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