Money & the Law: Developers tap novel mode of financing
Land developers are, of necessity, a creative lot. They are constantly looking for new ways to finance their projects, which require large up-front expenditures for streets, sewers, water, gas, electricity, parks, schools, highway interchanges, bridges, new fire stations for the fire department, etc.
Going back a few decades, land developers relied largely on bank loans to finance their projects. But then they discovered “special districts.” Special districts are mini-governments that have the power to collect property taxes and issue bonds. (A bond is just a promissory note by another name.) The owners of these bonds don’t pay income tax on the interest they earn, so the interest rate on the bonds is substantially less than what banks charge for a land-development loan.
Land developers have also refined the art of passing on to homeowners associations the costs associated with their projects, such as landscaping, gates and fencing. Under this strategy, assessments collected by the association provide the funding.
The hot new innovation in land-development funding is a “transfer fee covenant.” Although there are many variations on the theme, a typical example might look like this:
The developer agrees with an investor to record a document affecting all of the land in the development stating that, for the next hundred years, every time a lot changes hands, a fee equal to 1 percent of the sale price fee will be paid to the investor. The investor in turn gives the developer money. The amount paid by the investor is based on projections as to the number of and amount of transfers likely to occur over the next hundred years. The formula includes a handsome rate of return for the investor.
These transfer fee-covenant arrangements have resulted in a major debate within the legal community, and politically as well. Are they a good idea, because they help to defer the front-end cost of land development and thereby reduce the cost of housing? Or are they evil monsters that strangle the marketability of property and export wealth to strangers in distant lands?
This debate has led to legislation in at least 11 states (but not yet in Colorado), ranging from a near-complete prohibition on transfer fee covenants to a mere requirement that they be disclosed any time a sale of property is contemplated.
Although these private investor transfer fee arrangements are a recent invention, the general idea of real estate transfer fees is not. Here in Colorado, every time a property is sold in an arm’s-length transaction, a “documentary fee” is paid to the state. This fee is .0001 of the purchase price. So, on a $300,000 home sale, the fee is $30. In some mountain communities — notably Aspen — a 1 percent transfer fee is charged. On a $1 million sale, this fee comes to $10,000.
Under Colorado’s Common Interest Ownership Act — which ranks right up there with the Internal Revenue Code as one of the world’s most convoluted statutes — homeowners associations are allowed to charge a transfer fee of up to 3 percent.
And, if you really want to go back in time, many centuries ago the king of England collected a fee whenever an interest in land was transferred (although, as you probably know, this ended in 1290 with the passage of the Statute of Quia Emportes.)
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Jim Flynn is a private attorney
at Flynn Wright & Fredman LLC in Colorado Springs. Reach him at jtflynn@fwflegal.com.
