Stay in Your Wheelhouse. It's Less Likely to Lead to a Claim.
It’s easy to fall into the trap of making a property sound better than it really is. An extra adjective or two can make an average property sound like the best thing since sliced bread. But when agents cross over into blatant promises of profitability, performance, or future value, the risk of a claim and unwanted litigation becomes excessive.
Here’s a real-world scenario where a real estate agent went too far with promises and guarantees with perilous consequences.
SITUATION
A real estate agent marketed a commercial property that included street level retail and residential units on the upper two floors. The residential units were producing a steady stream of revenue since they were occupied by longtime residents who were making timely rental payments. However, the owner of the property operated a failing business on the ground level and was eager to sell the entire building before foreclosure action was undertaken by the mortgage holder.
PROBLEM
The real estate agent was overly optimistic about the location of the property and erroneously believed that the street level retail could be successful. In addition, the agent felt the residential rents could be increased since the tenants were comfortable living there and were unlikely to move.
MISTAKE
While working with a prospective buyer, the real estate agent guaranteed the buyer’s greeting card business would generate a positive cash flow as street level retail and the residential tenants would absorb an increase in their monthly rent.
RESULT
Given these assurances, the buyer decided to acquire the property and notified the tenants of their respective rent increases shortly after the close of escrow. Within the first few months, four of the six tenants told the new owner they were unable to pay the increase and were moving. The buyer experienced difficulty in finding new tenants willing to pay what was needed in order to make the residential component successful. Compounding the problem, the buyer’s greeting card business was not seeing the desired foot traffic and corresponding revenue. Over the ensuing months, the status of the business remained unchanged so the buyer sued the real estate agent alleging that he intentionally misrepresented the property’s profit potential. Damages sought included lost business profits and lost rental income. The parties ultimately resolved the litigation for $50,000 in lieu of enduring a two-week trial.
PREVENTION
Agents should never make promises or guarantees about the revenue potential or future value of any property marketed for sale. Acting outside their scope of expertise is a dangerous proposition and such tasks should be left to a buyer as part of their due diligence obligation. Agents should always recommend in writing that buyers seek the counsel of qualified accounting and financial planning experts to help them make decisions on whether to acquire revenue-producing property. Following this practice will not only result in satisfied buyers, but will help avoid unwanted litigation. It should be noted that most, if not all, real estate errors and omissions policies do not provide coverage for claims arising out of promises, warranties, or guarantees of the future value of property, or the income potential or performance of a business.
For more information about E&O coverage and other risk management topics, visit pearlinsurance.com.This article was produced in conjunction with AXA XL and is not to be taken as legal advice.