A Fee That Only Developers Could Love

REBECCA AND TRENT DUPAIX of Eagle Mountain, Utah, spent a year searching for their dream home. The couple, who have five children, considered 15 to 20 houses before finding “the one.”

Justin Ailes of the American Land Title Association, with the Congressional aide Kelly A. Dixon, says that the idea of charging a 1 percent resale fee on homes “doesn’t pass the smell test.”
They were thrilled when they closed on a $227,000, rock-and-stucco home with five bedrooms and two and a half baths in March 2009.

But four months later, when a local television reporter was doing a story on housing taxes in their subdivision, the Dupaixs discovered that their sales contract included a “resale fee” that allows the developer to collect 1 percent of the sales price from the seller every time the property changes hands — for the next 99 years.

Mrs. Dupaix, 34, says she and her husband had no clue about the fee when they closed on the house. “Of course we were upset,” she says. “We didn’t know about it, and our closer at the title company didn’t know about it.”

Other buyers gutsy enough to venture into the battered housing market in the hope of scoring a bargain might be wise to check the fine print before popping open the Champagne and signing on the dotted line.

A growing number of developers and builders have been quietly slipping “resale fee” covenants into sales agreements of newly built homes in some subdivisions. In the Dupaix contract, the clause was in a separate 13-page document — called the declaration of covenants, conditions and restrictions — that wasn’t even included in the closing papers and did not require a signature.

The fee, sometimes called a capital recovery fee or private transfer fee, has been gaining popularity among companies that have been frantically searching for new ways to gain access to cash in the depressed housing market.

“Developers are desperate,” says David Steffensen, a lawyer and a former developer in Salt Lake City. “They’re facing projects that are upside down” because the property value has fallen below the loan balance and lenders are refusing to refinance. “It’s a ticking time bomb,” he adds.

Freehold Capital Partners, a real estate financing firm founded by the Texas developer Joseph B. Alderman III, has been leading the charge. According to William White, Freehold’s chief operating officer, the firm has signed up more than 5,000 developers who are adding the covenant to developments worth hundreds of billions of dollars that will be built out over the next decade in 43 states.

Many developers see the resale fee as a creative way to get new financing. They are hoping to one day use the trickle of cash from these fees as collateral for a loan, or to get cash up front if pools of the fees are packaged into securities to be bought and sold on Wall Street. Freehold has begun shopping the idea of securitizing the resale fees, much as subprime loans were packaged and sold to investors.

Someone selling a home for $500,000, for example, would have to pay the original developer $5,000. If the home sold again two years later for $750,000, the second seller would have to pony up $7,500 to the developer, and so on. Even if a home declines in value, the seller still must pay the 1 percent fee. Freehold gets a cut of the resale fee; if the fees are securitized, it retains a percentage of the cash generated from the securitization.

Freehold’s principals and lawyers have been aggressive in sales pitches to developers, but have declined to give details on their clients, securitization efforts or the company itself. Freehold moved its corporate office from Round Rock, Tex., to New York this year as it stepped up efforts to securitize the resale fees.

Mr. White characterizes the resale fee as a win-win deal for the developer and the home buyer. The fees let developers spread out the cost of building the roads, utilities and other infrastructure across all homeowners in a subdivision, rather than just the initial buyers. As a result, he said, the developer can lower the initial price of a home to the first buyer.

For example, he says, a typical $250,000 home may be able to sell for about $5,000 less. “The fee is a fair and equitable way to spread development costs, and results in lower costs to the average consumer,” Mr. White says.

Ted Thieman, founder of the real estate developer Thieman Enterprises in Vandalia, Ohio, sees Freehold’s securitization plan as the holy grail that will provide him with badly needed cash. He signed up with Freehold last year after lenders refused to provide financing for him to develop land in Dayton, Ohio.

“People are going bankrupt out here, and there’s no cash flow in our developments anymore,” he says. “This is the only source that’s available to us.”

Jeff Moseley, founder of Badger Creek Development in Brunswick, Ga., says he signed up with Freehold after watching his business tank with the economy. “I can’t sleep at night,” he says, adding that he had laid off all 32 of his employees.

He is hoping Freehold’s resale fee program will breathe new life into his business. “I thought it was an intriguing and compelling story,” says Mr. Moseley, who owns two development projects, encompassing about 220 lots.

Under his deal with Freehold, he will get about two-thirds of the revenue from the securitized fees while Freehold and other parties will get one-third.

Some developers are skeptical. Qualico, a Canadian company that owns Reytex Homes of Austin, Tex., turned down Freehold’s sales pitch when it was buying land from a Freehold affiliate in Texas. Qualico wanted to use the land to build entry-level homes and didn’t think the fee would fly with that market segment. First-time buyers are more likely than others to trade up and quickly sell a home, so the home often has little time to appreciate enough to offset the fee.

The resale fee “has disaster written all over it,” says Rick Akin, partner of the law firm Akin & Chardavoyne, which represented Qualico.

MR. ALDERMAN, 45, has a history in the real estate industry, dating back to 1990, that includes a few bumps in the road. In March 1994, he filed for Chapter 7 bankruptcy protection for businesses that operated as Alderman Homes Inc. and First Quality Homes Inc., which had offices in Texas and Florida.

He has also held positions as either a senior executive or registered agent for seven other businesses, many of which the Texas Comptroller of Public Accounts lists as “not in good standing” — a designation applied when a company has either not paid franchise taxes or failed to file a tax report or both.

Mr. Alderman says that the businesses were deemed not in good standing because he or his accountant didn’t file reports by the deadline and that no franchise fees are due. “My credit is perfect,” he adds.

Negotiations involving Mr. Alderman have sometimes been contentious. Mr. Akin says he had “tortured negotiations” with Mr. Alderman in 2006, when Qualico was trying to buy two parcels of land near Austin from Mr. Alderman’s development company. Mr. Akin says Mr. Alderman haggled over issues including who would pay to extend sewer and water services to the land tracts, as well as who would be reimbursed for building parks and streets in the subdivisions through the city’s Public Improvement District program.

“He wanted to be reimbursed for the money that we were going to spend for public improvements,” says Mr. Akin.

He says Mr. Alderman also did not resolve issues like easements and back taxes that affected the legal claim to the title. When Mr. Akin decided to cancel the purchase agreement on the second tract of land over title issues, he says he had to sue Mr. Alderman’s company to get back his client’s $1 million deposit. “In the over 25 years that I’ve been doing this, he was one of the most difficult sellers I’ve ever dealt with,” says Mr. Akin.

The dispute was settled out of court. Mr. Alderman says Qualico wanted to back out of both land purchases, but was allowed out of only one. He says the $1 million deposit wound up being applied to the first tract’s purchase. “If Mr. Akin believes that is hard negotiating, then so be it,” he says.

A COALITION of real estate trade groups, including the National Association of Realtors, the American Land Title Association and the Center for Responsible Lending, opposes resale fees and is lobbying federal and state authorities to ban them.

“The idea that someone who has no ownership stake or interest can continue to collect revenue off of a property that they may have built up to 99 years ago exploits an already complex transaction and doesn’t pass the smell test,” says Justin Ailes, director of government affairs at the land title association. The fee could hurt real estate values in the future if buyers are reluctant to purchase properties that have a 1 percent fee attached.

The coalition wrote to the Treasury secretary, Timothy F. Geithner, and to the Department of Housing and Urban Development, the Federal Housing Finance Agency, the Federal Trade Commission and others, urging them to bar the fees or use the consumer protection agency — to be created by the financial overhaul — to fight them.

Often, the fee is within dozens or hundreds of pages of documents, and for some buyers, like the Dupaixs, it may be in a separate declaration that does not require a signature. Buyers may not be aware of the fee until the closing — or, worse, when they try to sell the home years later and the fee shows up in the title search, Mr. Ailes says. If the seller won’t pay the fee, he says, a lien is slapped on the property.

“I am yet to find an owner that reads 300 or 400 pages” at closing time, says Charlie Orden, a broker and owner of the realty office Re/Max Town Centre in Orlando. And even if they do see it at closing, few buyers are going to walk away from a home at that point. He says he has started looking for the clause to warn potential clients well in advance.

Opponents have made some headway. The Department of Housing and Urban Development recently issued a letter indicating that the fees violated its regulations and that the agency would not insure mortgages on properties that included them.

The Federal Housing Finance Agency is considering a proposal to prohibit the transfer fees on all mortgages financed by Fannie Mae, Freddie Mac and the Federal Home Loan Banks. And 17 states have either banned or placed conditions on the practice.

Some bankers say Freehold will have a tough time selling the idea to Wall Street. The uncertain economy and housing market have made it next to impossible to predict when and how often a home will sell, or where home prices are headed — information that is needed to estimate cash flows to value the securities.

And some worry that an all-out ban of resale fees by states or the federal government could make the securitized paper worthless.

Dave Ledford, a senior vice president at the National Association of Home Builders, says he’s not sure Freehold can deliver on its big promises. “It’s almost in the category of ‘too good to be true,’ ” Mr. Ledford says.

Mr. White dismisses the criticism as sour grapes. He contends that Realtors oppose the fee because homebuyers might pressure them to lower their commissions to offset it. “Apparently 6 percent to a Realtor is justified, yet 1 percent to pay for roads and utilities isn’t,” Mr. White says. He says he believes title companies are worried that they might face legal claims if they miss the fee during a search.

As for bundling the future cash flow into securities, Mr. White sees little risk. The fee represents “a stable passive income stream,” he says, that will be generated whether home prices go up or down. Even if the federal government or other states ban the fees, the ban would most likely apply only to future developments, not existing ones, he says.

Mr. White says his firm encourages full disclosure of the fees. However, he was unwilling to disclose the names of the developers and residential developments that currently charge the fees.

In fact, Freehold was the financing company behind the fee in the Dupaix contract. Even the home builder, Prestige Homes, wasn’t aware of the fee, and demanded that the developer, Development Associates Inc., remove the clause from the paperwork, says Michael Cameron, the real estate agent who handled the sale for Prestige.

Mr. Cameron says Development Associates amended the “covenants, conditions and restrictions” document without the knowledge of the builder or buyer, and didn’t present the amended document at closing. He says Prestige pulled out of the subdivision after the incident. “It’s not good for the buyers, it’s not good for our reputation, and quite honestly, we thought it was unethical,” he says.

Nate Shipp, owner of Development Associates, says he signed up with Freehold on the condition that Freehold securitize income from the fees and then pass on some of that revenue to his company so it could lower the price for buyers. But so far, Mr. Shipp says, he has not received any money from the arrangement.

He says Freehold insisted that he add the resale covenant into the sales documents on all lots in his subdivision to qualify for its program. Because Mr. Shipp hadn’t received cash from a securitization, he has been deleting the clause from the sales contract as each home is sold. He says the fees on the Dupaix property and about 11 others were accidentally left in. “It was an honest mistake,” he says.

AS for Mrs. Dupaix, she says a resale fee wouldn’t necessarily turn her off of a home if the price were right.

If she had known of the fee in advance, she says, “we would have negotiated to get the price lower.”


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