Can a Developer Claim Profits From Your Sale?

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Can a Developer Claim Profits From Your Sale?

By June Fletcher
Special to RealEstateJournal.com

Question: I just signed a contract on a one-bedroom preconstruction condo in a hot new building in Washington, D.C. The contract states that the buyer must occupy the unit for at least 12 months before selling or renting it, or the "seller (the development company) shall receive 100% of the net sales proceeds. The deed of conveyance to the purchaser shall contain a covenant in favor of the seller for 100% of net sales proceeds." My Realtor told me not to worry because it wasn't enforceable. I have 15 days to get out of the contract. I intend to live there, but if I change my mind, I'd like to be able keep the profit from a sale. How can a seller still have control over a unit once it's sold? If this isn't enforceable, is there any pre-emptive legal action I can take to remove it from the contract? These clauses have popped up here in the past several months, but usually for only 50% of profits, not 100%.

-- Tom, Washington, D.C.

Tom: It amazes me how often folks rely on legal and financial advice from sales people, brothers-in-law, psychic readers, and even professional gossips like newspaper columnists instead of calling their accountants or lawyers. This is a big-bucks obligation we're talking about, which will have you on the hook for years. It should go without saying, but I'll say it anyway: If anything about a deal makes you queasy, consult an appropriate licensed professional before you sign anything. And remember that real-estate agents may have studied some basic contract law as part of their licensing training, but only as a means to their ultimate end, which is to sell property.

Your contract clause may sound draconian, and it's certainly off-putting, but it's not unusual, and not just in Washington, D.C. In fact, though you rarely saw them a year ago, such clauses are about as common in new-home developments these days as granite countertops and oversized bathtubs, and they probably aren't going to go away anytime soon. The main reason is the sizzling housing market, which has brought investors into the market in unprecedented numbers.

Investors often buy new homes or condos in pre-construction phases because they appreciate rapidly and can be "flipped" before the project is built out. Understandably, builders don't like this last-minute competition from owners when they're trying to close out sales in a project. Having a clause that discourages investors from buying in the first place eliminates this problem.

But there's another reason builders are putting these clauses in their contracts.

The major players in the secondary-mortgage market, Freddie Mac and Fannie Mae, don't want to buy loans in projects that are dominated by investors. Lenders follow the lead of Freddie and Fannie. A contract that discourages "flipping" shows a lender that the project will be occupied primarily by owners, who do a better job of maintaining property values than speculators and renters.

But how do builders get away with telling you what to do with your property after they've sold it to you? English common law going back several centuries does prevent "unreasonable restraint on alienation," or the ability to sell property; but it also allows developers to put provisions about how property can be used into deeds or covenants. Your contract says the builder is putting these provisions in the deed, so it's "probably enforceable," says Washington, D.C., real-estate attorney Stephen Hessler.

More bad news: The time to have taken "preemptive legal action" to get rid of the unwanted language in your contract was before you signed it, says Falls Church, Va., real-estate attorney Bob Diamond. "You could have simply crossed it out," he says.

Now, both attorneys say, the best thing to do is to ask yourself whether you really want this unit as an investor or an owner. If you're an investor who's likely to sell within a year, it's probably better to kick out of the contract and look elsewhere. But if you want to live in this condo, backing out of the contract now won't do you much good -- if you try to reapply, you'll probably be stuck at the bottom of a waiting list or have to pay more than your current contract.

You can, however, try to renegotiate the deal so that you'll have to pay only 50% of profits if you sell, not 100%, if you can indeed prove that this is the more common practice in your area. But if you do, promise me you'll have a lawyer at your side to carry your spear -- you can be sure the builder will.

-- Ms. Fletcher is a staff reporter for The Wall Street Journal. Her "House Talk" column appears most Fridays on RealEstateJournal.com. E-mail her your questions about the residential real-estate market. Please include your first name and city and state. If your question is answered and posted, we will show your first name and city. Due to volume of mail received, we regret that we cannot answer every question.

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