Exchanging

How to Write the Contract

How to Get One Done in the Real World

Excerpts from a Presentation to the National Association of Realtors Convention, November 1994, Anaheim, California

by

Dennis J. Gillig

Liberty Real Estate Group, Inc.

1040 S. Arlington Heights Road

Arlington Heights, IL 60005

847-259-9500

I. Overview of Exchanges

A. Simultaneous vs. Deferred

I prefer Simultaneous for the following reasons: First, you don't incur the cost of a third party escrow agent that happens when you use a deferred exchange. The escrow agents typically cost $500 to many thousands on larger transactions. If you have a competent attorney doing the closing you should be able to close a simultaneous exchange without the use of a special escrow. Second, you add a new "bunch" of conditions or rules when you go deferred. Simultaneous exchanges have been around for over 75 years. They have only a few simple points (the purpose of this article is not to cover the rules and laws but to be practical). Deferred exchanges require more laws and it is easier to trip. Third, I don't like deferred exchanges because something can go wrong and you can end up paying taxes. As I write this I have one heading that direction. We were to have closed the transaction on the replacement property last week. At the last moment the soil test showed contamination. No one expected it and we don't have a clue what will be happening. Fortunately I always recommend to clients that they designate at least three properties. She has two on which to fall back.

B. What do we really Exchange?

I suppose this goes back to the age old arguments about what we, real estate people, are really doing in life. Some sell real estate. That is, they are like the local food store. They have a product and they hawk it, sell it. Nothing wrong with that. Some of us are people-problem-solvers. We know that real estate can't write a check, only people do that. People write checks to solve problems. If get in there and find out what the problem is and solve it we get paid.

So, what do we exchange. In a numerical sense we exchange EQUITY, not price. In a human sense we exchange benefits. Other than pride or ignorance regarding price, humans give up a situation to acquire another situation. You must give up a set of benefits in order to acquire a set of benefits. The key to engineering an exchange is to find the right balance of benefits.

An exchange does not have to be tax-deferred but that is what we are usually talking about. Giving up money (cash) for a new automobile is an exchange of cash for car. If you want the FEELING of SEEING yourself in a new car and HEAR the remarks of friends you plunk down the cash. All humans receive information and use similar senses when dealing with their real estate. The wise person realizes that the motivation is not just money but the complete package of benefits.

II. Exchange Contracts

A. Contracts

1. No-price vs. Price in the contract

Here is a debate for you. Should you put the price in a contract when you are writing an exchange contract? Before we can go any further some folks will ask, "How can I write a contract with no prices?" Good question. Back to basics. We are exchanging, not selling or buying. Pretend you are back on the playground and trading baseball cards. Let's say I give you two Cal Ripkin Jr. for one Lou Gehrig. Assuming you want what I have and I want what you have, we make a deal. No money changes hands. I could say, "My Ripkin cards are worth $2.50 and I will give you those cards for your Gehrig card which is really only worth $2.25." Well, what would be accomplished other than finding something else about which we can disagree? Take a look at the sample contract later in the article for how you might write it. Essentially you are saying to the owner, "I will give you the equity in my property plus $XXX in cash/paper/other equity/personal property for your property." How does the "seller" of the replacement property react. Usually fine. The broker is the one that requires the explanation.

2. Writing the balancing clause

Exchange Agreement

This Exchange Agreement is entered into this ________ day of _________________, 1994 April 8, 1991, between Tom and Mary Smith, First Party, and Liberty Corporation, Second Party.

The First Party offers to exchange the real property identified as 114 Prairie Avenue, Arlington Heights, IL, herein called Property #1, for the real property owned by Second Party, The Pinewood Terrace Apartment Complex, Elgin, IL, a 167 unit apartment complex, herein called Property #2 (legal descriptions of all properties may be inserted later.)

EXISTING LOANS OF RECORD. This contract is intended to qualify this transaction under Section 1031 of the Internal Revenue Code as a tax deferred exchange for First Party. Both parties agree to cooperate in an exchange by signing such documents as may reasonably be required. First Party's property is currently encumbered by a first mortgage loan of $143,000, MOL. Second Party's property is encumbered by a first mortgage loan of $920,000 MOL.

EXCHANGE ADJUSTMENTS. Second Party will pay off the first mortgage loan of $920,000 MOL from the proceeds of this transaction so First Party may place a new first mortgage loan on the property as indicated in the paragraph labeled FIRST PARTY MORTGAGE COMMITMENT. In addition to the equity in the Arlington Heights, IL Property, Second Party is to receive $1,725,000 in cash, plus or minus prorations, and a certain note for $125,000. The terms of the note are: the amount of $125,000 bearing interest at the rate of 9% per annum with monthly payments based upon a 25 amortization schedule with the then current balance due at the end of the 84th month following closing and secured by a second mortgage on Property. Second Party agrees to assume the existing loan on Property #1 with release of liability to First Party, or acquire a new first mortgage loan, or pay off the current loan.

The above is about as complicated as it can get. But the concept is quite simple. Try it if you think you can carry it off.

III. The real marketplace

A. Networking sessions

The place for really doing marketing is not thru an MLS book or via flyers. Signs, ads, and other marketing tools are not bad, just not the best way. If you met with 10 others like you once a month and each went over each other's property situations and tried to assist each other, wouldn't that be great. When marketing a property the best way, in my opinion, is to meet with others and try to create transactions. All the other methods of marketing tend to be passive. Place the ad and wait. Plant the sign and wait. Mail the flyer and wait. Go to a marketing meeting and actively present the situation and then follow-up with actively trying to get a transaction together with someone else is the best way.

B. Marketing sessions

These sessions are the best of all. Concentrated efforts by a group can provide dynamic results. Of course it depends on the make-up of the group. Some groups are worn out and others don't grasp the idea of trying to market actively. They like the idea of sitting in the office and waiting for the phone to ring. Go and go consistently. Normally only licensed people can attend.

IV. Summary

A. Equity is the commodity and benefits make it happen

B. Balancing is done via negotiation

Whether you put prices in the contract, or not, the best point of negotiation is what Dee Fountain used to say, "Don't tell me what you won't do, tell me what you will do."