The Skinny:
Fluency in real estate and property law is a vital and high-value skill that all real estate investors should be eager to master.
What is Real Estate Law?
Real Estate or Property Law is the legal field that deals with property ownership, transfers, and uses. It is a fairly complex field with many subsets including contracts, construction, zoning / land use, environmental, and litigation. Nothing meaningful in real estate is done without property law. You do not own a piece of real estate without clean title and a proper deed. A piece of land for a future apartment building could be worth nothing if that use cannot be legally achieved. If the property is built, the value of the asset is not created by the property just existing, it is created by the income-producing contractual leases that are signed.
It is also a foundational component of the broader “rule of law”, which is the principle that everyone is subject to and protected by fair laws. When you read about prosperous countries, you will notice that strong property rights are almost always a cornerstone of their success and growth. It plays a crucial role in preserving individual liberty and societal stability. A property owner’s basic entitlements are the right to exclude trespassers, the privilege of deciding how to use it (though in modern times this right has been curtailed due to local governance), and the power to on pass ownership to successors. You simply cannot build a strong civilization if the land you own could be snatched away from you unilaterally by your neighbors or the government. No one would invest in their land or cultivate their resources and society would promptly collapse.
History of Real Estate Law:
Real estate law has been around a lot longer than I originally believed and I thought it would be fun to briefly highlight some of its lineage and how it relates to modern property law.
2000 – 1000 BC – In ancient Mesopotamia, the Babylonian King Hammurabi had some early provisions for property rights in his famous “Code of Hammurabi”. One potent passage is “if a man breaks into a house, they shall kill him and hang him in front of that very breach”. This code was not exactly known for eschewing cruel and unusual punishment.
Egypt had different phases of property ownership rights with varying levels of control, from the Pharoah stating that “all land belongs to the Gods” to the evolution of genuine private property rights after many centuries. These two parts of the world are referred to as the “cradle of civilization” for a reason, as it was the development of these more intricate structures that paved the way for countless future societies.
1000 BC – 500 AD – the Greek and Roman empires are of course well-known for their massive contributions to modern day civilizations as well. Greece is commonly cited as the birthplace of the “rule of law” and had some legendary thinkers, scientists, and leaders. Private property rights were a central part of their seminal legal system. The “younger” Roman Empire took additional steps to formalize a lot of the mechanisms of property ownership and transfer. One of the most famous sets of laws in history was the Romans’ “Twelve Tables” which had a dedicated section on property law. Both empires have had a major impact on modern property law and some of the concepts that were created or formalized by them include loans, collateral, common area maintenance, permitted uses, and boundary surveys.
500 AD – Modern Day – many systems from the Greeks and Romans were brought over to England, a historical epicenter of Europe. The Roman Empire conquered Britain in 43 AD and remained there for over 300 years until 410 AD. During this time they incorporated their own laws and customs, many of which have stuck around in some form to this day. One of the biggest contributions was the clear delineation of ownership and property rights.
English law was born out of Roman law, but for some reason I had historically believed the English created all modern legal matters. After the withdrawal of the Roman Empire and a few lost and seemingly lawless centuries, English common law was founded after the Norman Invasion in 1066. Feudalism also took hold around this time, which is a defunct system based upon land ownership and usage, essentially a pyramid in which the royals (e.g. lords) would grant the right to use land to underlings (e.g. tenants / vassals).
Feudalism ultimately fizzled out in favor of private property and capitalism, but many concepts have remained. Most of the terms we hear all the time today are in fact legacy terms from this era, such as “fee simple”, “leasehold”, “landlord”, “tenant”, and “easement”.
This is a pretty abbreviated summary as I could write a ton on the development of property law but the key takeaway is that whenever you are reviewing a real estate contract, remember that it has roots that are hundreds or thousands of years old. I think that is pretty awesome.
Why You Need to Understand Real Estate Law:
I strongly believe that fluency in real estate law is a prerequisite for success as a real estate investor. As noted earlier, nothing meaningful happens without a key document in real estate. How these documents are drafted and negotiated can have major impact on a property’s success or failure. You are the one with real skin in the game, whether it is your own money or your reputation as an owner / operator on the line. You should therefore not solely defer to the lawyers on your deals because they do not have the same incentives as you. Furthermore, I promise you that they are not infallible. They will miss things and you need to be the one to catch them.
The law is just like a language in a lot of ways, a really old language with verbose phrasing and archaic terms. Your goal should be to become fluent. To keep this analogy going, lawyers are “native speakers” but your goal should be to gain “full professional proficiency”. This will allow you to understand every single line of your documents (including the boring boilerplate) and become adept at spotting mistakes and areas of potential concern. It will also allow you to speak more effectively with your lawyers, so that you can ensure they are drafting and editing exactly the way you need them to. You will be able to converse with and challenge them on certain points and will become active instead of passive. Attaining this proficiency is something you should be eager to work on as it is a high-value skill in your career. For me, all of the legalese was initially intimidating and I was overly deferential to our attorneys. But once you get the hang of it, it becomes second nature and dare I say, enjoyable. To use another analogy, think of the movie “The Matrix”. In the movie, the “operators” use a computer with the encoded green symbols to observe what is going on in the system. While it is unintelligible to Neo when he first arrives, soon it becomes like the symbols are not even there and he sees the visuals as anyone with eyes would in the real world. This is how it will feel when you comprehend the world of law.
The Goal of Legal Documents:
In the movie “Back to the Future II”, Doc Brown says: “the justice system works swiftly now that they’ve abolished all lawyers”. The setting of that film (released in 1989) was 2015. Here we are in 2023 and lawyers are still running rampant. Why is that? Well, I would argue one main reason is because the importance of being swift does not come close to the importance of being thorough and judicious.
The two key objectives of legal documents are risk management and information discovery. Lawyers are trained to be adept at protecting their clients from risk. The reason some lawyers are very well compensated is because they are the best at this and their fee is well worth the added risk mitigation that their skills and expertise provide. Information discovery is closely related to this. For example, as a buyer in real estate, you are seeking to acquire something with asymmetric information. The Seller knows a ton more than you do and they are not really obligated to offer up ALL of their knowledge if the documents do not explicitly require them to. This is why document drafting is so important. Depending on the situation and the bargaining position, a buyer can utilize documents to learn as much as possible (e.g. via reps and warranties as well as closing conditions) about its potential investment and to protect itself from nefarious counterparties through default provisions. A potential lender (who should really be viewed as an investor in your deal) parallels your search for information with their own because they generally have the same concerns as you.
Types of Documents:
One way I like to differentiate between legal docs is to separate them into two categories: executory and operative. These are descriptors that lawyers learn and utilize mainly in academia. While they are not terms used in the practical day to day life of most lawyers, I find the categorizations useful for us laymen.
In plain english, an executory contract is simply one that is not immediately in full effect when it is signed because there are things that need to be done in order to make it effective. Examples of executory contracts include purchase agreements, loan commitments, and marriage licenses. While terms may be agreed upon, there are ongoing obligations to be performed to make them binding. In a purchase agreement, there is often a lot of things to do and the document is only in full force upon closing (because one of the ongoing obligations of the PSA is to provide the $$ for the property!).
Operative documents are the opposite. As soon as they are fully signed and delivered, they are binding and enforceable by law. Examples of operative documents include deeds, mortgages, and marriage certificates. Lease agreements have both operative (rights are enforceable until the lease end date) and executory elements (e.g. renewal and termination rights).
Summary of Key Documents:
Using this document categorization framework, here are the SparkNotes for each major document in a real estate transaction. There are obviously countless legal docs in real estate, so this section only highlights the biggest ones during an acquisition / financing.
EXECUTORY DOCUMENTS
Purchase and Sale Agreement (“PSA”) – this is one of two big kahunas in any real estate transaction. This is the document that outlines the terms and conditions of the sale. It is crucial to both buyers and sellers because how it is drafted determines how much of the two key document objectives (information discovery and risk mitigation) one can hope to achieve. If you sign a poor PSA as a buyer, you might end up being forced to buy a property that is a total disaster. If you sign a poor PSA as a seller, you might waste valuable time and resources on a buyer if they are legally able to leave you standing at the altar. See my post on the anatomy of a PSA for further detail.
Loan Commitment – most purchases are financed with a combination of debt and equity. The loan commitment is a key part in understanding what your likely “equity check” will need to be as well as getting feedback on what kind of terms, such as the interest rate, amortization, and prepayment flexibility, you will get based on what the property can support. As this is an executory document, it is not a bulletproof promise from the lender to provide you funds. Sort of like a pre-approval during a residential purchase, the commitment does not have much force until a full underwriting of you / the property is completed.
Title Commitment – a boring but hugely important part of any transaction is ensuring that a property is able to be cleanly transferred without being muddied by ownership claims from others. Said differently, you want to make sure the property can actually be yours. The commitment will call out any potential issues with the title (e.g. liens, encumbrances) and will list the conditions that must be met in order for a full title insurance policy to be issued. It is the actual policy (typically issued at closing) that is legally binding, not the commitment.
OPERATIVE DOCUMENTS
The Deed – this is the other big kahuna. This is the legal conveyance document that actually transfers ownership from one person to another. You do not get anything without the deed! You could technically skip the PSA altogether and just complete the transfer with a deed, but most buyers are not that spurious and will want to go through the proper due diligence process that comes with a PSA.
Loan Documents – I am grouping together three key loan documents under one category due to overlapping definitions and jurisdictional nuances. The three key operative loan documents (“loan docs” if you want to sound like a seasoned pro) are the mortgage, promissory note, and loan agreement which all work together in a real estate transaction.
The mortgage is a conveyance document (like the deed) that creates a security interest for the lender. It gives them the right to go after the property as collateral upon default. It is a misconception that the mortgage is the central element of a loan transaction, that role belongs to the promissory note.
The promissory note (“note” for short in pro parlance) is just a fancy sounding word for “IOU”. It explains what kind of loan is being made and the key terms such as amount, interest rate, and repayment period. It also outlines default triggers and remedies. Only the borrower, not the creditor, signs the note. It is worth calling out that a note without a mortgage is an unsecured debt, while a mortgage without a note is simply useless. A lender needs both in order to have an enforceable IOU and a path to get their money back if the borrower defaults via the collateral created by the mortgage.
The loan agreement is a way beefier and more complex upgrade from the note and is a vital part of any large financing. I view it as the master file that ties everything together. Nowadays, the loan agreement outlines all of the key facets that are found in the note, as well as a whole list of hurdles and obligations for both sides of the transaction. Both the borrower and the creditor sign this document and so both are protected by its terms.
Title Policy – this is the operative version of the title commitment. Once the title company has completed its review and are comfortable moving forward with insuring the buyer (and lender), policies will be issued at closing that become binding and enforceable. It is actually a fairly common phrase near closing to ask the various insurers something like “are we ready to bind?”, because of course you want to be protected as soon as your ownership begins and have the peace of mind that indemnification provides if something bad happens.
Summary:
Real estate and property law have been around for thousands of years, with many of the same concepts being applied today. It is a language that is intimidating at first but once you understand it, it becomes a valuable and enjoyable skill in your real estate investment toolbox. Being able to use legal docs and structures to your advantage will allow you to better learn about potential investments and protect yourself and your investors from risks.
Sources: Chicago-Kent Law Review, Oxford Dictionary, Law Academy, A Practical Guide to Commercial Real Estate Transactions (Third Edition)
