Myths About Capital Recovery Fees
Capital recovery fees (also called home resale fees and private transfer fees) have been in the news a lot lately. Here is where you can separate the truth from the myths.
Myth: Transfer fees are hidden.
Truth: Homeowner associations include transfer fees in the exact same document as HOA dues. Developers go one step further, and use a stand-alone instrument, with a bold header, easily identifiable by the title company. After all, if the fee is hidden, who will pay it?
Myth: Transfer fees increase the cost of homeownership.
Truth: It lowers the cost of homeownership. In return for agreeing to pay the fee at the time of a future sale, the homeowner pays less up front. A homeowner that pays $245,000 instead of $250,000, and agrees to pay 1% at the time of a future sale, will likely save more in interest payments than the total transfer fee. Other savings include lower closing costs, including a reduced real estate commission, a reduced title insurance premium, etc., and the opportunity costs (does the homeowner use the savings to pay down credit card debt?)
"The use of [transfer fee] financing serves to reduce the up-front costs of such projects and goals, which results in a more affordable home price to an initial buyer." Cal. Staff Analysis to AB 157447>
Myth: Transfer fees are new.
Truth: Transfer fees have been around for decades. Homes across the country have transfer fees dedicated to a variety of uses, from HOA maintenance to charity to infrastructure reimbursement. Data suggests that between three and four million homes nationwide currently have a transfer fee of some kind on them, with virtually no reported problems.
Myth. Homeowners are stuck with the fee.
Truth: Every homeowner that pays the fee voluntarily agreed to do so (by buying the house), and negotiated their price accordingly. For those who prefer not to pay the fee, and who instead prefer to pay 100% of infrastructure costs up front, and to finance those costs, and to then pass these expenses along to the next buyer, numerous choices abound.
Myth: Only the initial buyer saves money. Future buyers will pay more.
Truth: Each buyer pays less up front, enjoys the transaction savings and interest savings, and can sell for less. When the fee expires, the home value will rise, because the encumbrance is removed.
Myth: Transfer fees run in perpetuity.
Truth: While it is true that certain transfer fees payable to non-profits have been imposed in perpetuity, capital recovery fees (imposed by developers to spread development costs), run for 99 years.
While 99 years is a long time, it is important to remember that the fee is only paid upon each sale (not annually). The typical home will sell 8-11 times in 99 years, generating 8-11% in fees. Compare this to other fees used to reimburse the developer (such as Mello-Roos fees) which charge an annual assessment for periods of 20-30 years, leading to a significant debt burden on the homeowner. Transfer fees are clearly a better choice.
Myth: Transfer fees steal equity.
Truth: This myth is particularly flawed. If John paid $245,000 for home with a transfer fee and sold it for $370,000 John has made the same as Bill, who paid $250,000 for a home without a transfer fee and sold it for $375,000.00.
While it is true John will pay a transfer fee at closing, John has saved money every month he has owned the home through a reduction in his monthly carrying costs. More importantly, John made a consumer choice to buy a home with the fee and pay less up front. Bill elected not to pay the fee, and made his purchase decision accordingly.
Myth: There is no guarantee the seller will lower the price.
Truth: This argument is particularly disingenuous (and flawed) because it pre-supposes that a seller can sell for whatever price they desire. Studies confirm that homes with a fee will sell for less than the same home without the fee. This makes sense. A buyer decides what the home is worth, based on all factors related to the home, and simply will not pay the same for a home with a transfer fee as they will pay for the same home without the fee. Would you?
Myth: Transfer fees can reduce sales activity because buyers may not have enough cash to close.
Truth: The fee is almost always paid by the seller, which means the fee is a reduction at closing. This avoids a buyer showing up with insufficient cash to close. Transfer fees payable by the buyer are typically very small.
Myth: If there is a transfer fee, the Buyer gets less than full ownership.
Truth: First, a transfer fee is an encumbrance: it is not an ownership interest in the home. Second, few if any homes are sold free of encumbrances. There is an obligation to comply with subdivision restrictions, pay dues and assessments, grant easements to utility companies, etc., all of which are encumbrances against the land. In addition, most residential homes do not convey the mineral rights, oil rights, and, when it comes to commercial property, the air rights.
Myth: Opponents of transfer fees are looking out for homeowners.
Truth: Opposition comes almost exclusively from Realtors and the Title Industry. Although good people undoubtedly work as real estate agents and title insurance agents, and the function they play in the marketplace is important, since the fees collected by members of the National Association of Realtors and the American Land Title Association are all based on the sale price of the home, those two organizations are more than a little conflicted and their criticism of these transfer fees lacks credibility. NAR members fear that a seller faced with a transfer fee will ask the real estate agent to take the fee out of their generally 5-6% commission (the NAR calls this a Commission-ectomy.) The title industry fears they will miss the fee and have to pay a claim. These two special interest groups spend tens of millions each year to influence policymakers.
While the NAR and ALTA have gotten some other organizations enlisted to join a coalition, when this issue is fully analyzed it will become clear that continued use of private transfer fees is good for homeowners, creates jobs and will generate economic activity and local tax revenue.
Myth: When paid to the developer, the fee has no connection to the land.
Truth: Try owning a home with no streets, no wastewater lines, no sewer lines, no master planning, etc., all of which clearly benefit the land. A fee imposed to reimburse these costs is clearly connected to the land. There is no requirement that the fee be used as collected to provide improvements: it is enough that the purpose of the fee is to pay for the improvements. Also, a portion of every fee is allocated back into the community, which further benefits the community and everyone who lives there.
Myth: A transfer fee does not benefit the community.
Truth: Transfer fees provide important funding not only for infrastructure, but also for community associations and non-profit uses. Developers who create the funding and sell it off to investors (which is why capital recovery fees have been referred to as 'development bonds') can bring out-of-state dollars into the community, which restores project viability and avoids bank failures. This creates (or saves) jobs, and has a positive ripple effect.
Myth: A transfer fee interferes with marketability (restrains alienation).
Truth: Transfer fees have been around for decades, and there is no evidence that even hints at an impairment to marketability. The market adjusts the sales price to reflect the fee, just as it does for HOA dues, taxes, easements, etc.
Myth: A transfer fee can cloud title.
Truth: A transfer fee is an encumbrance of record, handled just like any other encumbrance. Homes have sold for decades with transfer fees, problem-free.
Myth: This is a way for greedy developers to make money.
Truth: A capital recovery fee reimburses the developer for millions of dollars in improvements, such as streets, roads, etc. In return, the developer lowers the sales price, and can even sell off the fee to build the project. Reimbursement of an expense is not a windfall.
Myth: This is some sort of exotic Wall Street deal like the ones that caused all the trouble.
Truth: The use of capital recovery fees, and the ability of developers to sell their rights to those fees, is a plain vanilla transaction that is fully documented and transparent. Furthermore, by pulling some of the cost of infrastructure out of the initial and future purchase price for the home, it helps to ensure that homeowners do not over-extend themselves. It is such over-extension, and real estate agents and mortgage brokers constantly pushing the homebuyer to get into loans that sounded 'too good to be true', in order to allow them to buy 'more house than they can afford', that helped push the economy to the brink. The future of home buying will be about value and about staying within ones means. Utilizing capital recovery fees helps to achieve such goals.
As to a transfer fee, it is a low-risk collateralized obligation. It does not depend on anything other than for the property to sell. Over eight billion in bonds have been sold backed by fees assessed to reimburse developers for infrastructure costs, including Mello-Roos fees, PID fees, etc., with zero defaults.
When you cut through the myths, the reality is that transfer fees are used for a variety of purposes that benefit the public. First, the fee can be imposed by homeowner associations as a way to reduce quarterly or annual dues. Second, the fee can be used to fund environmental initiatives and development concessions, such as open space, parks, etc. Third, the fee can be used to fund non-profit uses, such as libraries, medical clinics, affordable housing, the arts and more. Fourth, the fee can be imposed as a way to spread infrastructure costs, lowering the cost of homeownership. Fifth, the fee can be used to spread negative equity.
In the end, it is about consumer choice. It is about the things we want (such as streets, utilities, clean air, clean water, open space, etc.) and how we elect to pay for them.