Finder’s Fee in Real Estate Investing – Is it Legal?

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This week I received an inquiry from a real estate investor so fresh from an investment seminar that I could feel the weight of the credit card debt he racked during the event. The investor, like a gladiator looking to win his freedom with one last fight, was ready to tackle wholesaling property and make his fortune. As with many newly anointed investors looking to dip their toe into the property pool, he was short on cash but long on enthusiasm. A good thing provided his enthusiasm does not eclipse caution. Caution prevailed and the investor sought out my advice on the legality of finder’s fees before entering the arena.

Contrary to what I have read on many investor websites, paying a finder’s fee may not be illegal, but as with everything, the devil is in the details. Wholesaling transactions primarily fall into two categories:

  • Finder’s Fee Agreement; or
  • Assignment of contract.

This first is the simplest form of wholesaling but elicits the greatest confusion. To begin with, in most if not all states, a licensed realtor cannot pay a non-licensed realtor a finder’s fee. Google “finder fee” and “real estate” and you will find ample information on this topic. As a new investor reading up on this strategy you might think half of your armament has been taking from you before battle. However, so long as you are not tangling with real estate agents this is not a concern.

Why? Because areal estate licensing board cannot regulate non-licensed individuals entering into private agreements for finding real estate opportunities provided the agreement does not cross the line into brokerage services. Whew – I worked up a sweat writing that sentence. The distinction is a simple one and it was aptly discussed in a case I read last year. In Futersak v. Pearl (27 Misc 3d 897 New York Appellate 2nd Division) the Defendant sought to avoid paying a finder’s fee to Plaintiff on the purchase of property brought to the Defendant by Plaintiff. Defendant argued that Plaintiff was not a real estate agent therefore he was not entitled to receive the fee. The court disagreed and upheld the parties’ written agreement. In reaching its conclusion (by the way the court did so without any apparent struggle with the law) the court stated the following:

“The written agreement between the parties, and drafted by Defendant, explicitly refers to Plaintiff being compensated in the role of a finder. There is nothing in the agreement explicit or implied that Futersak was an agent of Defendants in the actual or functional meaning of that term and relationship. Futersak had no explicit or implied power to bind Defendants. He did not have the power to negotiate the transaction. Futersak did not have the power to do anything except find and introduce prospects.”

Lessons to be learned from this case:

Always have a written agreement between yourself and the cash investor you are working with.

  • The agreement should not contain any language that might imply a brokerage arrangement. The agreement should be simple and to the point and contain language that as the finder you will be compensated for finding prospective business opportunities, researching an area, finding a willing seller, performing due diligence, researching market conditions, etc..
  • Your agreement should state that you will not negotiate with the seller or any party on behalf of the cash investor, you do not have the ability to bind the cash investor, nor will you serve in a fiduciary capacity to the cash investor.
  • You might also possibly consider becoming a partner with the cash investor. In the finder’s fee agreement it might state that the Finder is entitled to an ownership interest of X% in any opportunity introduced to cash investor by Finder. Further this ownership interest should be convertible to cash at the election of cash investor or within X months after closing on the investment.

Now I have to put on my C.M.A. hat and state that you should run any purported finder’s transaction by a licensed attorney to ensure you are compliant with state law.

Next week in part 2 of this post I will discuss assignment of contracts.

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20 Comments

  1. Timely article. I get this question for referral fees on loans as well. I’m usually err on the side of caution and say I can’t pay fees, but to my knowledge HUD has allowed it in the past to be paid to non licensed individuals but the fee for a California real estate loan was capped at $500.00 and there was a myriad of disclosures to fill out, and additional rules to follow so most LO’s, including myself, didn’t pursue this avenue . However, with the new loan originator compensation guidelines set to hit April 1, 2011 that’ll probably go away as well.
    california real estate loan

  2. Clint it’s a good article.

    I would like to add that people use REALTOR interchangeably with license laws. One has nothing to do with the other.

    In my state of Georgia for example I am a licensed real estate broker bound by licensing laws.REALTOR is just a NAR affiliation where you subscribe to their code of ethics.

    The state real estate commission as they put it “could care less about third party real estate companies NAR,mls’s,etc.” The commission is there to uphold license laws and statutes and protect the interest of the general public.

    Another distinction regarding fees is RESPA (real estate and settlement procedures act).

    Many do not know that RESPA only applies to residential transactions and not commercial ones. So the laws vary based on what type of transaction you are trying to do.You can do many more types of structure or fee agreements in the commercial arena.

    I am just posting those for others so they know.

  3. Thanks for the great article, Clint. As one who acts as a “finder” for commercial transactions, this information is very useful for me.

  4. This seems to be an ongoing semantics issue. In our realty association, some members swear that it’s illegal to pay bird dog fees. Others say it’s OK as long as a real estate agent isn’t involved. I think it’s just paying for information. It could be in any realm of business. In this case it’s just someone who has the time to hunt for deals that an investor may close and that person should be compensated because the investor is too busy doing other things in his business.

  5. Pingback: Finder’s Fee Arrangements in Real Estate Investing « Clint Coons Blog

  6. I’m a licensed agent (REALTOR) in two states (Illinois & NW Indiana) and am a little confused on the law as far as me being a investor/realtor. I’m starting out as a locater finding the property, making an offer and due diligence. I then assign it to an investor for a fee of 10%before closing. Is this legal and does the fee have to go trough my broker house? Your advice is appreciated. Thank you in advance.

    Frank

  7. Frank,

    This is a question your licensing board. The thrust of my article has to do with individuals receiving or paying a finder’s fee. It is clear that most realtors can not pay a finders fee to a non realtor.

  8. A few of the responders have hit the nail on the head here. I believe the real issue is disclosure. Above and beyond what is legal and what is not, a top broker should and will disclose any and all gifts, incentives and or conflicts of interest immediately. This is the only way to build trust in your clients and prospects. I have seen deals and long term relationships fall apart because somebody neglected to disclose some small detail.

    Nick

  9. A REALTOR is a member of the National Association of Realtors. An individual who has a license to sell real estate, but is not a member of the Association, is a real estate licensee. They can be referred to as real estate agents, real estate salesmen, or real estate brokers (if they are licensed as such.) Please don’t use the designation so lightly as to include all who sell real estate. Thank you.

  10. This is an old post, but having just read it today, I still felt the need to comment regarding the Realtor vs. real estate licensee issue (warning: if you do not appreciate blunt and cynical, please do not read):

    I am a licensed salesperson in two states (covering parts of Ohio and Indiana), as well as a real estate investor. I wear both hats because I like it, and I’m on the side of the fence who believes it’s better to have a license when investing.

    I am also a Realtor – not by choice, but by requirement – solely to have access to the respective Boards’ MLS systems. I am required to pay dues to both the MLS systems, as well as the local , states, and national Boards of Realtors, which frankly, I detest more than any tone I could imply in print.

    Yes, Realtors are required to subscribe to a code of ethics (which are all common sense to an ethical business person anyway) in order to have the “privilege” of using the title. Does most of the general public know the difference, and that not all agents are Realtors? No, nor do they give a da**. Most people (including many Realtors, by the way), aren’t even able to pronounce the term correctly … and it’s NOT “real-a-tor”(!) … Yet, when I hear a mispronunciation, I do not correct them, because, well … what’s the point?

    Anyway, the Board of Realtors has done enough marketing over the years (made possible by millions of dues-paying members) to make the general public believe that a Realtor is a profession, and not just a (BS) designation/membership, and anyone (always a Realtor, for some reason) attempting to explain the difference usually comes off looking like some know-it-all with a holier-than-thou attitude, as if paying those dues to the Board makes them a more ethical person (FYI: it doesn’t – you can’t put a price tag on morals/ethics/integrity). The most corrupt and conniving licensees with whom I’ve had the misfortune of doing business are (still) Realtors.

    Any other politically-oriented group solicits contributions from members and the general public, but NAR is the only one I can think of that makes it practically mandatory in order to do business (as a licensee) in real estate. They are reactive instead of proactive in most cases, and they and their lobbyists are only worried about one facet of real estate: retail buyers and sellers. They’re finally realizing that there’s more to the market than that. I’m pretty sure it’s only because you’d have to be living under a rock to miss it at this point … hmmm sellers can’t sell; buyers can’t get loans; whatever will we do?!

    I just got an email from the local Board about a month ago telling their membership that “working with investors can increase their client base, and their volume of business”. Wow, really? Now all they have to do is tell their membership that wholesaling is not illegal, and that creative financing is what they need to learn to move the inventory and help the housing market recover. I won’t hold my breath waiting for that one – besides, the low prices around here make for killer cash flow, and killer deals!

    Frankly, the NAR is worse than labor unions (also unnecessary if you are a good/ethical employee, but that’s a whole other topic). If you’d like to own a firearm, are you required to join or contribute to the NRA? No. If you want to invest in real estate, are you required to join your local REIA? No (although it’s wise to do so!). I could go on, but this is already long enough … maybe I should contribute to Bigger Pockets instead of commenting? LOL

    Now, on to my point: I don’t need to pay dues to a (politically-oriented) Board to show the people with whom I do business that I am an ethical person – my actions and business practices prove that. If I had the choice of being a member of the MLS without joining the Board of Realtors, the NAR wouldn’t receive one penny from me, EVER.

    As one poster mentioned above, the State regulates licensees’ activities and could not care less about their memberships or designations. As an investor, I always disclose that I am a licensed real estate salesperson in all my business dealings, and that’s good enough for me, the State, and my customers and clients. I don’t use the term “Realtor” in those dealings, and I’d be willing to bet that nobody cares.

  11. The Futersak v. Perl case referenced above has been overturned. The New York appellate court ruled that in order to receive payment of a “finder’s” fee requires a real estate license. Not sure if there is a way around this?

  12. Gordon Locke on

    Billy Rae has it right. If the transaction is primarily a real estate related transaction, you can NOT enforce a claim for a finder’s fee unless you are a licensed real estate broker or a licensed real estate salesperson working for a. Licensed real estate broker. This would also true if the transaction involved the transfer of a business is real estate. The one exception is where the finder is a licensed securities broker and the transaction was the sale of the corporations stock either in a Federal or State registered transaction or a transaction that was exempt from registration, under the applicable securities law.
    This holds true in most other jurisdictions as well.

  13. Barbara Stapleton on

    I have to raise money for my real estate courses. Locating properties is the way I chose to go. Now, as a NYS resident, what to do??? I have located a couple of condemned properties for an experienced investor but how do I get paid for my info? Confusing, as some brokers offered me money for this service some years ago.

  14. Barbara Stapleton on

    I have to raise money for my real estate courses. Locating properties is the way I chose to go. Now, as a NYS resident, what to do??? I have located a couple of condemned properties for an experienced investor but how do I get paid for my info? Confusing, as some brokers offered me money for this service some years ago. Brokers in ALL industries buy leads, that’s all this is.

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