In November 2012, Colorado voters approved a constitutional amendment making Colorado the first state in the nation to legalize the use of recreational marijuana. Amendment 64 to the Colorado constitution became effective January 1, 2014 and since then, Colorado has been at the forefront of cannabis law and policy. During 2013, the state had to implement laws and policies to make the new amendment work. Governor John Hickenlooper and the legislature had to figure everything out from what the state’s role would be in regulating the sale and use of cannabis versus local government, to tax policy. Local governments were given the option to opt out and to prohibit dispensaries within their boundaries and nearly half of Colorado cities did so.

Tax policy became a huge challenge. How much could the state charge for this new “sin tax”? Ultimately, the state determined that the taxes on cannabis related products would be significantly higher than alcohol and tobacco. Currently, the state assesses a 15% excise tax on cannabis and products and a 15% sales tax on non-medical marijuana and products (on top of the state’s 2.9% sales tax). Local governments also levy their own sales tax and may assess an excise tax as well. Denver, for example has a 3.62% sales tax and a marijuana tax of 3.5%.

Recently, Denver Mayor Michael Hancock proposed increasing the marijuana tax to 5.5%. The extra 2% would be earmarked for the city’s affordable housing program. Mayor Hancock estimates that the new tax would generate $8,000,000 for affordable housing. His proposal also provides that the city set aside an additional $7,000,000 from its general fund for affordable housing. The $15,000,000 in new dollars into the affordable housing fund would mean 6,400 new affordable housing units over 5 years. Colorado’s marijuana industry strongly supports the mayor’s plan.

6,400 new units can go a long way to helping Denver with its affordable housing crunch. But, it is ironic that taxes on marijuana and related products would be used to fund affordable housing when the federal government still considers marijuana a banned substance. Consequently, if HUD or other federal dollars are used in the construction of these units, or if a tenant receives federal assistance for rental through HUD, FHA or other programs, potential tenants with marijuana related convictions could be denied housing in these new units. Similarly, the use of marijuana is banned in subsidized housing under federal law. If the new Denver units are constructed without federal subsidies, this won’t be a problem. However, a developer could, presumably, receive the Denver marijuana tax money through the Denver Housing Authority and also obtain a low interest HUD loan. In such an event, marijuana use or possession in the units would be prohibited despite being legal in Colorado, subjecting a tenant to arrest or eviction. It is ironic that the marijuana dollars would be good enough to build the building, but use of the product itself, though perfectly legal in the state, would subject a tenant to eviction.

Colorado has used direct marijuana tax revenue for many good projects since making recreational marijuana legal. By law, the 1st $40 million of the excise tax each year goes to schools and school construction. The state marijuana sales tax is used for enforcement, education and awareness programs. Denver’s proposal makes great sense. But, it is time for the federal government to align with the states. Housing programs are administered by the states because the program is too big for HUD to do. And, marijuana is a states’ right issue. If marijuana is legal in a state and state tax dollars can be used to solve a problem, the federal government should bend over backwards to allow it to happen without penalty.

For all the debate about the Trump 2017 Tax Reform, the creation of the Opportunity Zone Program could be an engine for economic development in low income communities. The goal of the program is to encourage investment of deferred capital gains into pooled funds which would then be invested in state designated, federally approved Opportunity Zones. Last week, Florida Senator Marco Rubio and South Carolina Senator Tim Scott (both Republicans) were in Miami to promote Governor Rick Scott’s newly designated Opportunity Zones. On their tour, Senators Rubio and Scott did a good job of preaching the potential benefits of the Opportunity Zones and what the investments could bring. But they did not explain the long process it will take to bring the dollars to the community or any potential pitfalls.

The program works similar to 1031 tax free exchanges. Taxpayers can defer long term capital gains if the capital gain portion of a sale is reinvested in a Qualified Opportunity Fund (a 1031 exchange requires that ALL net sales proceeds, gain and principal, be reinvested in a replacement property). A Qualified Opportunity Fund is an investment vehicle that is organized as a partnership or corporation for the purpose of investing in an Opportunity Zone. A designated Opportunity Zone is a census tract with a poverty rate of 20 percent or a median family income lower than 80% of the area average.

State governors were to nominate up to 25% of the eligible low income tracts as Opportunity Zones by March 21, 2018. Florida received an extension until April 20, 2018 and on April 20, Governor Scott nominated 427 areas, 25% of those eligible, for designation. The Treasury Department has 30 days to make the designation and when it does, the designation will be for 10 years.

The benefit to the taxpayer is a step up in basis. If the investment is for 5 years, the step up is 10%. If the investment is another 2 years, the taxpayer receives another 5% step up. On December 31, 2026, the tax payer will recognize the remaining deferred gain.

As Opportunity Zones are created and funded and investors create projects in Opportunity Zones, development should jump start in these low income areas – perhaps more quickly then would have occurred without this program. At least that is how Senators Rubio and Scott spun the program. And, it is a good thing any time dollars are targeted for development, particularly in low income neighborhoods. Obviously, for those of use in the real estate industry, more capital should mean more activity for all of us.

However, private dollars as well as state and local dollars are often already targeted in these same areas. In some cases, these efforts have had some success. In others, the successes are hard to find. Pumping money into any area, private or government, doesn’t work unless there is a plan. The local government has to be willing, and able, to work with developers to approve projects through its zoning code and permitting process. There has to be a vision and a master plan in place and the local governments must offer incentives to start up and small businesses to assure that there are essential non-governmental services (and governmental services) for the residents that are targeted with the new development. Otherwise, the government dollars will be wasted, or worse, go unfunded.

Opportunity Zones could truly spur meaningful growth and development. Or, they could be another case of putting the cart before the horse.

I always tell my clients that I am here to help. I am here to make their transactions easy. I am here to help relieve stress and pressure. I am here to answer questions. It is a familiar refrain. So why do clients wait until it is almost too late, if not actually too late, to call when they need help?

Just the other day, a friend stopped me and asked me if she needed a title search for the new house she was buying and closing on in a few days. I had done a closing for her several years before and she had referred other people to me, so she knew how I practice. My eyes grew very wide as I told her “of course you need a title search and title insurance”. “Will it take long? Will it cost much” she asked. After a lengthy discussion, my friend e-mailed her contract to me so that I could jump in and handle the closing for her.

What I learned what that, because the house was in Martin County, the seller was to provide the title and had selected the title company. The title commitment had already been issued but because my new client had no attorney, the title company didn’t bother to send it to anyone. When we called to ask for the commitment and copies of the closing documents, we set off all kinds of alarms. The client’s real estate agent became defensive. She said that the title company was handling title and we weren’t needed. Perhaps we had been hired to handle the sale of the client’s house. UH OH! I thought we were working with another real estate agent who doesn’t want to work with the client’s attorney. What is she hiding? Likewise, the title company was uncooperative. Once they knew that we were involved, they should have automatically sent us everything. However, we had to ask for every piece of paper, document by document, page by page.

At this point, it occurred to me that I needed to write this post. I’ve written about the need for real estate attorneys for residential closings before (see post HERE). Obviously, this closing is another example of that need. Your agent should protect you, but an agent is not an attorney and some agents, to this day, believe that attorneys only screw up deals. Good agents don’t think that way. If an agent steers you away from an attorney, you have a bad agent. Relying solely on a title company is also a bad idea. Title companies close title. They are responsible to follow bank instructions and escrow instructions only. They are responsible to the underwriter. If you don’t have an attorney, you likely aren’t providing sufficient instructions to the title company and therefore, aren’t getting adequate protections.

But this post isn’t just about using an attorney. It’s about answering the question, when should you call your attorney. Answer: not 10 days before closing! Here, we were able to clean up messes and prevent the client from accepting title with improper and unacceptable title exceptions. However, we did not have enough time to obtain a survey. The real estate agent told her she didn’t need once since she wasn’t getting a loan. (See prior post on need for surveys HERE).

Certainly, don’t wait until 3 days before closing. This same client got totally freaked out when the closing agent for the sale of her house contacted her real estate agent (a different one) to ask where the closing documents were. The closing agent also scheduled closing for 2:00 in the afternoon. The purchase of the new house was scheduled for 3:30 the same day. Funds from the sale were needed for the purchase. No one told the client how she was to provide the closing documents, how she was to get from Broward to Martin County in an hour with the closing funds or how all this was to work. She was a wreck. I now had 3 days to work it out with the buyer’s closing agent, do the documents, solve any title issues and coordinate 2 closings instead of 1. Both contracts had been signed 7 or 8 weeks prior.

And, finally, 2 days before closing is definitely not enough! My partner, Eric Assouline was with his client 2 weeks ago at a summary judgment hearing. After the hearing, the client casually mentioned that he was closing on an “investment property” in 2 days and needed to “protect” that property in case they lost in the litigation. Eric came back to the office to discuss with me. I asked Eric why we were just hearing of this now. Eric shrugged. Had the client talked to us at the time he signed the contract, we could have devised asset protection strategies and properly closed on the property. 48 hours prior to closing? The client had to proceed.

Like I said, I am here to help. But don’t wait to call. Don’t wait until the last minute!

Experienced borrowers know that the most important factor a lender looks at in underwriting a loan is the borrower’s ability to repay. Certainly, the value of the collateral is important. However, lenders aren’t in the business of owning and operating real estate or other assets. So, while loan to value (LTV) is important, it is never the sole factor in loan underwriting. Lenders want to be repaid.

The borrower’s and guarantor’s net worth, as shown on their financial statements, becomes very important. Does the buyer have the financial strength to repay the loan? Do the guarantors? Again, this is an important consideration, but it is not taken in a vacuum. Loan payments are made monthly. Borrows don’t borrow money with the intent of repaying it with their assets. Equity is generally funded up front. Loan payments are supposed to be made through the cash flow of the property or the business. Therefore, lenders must be certain that the property or business can generate enough revenue to cover all of its expenses and repay the loan. Accordingly, most loan commitments will contain a Debt Service Coverage Ratio (DSCR) requirement and a DSCR covenant will be added to the loan agreement.

DSCR is a simple calculation. Lenders generally use one of two formulas expressed as follows:

  1. EBITDA / (Current Maturities of Long Term Debt + Interest)
  2. NOI / (Current Maturities of Long Term Debt + Interest)

 

Depending on the type of business or property, lenders will require that the DSCR be maintained ranging from 1.2 to 1.5 or higher. If the targeted DSCR is 1.2, the property or business creates 20% more income than it needs to make its loan payments.

What should a borrower be concerned about when seeking a loan as it pertains to DSCR? How a lender reviews DSCR could affect whether a loan is in good standing. If the target is not met, a lender may have the right to declare a loan default or have the right to require that borrower make principal reductions to bring the loan into compliance. Be aware that distributions to partners or shareholders, even salaries paid to owners could affect DSCR unless permitted under the loan agreement or specifically excluded in the NOI calculation.

Borrowers should make sure that the lender does not have the right to review DSCR more often than annually. Cash flow in certain businesses or types of properties ebbs and flows, such as hotel. Frequent DSCR reviews could cause default because of a poor cash flow time period even though the annual test would show the borrower meets the target.

It is a good idea to negotiate the DSCR target as close to 1.0 as possible. This needs to be done at the commitment stage as it is an underwriting issue and a key basis for making the loan.

As a remedy for missing a DSCR Target, rather than default or principal pay down, offer to escrow cash as additional collateral until the next review. Another solution would be to request a new appraisal of the property. If the appraisal exceeds x% of the mortgage, the DSCR covenant would not apply. These solutions are particularly important early in the loan term as the underwriting is usually based on pro-formas that have been prepared by the borrower and adjusted by the underwriter. Sometimes, the business or property needs more seasoning.

Technical loan defaults are the hardest to cure. The DSCR covenant is among the easiest to breach and the hardest to cure. Borrowers need to plan for DSCR prior to making a loan application. The planning should to include strong, but realistic pro-formas and a strategy for negotiating with the lender for a fair DSCR loan covenant. This planning can help to avoid default problems during the loan term.

Spoiler Alert: No need to read on for the answer to the question posed in the title to this article. The answer is “all of the real or personal property owned by the violator once a certified copy of the order imposing a fine is recorded in the public records.”

But what does this mean in practical terms and why should you be concerned about it. Perfect case in point: A client who is a home builder had located a few vacant residential lots located in Loxahatchee, Florida being offered for sale at the very good price of approximately 50% the value of comparably situated lots by a very sophisticated investor who had purchased these and numerous other properties located in Palm Beach County at bargain rates over an extended period of time at tax deed sales (the “Seller”). Unfortunately, the Seller did little to maintain its large portfolio of properties acquired at tax deed sales during its tenure of ownership and many of these properties had been cited for code violations and built up numerous recorded liens over the years in the various incorporated and unincorporated areas of Palm Beach County in which they were located.

When our home builder client came to us with contract in hand to purchase the two vacant lots in Loxahatchee, our primary focus was to determine whether title acquired by the Seller through the tax deed sale was sufficient or remedial steps needed to be taken by way of a quiet title action in order to establish a proper chain of title. We of course also ran a municipal lien, tax and open permit search against the properties to see if any other issues were presented. The title commitment stated that there were 31 different Code Enforcement Liens recorded against 18 of the Seller’s properties located in Palm Beach County that also show up on the title to each of the vacant lots in Loxahatchee. But while the newly performed municipal lien and tax research noted that there were pending code violations lien against other properties owned by the Seller in Palm Beach County, the municipal lien and tax research specifically omitted any cost or liability figures associated with these 31 different Code Enforcement Liens recorded against 18 of the Seller’s properties because NONE of them were recorded against the specific vacant Loxahatchee lots that our client was purchasing for from the Seller.

So which research is telling the truth? The title commitment that states that 31 different Code Enforcement Liens recorded against 18 of the Seller’s other properties in Palm Beach County also affect title to each of the lots our client was purchasing or the municipal lien an tax research that omitted any cost or liability figures associated with these 31 different Code Enforcement Liens recorded against 18 of the Seller’s properties because the municipal lien and tax research stated that NONE of them were recorded against the specific vacant Loxahatchee lots that our client was purchasing? The Spoiler Alert at the outset of this article gives the answer away with the edited quote from Florida Statutes, Section 162.09 (3).   BELIEVE THE TITLE COMMITMENT. Clearly, if the municipal lien and tax research company is telling you that there are pending Code Enforcement Liens against other properties owned by the Seller in Palm Beach County, these same Code Enforcement Liens affect ALL properties owned by the Seller even though they were not recorded against the specific property which was the subject of the municipal lien and tax research.

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