I thought this was a great article by our friend Andrew Waite, editor, Personal Real Estate Investor Magazine.  He talks a lot about the whole concept of knowing your client or customer.  A practice that we all should be aware of and maintain in the front of our minds.  Andrew also cautions us about proclaiming ourselves to be an “Expert” in ANY field really, for the simple reason of limiting your liability.   Our North Conway Real Estate agents are the smartest around!!  Just ask one!  

In the late 1980s, I was involved in professional motor racing as a member of an Indy 500 winning race team. I was publishing telecommunications magazines in New York City. I discovered a family friend and fellow New Zealander was running a race team for a well-known American hospitality family. They needed sponsorship. One of our national advertisers agreed to sponsor the team. As a result I was asked to help on a permanent basis as their commercial director/sponsorship getter. As the factory Indy Car team they delivered the first 500 mile super-speedway wins for Honda. A crazy lifestyle but a real hoot!

High Risk or Risk Averse

I was immediately struck by how few Americans were represented in this top open wheel motor racing series. High speed oval racing was born in the United States and refined in America’s heartland; Speedway, Indiana. Chassis, motors, gear boxes, suspensions, brake, fuel and telemetry systems were all made in United Kingdom, Europe or Japan. American industry had gotten out of most racing, even NASCAR except for major brand representation.

Why? Lawyers and risk adverse company managers.

It just gets worse when you realize that much of the metallurgy and material sciences and telemetry technologies used in racing are the road going developments from the American aerospace industry and U.S. Defense Department applied research.

Why this was the case was for a perfectly legitimate and forgotten reason. In the 1970s and early 1980s American companies found they were faced with litigation and potential damages from unwanted legal attention when their name or products were associated with activities involving any risk. At best the costs to defend their interests, even if they won in court, or worse, negative media attention, were prohibitively expensive. The solution; take a pass.

Any risk is still a huge objection for most companies and their boards of directors. If in doubt, punt, because no matter how much special insurance is in place, as any litigation, damage awards and the public relations impact is not worth it.

Investors as “Honey Pot”

What does this have to do with real estate investing?

Real estate investors are the latest target for Realtors®. Investors are being promoted as the new “hot ticket” for sales success. The received wisdom is to become a real estate investor agent expert and learn how to sell to real estate investors. Take the class, earn the credential and collect the certificate, wear the badge and post the credential on your business card. “Now I are one!”

Personal Real Estate Investor magazine strenuously encourages agents to learn how to work with investors but only after checking with the broker and working out whether this activity is something they encourage. It’s about selling more homes, right? Yes, but not so fast.

We were recently invited to present the reasons that real estate companies should consider investors as a source of sales and commission revenues to one of the nation’s largest real estate sales companies. They were reluctant to look at investment sales as a business for the simple reason; this is contrary to their traditional owner occupied sales culture. They explained the relationship between a professional agent and a homebuyer as a limited and closed-end transaction. This mostly ends with the sale. Not so with a real estate investor. The relationship is dramatically different as it is advisory and open ended. This relationship introduces new levels of professional responsibility, especially when you include all of the third parties necessary for a successful relationship. Their point was that their liability for an undesirable outcome changes dramatically with an investor versus a homeowner.

Broker Errors & Omissions Advice

We checked with an expert in real estate agent training, management and E&O. He put us in touch with an E&O insurance agency located in New York that specializes in realty practice risk. In the opinion of this professional risk manager, any real estate agent investor sales activity is probably excluded in most real estate broker E&O schedules based on one or all of these four points.

1. Generally E&O insurance policies specifically exclude any discussion of future value of the property as a covered risk.

2. Exclusion schedules state that any suggestion of future value or use of language with a client that implies investment, this becomes a product subject to regulation by state securities regulators or the SEC so is specifically excluded as realtors are not licensed or qualified to discuss investment or future property values.

3. Any transaction that touches on investment or retirement legislation such as the 1974 ERISA legislation is specifically excluded from coverage.

4. And the most dangerous; any certification, badge or credential in a specialty automatically implies a higher degree of professional standard above that of the selling homes to owners and is subject to exclusion, particularly if there is any likelihood of future customer dissatisfaction.

“Ducks in a Barrel”

Pursuing a claim in the exclusionary zone against an investor certified agent in the broker E&O exclusionary zone is a plaintiff lawyer’s dream. Just as short sales and foreclosures could become the “next asbestos,” it appears ill-advised well- intentioned real estate investment advice, makes realtors, brokers and their brands easy targets. Add consumer activist lawyers and supposed deep pockets. Knowing this is precisely why insurance companies write these investment exclusions.

Any client investment demand against a broker would most likely begin settlement discussions immediately. An adverse judgment and precedent created by a jury decision could damage an industry.

A draconian but impractical solution to this liability is to prohibit agents from investment sales but this effectively eliminates some 20 percent or more of prospective business.

“Knowing your client” is the mantra of the securities investment business. By definition this would most likely be extended to apply to Realtor business that moves from transactional home sales to relational real estate investment advice. You are on notice.

Expert Advice Angst

There are a number of ways to mitigate this otherwise dark scenario. First; avoid any investor training that confers any sort of expert certification as this unduly raises individual confidence and reinforces liability. If you are a real estate agent there is no harm in learning what real estate investors do, join an investor association and take classes but understand where the lines are drawn. Second; understand where homes sales begin and end and where investment advice begins. Third; guard against well-intended real estate education promoters, no matter how much content, charisma or credentialing they offer, as your liability is exponentially increased. Fourth; beware of building any formal investment client referral team, no matter how qualified they may be as you have automatically become liable if they drop the ball. Your broker’s E&O certainly does not cover a failure to live up to a client’s expectations.

Brokers who insist on earning revenue from investment property sales should check with the E&O insurance carrier to ensure coverage. Consider adding an investment advice rider to the office coverage. A possible interim strategy is to have realtors have their investor clients sign releases and hold harmless agreements to protect the realtor and brokerage against any future negligence claim.

In the meantime, brokers should discourage agents from adding any sort of credential that claims certification or investment advice specialty or expertise as this is an obvious red flag to any legal bull seeking redress for a supposedly wronged investor client.

Also remember that the traded asset industry is becoming increasingly unhappy that clients are considering real estate as investments instead of stocks. Wall Street understands this and is expected to mount aggressive lobbying efforts in state departments of real estate to pay attention to this currently unregulated investment advice.

A Silver (Gold & Platinum) Lining?

Rather than walking away from this twenty percent of the house sale business, we believe there are alternatives that begin with good legal advice and repositioning the brokerage and agents to avoid any E&O issues.

The first step to stop offering unlicensed investment advice is to become licensed by building and staffing a real estate investment advice desk within the brokerage. Ensure this staff is trained and qualified to give pure investment advice with the Financial Industry Regulatory Authority Series and applicable licenses and E&O coverage. The broker’s investment team leader is now a registered investment advisor and can earn revenues for the brokerage and agents providing real estate investment advice as well as transactions commissions. This industry precedent already exists with the Tenant in Common sale experience. The brokerage will now likely meet the requirements of special investment E&O coverage.

From Legal Chum to Covered Professionals

To remain within the rules and E&O coverage, the realtors within this brokerage should not offer advice but find and refer their clients or prospects interested in investment to the licensed investment advisor so the broker and realtors are assured they are operating within their skills, licenses and E&O. Their careers and commissions are now most likely covered and protected. These realty investment advisors can now direct clients to the most suitable and appropriate investments for that client within a broad selection of titled real estate investment.

When I began reviewing real estate investment education I had no idea this is where we would end up. Education trends are fleeting, while brands, business reputations and careers are not. For investors, understand personal responsibility but also understand the depth of knowledge in any well-intentioned real estate agent investment advisor you encounter.

www.PersonalRealEstateInvestorMag.com
God bless and great investing.