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MODERNREAL ESTATEPRACTICE in North Carolina

Fillmore W. Galaty | Wellington J. Allaway | Robert C. Kyle Deborah B. Carpenter, DREI, Contributing Author

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REAL ESTATEModern

Practice in North CarolinaEIGHTH EDITION UPDATE REVISED

Fillmore W. Galaty

Wellington J. Allaway

Robert C. Kyle

Deborah B. Carpenter, DREI, Contributing Author

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This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional advice. If legal advice or other expert assistance is required, the services of a competent professional should be sought.

President: Dr. Andrew TemteChief Learning Officer: Dr. Tim SmabyExecutive Director, Real Estate Education: Melissa Kleeman-MoyDevelopment Editor: Julia Marti

MODERN REAL ESTATE PRACTICE IN NORTH CAROLINA EIGHTH EDITION UPDATE REVISED©2015 Kaplan, Inc.Published by DF Institute, Inc., d/b/a Dearborn Real Estate Education332 Front St. S., Suite 501La Crosse, WI 54601

All rights reserved. The text of this publication, or any part thereof, may not be reproduced in any manner whatsoever without written permission from the publisher.

Printed in the United States of America

ISBN: 978-1-4754-2964-0 / 1-4754-2964-9PPN: 1510-669C

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iii

Contents

Preface xAcknowledgments xii

C H A P T E R 1

Basic Real Estate Concepts 1Introduction 1General Characteristics of Real Estate 2General Concepts of Land Use and Investment 5The Scope of the Real Estate Business 7The Real Estate Market 10Related Websites 13Key Point Review 14Questions 16

C H A P T E R 2

Property Ownership and Interests 18The Concept of Property 19Estates in Real Property 26Ownership of Real Property 32Related Websites 39Key Point Review 39Questions 43

C H A P T E R 3

Encumbrances on Real Property 46Encumbrances on Real Property 46Property Taxation 53Key Point Review 58Questions 60

C H A P T E R 4

Property Description 63Describing Land 63Methods of Describing Real Estate 64Related Website 73Key Point Review 73Questions 74

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iv Contents

C H A P T E R 5

Transfer of Title to Real Property 78Methods of Transferring Title 78Title Records 93Public Records 94Title Assurance 96Related Website 101Key Point Review 101Questions 104

C H A P T E R 6

Land-Use Controls 107Public Land-Use Controls 108Privately Imposed Land-Use Controls 119Government Ownership 121Related Websites 121Key Point Review 121Questions 123

C H A P T E R 7

Real Estate Brokerage and the Law of Agency 126Introduction to Brokerage and Agency 127The Law of Agency 127General Agency Definitions 128Brokerage Defined 129Agency Relationships 132Agency Disclosure in North Carolina 139Duties and Liabilities of Agents 145Duties and Liabilities of Principals 153Nature of the Brokerage Business 154Related Websites 155Key Point Review 156Questions 159

C H A P T E R 8

Basic Contract Law 163Contracts 163Performance of Contract 169Broker’s Authority to Prepare Documents 171Key Point Review 173Questions 175

C H A P T E R 9

Agency Contracts 178Agency Contracts and Practices for Working with Sellers 178The North Carolina Residential Property Disclosure Act 197Working with Buyers 199Working as a Dual Agent 203Related Websites 204Key Point Review 204Questions 208

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v Contents

C H A P T E R 10

Sales Contracts and Practices 211The Sales Contract 211Installment Land Contract 226Option to Purchase Real Estate 228Related Websites 230Key Point Review 230Questions 232

C H A P T E R 11

Landlord and Tenant 235Leasing Real Estate 236Leasehold (Nonfreehold) Estates 236Types of Leases 238Lease Provisions 240North Carolina Residential Rental Agreements Act 244Laws Protecting Tenants in Foreclosure Situations 247Tenant Security Deposit Act 248Constitutional Rights of Tenants in Public Housing 250North Carolina Vacation Rental Act 250Other Landlord/Tenant Rules 250Related Websites 251Key Point Review 251Questions 254

C H A P T E R 12

Property Management 257Property Management 257Functions of the Property Manager 259Property Management Fee 261Typical Property Management Duties 261Risk Management for Property Managers 269Related Websites 271Key Point Review 271Questions 273

C H A P T E R 13

Real Estate Financing: Principles 275Basis Mortgage Terms and Concepts 276Security and Debt 276The Promissory Note 278Mortgage Loan Repayment Plans 285The Mortgage (or Deed of Trust) Instrument 288Related Websites 298Key Point Review 298Questions 301

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vi Contents

C H A P T E R 14

Real Estate Financing: Practices 304Introduction to the Real Estate Financing Market 305Types of Mortgage Loans 311Residential Lending Practices and Procedures 321Financing Legislation 327Related Websites 330Key Point Review 330Questions 334

C H A P T E R 15

Closing the Real Estate Transaction 338Preclosing Procedures 338Conducting the Closing 343RESPA Requirements 345Preparation of Settlement Statement 348Prorations 354Sample Settlement Statement 360Related Websites 370Key Point Review 370Questions 372Settlement Statement Problem 374

C H A P T E R 16

Basic Residential Construction 375Architectural Types and Styles 376Foundations 376Framing 378Elements of Construction 378HVAC 384Government Regulation 385Related Website 386Key Point Review 386Questions 387

C H A P T E R 17

Real Property Valuation 388Appraising 389Value 390The Appraisal Process 393Approaches to Value (Appraisal Methods) 398The Profession of Appraising 408Related Websites 409Key Point Review 409Questions 411

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vii Contents

C H A P T E R 18

Property Insurance 415Basic Insurance Concepts 415Homeowners’ Insurance 416Related Websites 421Key Point Review 421Questions 423

C H A P T E R 19

Federal Income Taxation of Real Property Ownership 425Introduction 425Tax Benefits for Homeowners 426Tax Benefits of Selling Real Property 426Tax Benefits of Real Estate Investment 430Related Website 434Key Point Review 434Questions 436

C H A P T E R 20

Fair Housing and Ethical Practices 439Equal Opportunity in Housing 439Federal Fair Housing Act 440Equal Credit Opportunity Act 447North Carolina Fair Housing Act of 1983 447Sexual Harassment 448Implications for Brokers 448Americans with Disabilities Act 450Fair Housing Prohibited Practices 451Professional Ethics 454Related Websites 455Key Point Review 455Questions 458

C H A P T E R 21

Environmental Issues and the Real Estate Transaction 461Environmental Issues 462Hazardous Substances 462CERCLA and Environmental Protection 473North Carolina Environmental Issues 474Liability of Real Estate Professionals 475Related Websites 477Key Point Review 477Questions 480

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viii Contents

C H A P T E R 22

Basic Real Estate Investment 482Investing in Real Estate 482The Investment 484Leverage 485Calculating Profitability 486Forms of Business Ownership (for Investment Purposes) 488Related Websites 489Key Point Review 490Questions 492

A P P E N D I X AStudy Tips and Comprehensive Practice Examination 493Preparing for the Exam 493Comprehensive Practice Exam 496

A P P E N D I X BResidential Square Footage Guidelines 509

A P P E N D I X CReal Estate License Law and Commission Rules 534Key Point Review 625Questions 629

A P P E N D I X DNorth Carolina Real Estate Forms 633

Math FAQs 727Glossary 787Answer Key 811Index 824

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Since its first printing in 1994, Modern Real Estate Practice in North Carolina has provided thousands of readers with valuable real estate information, presented in a logical and accessible manner. Specifically tailored to North Carolina law and practice, Modern Real Estate Practice in North Carolina sets the standard for real estate textbooks, whether it is used to prepare for the licensing examination, for a college or university program, or simply for personal knowledge.

■■ FEATURES

Real estate students and instructors alike will appreciate the following features:

■■ Each chapter opens with learning objectives that list what concepts and information you should be able to identify, describe, explain, and distinguish when you have finished.

■■ Key terms are provided at the beginning of each chapter. This feature iden-tifies terms to watch for as you read and helps you study and review as well.

■■ Margin notes serve as memory prompts for more efficient and effective studying of important concepts and vocabulary.

■■ For example scenarios help illustrate how issues like fair housing, agency, and brokerage affect real estate professionals and real estate transactions.

■■ Chapter review and sample exam questions feature many fact-patterned problems that encourage you to understand and apply information rather than just memorize it.

■■ Math FAQs: Answers to Your Most Frequently Asked Real Estate Math Questions helps you apply the basic math principles that real estate pro-fessionals use when working with clients or customers. In addition, math rationales are included in the answer key for the chapter quizzes.

■■ Quick Math Reference is a great time-saving reference tool. The most fre-quently used real estate math equations are printed inside the front and back covers of the book.

■■ FEATURES OF THIS EDITION

■■ Legislative updates. Content throughout the chapters and questions and answers reflects the latest changes to North Carolina Real Estate License Law and Commission Rules.

■■ Key Point Reviews are chapter summaries organized into key point, bulleted reviews providing you with a quick review tool of the most essential content covered in each chapter.

■■ Forms Appendix: Important North Carolina forms subject to change are placed in a separate appendix in the order encountered in a basic residential sales transaction with other purpose forms following.

Preface

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xi Preface

■■ Questions and answers in the chapter quizzes and the practice exam reflect the current economic climate.

■■ Web links are updated and placed at the end of each chapter for easy reference.

■■ New topics have been added including: Oil and Gas Rights Disclosure, North Carolina Broker Price Opinion Law, Commercial Real Estate Broker Lien Act, Consumer Financial Protection Bureau, and more.

■■ Content updates are incorporated throughout the book and include: expanded coverage of the revised forms, easements, condemnation process, standard practices of a listing agent and a buyer’s agent, working with out-of-state brokers, property management including laws affecting tenants in foreclosure situations, specific performance, standard addenda to the sales contract, secondary market update, loan qualification, buyer’s due diligence process, and broker price opinions.

■■ Study and exam tips to help students prepare for, take, and pass the real estate exam are contained in Appendix A, preceding the practice exam.

One thing, however, has stayed the same. As in all previous editions, the goal of Modern Real Estate Practice in North Carolina is to help you understand the dynam-ics of the real estate industry and prepare you for the licensing exam. In this edi-tion, we have met that challenge, providing you with the critical information you need to pass the real estate examination, buy or sell property, or establish a real estate career.

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■■ CONTRIBUTING AUTHOR

The publishers would like to thank Deborah B. Carpenter of Raleigh, North Car-olina, who served as contributing author for the Eighth Edition Update of Modern Real Estate Practice in North Carolina. From her first interaction as a reviewer on the Fifth Edition, Deb has developed an intimate acquaintance with and under-standing of the material in this textbook. Deb worked as a Consulting Editor on the Sixth Edition and became a Contributing Author in the Seventh Edition and Seventh Edition Update of Modern Real Estate Practice in North Carolina.

As the owner and lead instructor of Real Estate Success Academy, Deb’s passion for teaching has helped countless students prepare for a successful career in real estate. Deb is a two-time recipient of the North Carolina Educator of the Year Award and the NCREEA President’s Award for Exceptional Service. She also holds the highly respected Distinguished Real Estate Educator (DREI) designa-tion for excellence in classroom instruction. Deb has served with the Real Estate Educators Association (REEA) and the North Carolina Real Estate Educators Association (NCREEA) in many leadership positions, including past president of the NCREEA. In her position as broker-in-charge of a large Keller Williams Mar-ket Center in Cary, NC, Deb keeps on top of current market trends and concerns.

■■ REVIEWERS

For their input in the development of the Eighth Edition Update and its revision, the authors wish to thank the following individuals:

■■ Bruce W. Moyer, Director of Education and Licensing, North Carolina Real Estate Commission

■■ Stephen L. Fussell, Sr. Consumer Protection Officer, North Carolina Real Estate Commission

■■ Deborah H. Long, DREI, EdD, Long Talks and Fonville Morisey Center for Real Estate Studies

■■ Sherry Steele, Kaplan Professional Schools, Colorado

Each new edition of Modern Real Estate Practice in North Carolina builds on earlier editions. For their input in the development of the Eighth Edition, the authors wish to thank the following individuals:

■■ Larry A. Outlaw, former Director of Education and Licensing, North Caro-lina Real Estate Commission

■■ Patricia A. Moylan, Legal Education Officer, North Carolina Real Estate Commission

■■ Deborah H. Long, DREI, EdD, Long Talks and Fonville Morisey Center for Real Estate Studies

Acknowledgments

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1

Basic Real Estate Concepts

■■ LEARNING OBJECTIVES When you have finished reading this chapter, you should be able to

■■ describe the physical and economic characteristics of real property; the concept of land use and development, including highest and best use; and the advantages and disadvantages of real estate investments.

■■ identify the various careers and areas of real estate specializations and the professional organizations that support them.

■■ explain the operation of supply and demand in the real estate market.

■■ define these key terms:

brokerbusiness cycleschatteldemandheterogeneity

highest and best uselandmarketnonhomogeneitypersonal propertypersonalty

provisional brokerreal estatereal propertysitussupply

■■ INTRODUCTION

It is important that real estate students understand the basic characteristics of real estate, how real estate is used, and the real estate market. This chapter presents those fundamental concepts and lays the foundation for the exciting and chal-lenging study of real estate practice.

1C H A P T E R

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2 Modern Real Estate Practice in North Carolina

■■ GENERAL CHARACTERISTICS OF REAL ESTATE

There are two major classifications of property: real property and personal prop-erty. The distinction between these two types of property is an important one. Real property is defined as the land, everything that is permanently attached to the land, and everything that is appurtenant to (or goes with) the land. Personal property, or personalty, is considered to be all property that does not fit the defi-nition of real property. The primary characteristic of personal property is movabil-ity. Items of personal property, also referred to as chattels, include such tangibles as furniture, clothing, money, bonds, and bank accounts. In other words, a chattel is an item of movable personal property.

Land, Real Estate, and Real Property

The words land, real estate, and real property are often used interchangeably. How-ever, for a full understanding of the nature of real estate and the laws that affect it, brokers need to be aware of subtle yet important differences in meaning.

Land. Land is defined as the earth’s surface extending downward to the center of the earth and upward to infinity, including things permanently attached by nature, such as trees and water (see Figure 1.1).

Land includes the minerals and substances below the earth’s surface together with the airspace above the land up to infinity. The surface, subsurface, and airspace can be owned separately as surface rights, subsurface rights, and air rights and can be severed by separate conveyance. A specific tract of land is commonly referred to as a parcel.

Real estate. Real estate, or realty, is defined as land at, above, and below the earth’s surface, including all things permanently attached to it, whether natural or

Air Rights

Surface Rights

The Bundleof Rights

PhysicalImprovements

Subsurface Rights

Earth’s surface to the center ofthe earth and the airspace above theland, including the trees and water

Land plus permanenthuman-made additions

Real estate plus“bundle of legal rights”

Land Real Estate Real Property

F I G U R E 1.1

Land, Real Estate, and Real Property

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3Chapter 1 Basic Real Estate Concepts

artificial (see Figure 1.1). The term real estate is therefore somewhat broader than the term land and includes not only the physical components of the land provided by nature but also all human-made permanent improvements on and to the land. Land is referred to as improved when streets, utilities, sewers, and other improve-ments are brought to the land, therefore making the land suitable for building.

Real property. Real property is defined as the land itself, the improvements thereon, and the interests, benefits, and rights inherent in the ownership of real estate (see Figure 1.1).

The broader term real property includes the physical surface of the land, what lies below it, what lies above it, and what is permanently attached to it, as well as all the rights of ownership that are usually referred to as the bundle of legal rights (including the right to possession and use, right to exclude others, the right to profit from the land, and the right to dispose of or encumber the land).

I N P R A C T I C E When people talk about buying or selling houses, office build-ings, land, and the like, they usually call all of these things real estate. For all practical purposes, the term is synonymous with real property, as defined here. Therefore, in everyday usage, real estate, or realty, includes the legal rights of ownership specified in the definition of real property.

Physical and Economic Characteristics of Real Property

Seven characteristics define the nature of real property and affect its use. These characteristics fall into two broad categories: physical characteristics and eco-nomic characteristics (see Figure 1.2).

PhysicalCharacteristics

EconomicCharacteristics

Real Estate

Scarcity Immobility

Improvements

Indestructibility

Permanenceof Investment

Uniqueness

Location

F I G U R E 1.2

Characteristics of Real Estate

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Physical characteristics. Land has three physical characteristics that set it apart from other commodities: immobility, indestructibility, and uniqueness.

Immobility. It is true that some of the substances of land are removable and that topography can be changed, but the geographic location of any given parcel of land can never be changed. Because land is immobile, the rights to use land are more easily regulated than are other forms of property use.

Indestructibility. Land is durable and indestructible (or permanent). The permanence of land, coupled with the long-term nature of the improvements placed on it, has tended to stabilize investments in land. However, while land is indestructible, the improvements on it depreciate and can become obsolete, thereby reducing values—perhaps drastically. (Depreciation should not be con-fused with the fact that a given location can become undesirable economically, therefore creating a decrease in market value.)

Uniqueness. No two parcels of land are ever exactly the same. Although they may share substantial similarity, all parcels differ geographically. The uniqueness of land is also referred to as its nonhomogeneity or heterogeneity. In fact, it is the uniqueness of each parcel of land that gives rise to the remedy of specific performance for the breach of a real estate contract. Under the doctrine of specific performance, the party harmed by the breach of a real estate contract can ask a judge to force the breaching party to carry out the terms of the contract rather than ordering the breaching party to pay monetary damages. Because each parcel of land is unique, monetary damages cannot compensate the damaged party for the loss of that particular parcel.

Economic characteristics. The basic economic characteristics of land are the factors that influence its value as an investment: scarcity, location, improvements, and permanence of investment. (SLIP is the mnemonic.)

Scarcity. Although land is not thought of as a rare commodity, its total supply is fixed. Even though a considerable amount of land in the United States is still not used or inhabited, the supply of land in a given location (i.e., ocean front) or of a particular quality may be limited, therefore creating increased demand for that specific land. Because no more land can be produced, the increasing use of land has a positive impact on value.

Location (area preferences). Area preference, sometimes called location, refers to people’s choices and tastes regarding a given area. Location is one of the most important economic characteristics of land. Situs is a related term regard-ing location that takes into consideration social factors in addition to economic factors.

Improvements. Any addition or change to land or a building that affects the property’s value is referred to as an improvement. Improvements of a private nature, such as the house, fencing, et cetera, are referred to as improvements on the land, whereas improvements of a public nature, such as sidewalks, sewer systems, curb-ing, et cetera, are referred to as improvements to the land. Additions or alterations to the property that are merely repairs or replacements may not be considered to

Three Physical Characteristics of Real Estate 1. Immobility2. Indestructibility3. Uniqueness

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be improvements. Brokers should be aware that the term improved land has two meanings. If buildings are constructed on the land, the buildings can be consid-ered improvements. If the land has been prepared for development, such as with grading, installation of utilities, et cetera, the land may be referred to as improved land.

Building an improvement on one parcel of land affects the value and utilization of neighboring tracts and can have a direct bearing on whole communities. For example, improving a parcel by constructing a shopping center or selecting it as the site for a nuclear power plant can directly influence a large area. Such land improvements can influence not only other parcels and other communities favor-ably or unfavorably, they may affect the use, value, and price of the land.

Permanence of investment. Once land is improved, the total capital and labor used to build the improvement represents a large fixed investment. Although even a well-built structure can be torn down to make way for a newer building or another use of the land, improvements to the land such as drainage, electricity, and water and sewer systems remain because they generally cannot be dismantled or removed economically. The owner has no way to transfer the investment to another parcel of land. The return on such investments, therefore, tends to be long-term and relatively stable. This permanence generally makes improved real estate unsuitable for short-term, rapid-turnover investing. A disadvantage of own-ing real estate is that it lacks liquidity.

■■ GENERAL CONCEPTS OF LAND USE AND INVESTMENT

The various characteristics of a parcel of real estate affect its desirability for a specific use. For example, contour and elevation of the parcel, and availability of transportation and natural resources, such as water, all affect the use that can be made of a property, and the way in which a property is used has a dramatic impact on the value of that property.

Highest and Best Use

The highest and best use is the use that will give the owners the greatest actual return on their investment. Extensive studies are often prepared to determine whether a property is being properly utilized. For example, a highest-and-best-use study may show that a parking lot in a busy downtown area or a farm surrounded by urbanized land is not the current highest and best use of the property.

If a property can be put to its highest and best use, its value will be maximized. For example, if the highest and best use of a piece of property is as a high-rise office building rather than as a parking lot, changing its use accordingly will increase its value and also will give the owners the highest return on their investment.

Although a property can have only one highest and best use at any given time, the highest and best use can change. Because of changes in socioeconomic conditions, a property’s highest and best use may be a retail shopping center today but a large apartment complex five years from now.

Four Economic Characteristics of Real Estate

1. Scarcity2. Location3. Improvements4. Permanence of

investment

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Land-Use Controls

The potential uses of real property are limited by various land-use controls. Property owners cannot simply decide to tear down their single-family home and replace it with a convenience store. Chances are they would be violating a land-use law. The regulation of land use is accomplished through both public and private land-use controls, discussed in Chapter 6.

Real Estate as an Investment

Real estate, no matter what its use, is virtually always considered an investment. Customers often expect a real estate broker to act as an investment counselor. Though brokers should possess a basic knowledge of real estate investment, they should always refer a potential real estate investor to a competent accountant, lawyer, or investment specialist who can give expert advice regarding the inves-tor’s specific interest or objective.

So real estate practitioners can deal with customers on a basic level, real estate brokers should possess a rudimentary knowledge of real estate investment. Such knowledge begins with a brief examination of the traditional advantages and dis-advantages of investing in real estate, as discussed in Chapter 22.

Advantages of real estate investment. Historically, well-located and fairly-priced real estate investments have shown a good rate of return, often higher than the prevailing interest rate charged by mortgage lenders. Theoretically, this means that an investor can use the leverage of borrowed money to finance a real estate purchase and feel relatively sure that, if held long enough, the asset will yield more money than it costs to finance the purchase. It should be remembered that part of the return must make up for the value lost by a depreciating asset, such as a building.

Most real estate values tend to keep pace with the rate of inflation. Such an infla-tion hedge provides the prudent real estate investor with relative assurance that if the purchasing power of the dollar decreases, the value of the investor’s assets will increase to offset the inflationary effects. In addition, real estate entrepre-neurs may enjoy various tax advantages, which are discussed in more detail in Chapter 22.

Disadvantages of real estate investment. Unlike stocks and bonds, real estate is not a liquid asset. This means that an investor may not be able to sell real estate quickly without taking a loss. Contrast this with the investor in stocks listed on the New York Stock Exchange, who needs only call a stockbroker to liquidate assets when funds are needed quickly. Even though a real estate investor may raise a limited amount of cash by refinancing the property, that property is usually listed with a real estate broker, and the investor may have to sell at a substantially lower price than full market value to facilitate a quick sale.

In addition, it is difficult to invest in real estate without some degree of expert advice. Investment decisions must be based on a careful study of all the facts in a given situation, reinforced by a broad and thorough knowledge of real estate and

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the manner in which it affects and is affected by the marketplace—the human ele-ment. Unsophisticated investors should seek legal and tax counsel before making any real estate investments.

Rarely can a real estate investor sit idly by and watch the invested money grow. Management decisions must be made. For example, should the investor manage the property personally or would it be preferable to hire a professional property manager? How much rent should be charged? How should repairs and tenant grievances be handled? Is sweat equity (physical improvements accomplished by the investor personally) required to make the asset profitable?

Finally, and most important, a high degree of risk often is involved in real estate investment. There is always the possibility that an investor’s property will decrease in value during the period it is held or that it will fail to generate sufficient income to make it profitable. External influences beyond the investor’s control may come into play in negative or positive ways, affecting the value of the investment.

■■ THE SCOPE OF THE REAL ESTATE BUSINESS

Billions of dollars’ worth of real estate is sold each year in the United States. Add-ing to this great volume of sales are rental collections by real estate management firms, appraisals of properties ranging from vacant land to modern office and apart-ment buildings, and the lending of money through mortgage loans on real estate.

Millions of people depend on some aspect of the real estate business for their liveli-hood. As the technical aspects of real estate activities become more complex, real estate offices require an increasing number of people properly trained to handle such transactions. Many professionals and business organizations, such as lawyers, architects, surveyors, accountants and tax specialists, banks, trust companies, and abstract and title insurance companies also depend on the real estate specialist.

Real Estate: A Business of Many Specializations

Despite the size and complexity of the real estate business, many people think of it as being comprised only of brokers. Actually, today’s real estate industry employs millions of knowledgeable individuals who are well trained in specialty areas such as appraisal, property management, financing, development, counseling, and edu-cation. Each of these areas is a business unto itself, but every real estate profes-sional must have a basic knowledge of all of these specializations to be successful.

Real estate brokerage. The business of bringing together people interested in completing a real estate transaction is called brokerage. Usually, the broker acts as an agent who negotiates the sale, purchase, or rental of property on behalf of others for a fee or commission. The commission, generally a percentage of the amount of the transaction, is usually paid by the seller in a sales transaction or by the owner in a rental transaction (although it can be paid by any party). Brokerage is further discussed in Chapter 7.

North Carolina’s real estate license law (G.S. 93A-1 & 2) stipulates that a person must be licensed as a real estate broker if he or she lists or offers to list; sells or

In North Carolina

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offers to sell; buys or offers to buy; auctions or offers to auction; negotiates the purchase, sale, or exchange of; leases or offers to lease; or rents or offers to rent any real estate for others for compensation or the promise of compensation. The license law also requires that a provisional broker that engages in any of these activities must be under the supervision of a real estate broker-in-charge.

Appraisal. The process of estimating the value of a parcel of real estate is appraisal. Although brokers must have some understanding of valuation as part of their training, qualified appraisers are generally employed when property is financed or is sold by court order. The appraiser must have sound judgment, expe-rience, a detailed knowledge of the methods of valuation, and be licensed as an appraiser. Appraisal is covered in Chapter 17.

Property management. Someone who handles the operations of a property for its owner is involved in property management. The property manager may be responsible for soliciting tenants, collecting rents, altering or constructing new space for tenants, ordering repairs, and generally maintaining the property. The manager’s basic responsibility is to protect the owner’s investment and maxi-mize the owner’s return on the investment. Property management is discussed in Chapter 12.

Financing. The business of providing the funds necessary to complete real estate transactions is called financing. Most transactions are financed by means of a loan secured by a mortgage or deed of trust by which the property is pledged as security for the eventual payment of the loan. This and other methods of real estate financing are examined in Chapter 13 and Chapter 14.

Property development. This specialty includes the work of developers, or subdividers, who purchase raw land, divide it into lots, build roads, and install sewer systems. Property development also includes the skills of architects and build-ers, who improve the building lots with houses and other buildings and who sell the improved real estate, either themselves or through brokerage firms. Prop-erty development is discussed in Chapter 6. House construction is discussed in Chapter 16.

Counseling. Providing competent independent advice and guidance on a vari-ety of real estate problems is known as counseling. A counselor attempts to furnish the client with direction in choosing alternative courses of action. Increasing the client’s knowledge is every counselor’s function in rendering services.

Education. Education is the provision of information to both the real estate practitioner and the consumer. Colleges, universities, private schools, and trade organizations conduct courses and seminars on all aspects of the business, from the principles of the prelicensing program to the technical aspects of tax and exchange law.

Other areas. Many other specialties and professionals also are part of the real estate business. Practitioners associated with mortgage banking firms and those who negotiate mortgages for banks and savings associations are examples of pro-fessionals associated with these other areas of specialty. Members of corporate real

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estate departments as well as officials and employees of government agencies such as zoning boards and assessing offices are further examples.

Professional organizations. The real estate business has many trade orga-nizations, the largest being the National Association of REALTORS® (NAR). Organized in 1908, NAR sponsors various affiliated organizations that offer pro-fessional designations to brokers and others who complete required courses (see Figure 1.3). NAR, along with the state and local boards, serves the interests of its members by keeping them informed of developments in their fields, publicizing

the services of its members, improving standards and practices, and recommend-ing or taking positions on public legislation or regulations affecting the operations of members and member firms.

The majority of local real estate associations throughout the United States and Canada are affiliated with NAR. Members of the North Carolina Association of REALTORS® (NCAR) and affiliated local boards subscribe to the association’s strict Code of Ethics and are entitled to be known as REALTORS® or REAL-TOR-Associates®. The term REALTORS® is a registered trademark. In North Carolina there are just under 90,000 licensed brokers, of whom approximately 41,000 are REALTORS®. All REALTORS® are brokers, but not all brokers are REALTORS®. Please do not confuse NCAR with the North Carolina Real Estate Commission (NCREC), which is the regulatory licensing agency of the state.

Among the many other professional associations is the National Association of Real Estate Brokers (NAREB), whose members also subscribe to a code of ethics. Members of NAREB are known as Realtists.

F I G U R E 1.3

National Association of REALTORS® Institutes and Sample Professional Designations

Institute Designation(s)

National Association of REALTORS® (NAR)

Graduate REALTORS® Institute (GRI)Certified International Property Specialist (CIPS)Certified Property Manager® (CPM®)Accredited Buyer Representative® (ABR®)

American Society of Real Estate Counselors (ASREC)

Counselor of Real Estate (CRE)

Commercial Investment Real Estate Institute (CIREI)

Certified Commercial Investment Member (CCIM)

Institute of Real Estate Management (IREM)

Accredited Management Organization® (AMO®)Accredited Resident Manager® (ARM®)

REALTORS® Land Institute (RLI) Accredited Land Consultant (ALC)

Society of Industrial and Office REALTORS® (SIOR)

Professional Real Estate Executive (PRE)

Women’s Council of REALTORS® (WCR) Leadership Training Graduate (LTG)

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Uses of Real Property

Just as there are many areas of specialization within the real estate industry, there are many different types of property in which to specialize. According to its use, real estate can generally be classified into one of five categories:

1. Residential—all property used for housing, from acreage to small city lots, both single-family and multifamily, in urban, suburban, and rural areas

2. Commercial—business property, including offices, shopping centers, stores, theaters, hotels, and parking facilities

3. Industrial—warehouses, factories, land in industrial districts, and power plants

4. Agricultural—farms, timberland, ranches, and orchards5. Special-purpose—churches, schools, cemeteries, and government-held lands

The market for each of these types of properties can be further subdivided into the sales market, which involves the transfer of title, and the rental market, which involves the transfer of space on a rental basis.

I N P R A C T I C E Although in theory a real estate broker or firm can perform all the services listed above and handle all five classes of property, this is rarely done except in small towns. Most real estate firms tend to specialize to some degree, espe-cially in urban areas. In some cases, a real estate broker may perform only one ser-vice for one type of property. Residential property brokers and industrial property managers are two examples of such specialization.

■■ THE REAL ESTATE MARKET

In literal terms, a market is a place where goods are bought and sold, where value for those goods is established, and where it is advantageous for buyers and sellers to trade. The function of the market is to facilitate this exchange by providing a set-ting in which the supply and demand forces of the economy can establish market value. The real estate market is a free market and is local in nature.

Supply and Demand

The economic forces of supply and demand continually interact in the market to establish and maintain price levels. Essentially, when supply increases, prices drop as more producers compete for buyers; when demand increases, prices rise as more buyers compete for the product.

Production slows or stops during a period of oversupply. When the market cannot meet the demand, production increases to take advantage of demand. Supply and demand are balanced at what is called the point of equilibrium.

■■ F O R E X A M P L E Here’s how one broker describes market forces: “In my 17 years in real estate, I’ve seen supply and demand in action many times. When a car maker relocated its factory to my region a few years back, hundreds of people wanted to buy the few higher-bracket houses for sale at the time. Those sellers were able to ask ridiculously high prices for their properties, and two houses actually sold for more than the asking prices! On the other hand, when the naval base closed and

Five Categories of Real Property

1. Residential2. Commercial3. Industrial4. Agricultural5. Special-purpose

When supply increases and demand remains stable, prices go down.

When demand increases and supply remains stable, prices go up.

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2,000 civilian jobs were transferred to other parts of the country, it seemed like every other house in town was for sale. We were practically giving houses away to the few people who were buying.”

Supply and demand in the real estate market. Characteristics of goods in the marketplace determine how quickly the forces of supply and demand will be able to achieve equilibrium. Such characteristics are the degree of standardization of the product, the mobility and financial stability of the product, and the mobility of the parties (buyer and seller).

Real estate is not a standardized product; no two parcels can ever be exactly alike. Each parcel of real estate is unique because it has its own geographic location.

Because real estate is fixed in nature (immobile), it cannot be moved from area to area to satisfy the pressures of supply and demand. Property buyers are also generally limited in their mobility—retirees are a major exception in regard to residences. For these reasons, the real estate business has tended toward local mar-kets, where firms can maintain detailed familiarity with market conditions and available units. The increasing mobility of the population, the growing impact of new technologies in communication, and data handling have resulted in the geographic expansion of real estate firms.

Where standardization and mobility are relatively great, the forces of supply and demand balance relatively quickly. But because of real estate’s characteristics of uniqueness and immobility, the real estate market is generally relatively slow to adjust. To a certain extent, the product can be removed from the market (as when a home offered for resale is withdrawn), yet an oversupply of product usually results in a lowering of price levels. Because development and construction of real estate take a considerable period of time from conception to completion, increases in demand also may not be met immediately. Building may occur in uneven spurts of activity owing to such factors.

Factors affecting supply. Factors that tend to affect supply in the real estate market include the labor force, construction costs, government controls, and monetary or financial policies.

Labor force and construction costs. A shortage of labor in the skilled build-ing trades, an increase in the cost of building materials, or a scarcity of materials tends to decrease the amount of housing built or increase its cost. The impact of the labor force on price levels depends on the extent to which higher costs can be passed on to the buyer or renter in the form of higher purchase prices or rents. Technological advances that result in lower-priced materials and more efficient means of construction may tend to counteract some price increases.

Government controls and financial policies. The government’s monetary policy can have a substantial impact on the real estate market. The Federal Reserve Board (the Fed) establishes a discount rate of interest for the money it lends to commercial banks. That discount rate has direct impact on the inter-est rates the banks charge to borrowers, which in turn plays a significant part in people’s ability to buy homes. The Federal Housing Administration (FHA) and

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the Government National Mortgage Association (Ginnie Mae) can also affect the amount of money available to lenders for mortgage loans.

In 2008, America’s greatest challenge became the uncertainty of the financial institutions. Until then, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), which were private companies under congressional charter, had been the driving force of monies to provide loans to low-, moderate-, and middle-income families. Failed judgments in buying mortgages on the secondary market and irregular accounting practices contributed to the unpredictable and chaotic real estate market in 2009. This resulted in the federal government taking over Freddie Mac and Fannie Mae by placing them into conservatorship.

Virtually any government action has some effect on the real estate market. For instance, federal environmental regulations may increase or decrease the supply and value of land in a local market. Real estate taxation is one of the primary sources of revenue for local governments. Policies on taxation of real estate can have either positive or negative effects. High taxes may deter investors. On the other hand, tax incentives can attract new businesses and industries. Of course, along with these enterprises come increased employment and expanded residen-tial real estate markets.

At the local level, real estate taxation is one of the primary sources of revenue for government. Policies on taxation of real estate can have either positive or nega-tive effects. Tax incentives have been one way for communities to attract new businesses and industries to their areas. And, of course, along with these enter-prises come increased employment and expanded residential real estate markets.

Local governments also can affect market operations and the development and construction of real estate by applying land-use controls. Building codes and zon-ing ordinances are used by communities to control the use of land. Real estate values and markets are thereby stabilized. Community amenities—for example, churches, schools, and parks—and efficient government policies are influential factors affecting the real estate market. Local governments can negatively influ-ence development by imposing excessive fees or overly restrictive zoning and building codes.

Factors affecting demand. Factors that tend to affect demand in the real estate market include population, demographics, and employment and wage levels.

Population. Because shelter (whether in the form of owned or rented prop-erty) is a basic human need, the general need for housing grows as the population grows. Even though the total population of the country may continue to increase, growth is not uniform. Some areas grow faster than others, and some do not grow at all. Some places have become modern-day ghost towns, where the exhaustion of natural resources or the termination of an industrial operation has resulted in a mass exodus.

Demographics. Not only population but the makeup of that population—demographics—affects demand. Family size and the ratio of adults to children; the number of people moving into assisted care facilities and retirement communities;

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the effect of doubling up, where two or more families use one housing unit; and the changing number of single-parent households all contribute to the amount and type of housing needed. Also pertinent are the number of young people who would prefer to rent or own their own residences, but for economic reasons, have roommates or remain in their parents’ homes.

Employment and wage levels. Home ownership and rental decisions are closely related to the ability to pay. Employment opportunities and wage levels in a small community can be affected drastically by decisions made by major employ-ers in the area. Individuals involved in the real estate market in such communities must keep well informed about the business plans of local employers.

To estimate how changes in wage levels will affect people’s decisions concern-ing real estate, it is also important to look for trends in how individual income is likely to be used. General trends in the economy (availability of mortgage money, interest rates, rate of inflation, and the like) will influence an individual’s spend-ing decisions.

Business cycles. The upward and downward fluctuations in business activity are called business cycles. Although business cycles often seem to recur within a certain number of years, they are actually caused primarily by forces such as popu-lation growth, taxes, interest rates, wars, and oil embargoes. A business cycle can generally be characterized by four stages: expansion, recession, depression, and revival. The movements of a cycle are usually gradual and indistinct.

The real estate cycle. As stated earlier, the real estate market is slow in adjust-ing to variations in supply and demand. Because one factor of a real estate cycle is building activity, the time lag between the demand for units and the completion of those units causes real estate cycles to peak after the rest of the economy does and to take longer to recover from depressed periods than do other economic sec-tors. The local character of the real estate market creates many local conditions that may not correspond to the general movement of a real estate cycle.

Governmental anticyclical efforts. Ever since the Great Depression of the 1930s, the federal government has attempted to establish fiscal and monetary policies to prevent extreme fluctuations in the business cycle. By increasing gov-ernment spending during times of recession and taking money out of circulation through taxation and control of lending institutions during times of inflation/expansion, the government attempts to promote steady, gradual economic growth.

■■ RELATED WEBSITES

Building Owners and Managers Association International: www.boma.orgCommercial Investment Real Estate Institute: www.ccim.comCounselors of Real Estate: www.cre.orgInstitute of Real Estate Management: www.irem.orgNational Association of Exclusive Buyers Agents: www.naeba.orgNational Association of Independent Fee Appraisers: www.naifa.comNational Association of REALTORS®: www.realtor.orgNorth Carolina Association of REALTORS®: www.ncrealtors.org

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North Carolina Real Estate Commission: www.ncrec.govReal Estate Buyer’s Agent Council: www.rebac.netReal Estate Educators Association: www.reea.orgREALTORS® Land Institute: www.rliland.comSociety of Industrial and Office REALTORS®: www.sior.comWomen’s Council of REALTORS®: www.wcr.org

■■ KEY POINT REVIEW

Land

■■ is the earth’s surface,■■ extends downward to the center of the earth with subsurface rights, and■■ stretches upward to infinity with air rights.

Real estate includes

■■ land at, above, and below the earth’s surface, plus■■ all things permanently attached to the land, both natural and man-made.

Real property includes

■■ interests,■■ benefits, and■■ rights that are automatically included in the ownership of land and real

estate.

The characteristics of real estate include the following:

■■ Physical — Immobility — Indestructibility — Nonhomogeneity, or uniqueness

■■ Economic — Scarcity — Location (most important) — Improvements — Permanence of investment

Real estate brokerage is the business of bringing people together in a real estate transaction conducted by

■■ a broker who is a person or company licensed to list, lease, buy, exchange, auction, negotiate, or sell real property for others for compensation and who may be the agent of buyer, seller, or both, or

■■ a provisional broker who conducts brokerage activities on behalf of the broker.

Appraisal is the process of estimating a property’s value (typically, market value) that is based on established methods and an appraiser’s professional judgment and is regulated by the following:

■■ Licensing or certification is required for many federally related transactions.■■ North Carolina requires licensing or certification for local transactions.

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Property management is conducted by a property manager, a person or company hired to maintain and manage property on behalf of its owner whose

■■ scope of work depends on a management agreement, and ■■ basic responsibility is to protect owner’s investment while maximizing the

owner’s financial return.

Financing is the business of providing the funds that make real estate transactions possible through

■■ mortgage or deed of trust loans secured by the property, and■■ commercial banks, savings associations, mortgage bankers, and mortgage

brokerage companies.

Property development involves splitting a single property into smaller parcels (subdividing) and constructing improvements on the land (development).

Counseling involves independent advice based on sound professional judgment.

Education provides real estate information to practitioner and consumer alike.

Types of real property include the following:

■■ Residential—single-family and multifamily■■ Commercial—office space, shopping centers, stores, theaters, hotels, parking

facilities■■ Industrial—warehouses, factories, land in industrial districts, power plants■■ Agricultural—farms, timberland, ranches, orchards■■ Special-purpose—schools, places of worship, cemeteries, government-held

property

The real estate market reflects principles of supply and demand, influenced by the uniqueness and immobility of parcels of real estate so that

■■ when the supply increases and demand remains stable, prices go down; and■■ when demand increases and supply remains stable, prices go up.

The factors affecting the supply of real estate include the following:

■■ Labor force availability■■ Construction and material costs■■ Government controls—environmental restrictions, land use, building codes,

zoning■■ Government financial policies that impact interest rates and the money

supply

The factors affecting the demand for real estate include the following:

■■ Population—some areas grow faster than others; some decline■■ Demographics—family size, lifestyles, niche marketing■■ Employment and wage levels—influence housing affordability

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QUESTIONS

1. Which of the following best defines real estate?a. Land and the air above itb. Land and the buildings permanently affixed

to itc. Land and all things permanently affixed to

itd. Land and the mineral rights in the land

2. Which of the following is NOT a physical char-acteristic of land?a. Indestructibilityb. Scarcityc. Immobilityd. Uniqueness

3. The term heterogeneity refers to which of the following?a. Scarcityb. Uniquenessc. Mobilityd. Indestructibility

4. Situs refers toa. view from the property.b. improvements made to the building site.c. societal factors that are related to the

location.d. immobility of real estate.

5. Which of the following is NOT an economic characteristic of real estate?a. Indestructibilityb. Scarcityc. Permanence of improvementd. Location

6. Which of the following physical and economic factors would a land developer take into consid-eration when determining the optimum use of a parcel of land?a. Transportationb. Available natural resourcesc. Contour and elevationd. All of the above

7. A theater or a hotel would be classified under the real estate category ofa. residential.b. commercial.c. agricultural.d. industrial.

8. The demand for real estate is influenced by thea. number of real estate brokers in the area.b. ethnic makeup of neighborhoods. c. wage levels and employment opportunities

in the area.d. price of new homes being built in the area

versus the price of existing homes.

9. The designation REALTOR® refers toI. any licensed real estate broker.

II. an active member of the National Associa-tion of REALTORS®.a. I onlyb. II onlyc. Both I and IId. Neither I nor II

10. Which of the following statements is/are TRUE of business cycles?I. Business cycles involve periods of expan-

sion, recession, depression, and revival.II. The real estate business cycle is quicker to

recover from depressed times than other business sectors.a. I onlyb. II onlyc. Both I and IId. Neither I nor II

11. All of the following factors tend to affect supply EXCEPTa. the labor force.b. construction costs.c. government controls.d. demographics.

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12. Real estate can be a poor investment ifa. the inflation rate is high.b. the investor plans to hold the investment

for a long time.c. the investor needs ready cash.d. land values are appreciating in the area.

13. In general, when the supply of a certain com-modity increases, pricesa. tend to rise.b. tend to drop.c. tend to stabilize.d. can no longer be established.

14. In general terms, a market refers to which of the following?a. Place where goods are standardized for sellb. Amount of goods available at a given pricec. Quality of goods available to the publicd. Place where the value of goods is

established

15. The demand for real estate in a particular com-munity is LEAST affected bya. population.b. wage levels.c. employment.d. international trade.

16. The real estate market is considered local in character for all the following reasons EXCEPT a. land is fixed or immobile.b. consumers generally invest in real estate

that is near their home or work.c. local controls can have a significant impact

on the market.d. most people eagerly visit and invest in real

estate in distant areas.

17. Highest and best use of real estate willa. maximize the property’s value.b. stay constant throughout time.c. always be the property’s current use.d. not be affected by local economic trends.

18. A major manufacturer of automobiles announces that it will relocate one of its fac-tories, along with 2,000 employees, to a small town. What effect will this announcement MOST likely have on the small town’s housing market?a. Houses will likely become less expensive as

a result of the announcement.b. Houses will likely become more expensive

as a result of the announcement.c. Because the announcement involves an

issue of demographics, not of supply and demand, housing prices will stay the same.

d. The announcement involves an industrial property; residential housing will not be affected.

19. A buyer is interested in a house that fits most of her needs, but it is located in a busy area where she is not sure she wants to live. Her concern about the property’s location is calleda. physical deterioration. b. area preference. c. permanence of investment.d. immobility.

20. A professional estimate of a property’s market value, based on established methods and using trained judgment, is performed by aa. real estate appraiser.b. real estate broker.c. real estate counselor.d. home inspector.

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More Tools from Dearborn™ Real Estate Education—the Source for All Your Professional Education Needs

Guide to Passing the AMP Real Estate Exam • North Carolina Exam Review CD-ROM • The Language of Real Estate

Questions & Answers to Help You Pass the Real Estate Exam • Mastering Real Estate Math • Power Real Estate E-Mails & Letters

Before Hitting Send: Power Writing Skills for Real Estate Agents

MODERNREAL ESTATEPRACTICE in North CarolinaEIGHTH EDITION UPDATE REVISED

New and greatly expanded topics include:

• Review of the updated Offer to Purchase and Contract with particular attention to the Due Diligence concept

• Review of standard addenda for the Offer to Purchase and Contract

• Property management duties including calculations for a sample operating budget

• Short sales

• Updated coverage of the secondary market and loan qualification standards

• Broker Price Opinions

In addition, you will find many special features, among them:

• Bulleted Key Point Reviews in place of summary paragraphs at the end of each chapter for ease of review

• North Carolina margin tags to identify state-specific laws and practices

• Website addresses located at the end of each chapter to expedite student research

• Forms appendix contains newly updated forms

Contents:

Basic Real Estate Concepts

Property Ownership and Interests

Encumbrances on Real Property

Property Description

Transfer of Title to Real Property

Land-Use Controls

Real Estate Brokerage and the Law of Agency

Basic Contract Law

Agency Contracts

Sales Contracts and Practices

Landlord and Tenant

Property Management

Real Estate Financing: Principles

Real Estate Financing: Practices

Closing the Real Estate Transaction

Basic Residential Construction

Real Property Valuation

Property Insurance

Federal Income Taxation of Real Property Ownership

Fair Housing and Ethical Practices

Environmental Issues and the Real Estate Transaction

Basic Real Estate Investment

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For comments or queries about this product, please email us at [email protected].

332 Front Street South, Suite 501, La Crosse, WI 54601www.dearborn.com, 800.972.2220

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