The Economics of Private Transfer Fee Covenants

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Apr 22, 2010, 06:21 ET

ATLANTA, April 22 /PRNewswire/ -- The following article is by Dr. Tom McPeak, Ph.D., regarding the economics of private transfer fee covenants.

As a Land Economist, I have always been fascinated by the allocation of land resources. One emerging area in this field is the use of private transfer fees (also called reconveyance fees) to allocate increasing development costs and fund infrastructure.

A private transfer fee is created when a real estate developer files a legal instrument (typically called a private transfer fee covenant) in the real property records. Unlike a government transfer tax (which simply adds to the cost of home ownership), private transfer fees are paid by parties who willingly assume the obligation, and who negotiate their price and terms accordingly.

From a typical developer's perspective, a private transfer fee represents an alternative to putting 100% of development costs onto the shoulders of first-time buyers. In addition, if the future income stream could be sold off, much needed liquidity would be brought to the project. In return, the developer can lower the sales price, pay down bank loans, and even restart failed projects (creating jobs).

From the buyer's perspective, the willingness to pay a fee in the future in return for a lower initial price will result in lower acquisition costs, reduced carrying costs, and reallocation of the savings (i.e. does the buyer pay down high interest credit card debt with the savings). In addition to the quantifiable savings, a buyer may consider intangible issues such as the portion of the transfer fee that goes to non-profits, and whether the Buyer can qualify for the lower priced home (with a transfer fee) but would be unable to qualify for the higher priced home (without a transfer fee). All of these variables go into the decision-making process and both buyer and seller make an economic decision based upon their respective perceptions of the market value of the trade. If these perceptions match, a bargain is struck and the transaction is Pareto-efficient.

The assumption is that the seller will lower the sales price. This assumption is well-founded because economic theory suggests that buyers armed with the facts will not pay the same for a home with a transfer fee as they will pay for the same home without a transfer fee. It would be illogical to argue otherwise. (Having said that, the illogical nature of this argument does not appear to have prevented organizations from making the argument.) As is often the case, economics lies at the heart of the decision. Realtors apparently see transfer fees as a threat to commissions and the title industry see transfer fees as a potential liability for which they will be held responsible. Each entity is responding in an economically predictable way by protecting its own interest.

The community benefits because a portion of the income from a private transfer fee covenant is virtually always allocated to a non-profit operating within the community. This provides long-term sustainable revenue for clean air, clean water, youth programs and other benefits to the community while reducing reliance on government funding. This builds stronger property values, which in turn protects and enhances the fee stream. (See charitable endowment program of Freehold Capital Partners at http://www.freeholdcapitalpartners.com)

Since the amount of the future fee stream is dependent on long-term sustainable value, it is in the developer's economic interest to take a longer-term view of the project. Simply stated, in lieu of accepting a lump sum and having no further economic interest in the project, developers imposing a private transfer fee covenant have a vested interest in ensuring that the project value remains as high as possible for as long as possible, and in fact investors looking to buy the future income stream would be expected to scrutinize the long-term merits of the project. This mutuality of interest benefits home buyers, taxing authorities, and the community in general.

When the parties to a transaction come away satisfied with the bargain they have made, it is referred to as a Pareto-efficient transaction. An economic system that is Pareto-efficient is an important metric for evaluating economic efficiencies and public policies. Private transfer fee covenants balance the needs of the buyer, the developer, and the community in a Pareto-efficient way by more efficiently restructuring the economics of the real estate transaction.

About Dr. Tom McPeak, Ph.D.: In 2000 I began teaching at one of the nation's top business schools, the Terry College of Business at the University of Georgia. I received my Ph.D. in Resource Development (Land Economics) from Michigan State University. I have studied private transfer fee covenants for several years.

Source: Dr. Tom McPeak, Ph.D.

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SOURCE Dr. Tom McPeak, Ph.D.