"My Agent Said I'd Profit From Rental Income": Is A Wave of Vacation Homebuyer Lawsuits Coming?

  • Hannah Sirois
  • 10/1/20

Before the pandemic, rental homebuyers not only bought into the idea of owning a property in an idyllic vacation spot or sought-after metro location; they bought into servicing their ongoing obligations with what would almost certainly be an endless stream of vacation rental revenue. Often leveraged and banking on renters for income, 42% of vacation real estate investment buyers buy their properties to generate income through renting. As CNN recently reported, many short-term rental hosts are now seeking to offload their rental homes. I've started to wonder, could their next step be to sue the agents they bought them from in the first place?

As a real estate broker in Hawaii who has worked in the vacation/second home market for over three decades, I’ve witnessed an evolution of consumer expectations when it comes to acquiring vacation real estate. In the 1980s, vacation buyers acquired properties based on affordability and a desire to incorporate real estate into their lifestyle. In the early 1990s, buyers often added the tax consequence of the purchase and a simple cash flow analysis, requesting revenue and expense information from the listing agent. The 2000s marked the emergence of younger buyers who were prone to debt, appeared less emotionally attached and made buying decisions based upon a pro forma.

As the requests for revenue/expense information evolved from one-off requests to rote, real estate agents came to expect financial requests. All too often, they advertise their listings as “successful vacation rentals” and post historical financial information on the multiple listing service (MLS) without disclaimers. Others take on the added risk of building out pro formas for buyers.

In real estate, the Covid-19 quarantines and ensuing bottoming out of the vacation rental industry is forcing a long-overdue discussion of a larger-looming issue relating to risk and rental representation that is normally only raised by attorneys: When is the purchase of a rental home the purchase of property, and when does it become the sale of a security?

As many struggle to survive this dramatically altered economic landscape, some are retooling to exit the pandemic better adapted for what is now an irrevocably changed way of life, work and commerce. Those companies and independent contractors that emerge from potentially the worst recession in our lifetimes will be reinvented, now more resilient and more responsive. The real estate industry needs to reemerge as more reliable, too.

Reliability means avoiding negligence at all costs by doing the right thing for the right reasons at the right time and understanding the known risks in day-to-day practices. For real estate agents, one such risk has intensified from decade to decade and from one crisis to the next: the potential for breaking federal and/or state securities laws. 

When VRBO, now owned by Expedia, emerged in 1995, it was a platform that connected willing vacation property owners with a vacation rental desiring audience. Owners developed rental standards, competed on the open market for bookings and developed pro formas. With the advent of additional platforms and the proliferation of vacation rental management companies that observed healthy profit centers, millions pursued, and continue to seek, vacation home properties in desirable markets and attached business models to them.

In the meantime, real estate attorneys representing sellers remain uniform in their warnings to the real estate industry and insistence on contracts with language similar to the following, which legal counsel for a client of mine recently included in a sales contract:

No Rental Representations: Buyer hereby acknowledges and agrees that: (a) no representations have been made by seller or its agents as to the feasibility of renting the property or otherwise generating income or deriving economic benefit from ownership of the property; (b) seller and its agents have made no representations contrary to this section with respect to the tax treatment or other economic benefit or consequence relating to the purchase of the property; (c) seller may, as a condition of closing, require of buyer or anyone else connected in any way with the offer to sell and the purchase of the property, the execution and delivery to seller of such waivers, affidavits, or other documents as may be required to satisfy seller that the offer to sell and the purchase of the property are not in violation of any federal or state securities laws or regulations.

Yet some real estate agents knowingly or unknowingly aid and abet, if not encourage, the consumer in making a purchasing decision through the reliance on rental representations and projections often presented by the agent. These representations are, in many cases, in complete violation of the purchase agreement and SEC laws. Once a real estate agent communicates to the purchaser the possibility of renting or otherwise generating income from ownership of the property, the purchaser may no longer be acquiring real estate, but rather a security.

We are entering an entirely new age of vacation homebuyer expectations and realities. Knowing that the sale of a property can easily evolve into the sale of a security, agents need to retool and, through industry associations, receive education on the intersect of SEC laws and the sale of real estate.

Why the urgency? As states reopen, many owners of vacation rental properties are already in the red and upside down. As a consequence, a wave of foreclosures may ensue, and legal action potentially involving the agent may be in store.

If R stands for Realtor, it also stands for resilient, responsive and reliable. Let’s get the reliable element right because our clients and customers now and in the future look to the real estate agent to both uphold the law and help them make informed decisions. To increase our reliability as an industry, the National Association of Realtors, state associations and principal brokers need to acknowledge the risk of violating securities law by offering agent training on the topic. By doing so, the industry will show that it takes this issue seriously, on a level akin to each state’s mandatory disclosure laws. In-office training and mandatory continuing education courses should inform the agent of the danger inherent in offering pro formas and other documents purporting income potential for vacation rental properties, as well as what the buyer’s due diligence responsibilities are. Knowing the law and acting accordingly will add the reliability that consumers need from any real estate agent.  This blog orignially appeared on : Forbes.com, on July 22, 2020. 


 

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