your house to be next to a gas
station? Well, luckily for you, the gas station would not want to be near you either. This is where
zoning comes in.
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Zoning is a police power. Do not think of the men in blue when you think of police power.
Remember, the police power is the state’s power to create laws to maintain public health, safety,
morals, and general welfare.
Zoning for land use is generally divided into:
▪ Residential
▪ Commercial
▪ Agricultural
▪ Industrial
▪ Special use properties
Each of these land uses also falls into a specific subdivision. For example, a multi-family unit
would be zoned as R-3 where the R stands for Residential.
“Special purpose properties” would be for properties that are there to benefit the public such as:
▪ Schools
▪ Hospitals
▪ Police Stations
“Zoning ordinances” are a set of laws which control the:
▪ Height of buildings
▪ Setback
▪ Density
▪ Floor area ratios
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▪ Buffers
▪ Buffer zones
▪ Variances
A setback is the distance from the edge of the road or sidewalk to the structure that was built. It
can also be the distance from the center of the road, check with your local zoning to see where
the setback line is for you.
Density is usually associated with subdivisions and restricts the number of houses that can be
built per acre within that subdivision.
A floor area ratio is the ratio of square footage to land area. The floor area ratio can be used in
zoning to limit the amount of building in a certain area.
A buffer is found between two lots, such as a fence, wall, or a row of trees.
A buffer zone is a space of land between two use districts such as a park, playground, or a
highway.
Down-zoning is a change in zoning to permit less intensive developments than are currently
permitted. So for example, a zone could go from commercial to residential.
A variance is an exception to the zoning rules. A variance is only granted in exceptional

situations and if it will not affect the rest of the community.
For example, suppose a "low density residential" zone requires every house has a setback of no
less than 100 feet. If one particular property was only 100 feet deep, it would be impossible to
build a house on the property. A variance could exempt the property from the setback rule and
allow a house to be built. Variances are granted lot by lot.
EMINENT DOMAIN
If you say it fast enough it would sound like you are saying “imminent doom”. Although it is not
that scary, it is not that far off!
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“Eminent domain” is the power of the state to seize a citizen's private property, to expropriate
property, or to seize a citizen's property rights. This is what makes it scary.
But it is not all bad as you would get monetary compensation. The property can be taken for
government use or on behalf of a third party for public or civic use. In some cases, it could be
taken for the purposes of economic development.
The most common uses of property taken by eminent domain are for public utilities, highways,
and railroads. Some jurisdictions require government bodies to offer to purchase the property
before resorting to the use of eminent domain.
The term “condemnation” is the name for the act itself whereby title is transferred from its
private owner to the government. It may not be the entire property; it could also be a smaller part
of it or an interest in it, like an easement. In most cases, the only thing that remains to be decided
when a condemnation action is filed is the amount of just compensation to be paid (note that is a
common question on real estate exams).
Do not confuse “condemnation” with a property being “condemned”. That would be when a
building has become so dilapidated that it is legally unfit for human habitation. The second type
of condemnation of buildings (on grounds of health and safety hazards or gross zoning violation)
usually does not take away the owner’s title but does require them to sort out the situation or else
the government will do it at the owner's expense.
“Inverse condemnation” is where the government takes private property but fails to pay the just
compensation. The owner then needs to sue the government to get any compensation. That's
right, inverse condemnation is essentially suing the government. An example would be if the city
widens a boulevard and thereby takes the entire parking lot of a market. The city offers to pay for
the lot, but the market claims it has lost all its business since no one can park and now it wants
the value of the entire parcel, including the market building. In this situation they would file for
inverse condemnation.
AGENCY
“Realtor” is a term within the trade, much like the term “Kleenex”. The catch is that many
people use the word realtor as a generic term, in the same way as you might ask for a Kleenex
when in fact any brand of tissue would be fine. Saying that you are a realtor means you are part
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of that designated organization known as "the board of realtors". Therefore if you are not a
realtor, you cannot say you are a realtor.
An “agent” is an individual or corporation who represents another. The other person or

corporation is known as the “principal”. A real estate broker does the representing and this
relationship is called an “agency”. And three parties are referred to in agency law: a “principal”,
an “agency”, and “third persons”.
In real estate transactions:
▪ the agency is the real estate broker who represents a client for specific purposes;
▪ the principal is the client (such as a seller, buyer, landlord, tenant, lender, or borrower),
who hires a broker to sell or lease property, to locate a buyer or tenant, or to arrange a
real estate loan with other persons;
▪ third persons are individuals or associations (corporations, limited partnerships, and

limited liability companies) other than the broker’s client. The broker contacts these third
persons on behalf of his client.
BASICS OF THE RELATIONSHIP
The principal asks the agency to do certain things for them. The principal is legally bound by the
acts of the agency, as it has been entrusted with carrying out duties on behalf of them.
An agency can be created by:
1. express agreement, whether oral or written;
2. implication, based on the custom or practice of the trade;
3. conduct of the principal. Under the legal doctrine of estoppel, the principal must admit to the
existence of an agency if it is properly formed.
As a real estate agent, the term “fiduciary relationship” comes up on a regular basis. A fiduciary
relationship is a legal relationship that creates a position of trust and confidence.
The acronym ACOLD will help you remember your duties in a fiduciary relationship.
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As an agent, you must:
▪ A - be Accountable
▪ C - use Care and skill
▪ O - Obey legal instructions
▪ L - be Loyal to your client
▪ D - Disclose all pertinent information.
When we say “loyalty”, what we mean is that the principal’s interest must come before anyone
else. It means keeping confidential information confidential — so any information that would
affect the bargaining position of the client. An example of this would be to not disclose that the
client is going through a divorce.
The “law of agency” defines the rights, duties, and responsibilities of all legal parties.
An “agency relationship” is a relationship in which an agent is authorized to perform certain acts

on behalf of a principal. If the agency relationship changes at any time during the transaction, the
change must be disclosed in writing, and the party must give consent to the change.
AGENCY RELATIONSHIPS
Dual Agency
Dual agency! Sounds like something out of a James Bond thriller, doesn’t it? Sadly, it is not that
exciting, but the meaning is not far off what you might imagine in the movies. This is a broker
working for the good guys and the bad guys.
You will often come across this when studying for your real estate exam, and people will often
tell you: “You will never use that after you pass!” That is not entirely true. This will come up in
your real estate career quite a bit.
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There are times when a buyer and a seller could enter into a dual real estate agency with their
real estate broker. This is not necessarily a bad thing; it all just depends how it is handled by the
people involved.
This usually happens when potential buyers don’t have an agent. They contact a seller’s agent
either at an open house or through an ad. They ask the seller's agent to submit an offer on their
behalf. If the agent does this, the agent would be acting as a dual agent.
Dual agency in a real estate transaction means the broker represents both the seller and the
buyer. Dual agencies can occur with one or two agents. To understand this further you have to
remember that the agent is not the one being hired, the broker is.
This may seem odd as a client only ever has contact with the agent and may never even see the
broker. But the agent works under a broker. Therefore, technically speaking, the agent is always
looking for business for the broker, not themselves. When the transaction is completed, the
broker is the one who is actually paid the commission. The broker will share the commission
with the agent who found this bit of business and who completed the transaction.
Understanding this will help you understand how a dual agency can often occur when there are
in fact two different agents involved. The buyer’s agent and the seller’s agent may be licensed
under the same broker.
With dual agencies there is a potential conflict of interest for the buyer and seller and this is why
it is not allowed in some states. In states where dual agencies are allowed, the real estate agency
must inform both the buyer and seller of a dual agency in writing.
Dual agency puts some restrictions on a real estate agent. Have you ever had to mediate an
argument between two friends or even a couple? It can be uncomfortable because the two parties
are at odds, and you must be looking out for both their interests and can’t take one person’s side.
The agent has to treat both buyer and seller with fairness and honesty. The agent has to give full
disclosure about the property but cannot reveal confidential personal information to either party.
Because you are looking out for both parties’ interests, when it is time to make an offer the real
estate agent cannot advise the buyer or seller on the price to offer and/or the price to accept. In
short, the agent’s loyalty is now compromised as they cannot try to advance the interests of one
party over the other. You have to stay totally neutral.
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Universal vs Special
A “universal agent” is one who has been given full power to act on behalf of a person or
business.
A “general agent” is authorized by the principal to perform any and all acts in the on-going
operation of the job or business. So, a real estate licensee acting as a property manager is a
general agent to the owner.
A “special agent” is one who has limited authority granted by the principal. The relationship with
the principal is not expected to be continuous. The listing contract creates a special agency
relationship with the seller. They can only fulfill certain duties written down in the listing
contract, and the relationship ends when the terms have been fulfilled.
Principal & Client

A “principal” is any person involved in a contract, such as a seller, buyer, principal broker, or an
owner who has hired an agency as a property manager.
A “client” is a party who has signed an agreement with an agency, and this agreement creates a
fiduciary relationship. A customer uses the services of a real estate licensee but signs no
agreement with an agency. So this could be a person who sees an ad in the paper and calls the
agent. Even though there is not a fiduciary relationship with the customer, the licensee must act
honestly and fairly with the customer.
When you list a property, you are representing the seller. As a licensed real estate professional it
is your duty to make sure that the buyer understands that you represent the seller.
A seller who enters into a listing contract with a brokerage firm is a client of the listing agent’s
company, not of the agent themselves.
The brokerage firm and the listing agent must act on behalf of the seller’s interest.
When a real estate broker enters into a contract with a buyer, the buyer becomes the client and
the seller becomes the customer.
A buyer’s broker may be paid by the seller, the buyer, or both. Because of the contractual
relationship, the agent is still a buyer’s agent even if the seller pays the commission.
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Attorney in Fact
An “attorney in fact” is a person authorized to sign documents on someone’s behalf. It can mean
any person who has been empowered to sign documents for another individual.
When an attorney in fact signs a document, the signature should also include the name of the
principal. For example, if Bob is signing on behalf of Bill, the signature might read, “Bob,
attorney in fact for Bill” or “Bill, signed by Bob, attorney-in-fact.” Attorneys in fact may only be
used for acknowledgments.
So basically, as far as those documents are concerned, Bob is Bill for that one act of signing.
This is essentially what attorney in fact means on its most basic level. You are given the authority
to be that person for that one act.
Note: Do not confuse this with being a practicing lawyer.
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COMMUNICATION
TYPES OF FRAUD
Actual Fraud
“Actual fraud” is an intentional misrepresentation or a representation which suppresses or
distorts the facts. It can also be making a promise with no intention to follow through.
Essentially, you are straight up lying.
An example would be telling a buyer that the roof of a property is completely fine when you
know full well that it is not okay at all. It would also be actual fraud for the agent to say: "Don’t
worry about the roof — if you buy this house, I will personally fix it, you have my word," when
they don’t even know how to fix or have no intention of fixing it.
Negative Fraud
“Negative fraud” is lying through omission. It happens when somebody does not disclose a
material fact in order to get somebody to enter into a contract that could put that person in a bad
situation regarding money, damage, or even personal harm.
An example would be an agent showing a home with roof problems and the client asking, "are
there any issues with the structure of the roof?" and the agent replying, "have I shown you the
basement?"
Constructive Fraud
“Constructive fraud” is lying without knowing you are lying. You didn’t necessarily intend to
deceive somebody.
An example would be an agent showing a home with roof problems and the client asking, "are
there any issues with the structure of the roof?" and the agent replying, "yes, its fine — the roof
is great," when the roof in fact has problems. The agent thought the roof was fine.
When this occurs you may hear the agent say, "Whoops, my bad."
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Negligence
“Negligence” is failing to perform a duty or exercise a reasonable level of care in a certain
situation.
Negligence is typically due to a lack of time, forgetfulness, or just plain laziness.
For example, if an agent is listing a property and there is a question regarding the zoning, the
agent should contact the zoning office.
Usually, this can be determined by a phone call or checking the website. If the agent knew that
there was a question regarding the zoning of a property and did nothing, the agent could be found
guilty of negligence.
Fraud may take the form of either misrepresentation or negligence. In either case, the agent may
be liable for damages incurred by the buyer because of the misrepresentation or the agent may
face disciplinary action and lose their license.
The owner may also be liable for damages because of the agent’s misrepresentations even if the
owner was not the source of the misinformation conveyed to the buyer.
Puffing
“Puffing” is an exaggeration of a fact. Many agents are guilty of puffing when showing a house.
We have all heard agents say, “MAN!! This is enormous!!” It’s not lying, but it’s close. Who
knows, maybe it is the biggest house the agent has ever seen, but more than likely the agent is
exaggerating to create a sale.
Puffing is usually an exaggeration made by a salesperson or found in an ad regarding the quality

of the property or the service on offer.
It is really more of an opinion than a fact, which is why

it is usually not considered binding. Puffing is legal as long as the statements themselves are not
fraudulent.
Stigmatized property
“Stigmatized property” means that a property may be undesirable for reasons unrelated to its
physical condition or features. These can include murder or suicide or even a belief that a house
may be haunted.
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It is the seller's responsibility to disclose any such past history of the property.
CONTRACTS
BASICS
An agent must have a working knowledge of contract law, because every aspect of the business
deals with the contract. A contract is an oral or written agreement to do or not do a certain thing.
Many oral (spoken) contracts are valid and enforceable. However, most contracts involving real
estate must be in writing to be enforceable.
The statute of frauds says that documents that must be in writing to be enforceable. In most
states, real estate documents such as sale contracts, deeds, and mortgages must all be in writing.
Some states allow an oral listing for less than one year. But to receive compensation, a broker
needs an employment contract in writing. So it is in an agent’s best interest to have a written
listing agreement.
Many real estate contracts contain a “time for performance”. For example, a listing contract has
an expiration date. An offer has a time period. And a sales contract has a date by which the
buyers must inspect the property, secure a mortgage commitment, and a close the sale. If a time
period is not specified, the law allows a reasonable time to complete the contract.
When the phrase “time is of the essence” is written in the contract, it means that everything must
be done within a specific time. If the requirements are not met, the promisor will have breached
the contract and the promisee can cancel the contract.
An “as is clause” in a contract means the buyer is buying the property as he sees it, with all
existing conditions. The seller is still bound to disclose property defects, but not to make repairs.
An “assignment” is the transfer of contract rights from one party to another. This could be the
transfer of a right, title, or interest in a property. A contract is assignable unless the contract or
state law forbids it. Personal service contracts are usually not assignable.
The party transferring the contract is called the assignor; the party receiving the transferring
contract is called the assignee.
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So for example, let’s say two years ago you entered into a five-year lease agreement and opened
your business. Today, a party wants to buy your business.
If you sell your business, and assignment is permitted, you may assign your lease to the new
owner.
If the lease is assigned, you are the assignor and the new owner is the assignee. The landlord
would now expect the lease payment from the new owner.
An assignment does not relieve the assignor from liability unless “novation” has been granted.
Novation is the substitution of one contract for new one and it takes away liability. Just
remember “Nova” is Latin for “New”, hence Novation — a new contract.
A “liquidated damage clause” is a provision in a contract for damages if a party breaks the
agreement.
In a sales contract, the earnest money may be considered liquidated damages if the parties agree.
That is, if the buyer breaches the agreement, the seller may keep the earnest money.
“Specific performance” is a court action to force a contract to be carried out.
For example, if all the requirements of a contract have been met, but the seller refuses to sell the
property, the buyer may sue for specific performance. Brokers do not sue for specific
performance.
A contract is cancelled when there is an agreement between the contracting parties to waive all
remaining duties and to terminate the contract. This means returning the parties to the same legal
position they were in before entering into the contract. It is called a “rescission”.
VALID CONTRACT ESSENTIALS
The essentials of a valid contract are:
▪ Capable parties
▪ Lawful object
▪ Consideration
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▪ Offer and acceptance
Capable Parties
To be a “capable party”, the person must have the legal capacity to contract. Typically, this
means the person must be at least 18 years old and of sound mind.
Other competent parties would include:
▪ A person given authority to enter into contracts on behalf of a corporation.
▪ A person with a proper power of attorney.
▪ A fiduciary given the authority to contract.
▪ An “emancipated minor” - somebody under 18 who is legally allowed to act on their own
behalf because they got married, served in the military, or through court action divorced
their parents.
Lawful Object
A contract must be entered into for a legal purpose. For example, when you see in the movies a
contract to kill, that is not really a contract because it’s not lawful.
A contract like this with an illegal purpose is void. A contract must also be entered into freely,
without duress, threats, blackmail, misrepresentation, or fraud.
Consideration
Normally, when we think of consideration we think of money, but consideration can be anything
of value. It is bargained for and received. Consideration can even be love and affection.
Offer and Acceptance

“Offer and acceptance” is also called mutual consent or a meeting of the minds. An offer must
contain the exact terms and conditions, and the offer must be accepted without changes. The
offer must be clear in character, the property must be accurately described to identify it, and you
must give an exact price.
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You cannot offer to buy a house for “a whole lot of money”. You must say one million dollars or
whatever the exact amount is you are offering.
Don’t forget the "or -ee" rule! The offeror is the party giving the offer; and the offeree is the party
receiving the offer. In real estate, the offer is usually made by the buyer and received by the
seller. An offer must be accepted without change by the offeree or the offeree’s authorized agent.
Before accepting, an offer or counteroffer can always be refused.
An offer is terminated by death or insanity of the offeror or offeree. Destruction of the property;
or a material change can also be cause of termination. A counteroffer occurs when the seller
changes any of the terms made by the offeror. This reverses the legal position of the parties and
the offeror becomes the offeree, and the offeree becomes the offeror. This means the counteroffer
is a brand new contract.
VALID, VOID AND VOIDABLE
A contract can be classified as “valid”, “void”, or “voidable”.
VALID
A “valid” contract is one that meets all the basic elements of contract law.
For example, you sign to buy a blue house, the house is blue, thus the contract is valid.
VOIDABLE
A “voidable” contract allows the option to rescind to either party. When the contract is written, it
is valid but it could be voided in the future. Most sales contracts are voidable contracts because
they contain contingency clauses.
For example, remember that blue house you wanted to buy?
Well, you signed a contract for a blue house but now you show up and the house is green! This is
voidable not void! That is because the violation of the contract should not stop you from being
able to buy the house. You signed for a blue house, but maybe you also like the color green? That
is why you have the option to continue with the contract making it voidable not void.
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A “contingency” is where things depend on a specific event that must occur before a contract is
binding, so: providing for a blue house when you sign for a blue house. If a contingency
provision cannot be met, the contract can be legally voided such as in the example given.
Contracts that are entered into under duress, misrepresentation or fraud are voidable.
If you are put under duress, that makes a contract voidable not void. For example, if a gun is put
to your head with a person saying, "Sign the contract or else I will shoot!" that is being put under
duress in its most intense form. But even that does not make the contract void. It is voidable
because that person pointing the gun at your head should not take away your ability to purchase
the property. What if you actually like the property? Well, now you can still buy it, even though
you were put under duress as the contract is voidable, not void.
VOID
A “void” contract has no legal force. It is missing an essential element; thus it is not a contract.
A contract to kill, for example, would be void, because it has an illegal purpose. You do not have
the option to kill somebody!
A more common example is if one of the parties involved is legally deemed mentally
incompetent. If that is true, the contract is void as it violates one of the four essential elements of
a valid contract. Which are — mutual consent, lawful object, capable parties, and consideration.
EXECUTED & EXECUTORY
An “executed” contract is when all parties have fulfilled their promises.
For example, a sales contract is complete when the transaction closes.
Do not confuse an executed contract with the act of signing a document, which is execution of
the document.
An “executory” contract is where one or both parties still have obligations yet to be performed.
For example, a sales contract is an executory contract until the buyer gets financing, and the
seller proves they have a clear and marketable title.
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BILATERAL VS UNILATERAL
A “bilateral” contract is one where there is a promise for promise. Sales contracts and listings are
examples of bilateral contracts. In a listing contract, the seller promises to pay if the agent finds
a buyer.
A “unilateral” contract is a one-sided agreement, that is, only one party makes a promise to do
something. A lease option is a unilateral contract until the option is exercised.
Another example of a unilateral contract is a lost dog sign, you find the dog, you get paid, but
you are not promising to go and look for the dog.
TYPES OF CONTRACTS
Land Contract
A “land contract” is a financial agreement between a vendor and a vendee. Generally, title is held
by the seller until final payment is made. The land acts as a security device. Usually, the seller is
responsible for paying taxes and insurance because the seller holds legal title to the property.
A land contract is also known as a “contract for deed”, “an agreement to purchase and sell”, or a
“land installment contract”.
In a land contract, the seller is the vendor, and the buyer is the vendee. The buyer has an
“equitable interest”, which means a beneficial interest in the property and gives the holder the
right to acquire legal title in the future.
Option Contract
In an “option contract”, the seller is the optionor and the buyer is the optionee. It is a unilateral
contract because the seller must sell, but the buyer has the option to buy.
When created, an option contract is a unilateral contract. But when the buyer uses the option, it
becomes a bilateral contract.
The option is assignable to another party unless the contract forbids it.
In a “lease option”, the lessee agrees to lease the property with an option to buy the property.
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The option is usually given in exchange for consideration; this could be money up front or added
to the rent. The lessee would be the optionee and the lessor would be the optionor as they are
giving the option to purchase at a designated time.
Implied Contract
An “implied contract” is a contract that is not in writing and is lawful because of the actions of
the parties and the circumstances they are in.
How does that happen? An old saying comes to mind: “If it walks like a duck, smells like a duck,
and sounds like a duck, then it must be a duck.” If it looks like a contract, then it probably is!
LISTINGS
A “listing” is an employment contract between principal and broker where the broker is being
employed to find a buyer and accept a deposit. It is the most essential element of a broker-
principal relationship.
A listing hires a broker to find a buyer, not to sell a house.
This is an important distinction.
Another important distinction: Remember the seller hires the broker to find a buyer, not the
agent. People think they are hiring the agent because for all practical purposes they are, as that is
who solicited the business and will be conducting the transaction. But in actuality, the agent is
working on behalf of the broker, therefore when the house sells and the seller pays a
commission, that commission is going to the broker, not the agent. The broker will then share
the commission with the agent as per their agreement.
The next big question people have is, "If you are telling me that the broker is hired to find a
buyer, then what does the agent of the buyer do?"
Think of it like this; The broker of the seller says to all the other brokers and their agents “I’ve
been hired to find a buyer for Mr. Smith’s property on Oak tree Lane! If you have a buyer and
they buy this property, I will share my commission with you for helping fulfill my contract with
Mr. Smith.” The amount that is going to be shared must be disclosed to the seller.
Now, in real life they do not stand on a house and use a megaphone, but that is the gist of how it
works. The more commonly accepted way is to put the property on the MLS.
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MLS stands for Multiple Listing Service. The MLS is a database of available properties listed by
real estate agents.
A listing agreement is a personal service contract. That means that if the principle or seller died,
or either party became incapacitated or the property was physically destroyed, such as by a fire
or a natural disaster, the listing agreement would be terminated. In short, remember that a
personal service contract needs a person there, therefore you cannot assign this contract to
another person.
The broker and seller may mutually agree to end the listing agreement.
Both the broker and seller have mutual responsibilities. If a party breaches their duty, the other
party can terminate the listing. For example, the broker is usually responsible for advertising a
property. If the broker fails to advertise the property, the seller could terminate the listing.
A material change can also lead to the listing being terminated. A “material change” is something
that would affect the value of the listed property. For example, when a property was listed, it was
zoned residential. The property was changed to a commercial zone after the contract was signed.
This material change would terminate the listing agreement.
Most listing contracts have a specific ending date. It can be as simple as: “This contract will
begin at 1 p.m. on Jan. 1, 2010 and it will end at midnight on Aug. 8, 2010.” Look at our listings
section to see which ones need an end date.
A listing contract contains many elements. You would want your listing to contain the following:
▪ Names of the parties to the contract
▪ The type of agency created
▪ The broker’s authority and responsibilities
▪ The location of the property (which may be a street address)
▪ Legal description or tax parcel number
▪ The listing price
▪ Beginning and ending dates
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▪ Real and personal property included
▪ The commission to be paid
▪ Authorization to advertise including the placement of a “For Sale” sign on the property
▪ Type of deed used for conveyance
▪ The terms for termination of the contract
▪ An indemnification clause
▪ Fair housing and anti-trust information
▪ The signatures of parties authorized to perform
▪ The protection period clause
The “protection period clause” is also known as a safety clause, extender or carry-over clause.
The purpose of this clause is to allow the agent to close deals with buyers found during the term
of the listing.
For example, let’s say that last week you showed a property to a buyer on Thursday, the listing
expired on Friday, then they come back and make an offer on Saturday. You would still get paid
because you were able to close the deal with the buyers you found during the term of the listing.
This only covers the amount of time agreed upon in the protection period clause.
If a broker is interested in buying a property that she or he has listed, this provision needs to be
included in the listing agreement. It is legal for an agent or broker to buy listed property. Most
states require licensees to disclose that they have a license before an offer is made on any
property that they are interested in purchasing. Many states require this disclosure to be in
writing, and they may also require the disclosure of the broker’s profit in the transaction. This is
called "listing with an option"
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TYPES OF LISTINGS
Exclusive Listing
In an “exclusive listing” only one broker can be hired. The listing belongs to that broker
exclusively. Because only one broker can be hired there must be a specific termination date.
If two exclusive listings are signed, the seller could be liable for two commissions. This is stated
on the contract.
Remember, in a listing there should only be one commission, the seller hires that broker to find a
buyer. People think there are two commissions, one to the broker of the seller and one to the
broker of the buyer; some people think there are four once you include the buyer’s agent. But in
actuality there is only one, the broker of the seller gets the commission and then shares that one
commission with the broker of the buyer for helping him/her find a buyer. The way that
commission is divided must be disclosed to the seller. The brokers will then share that
commission with the agent who facilitated the transaction on their behalf.
Exclusive Authorization and Right to Sell Listing

An “exclusive authorization and right to sell listing” is most commonly referred to as a “listing”.
When you see a “For Sale” sign in front of the house with the broker’s name on it on a typical
Sunday afternoon; it is more than likely just that: an exclusive authorization and right to sell
listing.
The key element here is that regardless of how a buyer wants to buy the house, the broker is
getting paid a commission. This helps avoid any potential conflict between the broker, who is
trying to solicit a buyer, and the seller who hired them to list the property. The owner agrees to
sell the property through the listing broker.
To put it in more technical terms: The listing broker does not need to show that he/she is the
“procuring cause” of the buyer.
Exclusive Agency Listing

“Exclusive agency listing” is much like the exclusive right to sell listing. The seller only works
with one broker. However, there is one huge difference. In an exclusive agency listing, if the
owner sells the house themselves, the agent gets no commission. This means that the agent has to
prove they were the reason the buyer came to buy the house.
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To use the terms of the real estate exam, “the agent would have to prove they were the procuring
cause of the buyer.”
Imagine there was a broker’s “For Sale” sign in the front yard of the house, and right next to it
there was a “For Sale by Owner” sign. Thinking about that image makes you realize why agents
do not like to use an exclusive agency listing. If somebody is buying the house, the last thing you
want to do is fight with the seller about who found the buyer. Remember, under an exclusive
agency listing, if the seller can prove the owner brought them there, they will pay you nothing!
Open Listing
Imagine if a seller wanted to sell a house and a broker came up to him and said: "If I bring a
buyer, will you pay me a commission?" The seller says, "Yes, of course." Then 10 minutes later
another broker comes up to him and said, "If I bring a buyer, will you pay me a commission?"
The seller says, "Yes, of course". This keeps happening over and over again and the seller has
agreed to the same deal with all of those brokers! This would most probably be an “open listing”.
It doesn’t sound like a bad thing, right? Whoever brings the buyer, gets paid for it, as long as
they are the principle in the transaction or have an active real estate license.
The problem with this is: why would you spend time and money advertising somebody’s house if
there is a good chance somebody else will get paid and you will get nothing?
As the broker, you would have to prove that you were the one who brought the buyer. This can
be very tricky to do. Imagine if every broker’s sign was in the front yard. How would you prove
which brokers sign drew that buyer in? This is just one of many complications with this type of
listing. That is why you do not see this in a standard residential sale. However, there are
situations where this type of listing works.
For example, a developer would enter into open listings with local brokers. The brokers bring
their buyers to the subdivision and if their buyer buys, then they get paid.
That makes this a non-exclusive listing, as it is not exclusive to just one broker.
Net Listing
A net listing is when an agent agrees to sell a property for a minimum price. Anything over the
minimum price belongs to the agent as commission. So in a net listing, there’s no agreed selling
price and no agreed commission.
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For example, a home owner wants $500,000 for their house.
If the agent sells it for $550,000, they made $50,000. Sounds great, right?
The problem is that if the agent sells it for $500,000, the agent makes nothing.
So in this case, the agent would have to manipulate the list price in order to earn a commission
— which would be illegal in most states.
An agent must account for all money and property that comes into his or her possession.
Normally, this just means the earnest money deposits. State laws regulate when the broker must
put the earnest money into an escrow or trust account.
EARNEST MONEY DEPOSIT
The earnest money deposit is to show you are serious about buying a house.
And a proposal? What comes to mind when you think of proposals?
That's right: marriage!
When a man proposes to the love of his love, nobody would take him seriously without that one
special item: a ring!
Can you imagine what a proposal would be like without a ring? There will be only one response
if he forgets the ring: "What a loser!"
Nobody would take that offer seriously.
The point here is that an earnest money deposit works in just the same way as an engagement
ring. It is there to show that you are serious about your offer, and if something falls through
during the process, you might lose that deposit. It’s only once the bride and groom say "I do" that
escrow is closed!
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VALUATION & MARKET ANALYSIS
DEPRECIATION
Depreciation is any loss in value of a property over time.
Tax laws allow investors to depreciate the value of improvements they make to a house. The
term "depreciation" is often used for income taxes. This type of depreciation reduces taxable
income and is usually calculated using the “straight-line method”. This method assumes
depreciation occurs at the same rate over the structure’s economic lifetime or the time period that
improvement can be used. The cost of replacement of the improvement can be added to this
initial cost and this sum total is the depreciation which the property has suffered.
Depreciation can be either “incurable” or “curable”. What does that mean? If the value of a
property increases by the same amount of money as the cost of the improvement (or more), then
it is “curable”. The appraiser cares about whether a problem can be repaired, but also if the repair
makes financial sense. For example, if spending $5,000 to repair a roof would add $5,000 or
more to the value of a house, then the deterioration of the roof is said to be curable. If fixing the
roof would just increase the value by $650, then the condition of the roof would be considered
incurable.
Types of Depreciation
Economic Obsolescence
“Economic obsolescence” is a form of depreciation. It is caused by factors that are not on the
property, in the property or even within the property lines. It might be caused by something like
the neighborhood experiencing a rise in crime. It can also be caused by economic factors, such as
changes in the job market. Recession or a national economic depression that reduces property
value can also be economic obsolescence.
Examples of causes of economic obsolescence can include:
▪ flight patterns be changed to go over your house
▪ a highway being constructed nearby
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Functional obsolescence and economic obsolescence can be difficult to differentiate at times. For
example, when consumer tastes change, older properties can lose some of their desirability. This
happened when builders starting putting master bedrooms in homes. The older homes with no
master bedrooms lost some of their appeal. Lack of a master bedroom was earlier cited as an
example of functional obsolescence. It could perhaps be argued that actually it was the other
more desirable properties that caused that loss in value, and this was outside of the property lines
of the property in question, so that this should be considered economic obsolescence. In the end,
it probably makes no real difference whether a specific factor is considered functional or
economic obsolescence, as long as it is not considered (and deductions made) twice.
“Economic obsolescence” is almost never curable. For example, if there is a sudden spike in
crime rates in the neighborhood, there is no one the home owner can pay to fix
the neighborhood. Even if an owner had that kind of money, it would never add enough value to
that owner's property.
Obsolescence is a form of depreciation which occurs when a property is no longer wanted even
though it is still in good condition.
Functional Obsolescence
“Functional obsolescence” is defined as a “form of depreciation resulting in a loss in value due
to conditions within the property”.
Some examples are:
▪ poor design
▪ too many or too few materials
▪ excess construction
▪ lack of utility, in other words there are features that are not practical or
desirable.
▪ overly costly operating expenses.
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Think about if you have two cars and the house only had one car garage…. Functionally
obsolete!
Functional obsolescence is a form of depreciation due to lack of care for the improvements. It
can be caused by many factors, including changing consumer demands, buildings which no
longer suit the needs for this particular neighborhood, or improvements in design or construction
techniques.
For example:
Most of the tract homes built 70 years ago were planned so that all of the bedrooms were the
same size. That was considered fantastic back then. However, that would not go down so well
these days, as newer houses are expected to have one master bedroom (if not more). A master
bedroom needs to be bigger than the others and have its own bathroom facilities. The houses
constructed back then are now considered functionally obsolete because there is no master
bedroom.
A garage with space for only one car is another example of functional obsolescence.
Physical Deterioration
“Physical deterioration” is the most obvious form of depreciation because you can see it. It is a
loss in value due to age or the elements. Mother Nature will eventually take her course on
buildings and homes and will eventually wear them out. When your maintenance does not keep
up with the natural wear and tear, you will have physical deterioration. Physical deterioration is
not a form of obsolescence. This would hurt the property’s effective age. Your house is simply
falling apart!
Most forms of physical deterioration are curable. For example, suppose your house needs new
paint costing about $6,500. There is a chance a prospective buyer would pay an extra $6,500 for
the house once painted, which would cover the painting expenditures. This would be an example
of curable physical deterioration.
Curable physical deterioration examples:
▪ Paint jobs
▪ Roof repairs
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▪ Deferred maintenance
▪ Repairs to the heating or cooling system
▪ Repairs to faulty wiring
▪ Replacing loose tiles
▪ Repairing a breakage
▪ Replacing dated construction material
▪ Repairing normal wear and tear
If the bearing walls have to be replaced or if the foundation of a property is busted, it would be
considered incurable physical deterioration. In theory, everything is repairable; in theory, you
can rebuild the entire house from scratch, but at some point the cost goes beyond reason.
There are appraisers who use an additional category called “short-lived incurable physical
deterioration”. This category would include items which wear out faster than the improvements
themselves. For example, suppose that the original furnace in a home is not as desirable as
newer, more energy-efficient furnaces which are now available. The existing furnace is
still functional, and it might not be cost effective to replace the furnace now, since the price of a
new one might not significantly increase the value of the property. However, when the existing
furnace is totally worn out and needs to be replaced, then it would make sense to put in a newer,
updated furnace. This is called short-lived incurable physical deterioration, because although it
doesn’t make sense to repair it today, eventually it might be.
Some appraisers include this short-lived physical deterioration as being curable, rather than
incurable. They do this because they think that it will eventually be fixed. You can find decent
people on both sides of this debate. Perhaps the most important thing to remember is that the
appraiser will be consistent in how they deal with this issue. Whether it is considered curable or
incurable, the same standard is applied for all comparable properties.
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EFFECTIVE AGE VS ECONOMIC LIFE
“Effective age” is the age of a property based upon its condition not its actual age.
If an appraiser looks at a building that is 25 years old, which is in the same condition as your
average 11-year-old building because it has been well maintained, the Appraiser may use the 11-
year-old age as the effective age of the property.
“Economic life” is the length of time a piece of property may be put to profitable use, usually
less than its physical life.
DETERMINING VALUE
Steps in the appraisal

These are the steps in the appraisal process:
▪ State the purpose
▪ List the data needed and its sources
▪ Gather, record, and verify the data
▪ Gather, record, and verify the specific data such as site development
▪ Gather, record, and verify the data for each approach
▪ Analyze and interpret the data
▪ Reconcile data for final estimate
▪ Prepare an appraisal report
The type of value being estimated would be found in the “statement of purpose section” of the
report.
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An appraiser’s report will not mention the buyer’s financial condition because it doesn’t matter
how you pay for the property. The appraiser is interested in the value of the property itself.
Essential Elements of Value

“Market value” is the current value on the open market.
The original cost of an item will have no effect on its value. Cost is the amount of dollars spent
to produce an item.
The Four Essential Elements of value are:
▪ Scarcity, how much of there is it?
▪ Transferability, can it be sold?
▪ Utility, can it be used?
▪ Demand, does anybody want it?
Just think of the acronym: “STUD”.
“Market price” is the actual selling price of the property. Market value, cost, and market price
might be the same, but they seldom are.
For example, using the “market data approach”, an appraiser decides the market value of a
property is $175,000. But under the “cost approach”, it would cost $190,000 to build the
property from scratch. The property sold for $200,000, which makes the price $200,000, because
that is what somebody is willing to pay.
The appraiser is hired to decide the market value of the property, not the price of the property.
Assemblage and Plottage

Two ways to increase value are through “assemblage” and “plottage”. Assemblage means
combining two or more parcels. Plottage is an increase in value by combining two or more sites
so that they are now more valuable than they were separately.
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An appraiser is paid according to the time they take making the appraisal, they are not paid
a percentage of the sale price of the property. An appraiser must be neutral.
APPRAISAL METHODOLOGY
Gross Rent Multiplier

“Gross rent multiplier” is the ratio between the price of a property and its annual rental income
before expenses such as property taxes, insurance, and even utilities for vacation rental
properties.
Other expenses could include the cost of hiring a property management company. To sum up the
Gross Rent Multiplier (or GRM), it is the number of years the property would take to pay for
itself in gross rent.
For the investor, a higher GRM (perhaps over 20) is a less interesting opportunity, whereas a
lower one (perhaps under 15) is much better.
The GRM is calculated with the following formula:
Purchase Price divided by Gross Annual Rental Income =GRM

For example: $180,000/$15,000 = 12.
The GRM is useful for comparing and selecting investment properties when depreciation, regular
costs (such as property taxes and insurance), and rental costs (such as utilities and repairs) are
uniform. These costs are often more difficult to predict than market rental return, so the GRM
acts as an alternative to looking at net investment return when this is difficult to estimate.
When you measure the rental value for a property using the net income rather than the gross
income, it is called the “capitalization rate” or “cap rate”.
In contrast to the GRM, the cap rate is not a multiplier but a rate of annual return. Gross Rent
Multipliers are found by dividing the price of the property by its rent.
▪ $100,000 property divided by $10,000 annually in rent would give you an annual GRM
of 10.
▪ $100,000 property divided by $1,000 monthly in rent would give you a monthly Gross
rent multiplier of 100.
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▪ If you are given a monthly rent amount and an annual GRM then multiply that monthly
number by 12, because you always want to use annual figures when possible.
Cost (Replacement) Approach

“Cost approach” is a way of calculating the value of a property. First, you take the replacement
cost of the building which was estimated by the appraiser. Add the estimated value of the land.
Finally, subtract the depreciation. The “replacement cost of improvements” is the cost to replace
an improvement with another improvement which is just as useful.
Basically, how much would it cost for a brand new replacement?
This is usually used to appraise special purpose properties, like libraries, schools, and police
stations. You want to use it for these types of buildings because they will be difficult to compare
to other buildings in the area, so you cannot use the market data approach. They are also not
designed to bring in income, so you can’t use the income approach or a gross rent multiplier.
Cost approach sets the upper limits of value because essentially you are looking at what it cost to
replace a building from scratch.
This approach is best for appraising new property, not old; the older the building is, the more
variables there are estimating its value. If something was built yesterday, then the estimated
amount it cost to build is much more accurate.
If you had to appraise a property from 1910, you would be using the current cost of reproduction;
the cost it took to build it in 1910 would not be a factor.
The methods for estimating the cost of construction are:
Unit-in-Place Method
“Unit-in-place” calculates the added cost of single units installed.
Square Footage Method

“Square footage” uses exterior dimensions to calculate the cost per square foot.
Quantity Survey Method

“Quantity survey” calculates the cost of labor and materials to build each part of a building, it is
very accurate but time consuming.
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CAPITALIZATION (INCOME) APPROACH
“Income capitalization” is used by appraisers and real estate investors use to estimate the value
of real estate which produces an income. It is based on the expectation of future benefits.
This method of valuation compares value to market rent and resale value.
Capitalization (income) approach effectively converts income into value.
We all know that a property that makes more income will increase the value.
The capitalization approach helps to estimate exactly how much.
A shopping center is a great place to use this approach.
Determining the cap rate is a very difficult part of this approach.
Methods used to estimate the capitalization rate are the “market comparison method”, the “band
of investment method”, or the “summation method”.
The cap rate is directly related to risk:
A hardware store would have a high cap rate because it is a higher risk. A Post Office building
would have a lower capitalization rate because it is a lower risk.
“Capitalization rate” (or “cap rate”) compares the net income and its capital cost (the original
price paid to buy the asset) or sometimes its current market value. Calculating the rate is fairly
easy:
For example, if a building is bought for $1,000,000 and it produces $100,000 in net income (the
amount left after fixed costs and variable costs are subtracted from gross income) during one
year, then:
$100,000 / $1,000,000 = 0.10 = 10%
The asset's capitalization rate is ten percent.
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Capitalization rates are a measure of how fast an investment will pay for itself. In the example
above, the purchased building will be fully capitalized (pay for itself) after ten years (100%
divided by 10%). If the capitalization rate were 5%, the payback period would be twenty years.
Note that a real estate appraisal in the U.S. uses net income. Cash flow equals net income minus
debt service. When you can’t find detailed information, you can estimate the capitalization rate
from net income to determine cost, value, or required annual income.
MARKET DATA APPROACH
The “market data approach” or “sales comparison approach” involves finding value by
comparing a property to other properties of similar size and condition in the same area. If two
similar properties are $400,000, then your property would be estimated at $400,000.
It is one of those things where the definition is in the name, kind of like “jumbo shrimp”. You are
comparing sales in the market — hence the name “Market Data Approach” or “Sales
Comparison”.
If you think about it, you use this approach every day when you go shopping: what is a good
price for the shoes I want? Well, how much are similar pairs of shoes?
Appraisers usually use comparable homes that were sold within six months of the appraisal. If
you are becoming a residential real estate agent, you will soon become very familiar with this
approach. The market data approach is widely accepted as the most accurate way to compare
residential real estate.
This approach is also perfect for vacant lots. When there is a vacant lot, there are not many
variables so it is easier to get a direct comparison to the property in question. Whereas, a house
with lots of extensions and improvements to take into consideration makes it difficult to
compare it to other properties.
This is the most difficult aspect of this approach. When comparing two properties, you need to
deduct any features. For example, if one property has a pool and the other does not, you need to
account for the value of the pool. Finding out the value of the pool can be very tricky.
Evaluating the property means adjusting the value of the home by adding and subtracting for
size, location, amenities, and condition in comparison to other recently sold properties in the
market. This approach uses entire properties as units of comparison. The basis of the market data
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is the “principal of substitution”. “Market data” is usually used to establish rent schedules. How
much do you want to charge somebody for rent? Just ask the tenants next door how much they
are paying — it is that simple.
Market data becomes less reliable during times of rapid economic change or instability, when
there is an inactive market, or when analyzing unique properties.
APPRAISAL THEORY
PROGRESSION AND REGRESSION
When you go out to a party to meet a girl or a guy, you choose the friends you go with wisely.
Should I go with someone who is more desirable than me in order to raise my status by being
seen with them? Or should I go with someone much less desirable than me in order to raise my
status and make me look good?
You can make the call in your personal life, but in real estate terms you would absolutely want to
go with the more desirable person.
What do I mean by this? Let me explain: In real estate your value will increase if it is in the area
of much more desirable homes, and it will decrease if it is in an area of less desirable homes.
Therefore, when you are looking at buying a home, it may be tempting to buy a huge house in a
less desirable neighborhood because you always wanted a big house with a big yard, and in that
neighborhood you can afford those things. If that is what makes you happy, then go for it!
However, from an investment stand point that is a bad move.
From an investment standpoint, it would make much more sense to take that money and get a
much more modest house in a much nicer area. You may not be able to afford your dream home,
but as a result of being around much more expensive properties the value of your property will
go up.
In appraisal terms, we are talking about the principle of progression and regression.
The “principle of progression” is that the value of less expensive properties will increase when
more expensive properties come into the area. So if your home is worth $500,000 and it is
surrounded by $1,000,000 homes, the value of your property will go up.
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The “principle of regression” is that the value of more expensive properties will decrease when
less expensive properties come into the area. So if your home is worth $500,000 and it is
surrounded by $100,000 homes, the value of your property will go down.
PRINCIPLE OF CONTRIBUTION
In some of your books, this may be called the “principle of marginal contribution”. This
principle of contribution states that the worth of an improvement is what it adds (or contributes)
to the market value of the entire property, not just what it cost to add the improvement. This is a
key factor when deciding to add to existing improvements.
People who buy real estate often believe that if they spend money to add additional
improvements to their property, that the market value of their property will go up by the cost of
that improvement that they added on. For example, many people have added swimming pools to
their homes or have remodeled their homes may assume that these improvements will add
significantly to the market value of their properties. This is not always the case.
Swimming pools are a common example of this. Having a pool could add between $5,000 and
$10,000 to the value of a home, depending on size, location, design, etc.... Given that a pool
costs $10,000 - $20,000 or more, people should only build swimming pools because they like to
go swimming, because it is not necessarily a wise investment which will increase financial value
upon sale.
There are times when an improvement can add more than its cost to the resale value of a
property. Sometimes, adding an additional room can be a very simple procedure because when
people search for homes, the first thing they look at is almost always how many bedrooms there
are. The additional bedroom can exceed its cost of installation.
It is the appraiser’s job to be aware that there can be huge differences in the value of different
improvements in different circumstances. A swimming pool in Las Vegas would be worth much
more than a pool in Boston. Appraisers will need to run detailed comparisons of similar
properties to determine how much value that improvement added.
This is all the principle of contribution: how much would an item contribute to the value?
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PRINCIPLE OF CONFORMITY
The “principle of conformity” is that conforming to land use objectives contributes the most to
economic stability in a residential community. This is why homes are built in the same style as
the other properties in that same area — because the values will go up.
In some areas, properties were not developed at the same time or were not well planned
(individuals purchased vacant lots and set about building their own homes on those lots). Very
often, these areas suffer from not having a sense of conformity. Some of the residents had a lot
more money and different ideas of beauty than the others, this resulted in an eclectic mixture of
properties with different sizes and design in the area and hurt property values.
Conformity is also important in commercial areas. The stores in an area should appeal to the
same types of people to be successful. For example, it is no mystery why we tend to
see Starbucks and Subway; They tend to appeal to the same type of clientele — hungry people.
So having both near each other makes a great deal of sense. There is a reason there is a food
court in the mall.
It is important that the principle of conformity not be taken too far, however. Imagine if
Starbucks was smack in-between two other coffee shops. As with residential properties, it is
preferable that a neighborhood has similar types of homes, but too much similarity can become a
bad thing. When all the homes on the street are exactly the same, it does not raise the value and it
does start to look like something out of a horror movie.
PRINCIPLE OF SUBSTITUTION
The “principle of substitution” is the basis for the market data approach.
This principle says that the maximum value of a property is usually the cost of a similar property
that has the same use, design, and income. As an easy example, why would anyone pay
$1,000,000 for a house when they could purchase a different house in the same area which is
equally desirable for only $750,000?
Same as when you go buy shoes: why would you pay more for one pair if there was another pair
with the same look, feel, and design one store over at a cheaper price?
One of the major factors for this to be effective is that there must be other properties in the area
which could be substituted for the subject property and which have recently sold.
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PRINCIPLE OF HIGHEST AND BEST USE
“Highest and best use” shows the highest value for a piece of real estate. Highest and best use is
based on the use which gives the highest value for real estate — its current use is not
relevant. This would be done by conducting a site analysis. If the use is temporary, it would then
be considered the interim use.
When deciding what use would be the highest and best use, the appraiser needs to consider many
possible uses of the property. A potential use cannot be considered to be the highest and best use
unless it is all four of the following:
▪ Legally allowable
▪ Physically possible
▪ Financially feasible
▪ Maximum utility / Profitability
Legally Allowable
A prospective use cannot be considered the highest and best use unless that use is allowed under
current building codes, zoning ordinances, environmental laws and other government
regulations. For example, if an area is zoned as residential, it would be hard for an appraiser to
state that the highest and best use of that real estate would be as a commercial building.
Properties with a use that existed prior to current zoning laws or other regulations can sometimes
keep their original use. This is known as being “grandfathered in”. They are usually permitted
even though they do not meet current regulations or zoning requirements. However, it is possible
that some of these uses could not be reproduced if some relevant improvement is badly damaged
or destroyed.
Physically Possible
Not all properties can be developed for all uses. A potential use must be physically possible.
Potential uses can be limited by the size, shape, topography, and other characteristics of the site.
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As an example: a 50,000-square-foot single story warehouse would not fit on a 15,000-square-
foot site; therefore, that use would not be physically possible.
Financially Feasible
A property must be economically feasible. Suppose that a lot is physically, legally, and
geographically suitable for an office building. If there’s already a ton of office space on the
market, this use is not currently economically feasible.
Maximum Utility / Profitability

Finally, the use must generate the highest net return (profit) for the developer. All remaining uses
which are legally allowed, physically and economically possible must be tested to decide which
use will gain the most profit.
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FINANCING
FINANCING BASICS
“Assume” vs “Subject to”

It is important to understand the difference between “assuming” a mortgage and being “subject
to” mortgage. When a buyer buys a property and assumes a mortgage, the buyer becomes
primarily liable for the debt and the seller becomes secondarily liable for the debt.
Remember: “Subject to” means seller liable, buyer not liable. “Assume” relieves seller, buyer is
liable.
The word “assumption” is used when a buyer assumes personal liability for an existing debt. If
the buyer defaults, the seller no longer has responsibility as the buyer has “assumed” the loan.
The term “taking subject to” is when the buyer incurs no liability to repay the loan. The loan
stays in the seller’s name, but the buyer gets the deed and controls the property. Although the
buyer makes the mortgage payments, the seller remains responsible for the loan. When the
property is sold subject to the loan, the buyer is not liable to pay the lender and the original
borrower is still primarily liable to the lender.
For example:
A qualified veteran negotiates a VA-guaranteed loan to purchase a home; he moves to another

state, the buyer purchases the property subject to the mortgage. Because the new buyer is not a
qualified veteran, if they default on the loan, the veteran is still primarily liable to the lender.
When a buyer “assumes” a loan, it has to be done with the lender’s approval. An assumption
agreement is prepared by the lender and signed by the buyer during escrow. The lender would
normally ask for a credit history from the buyer before approving the assumption and the
payment of assumption fees: the same as if the buyer was qualifying for a loan with that lender.
When a buyer takes title to property “Subject to” the loan, the lender is not notified of the
transaction or asked for their approval, because the seller is not released from responsibility. The
buyer is making the payments instead of the seller in this case. The seller will be asked to
provide escrow with their last payment record. This will be used to calculate the exact principal
balance at close of escrow. The lender may have the right to accelerate the loan when/if they get
notified of an ownership transfer.
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Servicing the Loan
Once the loan has been created, the lender must service the loan.
“Servicing” the loan includes collecting the mortgage payment and sending it to the secondary
mortgage market, sending a monthly statement to the borrower, providing a contact number for
borrower questions, escrow instructions for taxes and insurance, accepting additional payments
applied to the principle and working out the payoff should the borrower request it.
Lenders make their money from finance charges and reoccurring income. Finance charges
include origination fees and discount points. The reoccurring income is the interest collected on
the loan.
An “origination fee” is a fee paid to a lender for processing a loan application. The origination
fee is written in the form of points. “Discount points” increase the lenders yield, a point is equal
to one percent of the loan amount.
INVESTING
From a financial standpoint, an investment is a commitment of a certain amount of dollars with

the expectation of a profit in the future.
ADVANTAGES OF INVESTING IN REAL ESTATE
Appreciation
“Appreciation” is the biggest advantage of investing in real estate. It is the increase in property
value over time. You always hear people say that you should buy property and hold onto it until
you have to sell it regardless of what happens in the market.
Cash Flow
Income property has made many people very, very rich. Who wouldn't want to have a check
come in every month? Get a quality tenant and it can be a gold mine.
Leverage
Using somebody else's money to make money? What’s the point in that? It is not even your
money! People will lend you more money when you have more real estate as you have more
collateral.
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Equity
This is the difference between the current market value of the property and the amount the owner
still owes on the mortgage.
Simply said, equity is all the money you can put into your bank account when your property is
sold and you pay off your debts.
DISADVANTAGES OF INVESTING IN REAL ESTATE
Knowledge
It is not a game for the novice. You have to research the market and financing before taking your
first step.
Long Term Gains (Liquidity)

It is not very liquid. Stocks can be converted to cash quickly, but real estate cannot be. This is
why real estate is a long term investment. Your money is not very accessible if you place it into
real estate.
Risk
Real estate may not be as big of a risk as many other businesses. However, there is still risk, as
things can happen that you do have no control over.
INVESTING TERMS
Pyramiding
“Pyramiding” is the process of borrowing against one property to invest in another.
Arbitrage
“Arbitrage” is when you borrow money at one interest rate and lend it at a higher interest rate.
Syndication
“Syndication” is pooling money for investment purposes. Syndications may be formed as:
▪ Common ownership
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▪ Joint ownership
▪ Corporations
Partnerships
A “security” is joining with others for investment purposes; profit is made from the efforts of
others. Stocks and bonds are examples of securities.
Usually, somebody selling a security must be licensed.
A “partnership” is an association of two or more person as co-owners. A partnership can hold

title to real estate. If the proper documents are filed, the partnership does not need to pay taxes,
but each individual must pay taxes on the money given to her or him.
In “general partnership”, all partners must participate in management and are personally liable
for all partnership activities. In a “limited partnership” there is at least one “general partner” and
the others are “silent partners”.
In a “limited partnership”, the individuals are only liable to the degree of their investment and
have no say in management.
A “joint venture” is joining two or more people in a business transaction. Joint ventures usually
have a time limitation. When people create a joint venture, there is no intention to enter into a
continuing relationship.
In a “real estate investment trust”, there must be at least 100 investors who pool their money
together and participate in large real estate projects.
These investors are beneficiaries who transfer title to a trustee who manages the properties for
them. A real estate investment trust avoids double taxation and passes on income if certain
criteria are met.
If at least 75% of the trust assets are in real estate, and if the trust passes 95% or more of their
annual income to the investors, the trust is exempt from paying corporate tax. The investors
receive certificates of ownership as evidence of their investment. These certificates (or shares)
are freely transferable.
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A “corporation” is a legal entity created under state law. The law views a corporation as an
artificial person. A corporation has a “perpetual existence”, meaning it cannot die but it can be
legally dissolved.
The advantages of a corporation are that it is a legal person created by law and it will continue
even after the death of its officers. The stockholders can only lose the amount of money invested,
and investors can freely transfer their shares of stock.
The disadvantage of a corporation is that if a corporation makes a profit the corporation must
pay taxes. The investors must also pay taxes on the profit distributed to them, so there is double
taxation. If the corporation suffers a loss, it cannot pass the loss into the shareholders.
LOAN CLAUSES
A clause is the term used to identify a certain section of the contract or policy. There are many
different clauses that can come up in regards to a loan.
ACCELERATION CLAUSE
The “acceleration clause” is the clause in a mortgage or trust deed that says that the entire debt is
due immediately if the borrower defaults under the terms of the contract.
ALIENATION CLAUSE
An “alienation clause” is the clause in a mortgage or trust deed which explains that the lender
can ask for the balance of the loan immediately if the property is sold or transferred by the
borrower. This stops the borrower from assigning the debt without the lender's approval. It is
also known as a “due-on-sale clause”.
PREPAYMENT CLAUSE
A “prepayment clause” allows the borrower to pay the debt before the due-date.
A “prepayment penalty” is a fee the borrower pays if they pay off the loan early.
This fee compensates the lender for interest and other charges that would otherwise be lost.
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The prepayment penalty is based on a percentage of the loan balance.
LOCK-IN CLAUSE
A “lock-in clause” in a loan agreement stops the borrower repaying a loan prior to a specified
date.
SUBORDINATION CLAUSE
A “subordination clause” in a mortgage makes the holder secondary or subordinate to a future

lien. That future lien would take priority.
TRUTH IN LENDING
The “Truth in Lending Act” is a United States federal law which protects consumers in credit
transactions. Clear disclosure of key terms of the lending arrangement and all costs must be
given to the borrower.
The Federal Trade Commission enforces the Truth in Lending Act. Truth in lending also gives
consumers the right to cancel some credit transactions that involve a lien on a consumer's main
home. The borrower usually has the right to rescind the agreement until midnight on the third
business day after the promissory note was signed.
APR
The lender must disclose the Annual Percentage Rate (APR) to the borrower. Annual Percentage
Rate (APR) is the interest rate the borrower will pay on a loan and includes one-time fees.
In other words, the APR is the total cost of credit to the consumer, written as an annual
percentage of the amount of credit granted. APR should make it easier to compare lenders and
loan options.
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LOAN TERMS
“Amortization” is a gradual reduction of a loan debt through regular installments which include
the principal and interest. This should pay off the debt by the end of a fixed period.
A “fully amortized loan” will be completely paid off at the end of the loan term.
A “balloon loan” would is a partially amortized loan. It is a partially amortized because at the
end of the loan term, the entire debt is not fully paid. So one huge payment is due at the end of
the term which is called the balloon payment.
A “buy down” means getting a lower interest rate by paying additional points to the lender. The
lower rate may apply for the full duration of the loan or for just the first few years. A buy down
may be used to qualify a borrower who would otherwise not qualify. This is because a buy down
results in lower payments which are easier to qualify for.
“Equity” is the interest or value that is left in the property after payment of all liens or other
charges on the property. An owner's equity is normally the interest minus the mortgage debt.
For example, say your home is worth $300,000 and you have $200,000 in debt. You would have
$100,000 in equity. Simply said, it’s the money left over after you sell a house that you can go
buy a cookie with.
Owners can negotiate a “Home Equity Line Of Credit” (HELOC) against the equity. The home
equity usually has a set limit and can be used by an owner much like a check book account or a
credit card.
Usually, the payments are interest-only and the principle amount is due at the end of the loan
term.
An “Adjustable Rate Mortgage” (ARM), is a mortgage with an interest rate that changes over
time according to the Index. The interest rate is calculated according to the index plus the
mortgage. A margin which represents the lender’s profit and the cost of doing business will
remain constant over the life of the loan. An ARM will have a rate cap. The rate cap will limit
how much adjustments can change over the life of the loan. A payment cap is the maximum
adjustment amount for a payment. An adjustment period indicates how often a rate can be
changed.
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A “blanket mortgage” covers more than one parcel in a lot and may be negotiated by a developer.
A “release clause” is a provision found in many blanket mortgages allowing the mortgagor to get
partial releases of specific parcels from the mortgage on payment.
A “growing equity mortgage” is also known as a “rapid payoff mortgage”. When borrowers
negotiate a growing equity mortgage they know the monthly payments will increase. However,
the payment increase applies directly to the principle and reduces the term of the loan.
A “graduated payment mortgage” is also known as a “flexible payment plan”. Payments start out
low and increase by a certain percentage each year for a specific number of years. The payments
then level off for the remaining term of the loan.
A “graduated payment mortgage” can cause negative amortization. Negative amortization is an

increase in the outstanding amount because the monthly payment does not cover the monthly
interest due. This is dangerous because the debt increases as payments are made.
An “open mortgage” allows a borrower to pay off the loan before the end of the term. So the
borrower who negotiated a 30-year fixed rate mortgage can make extra payments and pay the
loan off before the 30-year term.
An open-end mortgage allows the borrower to get extra funds from the original loan without
redoing the original paperwork. It works a little like a credit card: A credit card has a credit limit
and we can use the credit card up to that limit; if we had to complete the paperwork every time
we used a credit card, we probably wouldn’t bother using it at all!
A “construction loan” is an example of an open-end loan. If a borrower negotiates a construction

loan, the borrower will receive the money in a series of withdrawals as the building develops.
The borrower does not have redo the paperwork at each stage of construction.
A construction loan is also called a short term loan or an interim loan because the loan is only
for the period of construction and is not the end loan. A borrower must negotiate a long-term
mortgage upon completion of the home. This is also called a take-out loan.
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A “package mortgage” includes both real and personal property. If a furnished condo is
purchased in a resort community, the borrower may negotiate a package mortgage which covers
the condo and the furnishings.
The term “participation loan” can have different meanings:
1) A loan that requires interest plus a portion of the profits as payment.
2) A loan made or owned by more than one lender; the joint investors share profits and losses
according to how much of the loan each owns.
In a “shared appreciation mortgage loan”, the lender creates the loan below the market rate in
return for a guaranteed share of the appreciation the borrower will get when the property is sold.
A “purchase money mortgage” is any type of financing for buying real estate, but it usually
refers to an extension of credit to the buyer. In purchase money mortgage, which is also known
as a “take back mortgage”, title passes at closing and the seller takes back a note for part of the
property or the entire thing.
A “reverse mortgage” is a loan for home owners 62 years of age and older. There are no income
or credit ration qualifications to qualify for a reverse mortgage, and there are no monthly
payments made to the lender. The loan is repaid when the borrower no longer resides in the
property.
If the owner does not have an existing loan on the property, they can negotiate a loan and receive
a monthly payment guaranteed to them for the rest of their lives as long as they live in the house.
They may take their money in a lump sum, open a line of credit, or a combination of both. If
there is already a lien on the property, it could be paid off by the reverse mortgage and relieve
the senior from making the monthly payments.
A “straight note” is a mortgage where the borrower must pay the interest due on the principle
mortgage amount during the specified term. The principle loan must be repaid at the end of the
term.
A “wraparound loan” is a way of refinancing where the new mortgage is placed in a secondary,
or subordinate position; the new mortgage includes the unpaid balance of the first mortgage and
whatever additional sums are given by the lender. In essence, it is another mortgage where
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another lender refinances a borrower by lending money over the existing first mortgage amount
without disturbing the first mortgage.
In a “sale lease back”, there is the property is sold and leased back at the same time. The seller
will become the tenant of the new owner. Hence the name sale-lease back. The advantage of a
sale-lease back to the seller is that the money gained from the sale and all future rents paid are
100% deductible.
The main advantage to the buyer is they have a quality tenant.
“Interest” is the amount paid for the use of money, usually an annual percentage. Think of it as
rent on money: you pay rent to use somebody’s property to live, that is their resource, now you
are paying to use somebody’s money.
“Simple interest” is the common type of interest paid on home loans. Simple interest is
calculated as a percentage of the original principal amount.
“Usury” is charging extremely high interest rates on a loan and it is illegal. Usury is often
referred to as “loan sharking”. State usury laws decide the highest interest lenders can charge on
loans. The state laws vary with each type of loan.
PRIMARY AND SECONDARY MARKET
PRIMARY MARKET
The “primary mortgage market” is where lenders make mortgage loans directly to borrowers
such as savings and loan associations, commercial banks, insurance companies, and mortgage
companies. These lenders sometimes sell their mortgages into the secondary market to
institutions such as FNMA or GNMA.
“The Federal National Mortgage Association”, also known as “Fannie Mae” is a federally-
sponsored private corporation which provides a secondary market for housing mortgages.
The “Government National Mortgage Association”, known as “Ginny Mae”, is a governmental

secondary market that mainly deals in recycling VA and FHA mortgages, particularly those that
are highly leveraged.
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The Savings and Loan Association is a state or federally-chartered intermediary that accepts
deposits from the public and invests those funds mainly in residential mortgage loans.
Commercial banks offer a full range of retail banking products and services, such as checking
and savings accounts, loans, and investments to individuals and businesses.
Insurance companies prefer income-producing properties and long-term industrial projects. They
often demand a participation loan which is a loan that requires interest plus a portion of the
profits as payment.
Mortgage brokers are real estate financing professionals who act as the intermediary between
consumers and lenders during mortgage transactions. A mortgage broker creates loans, while the
mortgage lender actually funds the loans.
A mortgage banker is a direct mortgage lender. No middlemen here. A mortgage banker or lender
funds loans in his or her own name and is usually more competitive than a broker in terms of
“points” and “fees”.
SECONDARY MARKET
Once a loan is created on the primary market, it may be sold on the secondary market. The
secondary market is where lenders and investors buy and sell existing mortgages or mortgage-
backed securities. This frees up funds for more mortgage lending. The secondary market is the
resale market place of loans.
If you understand the history of the secondary market, it will you help you understand what it is
and why it exists.
Before the stock crash of 1929, most lenders required a borrower to have a down payment of 20
to 40 percent. If that was the case today, not many people would be able to afford a home! You
would have to be very, very rich in order to get a loan; you’d have to have a lot of money to get
money. Talk about the rich getting richer!
Not only did the lenders ask for a large down payment, but the loan was a straight mortgage.
This meant they would only pay the interest. The term was typically 1 to 7 years, and at the end
of the 7 years, if the borrower could not pay the entire balance, a new loan would be negotiated.
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After the stock crash, the government needed to stabilize the economy and stimulate the stock
market. In 1934, the government introduced FHA-insured loans. The FHA’s main purpose is to
insure lenders from loss.
The FHA made it possible for more people to buy a home. They did this by decreasing the down
payment needed and allowing a smaller monthly payment that would extend the loan over the
course of 30 years. A portion of the payment would be applied to the principal and the remainder
would be interest. This is more of what you are used to seeing today.
A 30-year fixed rate mortgage with monthly payments was a new concept at the time. There was
much more risk involved with this than there was lending to a wealthy person with many assets.
To reduce the risk to the lender, the FHA said the lender had to verify the borrower’s
employment, have the property appraised by a neutral third party, and have a title search. If the
government guidelines were met, then the lender would negotiate the loan.
The lenders and the government knew that in a 30-year loan there is a greater chance of default,
so the government insured the loan. The borrower was charged a one-time up-front insurance
premium based on the loan amount and one half percent annually on the loan balance.
If the borrower defaults on the loan and the loan amount exceeds the price of the property, the
FHA will pay the difference.
Great, right? Not quite. By 1938, the lenders who offered the FHA-insured loan had a problem.
These banks were used to doing loans and getting money back very quickly, so they would have
money to lend out to a new borrower. But now, with smaller down payments and having to wait
30 years to recover the debt, there was not as much money on hand to lend to a new borrower.
So in 1938, the government created the Federal National Mortgage Association (or Fannie Mae).
This was created to buy FHA-insured mortgages from lenders. This created the secondary market
place and would provide lenders with the money to lend out to new borrowers.
As Fannie Mae started buying loans from lenders, the loan had to meet Fannie Mae guidelines.
Today, Fannie Mae is a quasi-government agency that is privately owned, and Fannie Mae stock
may be purchased on the New York Stock Exchange. Fannie Mae buys mortgages on the
secondary market, pools them together, and then sells them back as mortgage securities to
investors on the open market. Monthly principle and interest payments are guaranteed by Fannie
Mae, but not by the US government.
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In 1968, Fannie Mae was split, and the Government National Mortgage Association (or Ginnie
Mae) was created. Ginnie Mae is a federally-owned corporation in the Department of Housing
and Urban Development. Ginnie Mae administers special assistance programs.
The main focus of Ginnie Mae is to insure liquidity for US government insured mortgages.
Included mortgages are those insured by the FHA and VA.
FHA & VA
FHA and VA loans are classified as unconventional loans because they are backed by the
government.
Federal Housing Administration

The Federal Housing Administration, generally known as “FHA”, insures loans made by
approved lenders throughout the United States and its territories. It is the largest insurer of
mortgages in the world, insuring over 34 million properties since it began in 1934. The FHA
became a part of the Department of Housing and Urban Development's (HUD) Office of
Housing in 1965.
FHA mortgage insurance gives lenders protection against losses when homeowners default on
their mortgage loans. The lenders take on less risk because the FHA will pay a claim to the
lender in the event of a homeowner's default. Loans must meet certain requirements established
by FHA to qualify for insurance.
In summary:
▪ The FHA was created because the housing market was flat on its back in the 30’s.
▪ FHA does not make loans.
▪ Lenders must be approved to negotiate FHA loans.
▪ FHA loans have a low down payment.
▪ They have less stringent qualifying standards.
▪ Closing costs may be financed.
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▪ There can be no pre-payment penalty as long as the lender receives a minimum of 30 days’
notice of pay-off.
▪ The borrower must have a cash down payment, but the cash may be a gift.
▪ FHA loans are not assumable without complete buyer qualification.
▪ Eligible properties for the FHA loan would be single family homes, one to four-unit owner-
occupied condominium communities.
▪ FHA loans are fully amortized, so balloon mortgages are not allowed.
▪ If discount points are charged they may be paid by the buyer or the seller.
VA Loan
The VA home loan guaranty program was established in 1944 to aid veterans returning from war.
The goal of VA home loan benefits was to help veterans buy or refinance a home out of gratitude
for the sacrifices they made by serving our country.
A VA loan can be used to buy a house, condominium, or townhouse. You can also build a home,
make energy-efficient home improvements, or refinance your mortgage.
There are several reasons why a VA loan may be preferable to a standard loan. Most importantly,
if you qualify, you can get a VA loan even if you don’t qualify for other loans.
The VA doesn’t require a down payment, while the lender may require one.
VA loan rates are often lower interest rates than conventional loans, and you can negotiate the
interest rate with the lender.
There are no mortgage insurance premiums on VA loans, and assumable mortgages are
permitted.
Closing costs can be lower than other forms of financing, and there is no penalty for prepaying
your mortgage, as in some other forms of loans.
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In addition, VA assistance is available to those who qualify if temporary financial difficulty
occurs.
TRUST DEEDS AND MORTGAGES
TRUST DEEDS
In a “trust deed”, in order to get the loan, the trustor signs the deed of trust and gives legal title to
the trustee.
The trustee receives that legal title; the legal title represents the right to sell the property.
The trustee is usually a title insurance company or an attorney that is invisible to the public.
They are a neutral third party that holds the title for the beneficiary (which is the lender).
When they say the borrower has “title”, they mean “equitable title”. Equitable title is the right to
possession and the right to acquire legal title once one condition has been met. This condition is
paying off the loan. That is a fancy way of saying, you can live there and enjoy the property, but
if you mess up you can lose your property. Defaulting can mean more than just not paying the
loan; it can be doing something to damage the value of the property.
When the final payment is made, the lender signs a request of reconveyance to the trustee and the
trustee will issue a reconveyace deed to the trustor.
A “reconveyance deed” is used with a trust deed to clear the title of any liens related to the note
and trust deed. Simply said, it is the evidence that you do not owe any more money. After you
pay off your loan, you do not want to lose that piece of paper! That is your evidence that the debt
was paid off.
If the borrower defaults on the loan, the beneficiary would notify the trustee. The trustee would
notify the trustor and give them a time period to get the payments up to date. If the payments are
not made, the trustee arranges an out-of-court foreclosure, also known as a “trustee’s sale”. Or
what is more commonly known as just “foreclosure”.
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MORTGAGE
A “mortgage” is a pledge of property to the lender as security on the payment of a debt.
The basic steps for securing a mortgage are:
▪ Qualifying the buyer, which includes securing a credit report and employment history.
▪ A good debt-income ratio. A debt-income ratio is a loan-qualifying tool. If you had a

million dollars and owed ten dollars, that would be a good debt income ration. However,
if you had ten dollars and owed a million dollars, that would be terrible.
▪ Do not forget the property: it must be appraised because that property is the collateral for
the loan.
The mortgagee is the lender receiving the pledge. The mortgagor is the one who borrows the
money to purchase property.
The borrower will sign a note. A note is an evidence of debt. It states the amount borrowed, the
interest rate, and the loan terms. In a note, the borrower is the promissor, and the lender is the
promisee. When recorded, the mortgage becomes a voluntary lien on the property. State law
governs the rights of borrower and lender in a mortgage document.
Remember, a lien is a legal interest that a creditor has in a person’s property.
States have different approaches to mortgages. They are classified as lien theory, title theory, and
intermediate theory states.
Most states are lien theory states that give the lender a lien interest in the property. This means
that if the borrower defaults, the lender would foreclose through a judicial sale.
A “judicial sale” is a sale made under court order rather than a voluntary sale by the owner or
one appointed by the owner.
The borrower borrows money from a lender. Before the lender gives the borrower the money, the
borrower must sign an "I.O.U." which is called the note. The note states the terms of the loan.
For instance, the rate of interest and the number of years which the borrower has to pay back the
loan. But more importantly for the lender — the note is proof of the loan.
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What security does the lender have once they give the money to the borrower? The security,
known as “collateral”, is the property which is bought with the funds given to the borrower (and
sometimes, other properties are pledged too). The borrower pledges that property to the lender.
“Mortgage” actually means “pledge”. The borrower pledges to give the lender the property if the
borrower cannot pay back the loan in full.
As noted in the previous section, the buyer/borrower pledges the property to the lender as
security for the loan.
Remember: The suffix “or” is used for the person who performs an action; the suffix “ee” is used
for the recipient of that action. Since the buyer/borrower is pledging the property, he/she is
“mortgaging” the property and in known as the “mortgagor”. The lender is the recipient of the
pledge and therefore is the “mortgagee”.
One way to remember the difference between the “mortgagor” and the “mortgagee”:
The "o" in "mortgagor" comes from the "o" in "borrower". The "e" in "mortgagee" comes from
the "e" in "lender":
MORTGAGOR - BORROWER
MORTGAGEE - LENDER
Otherwise, just remember: The mortgagor mortgages the property to the mortgagee.
Finally, it is worth pointing out that there was a time that the owner of a property could sell the
property and freely transfer the mortgage to a new owner. Due to the modernization of the credit
market, lenders want to know who owes them money. Since the new owner might not be as
creditworthy as the original owner/mortgagor, lenders now insert a “due on sale” clause. This
clause means a mortgage must be paid off when the property is sold.
Nowadays, a relative or friend might give the buyer a second loan on top of the bank loan.
Otherwise, the mortgagee is always a financial institution.
Much of the confusion concerning mortgages and notes today actually stems from a semantic
problem: Is "mortgage" a noun or a verb? Unfortunately, many people use the word "mortgage"
to mean a loan, saying things such as "I got a mortgage from the bank"; or "Who owns the
mortgage?" This leads to confusion since "mortgage" is really a pledge of property as security,
and does not have a separate existence from the note that it guarantees. Since "mortgage" really
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means to “pledge”, which is a verb, it should not be used as a noun. Here are some common
misuses of the word "mortgage":
WRONG
▪ I took a mortgage.
▪ I got a mortgage from the bank.
▪ I signed the mortgage.
▪ The owner of the mortgage is not the owner of the note.
CORRECT
▪ I got a loan from the bank.
▪ I borrowed money and I mortgaged the house.
▪ I signed the mortgage document.
▪ The owner of the mortgage is not the owner of the note.
▪ The title owner of the note/mortgage is not the equitable owner of the note/mortgage.
While the difference between "mortgage" as a noun or a verb might seem trivial, we will see that
misuse of the word has caused endless headaches, misunderstandings, confusion, and legal
wrangling.
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PRACTICE
FAIR HOUSING
At the urging of President Lyndon Johnson, Congress passed the federal Fair Housing Act only
one week after the assassination of Martin Luther King Junior on April 11, 1968. The 1968 act
expanded on previous acts and prohibited discrimination based on race, religion, national origin,
sex, and (as amended) handicap and family status for sales, rentals, and financing of housing.
Jones vs. Alfred H. Mayer is a United States Supreme Court case which held that Congress could
regulate the sale of private property to prevent racial discrimination based upon the Thirteenth
Amendment.
When the Fair Housing Act was first enacted, it prohibited discrimination only on the basis of
race, color, religion and national origin. In 1974, “sex” was added to the list of protected classes,
and in 1988, “disability” and “familial status” were added.
The Americans with Disabilities Act of 1990

The Americans with Disabilities Act of 1990 is a wide-ranging civil rights law that prohibits,
under certain circumstances, discrimination based on disability. The United States Department of
Housing and Urban Development is the agency which administers and enforces the Fair Housing
Act. Examples of violations of fair housing are steering and blockbusting.
Blockbusting
“Blockbusting”, which is also known as “panic selling” and “panic peddling”, is an illegal racial
discrimination practice where brokers try to change the racial composition of a neighborhood by
encouraging listings and sales in a neighborhood. It is basically the practice of saying: "You
better sell your house! Those people are moving into town! You do not want to live by them do
you?"
In short, fair housing is about getting rid of discrimination in practice and policy in the housing
market.
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Steering
“Steering” is the illegal practice of channeling home seekers to particular areas, to keep the same
racial composition of an area or to change the character of an area. This limits people’s choice of
where they can live.
It is a form of “redlining”. Redlining is the practice of denying, or charging more for, services
such as banking, insurance, access to health care, supermarkets, or denying jobs to residents of
certain areas, which are often racially determined. The term “redlining” was coined in the late
1960s by John McKnight, a sociologist and community activist. It refers to the practice of
marking a red line on a map to map the area where banks won’t invest; later, the term was
applied to discrimination against a particular group of people (usually by race or sex) irrespective
of geography.
SHERMAN ANTI-TRUST LAW
“Sherman anti-trust laws” prohibit price-fixing, group-boycotting, allocation of customers or

markets, or tie-in agreements. Price-fixing is prohibited. This means that competing brokers, real
estate governing bodies, or multiple listing organizations cannot agree to set sales conditions,
fees, or management rates. Group boycotting is also illegal under the antitrust laws.
This means that two or more brokers cannot conspire against another business, or agree to
withhold their patronage to reduce competition.
The allocation of markets or customers would occur when brokers agree to divide their markets
or customers and not compete for the other’s business.
Tie-in agreements are also illegal. For example, a broker owns 10 acres of vacant land. A builder
wants to buy the land, but the broker refuses to sell unless the builder agrees to list the property
afterwards with the brokerage firm. This tie-in arrangement is illegal.
An individual may be fined a maximum of $100,000 and be sentenced up to three years in prison
– and a corporation may be fined up to $1 million – for breach of the Sherman antitrust laws. In a
civil suit, an aggrieved person can get up to triple the value of the actual damages plus attorneys’
fees and costs.
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KEY CONCEPTS TO PASS YOUR

REAL ESTATE EXAM

THE -OR AND -EE RULE ............................................................................................................................6

PROPERTY OWNERSHIP ...........................................................................................................................7

EXPRESS EASEMENTS ..............................................................................................................................20

GOVERNMENT POWER ...........................................................................................................................24

4 POWERS OF THE GOVERNMENT .............................................................................................................24

TYPES OF FRAUD ..................................................................................................................................... 34

TYPES OF LISTINGS ..................................................................................................................................45

VALUATION & MARKET ANALYSIS ........................................................................................................48

PROGRESSION AND REGRESSION..............................................................................................................58

FINANCING BASICS ...................................................................................................................................63

TRUTH IN LENDING ..................................................................................................................................68

PRIMARY AND SECONDARY MARKET ..................................................................................................72

TRUST DEEDS .......................................................................................................................................... 77

FAIR HOUSING .........................................................................................................................................81

Let’s get started!

THE -OR AND -EE rule

The suffix "-ee" is used for the recipient of that action.

In real estate, you will hear words like:

A vendor sells to a vendee.

The grantor conveys property to a grantee, who receives it.

There may be a question which reads: "Who conveys property?"

The bundle of rights includes the right to:

▪ refuse to exercise any of these rights

Think of it like this:

Real vs. Personal Property

The word comes from the Latin appertinere: "to appertain."

Appurtenance is something which belongs to something else, it an be attached or not; it could be

An encroachment can be found by a survey. Encroachment is a form of trespass, so when an

▪ Fee simple absolute

▪ Fee simple defeasible

Fee Simple Defeasible

LESS THAN FREEHOLD ESTATES

Estate for Years

The duties of a property manager include:

▪ Preparing the budget.

▪ Offering concessions to attract tenants.

A property manager should have knowledge of the following:

▪ How to handle environmental hazards

▪ Liability from injury of anyone on the premise

▪ Loss due to fire

▪ Medical coverage for employees

▪ And casualty losses

▪ Avoid the risk by removing the problem.

▪ Deal with the risk by purchasing insurance with a large deductible.

▪ Control the risk by installing protective equipment.

▪ Transfer the risk by obtaining insurance with no deductible.

Creating an Express Easement

An “easement by necessity” is similar to an “implied easement”. It is an easement created by the

An “implied easement” is an unrecorded easement which is legally necessary; it could be for

How do you create an implied easement?

2. in existence at the time of the grant

5. reasonably necessary to the enjoyment of the premises granted

4 POWERS OF THE GOVERNMENT

To remember the government powers just think of the name PETE:

▪ P for Police Power

▪ E for Eminent Domain

No ordinary individual has any of these rights.

Zoning for land use is generally divided into:

▪ Special use properties

“Zoning ordinances” are a set of laws which control the:

▪ Floor area ratios