TG - Summer 2021 by Texas Real Estate Research Center

SUMMER 2021 ™

TEXAS REAL ESTATE RESEARCH CENTER

TEXAS A&M UNIVERSITY

Texas Real Estate Research Center COLLEGE STATION, TEXAS 77843-2115

In This Issue Homeowner’s Insurance Corpus Christi Housing Affordability Uri’s Impact on Texas Housing Seguin Manufactured Housing Development New TREC Addendum for Residential Leases Utility and Pipeline Easements Rental Tax Issues Q&A: Compensation Issues When Changing Brokers

EST 1971

TEXAS REAL ESTATE RESEARCH CENTER

SUMMER 2021 ™

TEXAS REAL ESTATE RESEARCH CENTER

Texas Real Estate Research Center’s

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TEXAS A&M UNIVERSITY

Texas Real Estate Research Center iii

SUMMER 2021

VOLUME 28, NUMBER 3 www.recenter.tamu.edu @recentertx

TIERRA GRANDE MAGAZINE TEXAS REAL ESTATE RESEARCH CENTER

2 | Storm Warning

14 It’s Real Seguin Welcomes Texas’ First CrossMod Manufactured Housing Development Housing affordability remains one of Texas’ most pressing concerns. For one potential solution, look no further than the Guadalupe County seat. By Harold D. Hunt

Winter Blast a Harsh Reminder of Need for Homeowner’s Insurance First an unprecedented winter storm, and now hurricane season. Make no mistake: Texans are weather weary. That goes double for uninsured homeowners, and there are more of those than you might expect. By Luis B. Torres and Joshua Roberson

6 | She Sells Resales by the Seashore Analyzing Corpus Christi Housing Affordability The challenge: to provide meaningful, high-quality housing affordability analyses specific to Texas cities and communities. TRERC has stepped up to that challenge, starting in the Coastal Bend. By Harold D. Hunt and Clare Losey

10 | Cold Comfort

Uri Slowed New Listings, But Not Much Else Highways, plants, and pipes weren’t the only things that froze during February’s winter blast. Texas’ housing inventory is still trying to thaw. By Joshua Roberson

18 | Devil in the Details Greater Disclosure of Residential Lease Status Required There are many details a buyer should be aware of when purchasing a residential property with a lease on it. Those details weren’t covered in TREC’s promulgated contracts. Until now. By Kerri Lewis

24 | Rental Tax Issues Worth Watching Tax laws are complicated, and the ones regarding real estate rental activities are no exception. This guide navigates real estate professionals through key issues impacting that sector. By William D. Elliott

28 | Practically Speaking Real Estate Questions Answered People’s jobs change. It’s a fact of life. But what happens if a licensee changes brokerages or places her license on inactive status in the middle of a transaction? Here’s what the rules say. By Kerri Lewis and Avis Wukasch

Who Knows What Easement Lurks? Utility and pipeline easements have a vital role in daily life, but occasionally a mystery emerges regarding who has rights and what those rights are. That’s when the courts step in and take the case. By Rusty Adams

Executive Director, GARY W. MALER Senior Editor, DAVID S. JONES Managing Editor, BRYAN POPE Associate Editor, KAMMY BAUMANN Creative Manager, ROBERT P. BEALS II Graphic Specialist/Photographer, JP BEATO III Graphic Designer, ALDEN DeMOSS Communications Specialist II, HAYLEY RIEDER

ADVISORY COMMITTEE: Troy C. Alley, Jr., Arlington, chairman; Russell Cain, Port Lavaca; Doug Foster, San Antonio; Vicki Fullerton, The Woodlands; Patrick Geddes, Dallas; Doug Jennings, Fort Worth; Besa Martin, Boerne; Walter F. “Ted” Nelson, Houston; Rebecca “Becky” Vajdak, Temple; and Barbara Russell, Denton, ex-officio representing the Texas Real Estate Commission. TG (ISSN 1070-0234) is published quarterly by the Texas Real Estate Research Center at Texas A&M University, College Station, Texas 77843-2115. Telephone: 979-845-2031. VIEWS EXPRESSED are those of the authors and do not imply endorsement by the Texas Real Estate Research Center, Mays Business School, or Texas A&M University. The Texas A&M University System serves people of all ages, regardless of socioeconomic level, race, color, sex, religion, disability, or national origin. Nothing in this publication should be construed as legal or tax advice. For specific advice, consult an attorney and/or a tax professional.

Circulation Manager, MARK BAUMANN

PHOTOGRAPHY/ILLUSTRATIONS: Courtesy of Dustin Arp, p. 1 (top); Getty Images, pp. 1 (bottom), 2-3, 10-11; JP Beato III, pp. 6-7, 14-15, 16-17; Harold Hunt, p. 9; Robert Beals II, pp. 12-13.

Lithography, RR DONNELLEY, HOUSTON

ON THE COVER: SUMMER 2021 Storm cell at Monahans Sandhills State Park. Photographed by JP Beato III.

Residential

Storm Warning Winter Blast a Harsh Reminder

of Need for Homeowner’s Insurance

A recent Texas Real Estate Research Center study found low-income households were less likely to have homeowner’s insurance than higher-income households, both in metropolitan and nonmetropolitan areas. This is also true among homeowners who do not have a mortgage. By Luis B. Torres and Joshua Roberson

n February 2021, Winter Storm Uri caused temperatures to fall overnight into single digits and lower across much of Texas, resulting in an estimated $130 billion in damage and economic losses and more than 150 deaths. If the estimates are correct, Uri is one of the costliest weather disasters in the state’s recent history. It also accentuated the importance of having homeowner’s insurance. Many homes were in need of repairs from damage caused by the snow and ice. Households with homeowner’s insurance avoided a major financial hit. Those without insurance, on the other hand, were faced with paying the full repair bill out of pocket. Identifying the location and characteristics of uninsured homeowners would enable the state to better allocate resources for home repairs following a natural disaster such

A Half Century of Serving Texas’ Real Estate Industry

This year, the Texas Real Estate Research Center celebrates its golden jubilee. While much has changed since 1971, one thing hasn’t: Our commitment to helping Texans make the best real estate decisions. Here’s a brief history of our first 50 years.

Figure 1. Uninsured Single-Family Homeowners by Metro Status, 2019 Not in metro Metro status indeterminable (mixed) In metro (central/principal city) In metro (central/principal city), status indeterminable (mixed) In metro (not in central/principal city) 0%

10% 15% Percent Uninsured

20%

25%

Sources: IPUMS USA, University of Minnesota, www.ipums.org, and Texas Real Estate Research Center at Texas A&M University

Figure 2. Average Household Income of Single-Family Homeowners by Metro Status, 2019 In metro (not in central/principal city) In metro (central/principal city), status indeterminable (mixed) In metro (central/principal city) Metro status indeterminable (mixed)

as a freeze. To that end, the Texas Real Estate Research Center used the U.S. Census Bureau’s 2019 Integrated Public Use Microdata Series (IPUMS) to estimate the number of uninsured households in Texas. The sample data sets include single-family attached and detached homes. Households that self-reported no property insurance payment were considered uninsured.

Comparison by Metro The Center found nonmetro homeowners were more likely to be uninsured than metro homeowners (Figure 1). Approximately 26.6 percent of nonmetro homeowners reported as uninsured compared with 11 percent in metropolitan areas in a central/principal city (Austin, Dallas-Fort Worth, Houston, and San Antonio) and 10.2 percent in metropolitan areas not in

1971

Not in metro $0

$30 $45 $60 $75 Thousands of Dollars

$90

$105

Sources: IPUMS USA, University of Minnesota, www.ipums.org, and Texas Real Estate Research Center at Texas A&M University

a central/principal city (rest of Texas’ Metropolitan Statistical Areas). In addition, the Center’s analysis incorporated average household income by metro status and found a relationship between being uninsured, having a lower household income, and living in a nonmetro area. Metropolitan areas had a higher average household income than nonmetropolitan areas (Figure 2), registering above $100,000 for both in and not in a central/ principal city compared with $71,326 for a nonmetro household.

May 18. Gov. Preston Smith signs legislation creating the Texas Real Estate Research Center and placing it at Texas A&M University. SUMMER 2021

$15

1972

Dr. Alvin B. Wooten named first director.

Figure 3. Uninsured Single-Family Homeowners by Metro Area, 2019 McAllen-Edinburg-Mission Brownsville-Harlingen Laredo Beaumont-Port Arthur Odessa Corpus Christi San Angelo Wichita Falls Midland Lubbock El Paso Waco Amarillo San Antonio-New Braunfels Houston-The Woodlands-Sugar Land Tyler College Station-Bryan Dallas-Fort Worth-Arlington Austin-Round Rock 0%

10%

15% 20% Percent Uninsured

25%

30%

35%

Sources: IPUMS USA, University of Minnesota, www.ipums.org, and Texas Real Estate Research Center at Texas A&M University

Figure 4. Average Household Income of Single-Family Homeowners by Metro Area, 2019 McAllen-Edinburg-Mission Brownsville-Harlingen Laredo Beaumont-Port Arthur Odessa Corpus Christi San Angelo Wichita Falls Midland Lubbock El Paso Waco Amarillo San Antonio-New Braunfels Houston-The Woodlands-Sugar Land Tyler College Station-Bryan Dallas-Fort Worth-Arlington Austin-Round Rock $0

Metropolitan areas in the Rio Grande Valley and along the Texas coast record the highest percentages of uninsured households (Figure 3). McAllen leads at around 37.5 percent, with almost two out of five households uninsured. Brownsville follows close behind with 34.9 percent. Despite being vulnerable to hurricane damage for decades, Beaumont and Corpus Christi register relatively high levels of uninsured homes—21.5 and 19.8 percent, respectively. In other words, one out of five homeowner households there is uninsured. In contrast, the smallest percentages of uninsured households are in Austin and Dallas-Fort Worth with 6.1 and 7.4 percent, respectively. As before, the study found a relationship between lower income levels and uninsured households in the metropolitan areas (Figure 4).

Mortgage Status and Insurance Coverage

ortgage status plays an important role in determining the likelihood of having property insurance given that mortgage contracts require a homeowner’s insurance policy. The mortgage lender has a potential financial interest in the home, which is the motive for requiring insurance. Only 4.1 percent of homeowner $25 $50 $75 $100 $125 households with a mortgage are Thousands of Dollars uninsured compared with 26 perSources: IPUMS USA, University of Minnesota, www.ipums.org, and Texas Real Estate cent who own their home free and Research Center at Texas A&M University clear of debt (Figure 5). It’s possible that mortgagors without insurFigure 5. Uninsured Single-Family Homeowners ance could have unconventional or mortgage-like debt by Mortgage Status, 2019 structures rather than more ubiquitous conventional mortgages. Under contract to purchase Once again, a relationship is found between having Morgage/deed of trust lower average household incomes and being uninsured. or similar debt Those who own their home free and clear of debt and are uninsured have an income of around $53,274 compared Owned free and clear with $95,873 for those who own their home and are 0% 5% 10% 15% 20% 25% insured (Figure 6). Percent Uninsured Homeowners who don’t have a mortgage are generSources: IPUMS USA, University of Minnesota, www.ipums.org, and ally characterized as seniors living in older homes that Texas Real Estate Research Center at Texas A&M University

1972

First research projects proposed: Study of Texas housing inventory, Texas licensee survey, development of real estate problems outline, and development of threeyear program of work.

1972

Dr. William G. ‘Bill’ Adkins named Center’s first chief economist. TG

are more susceptible to damage from extreme weather Figure 6. Average Household Income of Single-Family conditions. Homeowners by Mortgage Status, 2019 Winter Storm Uri was a harsh reminder of the importance of having homeowner’s insurance, but it’s hardly NO INSURANCE the first. A surprisingly high percentage of homeownMortgage/deed of trust or similar debt ers in the Gulf region are uninsured, living under the INSURANCE threat of hurricanes year after year. Many have suffered home damage as a result. Owned free and clear When one considers the link between household income levels and being uninsured, this raises important questions. Is homeowner’s insurance too expenUnder contract to purchase sive for households earning a lower income? Is the cost impeding them from protecting their homes from natural disasters? $0 $25 $50 $75 $100 Thousands of Dollars

Dr. Torres (ltorres@recenter.tamu.edu) is a research economist and Roberson (joshuaroberson@tamu.edu) a senior data analyst with the Texas Real Estate Research Center at Texas A&M University.

$125

Sources: IPUMS USA, University of Minnesota, www.ipums.org, and Texas Real Estate Research Center at Texas A&M University

About This Study

Written Exposures (Millions)

Figure 7. Texas Written Exposures by Policy Form 2.5 2.0

Amount of Insurance (Thousands of Dollars)

his study used 2019 data from the National 1.5 Association of Insurance Commissioners via the Texas Department of Insurance to 1.0 analyze Texas homeowner policies. Data are for owner-occupied properties with one to four 0.5 dwelling units. 0 The amount insured is based on the cost-based Dwelling Fire HO-1 HO-2 HO-3 HO-5 value of the insured property. Most policies in Policy Form Sources: Texas Department of Insurance, National Association of Texas are “H0-3,” which generally provides Insurance Commissioners, and Texas Real Estate Research higher coverage for Center at Texas A&M University disasters (Figure 7). This Figure 8. Texas Written Exposures by Policy Form and Amount of Insurance indicates homeowner households that have $500 and Over property insurance would $400 to $499 probably be protected by $300 to $399 the damage caused by $200 to $299 Winter Storm Uri. Cover$175 to $199 age can vary among poli$150 to $174 cies where lower (higher) $125 to $149 valued homes tend to $100 to $124 have less (more) coverage $75 to $99 (Figure 8). $50 to $74 $49 and under 0%

25% Dwelling Fire

50% HO-1

HO-2

75% HO-3

100% HO-5

Sources: Texas Department of Insurance, National Association of Insurance Commissioners, and Texas Real Estate Research Center at Texas A&M University

1973

First real estate conference: “Opportunities in Real Estate Under Urban Encroachment.” SUMMER 2021

1973

Center issues first report on rural land values for Texas, Oklahoma, New Mexico, and Arizona.

1973

First series of reports on statewide housing published.

Residential

She Sells Resales by the Seashore Analyzing Corpus Christi Housing Affordability The Texas Real Estate Research Center has conducted housing affordability analyses for housing planners and policymakers in several cities. An analysis of Corpus Christi, for example, found a shortage of homes for those in the lowest and highest income cohorts. By Harold D. Hunt and Clare Losey

ities across Texas consistently name housing affordability as the predominant issue facing housing planners and policymakers. Over the past several years, the Texas Real Estate Research Center has partnered with a number of these cities and provided them a series of housing affordability analyses. Corpus Christi is one of those cities.

Table 1. Results for Nueces County Using MLS Data (2017)

Income Cohort

Range in Family Income

Range in Maximum Home Price Affordable

Percent of Owner-Occupied Households

Percent of Owner-Occupied Units

Over or (Under) Supply

Extremely Low Income

$0–$24,600

$0–$86,539

16.3%

9.6%

(6,951)

Very Low Income

$24,601–$31,050

$86,540–$109,229

4.9%

6.4%

1,648

Low Income

$31,051–$49,700

$109,230–$174,837

13.7%

27.0%

13,836

Workforce

$49,701–$75,720

$174,838–$266,372

19.1%

32.6%

14,076

Market-rate

$75,721+

$266,373+

46.1%

24.4%

(22,608)

Sources: U.S. Department of Housing and Urban Development, CoreLogic, Nueces County Appraisal District, and Texas Real Estate Research Center at Texas A&M University

1977

Tierra Grande, the Center’s quarterly magazine, begins publication; initially sent only to brokers.

1979

Jack P. Friedman named chief economist.

This project used 2017 data to compute housing affordability. Assumptions for the home price-to-income multiplier included an interest rate of 4.28 percent, a loan-to-value (LTV) ratio of 89.5 percent, a debt-to-income (DTI) ratio of 39.75 percent, and the additional expenses of homeownership at 6 percent of property value. With a resultant value of 3.52, the price-income multiplier indicates that a household earning $50,000 could afford a home priced at $175,893. indings indicate that in both Nueces County and the City of Corpus Christi the lowest and highest income cohorts faced a supply shortage of owner-occupied units. For instance, in Nueces County extremely low-income households comprised 16.3 percent of the total population, but only 9.6 percent of homes in the county were affordable to these households (Table 1). Meanwhile, market-rate households represented nearly half (46.1 percent) of households in Nueces County, but only one-quarter (24.4 percent) of homes were affordable to them. The City of Corpus Christi showed similar proportions for demand and supply (Table 2). The lowest-income households had to spend more than what was reasonably affordable to them to purchase a home, while the highest-income households were “buying down” (spending less than is reasonably affordable to them and purchasing lower-priced homes). As anticipated, findings indicated housing affordability varies spatially across Nueces County. Map 1 shows median family income (MFI) by U.S. Census tract in Nueces County, while Map 2 displays the distribution of homes by sales price in the county. Higher-income households live in the suburbs, while lower-income households live in and around downtown. Meanwhile, the vast majority of homes for sale in Nueces County were priced from $100,000 to $300,000 and are in the suburbs and along the county’s periphery.

Modeling Housing Affordability in Corpus Christi The Center collaborated with the City of Corpus Christi Planning Department in 2018 to quantify both owner- and renter-occupied housing affordability in the city and Nueces County. This article focuses solely on the results for owner-occupied housing affordability. Results for renter-occupied housing affordability are at the City of Corpus Christi’s website (use the QR code to access).

Table 2. Results for the City of Corpus Christi Using MLS Data (2017)

Income Cohort

Range in Family Income

Range in Maximum Home Price Affordable

Percent of Owner-Occupied Households

Percent of Owner-Occupied Units

Over or (Under) Supply

Extremely Low Income

$0–$24,600

$0–$86,539

15.7%

9.8%

(5,335)

Very Low Income

$24,601–$31,050

$86,540–$109,229

4.7%

6.7%

1,782

Low Income

$31,051–$49,700

$109,230–$174,837

13.4%

28.6%

13,624

Workforce

$49,701–$75,720

$174,838–$266,372

19.4%

34.7%

13,744

Market-rate

$75,721+

$266,373+

46.8%

20.2%

(23,815)

Sources: U.S. Department of Housing and Urban Development, CoreLogic, Nueces County Appraisal District, and Texas Real Estate Research Center at Texas A&M University

1979

Tierra Grande wins Gold Quill from International Association of Business Communicators (IABC) as best nonprofit magazine in world. SUMMER 2021

1980

First Spanish-language publication, a homebuyer’s guide, published.

1981

Dr. Richard L. Floyd named second director.

The dearth of homes for sale downtown, coupled with the considerable proportion of lower-income households in that area, indicates such households would generally have to relocate to the suburbs to purchase a home. Such a phenomenon could leave downtown deserted, potentially posing significant issues for the vitality of the area. As such, the City of Corpus Christi is using the results from this study to inform and shape revitalization efforts in the greater downtown area neighborhoods.

A Future Role for the Center

Map 1. Median Family Income in Nueces County by Census Tract, 2016 $0- $24,600 $24,601 - $31,050 $31,051 - $49,700 $49,701 - $75,702 >$75,720

Source: U.S. Census Bureau

Quantifying housing affordability proves an especially important, albeit complicated, task. Cities and communities generally face a two-faceted challenge. Meaningful data and quality analyses are necessary to assess housing affordability and, therefore, to resolve the issues. However, those data are often elusive or proprietary, and common measures of affordability largely oversimplify the problem, failing to frame the issue fully.

Equipped with a considerable warehouse of data and a nuanced approach to modeling housing affordability, the Center remains committed to collaborating with cities and communities across the state to address their housing challenges. Dr. Hunt (hhunt@tamu.edu) is a research economist and Dr. Losey is a research intern with the Texas Real Estate Research Center at Texas A&M University.

Map 2. Spatial Distribution of All Residential Sales in Nueces County INTERSTATE

Nueces Bay 44 77

Corpus Christi Bay

$0 - $69,999 $70,000 - $99,999 $100,000 - $149,999 $150,000 - $199,999 $200,000 - $299,999 $300,000 - #399,999 $400,000 +

Source: Texas Real Estate Research Center at Texas A&M University

1981

Center funds $100,000 endowed professorships at University of Texas at Austin (now William Jennings Professorship) and at Texas A&M University (Julio Laguarta Professorship in Mays Business School).

1985

Dr. John Allen selected to lead research.

APRIL 2021 MULTIPLE LISTING SERVICE data show Corpus Christi had an overall housing inventory of only 1.8 months. The city’s lowest and highest earners had the fewest options. The “Extremely Low Income” cohort had a shortage of 5,335 affordable homes on the market, while the “Market-rate” cohort had a shortage of 23,815.

How the Texas Real Estate Research Center Model Works

quipping public and private markets and nonprofit organizations with meaningful data and quality analyses is important, so the Center continues to prioritize the development (and refinement) of a methodology to quantify housing affordability. Four major aspects of the Center’s methodology improve on existing measures of owner-occupied housing affordability: • By categorizing households into one of five income cohorts—extremely low-income (earning up to 30 percent of median family income), very low-income (31 to 50 percent), low-income (51 to 80 percent), workforce (81 to 120 percent), or market-rate earners (above 120 percent)—it computes affordability across the income distribution. • It computes affordability within individual U.S. Census tracts (virtually synonymous with “neighborhoods”). • It applies local estimates of the loan-to-value (LTV) and debt-to-income (DTI) ratios, as opposed to assuming a single estimate for all geographies. • It reflects the additional costs of homeownership beyond the direct mortgage payment (i.e., property taxes and insurance). Based on assumptions about the mortgage interest rate, LTV ratio, DTI ratio, and annual expenses associated with homeownership, the Center computes the home

1986

“Real Estate Center” becomes unofficial name replacing “Texas Real Estate Research Center.” SUMMER 2021

1987

price-to-income multiplier. This multiplier reflects the maximum home price affordable to a particular household. For instance, a multiplier of 3.0 indicates a household can afford a home price equivalent to three times its income. The Center uses the multiplier to compute the range in home prices that is affordable to a particular income cohort. Using the home price ranges affordable to each income cohort, the Center then computes demand and supply for each income cohort. Household demand for homeownership is simply a function of the proportion of households in a particular geography with incomes that fall in the income range for that cohort. The Center uses income data from the U.S. Census Bureau’s American Community Survey (ACS). Meanwhile, the supply of affordable homes is a function of the proportion of homes in a particular geography with estimated values that fall in the price range affordable to a specific income cohort. The Center generally uses Multiple Listing Service (MLS) data; however, in the event that the geography does not contain sufficient home sales, the Center uses data from the local appraisal district or the ACS. MLS data reflect homes that have recently sold, while the ACS obtains estimates of purported home value from the head(s) of household. MLS data provide a more accurate source of the home sales price, but they may not be available for smaller geographies.

Administration for Center moved from College of Agriculture to Mays College of Business & Graduate School of Business.

1989

Dr. Ted C. Jones named chief economist.

Residential

Winter Storm Uri didn’t slow down Texas home sales, but it did slow the pace of new listings. Meanwhile, housing inventory has yet to be helped by the reopening of the economy. By Joshua Roberson

1995

Dr. R. Malcolm Richards becomes Center’s fourth director.

1997

ver a year has passed since the start of the COVID19 pandemic. Remarkably, the housing market has remained incredibly robust despite negative pressures from both the economy and the virus. Then came Winter Storm Uri. Was a historic snowstorm able to knock the housing market off balance? Did a major change in health policy affect homebuyer or, more importantly, home seller sentiments?

Deep Freeze Uri hit the Lone Star State in mid-February. The novelty of snowfall in Texas quickly wore off as snow levels rose and temperatures dropped below freezing. The situation worsened

Dr. Mark G. Dotzour becomes chief economist.

1997

Real Estate Center Online News (RECON), first Center e-newsletter, begins publishing. TG

Weekly Sales (Thousands)

10.0

Figure 1. Sales Before/After Winter Storm Uri

7.5 5.0 2.5 0

3 4 5 6 7 8 9 10 11 12 Week in 2021 (January-March)

YTD New Listings (Thousands)

Source: Texas Real Estate Research Center at Texas A&M University

250

Figure 2. New Listings Before/After Winter Storm Uri

200

Uri 150 100 50 0

0 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 Day of the Year 2019 2020 2021

Source: Texas Real Estate Research Center at Texas A&M University

when Electric Reliability Council of Texas’ (ERCOT) electrical grid failed, leaving many residents without power and unable to keep warm. The impact on the housing market was severe but brief. Pending and actual sales declined dramatically during the week of the storm but returned with a vengeance the following week, once again demonstrating the high demand for housing (Figure 1). The pace of new listings coming to market also took a hit but, unlike sales, didn’t make the same dramatic comeback. Until mid-February, new listings were coming into play at rates similar to previous years. With housing in such short supply, this was a welcome sight. The pace of new listings

2005

Gary Maler named Center’s fifth director. SUMMER 2021

hasn’t been the same since Uri. In fact, Uri created a listings gap between 2021 and past years that continues to widen (Figure 2). This gap comes at a crucial point, just before the prime home-selling season begins. This shortfall in new listings has been statewide, with a few exceptions. Despite a rough oil market, Midland and Odessa are still ahead with their new listings pace even after the slowdown in February. The other exception is El Paso, which is not connected to the ERCOT power grid like the rest of the state. While Uri certainly had an impact on listings that week, it’s important to separate broader housing trends from the short-term shock brought on by the pause in business activity. Looking back, the shortage of listings is not only a Texas trend but a national one as well. Instead, unexpected shocks such as natural disasters have a way of exacerbating underlying trends. In other words, Uri likely spurred a decline in listings that had already been expected.

Is it Safe to Come Out Yet? In early March, Gov. Greg Abbott ended the state’s COVIDrelated business restrictions and mask mandate. For many service-related businesses, the policy change was a much-needed

2014

Gerald Klassen rejoins Center as university’s first research data scientist. Center enters “big data” revolution to explore patterns and relationships affecting Texas real estate.

Outlook Index

Figure 3. Future Company Outlook in Retail and Services Sector

0 –25 –50 –75

–100 2019

2020 Retail

Services

2021

Source: Federal Reserve Bank of Dallas

spark that hopefully will improve consumer confidence, provided virus conditions remain manageable. According to the Federal Reserve Bank of Dallas, the change in business sentiment, particularly for retail establishments, is apparent. Outlook for future business activity and overall company outlook are already on the rise (Figure 3). Expected revenues and employment opportunities are also on the rise but at lesser magnitudes. Optimism is increasing among businesses, but how about among consumers? onths after the governor’s announcement, it’s tough change in seller sentiment either, judging by the pace of new to tell if consumers are as eager to return to their listings. It’s uncertain if opening up the economy will do much former consumption habits. Google’s Mobility Index to alleviate housing market pressures on the supply side since shows many Texans appear more likely to venture away from the economy and the housing market have, for the most part, home now than they were at any other time since the start of acted independently of each other since the onset of COVID. the pandemic. Does that mean that they’re spending more? Possibly, but the answer is unclear. Heading to the Suburbs Although Google data show foot traffic at retail and recreOne of 2020’s biggest migration trends was the push toward ation locations throughout the state are on the rise, revenue the suburbs, at least for certain types of households. U.S. streams may not have caught up yet. Sources such as Womply, Census Bureau data show overall migration was down, but that a small business services company, claim revenues for many was largely driven by the downward spiral of renter household local businesses in Texas are still far below pre-pandemic movement. Homeowners, a much smaller cohort, had a record levels, suggesting business fortunes may not return overnight year of moves. even with looser restrictions. Nationally, most of the moveThe gap is widest for food accommodation and leisure Figure 4. Food Accommodation, Leisure & Hospitality ment was not from state to state but rather from a densely popuand hospitality businesses, Revenue Index Since COVID lated to a less densely populated which also suffered the largest 0% part of a metropolitan area. employment setbacks since the Although state-to-state migrapandemic. As of April 2021, –20% tion did expand in 2020, it was these sectors were operating at largely overshadowed by growth revenue levels that were nearly –40% in movement both within the 60 percent below February 2020 same county and to surrounding levels (Figure 4). –60% counties. What evidence of the Meanwhile, there’s been no national trend is there in Texas? hesitation among homebuyers –80% Change of address requests to buy during the pandemic. The 2019 2020 2021 collected by the U.S. Postal policy change doesn’t appear All Food Accomodation Service suggest there was serito have had much impact on Leisure and Hospitality ous movement to the outskirts sales so far. Unfortunately, Source: Opportunity Insights (https://tracktherecovery.org/) of Texas’ major metros, both in there doesn’t appear to be much Revenue Index

2015

Sept. 1. Dr. James Gaines named Center’s sixth chief economist.

2018

Jan. 10. First broadcast webinar, “2018 Austin Economic Outlook,” viewed live.

2019

29th Annual Outlook for Texas Land Markets draws record crowd of 509. TG

IN MID-FEBRUARY, WINTER STORM URI brought unprecedented cold weather to Texas. According to a University of Houston online survey, 69 percent of residents lost power at some point during the storm for an average of 42 hours, and 49 percent were without running water for an average of more than two days. Nearly a third reported water damage in their home.

Examples of Migration to Suburbs in 2020 Amarillo

absolute terms and year-over-year are basically calling the Aubrey (76227) Annual Sales 1,991 (+25%) growth (see map). Data tracking shots selling their homes in New Family Growth 1,361 (+16%) includes family movement in and record time and at aggresLubbock out of specific ZIP codes. Given sive price points with little 76227 known housing and migration wiggle room for negotiation. Dallas trends, these families more likely Given the underlying represent homeowners than renthousing dynamics, this adds New Braunfels (78132) ers, but the data don’t explicitly a variety of potential homeAnnual Sales 1,204 (+28%) distinguish between the two. buying motivations other New Family Growth 973 (+19%) Many of these areas were than the virus or a need to already high-growth territories, upgrade. Potential homeHouston 78132 and the pace only accelerated buyers may simply have no San Antonio 77583 after the pandemic. For example, choice but to move to outer in ZIP code 78132, which covers metro areas. Rosharon (77583) north New Braunfels, migration Annual Sales 1,339 (+27%) Returning to Normal? added a net of almost 1,000 new New Family Growth 735 (+28%) Texas’ housing market had families in 2020, amounting to Source: Texas Real Estate Research Center an aggressive first half of a 19 percent increase over the at Texas A&M University 2021, despite two major prior year. The influx of families events. coincided with a more than 25 Winter Storm Uri didn’t percent increase in home sales. stop home sales for long. However, it did slow the pace of Meanwhile, some of the deepest drops in net family migrahomes coming to market, a situation that has yet to be remetion came from core counties of Texas’ major metros. ZIP code died by the reopening of the Texas economy. For these reasons, 78660 in Pflugerville had an almost 30 percent drop. Annual housing supply continues to dominate concerns. home sales in that area fell almost 6 percent. However, to After a long break in everyday commerce, the return to full say demand there is struggling would be misleading. Instead, normal may take longer than hoped. what is likely happening is that sales in this market, and many others like it, have reached the point where the market can Roberson (joshuaroberson@tamu.edu) is a senior data analyst with the Texas no longer accommodate demand because of almost nonexisReal Estate Research Center at Texas A&M University. tent inventory. While sales are down, sellers in these areas

2021

Texas Real Estate Research Center returns as official name of Center. SUMMER 2021

2021

30 Annual Outlook for Texas Land Markets is Center’s first virtual conference. th

To download our full history, scan the QR code.

Residential

Developers have broken ground on the first residential subdivision in Texas consisting entirely of an upgraded class of HUD-code manufactured homes. These “CrossMod” homes qualify for conventional Fannie Mae and Freddie Mac financing. By Harold D. Hunt

he first residential subdivision in Texas exclusively offering “CrossMod” manufactured homes is currently under development about four miles outside Seguin. CrossMod is the Manufactured Housing Institute’s trademarked name for an upgraded class of national HUD-code manufactured homes (MH). It should not be confused with “modular” homes built to meet a specific local building code. “The goal for this development is to provide someone with a nice home that they are proud to own in a lower price range than starter homes in a traditional densely developed subdivision,” said Dustin Arp, president of New Braunfels-based Spark Homes LLC, the subdivision’s developer. CrossMods, which are only sold with land as real property, are eligible for financing under the same conventional loan terms as site-built, single-family homes through Fannie Mae and Freddie Mac. The two government-sponsored enterprises (GSEs) teamed up with the manufactured housing industry to develop and finance factory-built housing of similar quality to site-built starter homes but at a more affordable price point. While Fannie Mae has named its mortgage program MH Advantage, Freddie Mac has chosen the name CHOICEHome. “The GSE loan programs offer a rare opportunity for the MH industry to grow from representing only 9 percent of all new SUMMER 2021

home sales annually,” said Dave Busche, director of business development central region at Skyline Champion Homes. “MH finally has the chance to enter into mainstream homebuilding and really participate in the affordable housing solution.” “You also need a mix of FHA (Federal Housing Administration) and VA (Veterans Affairs) loan products along with the conventional loans being financed by Fannie and Freddie,” said Arp. “You can’t just offer conventional financing in a development like this. A CrossMod that qualifies under the MH Advantage or CHOICEHome programs can qualify for an FHA or VA loan. It is just less likely to make value on an appraisal, and the interest rate would be higher when compared with site-built homes. But the real difference is about $2,000 to $3,000 in added closing costs from cost surcharges such as points.” Arp’s least expensive floor plan starts at $185,000 with no options or upgrades. The majority of homes in the development will be priced between $200,000 and $230,000. Lot size is one acre while home sizes range from 1,113 to 1,789 square feet. “Developers choosing a subdivision model similar to production homebuilding on a typical 1/8-acre lot could probably reduce these prices by about $15,000 to $18,000,” Arp said.

Residential

A new contract addendum adopted by the Texas Real Estate Commission addresses leases on residential properties for sale. Contracts with residential leases executed after March 31, 2021, must include this addendum. By Kerri Lewis

he Texas Real Estate Commission’s (TREC) promulgated contracts previously addressed leases on residential properties for sale in two places. Paragraph 10 required copies of leases be delivered within seven days, and Paragraph 9 required any security deposits be turned over to the buyer at closing if the lease will continue. However, these general provisions do not address the many details a buyer should know when assuming a lease on a property. With this in mind, TREC adopted a new Addendum Regarding Residential Leases that is required on all contracts with residential leases executed after March 31, 2021. This addendum is designed to make sure parties affirmatively agree on whether the lease is going to be terminated by the closing date and possession turned over to the buyer or assigned and assumed by the buyer. If assumed, the addendum helps ensure that the seller discloses and the buyer is aware of the terms of the lease and any potential issues regarding lease status or current or prior tenants. A copy of the addendum is provided on page 20.

What is Considered a Residential Lease? The addendum defines “residential lease” as any lease of the property to a tenant. It includes not just the actual lease document but any addendum or amendment to the lease and any move-in condition form. The addendum covers leases (whether oral or written, or long-term or short-term) that give a person the right to occupy the property. It does not, however, cover a temporary lease between the parties to the contract. Under the addendum, the seller cannot execute or amend any residential lease after execution of the addendum without the buyer’s written consent.

Understanding the Structure of Addendum for Residential Leases There are two sections to choose under the addendum—Sections A and B. Parties will choose one or the other when completing the form. If there is an existing residential lease on the property, it is imperative that the listing agent take a copy of this addendum to the listing appointment so the agent can review these two options and what they entail with the seller before the property is listed.

Box A should be checked when the seller is sure the lease can be terminated and possession of the property delivered to the buyer at closing. The seller’s right to terminate the lease is determined by the terms of the existing lease. The seller should be encouraged to locate and review the lease documents early in the listing process so he will know how to proceed. If a seller is unsure whether he has the right to terminate, he should consult a real estate attorney to review the lease. emember, license holders cannot read and interpret lease terms for the seller. That would constitute the unauthorized practice of law. Keep in mind that if this box is checked, the seller will be in default of the contract if he cannot get the tenant out of the property on or before the closing date. Box B should be checked when the lease is going to be assigned by the seller and assumed by the buyer at closing. If this box is checked, the seller will have additional obligations and representations under the addendum. These are discussed in the next sections. Can this addendum be used for multiple leases on the property (for example, in a duplex or four-plex situation)? Yes, the addendum is designed to be used for all residential leases on the property. However, since the addendum form instructs license holders to choose only A or B, it anticipates the same disposition for all leases. In other words, all leases will be terminated, or all will be assigned. If the buyer wishes to live in one of the units and assume the lease on the other unit, the best practice is to use a different addendum for each unit.

The seller has two choices regarding delivery, each with different consequences. He can either deliver copies of the residential lease documents prior to the execution of the contract or within three days after the contract’s effective date. Similar to the Seller’s Disclosure Notice provisions, if the seller does not deliver the lease documents prior to execution of the contract, the buyer will have a period of time after receiving the lease documents to terminate the contract for any reason and have his earnest money returned. Length of this period is negotiable by both parties. If the seller wants to avoid creating an additional option period for the buyer, the listing agent should encourage the seller to find the lease documents early in the process so they can deliver the documents to the buyer prior to executing the contract. Can the license holder put a copy of the lease documents in the Multiple Listing Service (MLS) to satisfy the delivery of the lease documents prior to executing the contract? This is not a good idea as not all buyers—or their agents—may have access to the MLS. It may also create a violation of privacy action by the tenant under the lease. A best practice would be to note in the MLS that there are residential leases on the property, then send a copy of the lease documents to the buyer’s agent when the buyer is contemplating submitting an offer on the property.

This addendum is designed to make sure parties affirmatively agree on whether the lease is going to be terminated by the closing date and possession turned over to the buyer or assigned and assumed by the buyer.

Delivery of Lease Documents If the buyer is going to assume a lease on the property, the seller has the obligation to deliver copies of the residential lease documents to the buyer under Section B(1) of the addendum. Remember, the lease documents are defined by the addendum to include more than just the actual lease. SUMMER 2021

If the seller fails to deliver the documents within three days after the contract’s effective date, the buyer can declare the seller in default at any time before delivery up to closing and seek whatever remedies the buyer elects under Paragraph 15 of the contract.

Obligations Regarding Tenant’s Security Deposit Section B(2) of the addendum should be familiar as it simply moved the provision regarding security deposits from Paragraph 9 of the previous contract to this addendum. It reiterates the Texas Property Code provision that the seller is required to deliver any security deposits he holds to the buyer at closing, and the buyer is responsible for notifying the tenant that the buyer has acquired the property and holds the tenant’s security deposit. The amount of the security deposit must be set out in the notice to tenant.

Disclosure of Residential Lease Status Section B(3) is a significant change to selling property where a lease is assumed. It requires the seller to affirmatively acknowledge seven facts about the lease. These factors, which can be seen on the addendum at the end of this article, deal with the status of the lease, payment of rent, and any disputes or agreements with the current tenant or prior tenants. A listing agent should review each of these statements with a seller who will be assigning a lease as part of the sale of the seller’s property at the listing appointment. If significant issues exist, it might be best if the seller tries to resolve those issues prior to putting the property on the market. If any of the seven statements about the lease are not true at the time of contract, the seller can explain why that statement is not true using the space provided. or example, Section B(3)(c) states that, to the seller’s knowledge, no tenant has prepaid any rent. It is common in some areas to have the tenant prepay the last month’s rent. If that were the case, the seller would have to insert an explanation in the space at the bottom of B(3) stating that tenant has prepaid the last month’s rent for the month of ________ in the amount of $_______. This will notify the buyer to negotiate for that amount to be transferred to the buyer at closing and to send a notice to the tenant after closing acknowledging possession of the last month’s rent under the lease.

Change in Residential Lease Status Following Execution of the Contract Under Section B(4), if at any time after the execution of the contract (with the addendum) one of the seven statements under Section B(3) becomes untrue, the seller has an obligation to notify the buyer and remedy the situation. Time frames become particularly important in this section. The seller is required to promptly notify the buyer that a statement became untrue. That means as soon as the seller finds out about it. The seller has an obligation to cure the condition making the statement untrue within seven days after SUMMER 2021

giving the buyer notice that the statement became untrue. Note the addendum says, “Seller shall cure the condition . . .,” which means the seller must make his best effort to cure the condition. If the condition making the statement untrue persists beyond this seven-day period, the buyer has five days following the seven-day period to decide whether to terminate the contract and have the earnest money returned or waive the condition and close. If the buyer does not terminate within that five-day period, the buyer waives the right to terminate under this section.

Built-in Closing Extension A unique feature of the addendum is the automatic extension of the closing date to allow the time frames to cure and election to terminate to play out.

he last sentence of Section B(4) provides that the closing date will be extended daily as necessary to afford the parties time to provide notices under this paragraph. So, depending on when the statement in B(3) becomes untrue, the closing date could be extended up to 12 days. Note that if the seller is able to cure the issue making the statement in B(3) untrue within the seven-day period, the buyer’s right to terminate or waive does not arise. This is another set of timeframes that license holders will need to help their clients keep track of to navigate through the transaction. Nothing in this publication should be construed as legal advice for a particular situation. For specific advice, consult an attorney. Lewis (kerri@2oldchicks.com) is a member of the State Bar of Texas and former general counsel for Texas Real Estate Commission.

Legal Issues

Courts will solve any mysteries or disputes about the terms of an express easement. However, many such disputes can be avoided by careful negotiation and drafting. If a court can ascertain the terms intended by the parties, it will give them effect. By Rusty Adams

asements for electric lines and pipelines crisscross many miles of Texas land. Many of the easements exist without incident for decades. Sometimes, however, a change in circumstances leaves the easement owners and the landlords in dispute. A mystery arises. Exactly what rights are included in the easement? How much “easement” is in the easement? Who knows? The court knows, or at least it is tasked with deciding. Three Texas cases illustrate how the courts solve these mysteries under Texas law.

The first episode features an easement granted by one Mrs. Ida Wolcott, who by a “Deed of Right of Way” granted an easement to South Plains Pipe Line Company in 1928. By the time the dispute arose, the land belonged to Richard Knox and the easement to Pioneer Natural Gas Company.

The deed granted the easement “for the purpose of constructing and placing on, in and under the surface of the ground a pipe line . . . and for . . . placing, constructing, erecting, and maintaining . . . private telegraph or telephone line.” It gave the grantee the right to place poles, guy wires, and braces, as well as “to enter upon said lands at all times for the purpose of making additions to, improvements on, and repairs to [the lines] and to keep and maintain the same and to remove or replace the same.” It provided that the pipelines and telephone and telegraph lines “shall be constructed in an approved manner and with as little damage to said premises as may be practical considering the nature of the construction.” The grant did not define the location and width of the right of way. In 1928, South Plains laid a pipeline using eight-inch and ten-inch pipe. In 1938, by agreement, Pioneer was allowed to remove part of the ten-inch line and replace it with a 15-inch low-pressure line. In 1955, Pioneer decided to replace both of the existing lines with a 12-inch high-pressure line. When Knox refused, Pioneer moved ahead with the work, resulting in damage to the land. A lawsuit ensued. Although the grant did not define the location and width, the grantee had located and cleared a 30-foot right of way and used it for 27 years. Knox contended that by doing so, the location and width

had become fixed and definite and could not be expanded. The court disagreed, noting that the deed allowed a right-of-way “of sufficient width” to permit the pipeline and the right to enter for the purpose of “making additions to, improvements on, and repairs to” the pipeline to “keep and maintain the same and to remove or replace the same.” he court noted that although the extent of an easement created by prescription is fixed by use, that is not so in the case of an express easement created by a conveyance. In the latter case, “the extent of the right depends on a proper construction of the grant.” Unless the grant says otherwise, it is assumed that the parties contemplated changes in use. An easement carries with it the right to do whatever is reasonably necessary for the full enjoyment of the easement. The extent to which those rights may be exercised depends on the object and purpose of the grant and whether those rights are limited in the grant itself. The court also opined that details that impose no greater burden on the land are immaterial unless they are specifically addressed by the granting instrument. Bottom line: The court held that Pioneer could replace the pipeline because the deed said it could. For the complete story, see Knox v. Pioneer Natural Gas Co., 321 S.W.2d 596 (Tex. Civ. App.—El Paso 1959, writ ref’d n.r.e.).

This next legal thriller takes place in 1964, when the court was asked to construe an easement granted to Houston Pipe Line Company in 1926. The agreement in question was on a printed form that had been modified by the parties to reflect their agreement. It had provided that the right-of-way was “to lay, maintain, operate, repair, and remove a pipeline for the transportation of gas.” However, the words “and remove” had been struck from the agreement prior to signing. Additionally, a paragraph granting the right to construct additional pipelines was struck. Elsewhere in the document, removal of the pipeline was authorized, but only on termination of the easement. As in Knox, the size of the pipeline and the exact location and size of the easement were not defined. The pipeline was built and it was a beaut—an 18-incher that served its purpose for 33 years. In 1959, though, the company was ready for bigger and better things. It ceased transporting gas for a few weeks, removed the old line, and replaced it with a much bigger 30-inch line. Enter Dwyer, who asserted that the removal of the original line terminated the easement completely. He further asserted that, even if the easement were not terminated, it only authorized one pipeline, and the pipeline company was not allowed to replace it with a larger pipeline. The court held that the terms “operate” and “maintain” are “at least broad enough to include the right to remove and replace the original pipe with pipe of the same size when necessary” (emphasis added). Thus, stopping transportation of gas to replace the original pipe did not terminate the easement. This still left a crucial question unanswered: Was the company within its rights to replace the pipe with the larger pipe? The pipeline company pointed to Knox, saying that as easement holder, it was entitled to the full enjoyment of the easement, and to employ whatever means may be reasonably necessary for its full enjoyment. The court refused to follow Knox, distinguishing it by observing that in Knox, the instrument granted rights greater than those that were actually used. Specifically, the easement was to be “of sufficient width” to permit the pipeline, and included the right to enter for purposes of adding, improving, repairing, keeping, SUMMER 2021

fied purposes. The landowners, relying on Dwyer, contended that the width had become fixed by use at 30 feet. The dispute precipitated a lawsuit, once more involving the court to solve the mystery. The court reasoned that this case was more similar to Knox. While the easement in Dwyer did not include broad, forward-looking language, the easements in Knox and SWEPCO did. The SWEPCO easement specifically allowed for reconstructing and hanging new wires on the transmission line. The court refused to fix the width of the easement by use to 30 feet, and instead recognized a general easement, which includes the right to “unlimited reasonable use such as is reasonably necessary and convenient and as little burdensome as possible to the [landowner].” The court looks at the The final installment is a recent one express written terms of the document. involving an electric transmission line. If the court can tell what the terms are Southwestern Gas & Electric Comand the terms are unambiguous, the pany acquired easements and built a court gives them effect without supplytransmission line on wooden poles. The ing additional terms, such as the width easements, which were later acquired of the easement. It observed that if parby Southwestern Electric Power Comties want to write a pany (SWEPCO), fixed width into the defined a rightagreement, they may of-way but not a Many easements exist do so. However, the width. SWEPCO without incident for parties in SWEPCO was granted the did not. right to ingress decades. Sometimes, The court emphaand egress “for the sized that even such a purpose of constructhowever, a change in general easement is not ing, reconstructing, circumstances leaves unlimited. The holder inspecting, patrolling, of the easement must hanging new wires the easement owners use the land in a reasonon, maintaining, and and the landlords able manner and only removing said line and to the extent reasonably appurtenances.” The easein dispute. necessary. If the holder ments limited the numuses the easements in a ber of poles, towers, and way that is unreasonable anchors permitted, but gave or not reasonably necessary, or in a way SWEPCO the option to increase them by that violates express terms, the landgiving additional compensation to the owner may sue. This exciting episode is landowners. For decades, SWEPCO’s use found in Southwestern Electric Power of the easement had been limited to a Co. v. Lynch, 595 S.W.3d 678 (Tex. 2019). width of 30 feet. When negotiating or drafting an n 2014, SWEPCO started a modeasement agreement, parties have an ernization project, which included replacing the wooden poles with steel opportunity to be clear on specific terms. Neglecting that opportunity is a weed poles. SWEPCO made offers to landowners to increase the width of the easement that bears bitter fruit. Who knows what easement lurks? to 100 feet by giving them additional Nothing in TG should be considered compensation, and some landowners legal advice. For advice on a particular accepted. Nevertheless, with respect to situation, consult an attorney. those landowners who did not, SWEPCO maintained that it had the right to Adams (r_adams@tamu.edu) is a member of the modernize anyway, because the easeState Bar of Texas and a research attorney for ments were general easements, giving it the Texas Real Estate Research Center at Texas the right to use as much of the property A&M University. as reasonably necessary for the speci-

maintaining, removing, and replacing. In Dwyer, there was no such language. The grantee was permitted to lay, construct, maintain, operate, and repair a pipeline. Once it did so by laying the 18-inch line, it could not replace it with a substantially larger line that would place a substantially greater burden on the land that the original parties did not contemplate. A grant in general terms, the court held, becomes fixed and certain once the pipe is laid, and the grantee cannot change the easement. For the full program, see Houston Pipe Line Co. v. Dwyer, 374 S.W.2d 662 (Tex. 1964).

Taxes

Rental Tax Issues

Issues impacting rental real estate are constantly changing, and individuals who work in that market need to stay informed. Currently, passive loss limitations, whether real estate leasing is an investment or a business, and the self-employment tax are the issues most worth watching. By William D. Elliott

ental real estate is an active area in terms of taxation. The Internal Revenue Service (IRS) and the courts are continually fleshing out positions and issues. In recent times, the areas showing the most activity for new developments of rental real estate are passive loss limitations, whether real estate leasing is an investment or a business, and the selfemployment tax.

Rental Real Estate and Passive Activities Passive activity limitations are a principal conceptual idea that pervade tax reporting for a wide array of taxpayers, particularly real estate professionals.

Generally speaking, the tax regime of passive activity limitations requires losses derived from passive activities (passive losses) to be offset only by gains from passive activities (passive gains). Conversely, losses from nonpassive activities can be offset against any income. The importance of passive loss limitations to real estate investors and professionals cannot be overstated, and neither can the complexity of the subject matter. Income or loss from rental activities is generally considered to be passive. The exceptions to this rule offer hope that passive loss limitations can be avoided. There are four major exceptions to consider:

• Transient lodging leasing. Certain rental-related activities are deemed nonpassive because they are considered trades or businesses, not rental activities. Transient lodging activities, such as hotels, are obvious examples. Income or loss from activities under this exception are nonpassive if the taxpayer materially participates (as opposed to only invests). Material participation requires regular, continuous, and substantial involvement. The IRS has released temporary regulations amplifying this exception. The conceptual idea of the temporary regulations is that if property is rented for a short period (such

Worth Watching as seven days or less, on average) or if significant personal services are provided, then the rental real estate activities resemble a trade or business, not passive rental activity. If an activity satisfies the rules of the temporary regulations for this exception, then whether income or loss from the activity is passive or nonpassive depends on material participation by the taxpayer. • $25,000 loss deduction. Active participation by a taxpayer in rental real estate activity enables the taxpayer to deduct up to $25,000 of losses from rental real estate under certain circumstances free of the bar of passive loss limitations. This rule applies only to individuals. Any loss above $25,000 is carried over to the next year. To qualify, the individual taxpayer must own 10 percent of the value of the enterprise or activity and must “actively participate” in the rental property’s operations. To be an active participant in a rental real estate activity, an individual’s participation need not be regular, continuous, and substantial, but the individual must participate “in a significant and bona fide sense.” Active participation is thus defined to be less stringent than material participation and would include making management decisions or arranging for others to provide services. For example, the lower threshold of the active participation requirement is met by an individual who rents out a house that was previously his principal residence or rents out a vacation home when the property is not being used, even if a rental agent is retained and repairs and other services in connection with the property are performed by contractors. However,

SUMMER 2021

this minimal level of involvement must be shown by the taxpayer’s activities alone because the activities of agents and employees are not considered. The $25,000 loss amount is reduced for those whose adjusted gross income exceeds $100,000 and is totally phased out for adjusted gross income more than $150,000. Current developments in this self-rental exception include such issues as combining various selfrented properties and whether spousal activities should be combined with the taxpayer’s activities. • Self-rental property. Income from activity such as self-rental of property can be characterized as nonpassive even though the activity is passive. For example, property a taxpayer rents to a trade or business in which the taxpayer materially participates is self-rented property. Losses from self-rented property are characterized as passive, but income is nonpassive income.

• Real estate trade or business status. For taxpayers who qualify as real estate professionals, losses from rental real estate activities can offset nonpassive (or active) income from wages, interest, and dividends. To qualify for real estate professional status: Ŋ more than 50 percent of the taxpayer’s personal services during the year must be performed in real property trades or businesses in which the taxpayer materially participates, and Ŋ the taxpayer must perform more than 750 hours of service in the real estate trades or business. For a taxpayer to treat losses from a rental real estate activity as active (rather than passive), he must both materially participate in that specific rental real estate activity and meet the 50 percent and 750-hour eligibility requirements. Current developments in this exception include issue of aggregation of rental real properties to

FOR RENT

meet the material participation test. The Tax Court ruled that a trust held and developed rental and other real estate properties qualified for the exception for real estate professionals (Frank Aragona Trust v. Commissioner).

Rental Real Estate as Investment or as Trade or Business

he tax law contains a significant fault line over whether an activity qualifies as a trade or business or as an investment. Historically, the capital gain-ordinary loss rule has served to distinguish between the two. Today, however, that distinction involves other tax provisions, such as the Qualified Business Income (QBI) rule of Section 199A. The question is whether the taxpayer’s activities in connection with rental real estate property, whether conducted personally or through an agent, are so extensive that the activities give rise to a trade or business. Generally speaking, a taxpayer must be engaged in the activity with continuity and regularity, and the primary purpose for engaging in the activity must be for income or profit.

Based on IRS Chief Council Advice 201427016, taxpayers may group together one or more trades or businesses into one trade or business. In the pronouncement, the IRS permitted a taxpayer with a real property development trade or business and two rental properties to treat the three activities as one real property trade or business. In addition, in Miller v. Commissioner the taxpayer was engaged in both construction and rental activities. In measuring the hours spent on real property trades or business, the Tax Court combined hours spent on the activities as one real property trade or business. Grouping in this way is advantageous because the next step to qualify as a real estate professional requires the taxpayer to materially participate in his or her real property trades or businesses. Combining activities into one real property trade or business increases the likelihood the combined hours spent on the grouped business will satisfy the material participation requirement. Current developments involving this fault line mostly include judicial decisions in which property is sold at a loss, with the taxpayer arguing that he is engaged in a trade or business that

enables him to take an ordinary loss rather than a capital loss. When ruling on such cases, the courts commonly consider the: • taxpayer’s efforts to rent the property, • maintenance and repairs supplied by the taxpayer (or an agent of the taxpayer), • taxpayer’s employment of labor to manage the property or provide services to tenants, and • purchase of materials, the payment of expenses, and the collection of rent. In a decision rendered in 2020, taxpayers were denied trade or business treatment for restoration of a historical Newport, RI, home (Keefe v. Commissioner). The husband was a physician, the wife an art educator and historian. They extensively rehabilitated the home over a period of years. The house was never rented. They sold the property in 2009 at a substantial loss and took the loss as ordinary, claiming they were in the real estate leasing business. The Tax Court (later affirmed by the Second Circuit) found the taxpayer did not have regular and continuous rental activities, and thus held the sale produced a capital loss. ental real estate can be on either side of this fault line with significantly different tax outcomes. For example, in one case the Tax Court found a taxpayer operating a sole proprietorship in the sale and rental of portable signs was engaged in a trade or business (Stevenson v. Commissioner). The taxpayer purchased the portable signs, advertised their availability, received telephone calls for their rental, and maintained bank accounts for the rental venture. The QBI deduction relies on the basic definition of trade or business (found in Section 162), so there is a high likelihood that a continuous line of judicial decisions

will try to determine whether or not a trade or business exists. The IRS requires consistency of reporting. If a taxpayer owns tenancy-in-common interests in rental real estate and owns joint venture interests treated as a partnership, the IRS will be interested in whether the taxpayer treats both in the same manner for the QBI deduction.

Self-Employment Income Net earnings from self-employment equals gross income less allowable deductions from a taxpayer’s trade or business, as determined under the income tax rules, plus a distributive share of partnership taxable income or loss from any trade or business in which the taxpayer is not a limited partner, regardless of whether the partner’s involvement is passive or active. Certain deductions for income tax purposes are not allowed when calculating net earnings from self-employment even though they relate to the trade or business activity generating the self-employment tax liability. Rent from real estate is not selfemployment income unless it is received by a real estate dealer in the ordinary

course of business or unless substantial services are provided for the occupants. In general, an individual who is engaged in the business of selling real estate to customers with a view to the gains and profits that may be derived from such sales is a real estate dealer. Rents received on property held for sale in the ordinary course of business qualify as self-employment income, but rents received on property held for investment or speculation do not. urrent developments in this area of applying self-employment income to rental real estate are mostly judicial decisions. For example, the Tax Court decided that business interruption proceeds were not subject to selfemployment tax unless the individual is currently involved in the day-to-day conduct of his trade or business (Newberry v. Commissioner). The IRS took exception to the decision. Other cases involve the question of whether work by agents or employees or even downline agents is sufficient to subject the taxpayer to selfemployment taxes. From time to time, the IRS announces positions that influence how issues are interpreted. For example, the IRS has

taken the position that annual rental payments a farmer receives for land enrolled in the U.S. Department of Agriculture’s Conservation Reserve Program (CRP) are self-employment income regardless of whether the taxpayer is actively engaged in farming or is an inactive landlord or investor. The Eighth Circuit disagreed with the IRS and held that CRP payments made to nonfarmers constitute rentals from real estate and are excluded from the self-employment tax (Morehouse v. Commissioner. The IRS treats CRP payments as self-employment income when received by nonfarmers who purchase land already enrolled in the CRP program by previous owners and who personally take on the responsibility to fulfill the remaining CRP contractual obligations.

Stay Vigilant The reality is that new developments do not provide clarity on rental real estate issues. Judicial decisions are slightly helpful to those not directly involved. IRS interpretative pronouncements frequently leave as many questions as they answer. The bottom line for those in rental real estate is to remain vigilant for current issues. Tax laws are complicated, so be sure to consult a tax accountant or tax attorney before making financial decisions. For more information, including a discussion of issues surrounding the Qualified Business Deduction and Subchapter S, read the full version of this article online using the QR code. Elliott (bill@etglawfirm.com) is a Dallas tax attorney, Board Certified, Tax Law; Board Certified, Estate Planning & Probate; Texas Board of Legal Specialization; and Fellow American College of Tax Counsel.

SUMMER 2021

Q. What happens to compensation on pending business when an agent changes brokers? A. That depends on the terms of the independent contractor agreement and the policy of the broker/brokerage on compensation when an agent leaves the company. The agent should and legally can be paid by the broker who sponsored the agent at the time the transaction went pending.

Q. What happens to compensation on pending business if an agent places his license on inactive status with the Texas Real Estate Commission (TREC)?

A person with an inactive license at TREC cannot perform brokerage activities. However, if the person went inactive after a transaction was pending and another agent with an active license agrees to work with the client to close the pending transaction, a commission or a referral fee can be paid to the inactive license holder.

What the Law Says The Real Estate Licensing Act §1101.351 requires that a person be licensed to perform brokerage activity and that a sales agent may not engage in brokerage activity unless sponsored by and acting for a licensed broker. TREC Rule §535.3 expands on the statute, stating a sales agent may not receive a commission or other valuable consideration without the written consent of the agent’s sponsoring broker or the broker who sponsored the agent when the agent became entitled

to the commission or valuable consideration. TREC Rule §535.147 makes it clear that a broker or agent may not share a commission with any person who engages in brokerage activity and is not actively licensed as a broker or agent. TREC has interpreted these rules over the years to allow commission to be paid to an agent who earned the commission when the agent did have an active license but subsequently went inactive.

For Example Ralph Jinko was a sales agent with Equinox Properties. Jane Pear was the broker when the home Ralph sold to his brotherin-law went under contract. Ralph changed brokerage firms after the loan was approved but before closing. At closing, Jane called Ralph’s new broker, John Medico, and said she will send him Ralph’s check. John told Jane it would be a much cleaner paper trail if Jane would just pay Ralph under

whatever policy and/or agreement she had with Ralph when he worked for her. Jane insisted she could no longer pay Ralph because she did not hold his license. If the agreement Jane had with Ralph defined when commission was earned by Ralph and it was “earned” before he left Jane’s brokerage, then Jane is not violating any laws by paying Ralph the commission on that transaction directly.

Best Practice

A broker should have an independent contractor agreement with all sponsored agents and associated brokers. The agreement should make clear how compensation will be handled on pending transactions when an agent leaves the brokerage or places his license on inactive status. An independent contractor agreement is a contract between the broker and the sponsored agent or associated broker. As with any contract,

the terms of this agreement will control payment of commission. An alternative would be to have this information spelled out in the broker’s policy, which every associated person can access when needed. It is also a best practice to have agents and associated brokers sign an agreement acknowledging and agreeing to follow the broker’s policies.

Bonus Question Q. What is the standard commission for a residential listing? A. There is no standard commission. Your broker may set policy for what you will charge and what services you will provide for each seller you may represent. Remember that

any discussion with other agents or brokers or on your social media about builder’s commission offerings or broker offerings of a certain set commission rate will run afoul of the federal Sherman Anti-Trust Act of 1980.

Nothing in this publication should be construed as legal advice for a particular situation. For specific advice, consult an attorney. Lewis (kerri@2oldchicks.com) is a member of the State Bar of Texas and former general counsel for the Texas Real Estate Commission (TREC). Wukasch (avis@2oldchicks.com) is a broker and former TREC chair.

“John Allen's excellent explanation of the fundamental role of private property rights in providing wealth, harmony, and freedom deserves a wide audience.” —Armen Alchian

Originally published in 1987, John W. Allen’s essay has been dusted off and reissued. Download it today from the Texas Real Estate Research Center’s website using the QR code. TEXAS A&M UNIVERSITY SUMMER 2021

Texas Real Estate Research Center

TG - Summer 2021

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Cold Comfort

Rental Tax Issues Worth Watching

Practically Speaking

She Sells Resales by the Seashore

Devil in the Details

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