California Real Estate Principles, Ninth Edition

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REAL ESTATE

PRINCIPLES

REAL ESTATE PRINCIPLES

California REAL ESTATE PRINCIPLES

DENNIS J. MCKENZIE • MARY ELLEN BRADY

EDWIN ESTES, Jr.

California California

9e

9e

9e

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DENNIS J. MCKENZIE • MARY ELLEN BRADY

EDWIN ESTES, Jr.

MCKENZIE

BRADY

ESTES

Considered the first choice in California for individuals

searching for a reliable source to prepare for a rewarding career

in the real estate profession, this text is comprehensive and

substantive – yet very accessible and user friendly.

Continuing the legacy of this popular text, authors Brady and

Estes have fully updated and re-energized the content to

accurately represent modern real estate practice in California.

Coverage of the SAFE Act and its impact on mortgage brokers

has been added along with current information on homestead

laws, buyer’s agency, senior community exceptions to fair

housing laws, and much more.

Each chapter includes practical applications and 20-question

review exams to ensure mastery. The 150-question practice

exam is similar in format and content to the actual salesperson

exam with answers and chapter references, along with

test-taking hints.

OTHER VALUABLE FEATURES INCLUDE:

• Online Study Tools. WebTutor™ interactive quizzing and

flashcards are available online to reinforce key terms and

help you master material more efficiently.

• Current Forms & Contracts. The latest real estate forms

and contracts for California like the updated Residential

Purchase Agreement are included.

• Detailed Examples. Walk-thru examples help users

understand difficult real estate topics or situations.

• Comprehensive Glossary. Users appreciate this valuable

resource with complete definitions.

• Instructor Resources. In addition to full WebTutor™ and

ExamView

® support, adopters have access to mid-term and

final exams, chapter lecture outlines, and PowerPoint

® slides.

California Real Estate License Prep, 13e . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0-324-56060-5

California Real Estate Exam Prep Guide . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0-324-64497-3

California Real Estate Practice, 2e . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0-538-74055-8

California Real Estate Finance, 9e . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0-538-79832-7

California Real Estate Law, 8e . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0-538-73613-5

California Mortgage Loan Brokering and Lending, 4e . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0-538-73959-2

Essentials of Real Estate Economics, 6e . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0-538-73969-X

Computer Applications for Real Estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0-538-19148-0

Basic Real Estate Appraisal: Principles & Procedures, 7e . . . . . . . . . . . . . . . . . . . . . . . . . . 0-324-65261-5

Other California Real Estate Resources

9780538739658_cvr_wkg.indd 1 6/17/10 6:11 PM

Dennis J. McKenzie

Mary Ellen Brady

Cerritos College

Edwin Estes, Jr.

Mt. San Antonio College

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California

Real Estate

Principles

NINTH EDITION

California Real Estate Principles,

Ninth Edition

Dennis J. McKenzie, Mary Ellen Brady,

and Edwin Estes

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1 2 3 4 5 6 7 14 13 12 11 10

Brief Contents

Preface xv

1 INTRODUCTION TO REAL ESTATE 2

2 PART I: LEGAL DESCRIPTIONS, METHODS OF ACQUIRING TITLE,

AND DEEDS 20

PART II: ESTATES AND METHODS OF HOLDING TITLE 53

3 ENCUMBRANCES, LIENS, AND HOMESTEADS 70

4 REAL ESTATE AGENCY 94

5 REAL ESTATE CONTRACTS AND MANDATED DISCLOSURES 120

6 PRACTICAL REAL ESTATE MATHEMATICS 166

7 INTRODUCTION TO REAL ESTATE FINANCE 194

8 PART I: REAL ESTATE LENDERS 224

PART II: FHA, VA, AND CAL-VET LOANS AND THE SECONDARY MORTGAGE

MARKET 241

9 REAL ESTATE APPRAISAL 262

10 THE ROLE OF ESCROW AND TITLE INSURANCE COMPANIES 294

11 LANDLORD AND TENANT RELATIONS 316

12 LAND-USE PLANNING, SUBDIVISIONS, FAIR HOUSING, AND OTHER PUBLIC

CONTROLS 342

13 INTRODUCTION TO TAXATION 366

14 SINGLE-FAMILY HOMES AND MOBILE HOMES 388

15 PART I: A CAREER IN REAL ESTATE AND THE DEPARTMENT OF REAL ESTATE

LICENSE EXAMINATION REQUIREMENTS 408

PART II 427

ANSWERS TO CHAPTER PRACTICAL APPLICATION QUESTIONS 474

ANSWERS TO CHAPTER REVIEWING YOUR UNDERSTANDING QUESTIONS 486

Glossary 491

Index 513

iii

Contents

Preface xv

1 INTRODUCTION TO REAL ESTATE 2

Student Learning Outcomes 3

1.1 PRESENT AND HISTORICAL IMPORTANCE OF REAL ESTATE 3

Impressive Statistics • Historical Importance of Real Estate • Spanish Rule •

Mexican Rule in California • American Rule in California

1.2 PROPERTY RIGHTS 5

1.3 REAL PROPERTY VERSUS PERSONAL PROPERTY 7

Land • Water Rights • Affixed to the Land • Appurtenant to the Land •

Immovable by Law • Personal Property • The Status of Property Can Change

1.4 FIXTURES 11

Tests of a Fixture • Take Proper Precautions • Exception to the Fixture Rule

CHAPTER SUMMARY 14

IMPORTANT TERMS AND CONCEPTS 15

PRACTICAL APPLICATION 15

REVIEWING YOUR UNDERSTANDING 15

2 PART I: LEGAL DESCRIPTIONS, METHODS OF

ACQUIRING TITLE, AND DEEDS 20

Student Learning Outcomes, Part I 20

2.1 LAND DESCRIPTIONS 21

Early Methods Used • Present-day Land Descriptions • Lot, Block, and Tract

System • Metes and Bounds System • U.S. Government Section and Township

System • Sections in a Township • Pitfall

iv

2.2 METHODS OF ACQUIRING TITLE 29

Acquiring Property by Will • Special Terms • Probate • Acquiring Property

by Succession • Acquiring Property by Accession • Acquiring Property by

Occupancy • Acquiring Property by Transfer

2.3 INSTRUMENTS USED IN THE TRANSFER OF REAL PROPERTY 39

Essentials of a Valid Deed • Delivery of the Deed is Required • Acceptance •

Acknowledgment • Nonessentials in a Deed • Grant Deed • Quitclaim Deed

• Sheriff’s Deed • Gift Deed • Tax Deed • Warranty Deed • Trust Deed

(or Deed of Trust) • Deed of Reconveyance • Trustee’s Deed

2.4 THE RECORDING SYSTEM 46

CHAPTER SUMMARY, PART I 47

IMPORTANT TERMS AND CONCEPTS 47

PRACTICAL APPLICATION 48

REVIEWING YOUR UNDERSTANDING 48

PART II: ESTATES AND METHODS OF HOLDING TITLE 53

Student Learning Outcomes, Part II 53

2.5 ESTATES 53

Freehold Estates • Less-than-Freehold Estates

2.6 METHODS OF HOLDING TITLE 56

Ownership in Severalty • Concurrent Ownership • Important Characteristics •

Limited Partnership • For Married Couples or Registered Domestic Partners,

Which is Best: Joint Tenancy or Community Property?

CHAPTER SUMMARY, PART II 64

IMPORTANT TERMS AND CONCEPTS 64

PRACTICAL APPLICATION 65

REVIEWING YOUR UNDERSTANDING 65

3 ENCUMBRANCES, LIENS, AND HOMESTEADS 70

Student Learning Outcomes 70

3.1 ENCUMBRANCES 71

Nonmoney (Physical) Encumbrances • Easements • Creation of Easements •

Termination of an Easement • Other Types of Nonmoney Encumbrances

3.2 LIENS 77

Voluntary Lien • Involuntary Lien • General Lien • Specific Lien • Types of

Liens

Contents v

3.3 HOMESTEAD LAW 83

Declared versus Automatic Homestead • Requirements for a Formal Declared

Homestead • Dollar Protection for Formal and Automatic Homestead •

The Six-Month Rule • Homestead Protection • Termination of Homestead

CHAPTER SUMMARY 87

IMPORTANT TERMS AND CONCEPTS 88

PRACTICAL APPLICATION 88

REVIEWING YOUR UNDERSTANDING 89

4 REAL ESTATE AGENCY 94

Student Learning Outcomes 94

4.1 AGENCY 95

Employer-Employee and Independent Contractor Distinctions

• Creation of Real Estate Agencies • Actual Versus Ostensible Agent • Fiduciary

Relationship • Seller’s Agency • Buyer’s Agency • Single Versus Dual Agency •

Agency Disclosure Requirements • Subagents and Cooperating Agents • Buyer

Agency

4.2 SOME AGENCY VIOLATIONS 103

Trust Funds • Basic Rules of Entries • Recovery Fund • Responsibilities of

Principals to Agents and Buyers

4.3 REGULATION OF BROKERS AND SALESPEOPLE 107

Real Estate Broker Versus Salesperson • Regulation of Real Estate Agents •

Commissioner’s Former Code of Ethics • Filing Complaints • Trade Associations

4.4 TERMINATION OF A REAL ESTATE AGENCY 112

CHAPTER SUMMARY 113

IMPORTANT TERMS AND CONCEPTS 114

PRACTICAL APPLICATION 114

REVIEWING YOUR UNDERSTANDING 115

5 REAL ESTATE CONTRACTS AND MANDATED

DISCLOSURES 120

Student Learning Outcomes 120

5.1 LEGAL REQUIREMENTS FOR ENFORCEABLE CONTRACTS 121

Legal Effects of Contracts • Essential Elements of a Real Estate Contract •

Discharge of Contracts • Statute of Limitations • Provisions in Contracts •

Real Estate Licensees Should not Practice Law

5.2 AUTHORIZATION TO SELL 128

Different Types of Authorization to Sell

vi Contents

5.3 PURCHASE AGREEMENT AND DISCLOSURE RULES 131

The Offer and Acceptance • Rejection of the Offer • COUNTEROFFERS

• Real Estate Transfer Disclosure Statement • Summary of Mandated Disclosure

Requirements • OPTIONS • Broker Supervision and Recordkeeping

5.4 SAMPLE CONTRACTS 135

CHAPTER SUMMARY 136

IMPORTANT TERMS AND CONCEPTS 137

PRACTICAL APPLICATION 137

REVIEWING YOUR UNDERSTANDING 138

APPENDIX: SAMPLE FORMS 143

6 PRACTICAL REAL ESTATE MATHEMATICS 166

Student Learning Outcomes 166

6.1 REVIEW OF FUNDAMENTALS 167

Decimals • Converting Percentages to Decimals • Addition of Decimal Numbers

• Subtraction of Decimal Numbers • Multiplication of Decimal Numbers •

Division of Decimal Numbers

6.2 VARIABLES 170

Investment Problems • Problem 1 • Problem 2 • Discounting Notes •

Problem 3 • Appraisal Problems • Problem 4 • Problem 5 • Commission

Problems • Problem 6 • Problem 7 • Interest and Loan Problems •

Problem 8 • Problem 9 • Cost and Selling Price Problems • Problem 10 •

Problem 11

6.3 SQUARE FOOTAGE AND AREA CALCULATION 178

Problem 12 • Problem 13 • Improvements • Answers

6.4 PRORATIONS 180

Problem 14

6.5 DOCUMENTARY TRANSFER TAX 182

Problem 15 • Problem 16

6.6 USE OF FINANCIAL TABLES 183

Interest Computation • Problem 17 • Conventional Method • Use of Interest

Table • Amortization Tables • Problem 18 • Problem 19 • Problem 20 •

Problem 21 • Real World of Real Estate

CHAPTER SUMMARY 186

IMPORTANT TERMS AND CONCEPTS 187

PRACTICAL APPLICATION 187

REVIEWING YOUR UNDERSTANDING 188

Contents vii

7 INTRODUCTION TO REAL ESTATE FINANCE 194

Student Learning Outcomes 194

7.1 REAL ESTATE FINANCING INSTRUMENTS 195

Real Estate Financing Process • Promissory Notes • Straight Note •

Installment Note • Adjustable Rate Loans • Other Alternative Types of Real

Estate Loans • Deeds of Trust • Special Clauses • Junior Deed of Trust •

Taking Over a Seller’s Existing Loan • Installment Sales Contracts (Land Contracts)

7.2 FORECLOSURE PROCESS: TRUSTEE’S SALE 205

Trustee’s Sale • Rights of Holders of Junior Trust Deeds • Loan Modifications

7.3 TRUTH-IN-LENDING, EQUAL CREDIT OPPORTUNITY, AND THE REAL

ESTATE SETTLEMENT PROCEDURES ACT 208

Real Estate Advertisements • Equal Credit Opportunity Act • Real Estate

Settlement Procedures Act

7.4 REAL PROPERTY LOAN LAW 210

Exceptions to the Mortgage Loan Broker Law • Maximum Commissions • Other

Costs and Expenses • Balloon Payments • Insurance • Miscellaneous Provisions

CHAPTER SUMMARY 213

IMPORTANT TERMS AND CONCEPTS 214

PRACTICAL APPLICATION 215

REVIEWING YOUR UNDERSTANDING 215

APPENDIX A: WRAPAROUND DEED OF TRUST 220

APPENDIX B: LEVERAGE 221

8 PART I: REAL ESTATE LENDERS 224

Student Learning Outcomes, Part I 224

8.1 QUALIFYING FOR A REAL ESTATE LOAN 225

Credit (FICO) Score • Old Rule of Thumb Is Inadequate • Use of Multipliers and

Ratios • Trend Toward More Liberal Ratios • What Counts as Income? •

Debts • Summary of Qualifying Guidelines

8.2 INSTITUTIONAL LENDERS 228

The California Mortgage Market • Savings Form the Pool for Borrowing •

Commercial Banks • Savings Banks (Formerly Called Savings and Loans) •

The Savings and Loan Crisis • Life Insurance Companies

8.3 NONINSTITUTIONAL LENDERS 232

Mortgage Companies • Rules Regarding Mortgage Companies • Mortgage Banker

versus Mortgage Broker • The Financial Crisis of 2008 • New Regulations for

Mortgage Companies • Private Lenders • Real Estate Investment Trusts •

Credit Unions

viii Contents

8.4 PRIVATE MORTGAGE INSURANCE 236

Coverage and Cost of Private Mortgage Insurance

CHAPTER SUMMARY, PART 1 237

IMPORTANT TERMS AND CONCEPTS 237

PRACTICAL APPLICATION 238

REVIEWING YOUR UNDERSTANDING 238

PART II: FHA, VA, AND CAL-VET LOANS AND THE

SECONDARY MORTGAGE MARKET 241

Student Learning Outcomes, Part II 241

8.5 GOVERNMENT ROLE IN REAL ESTATE FINANCING 241

Federal Housing Administration (FHA) • Federal Housing Administration Programs

• How to Calculate FHA-Insured Loan Amounts (As of February 2010) •

Required Cash Investment • FHA Programs • Department of Veterans Affairs

(VA or G.I.) Loans • Who is Eligible for VA Loans? • General Information on VA

Loans • Calculating Discount Points for VA Loans • Cal-Vet Loans • Who Is

Eligible for Cal-Vet Loans? • General Information About Cal-Vet Loans

8.6 THE CALIFORNIA HOUSING FINANCE AGENCY (CALHFA) Program 251

Two Main Programs

8.7 SECONDARY MORTGAGE MARKET 253

Purpose of the Secondary Mortgage Market • Federal National Mortgage Associa￾tion • Federal Home Loan Mortgage Corporation • The Secondary Mortgage

Market Financial Crisis • Government National Mortgage Association • Special

First-Time Homebuyer Programs • Real Estate Loan Jargon

CHAPTER SUMMARY, PART II 257

IMPORTANT TERMS AND CONCEPTS 257

PRACTICAL APPLICATION 258

REVIEWING YOUR UNDERSTANDING 258

APPENDIX A: CASE STUDY—QUALIFYING FOR A HOME LOAN 261

9 REAL ESTATE APPRAISAL 262

Student Learning Outcomes 262

9.1 APPRAISAL CONCEPTS 263

Real Estate Appraisal License Requirements • Professional Designations • Home

Valuation Code of Conduct (HVCC) • Market Value • Market Value versus Price

Paid • Essential Elements of Value • Four Forces that Influence Value • Basic

Principles of Valuation

Contents ix

9.2 DEPRECIATION 268

Causes of Depreciation • Curable versus Incurable Depreciation • Accrued

Depreciation versus Recapture for Depreciation • An Additional Word about

Depreciation

9.3 APPRAISAL METHODS 270

Appraisal Process • Three Approaches to Value • Estimating Replacement

Cost • Estimating Depreciation

CHAPTER SUMMARY 288

IMPORTANT TERMS AND CONCEPTS 289

PRACTICAL APPLICATION 289

REVIEWING YOUR UNDERSTANDING 290

10 THE ROLE OF ESCROW AND TITLE INSURANCE

COMPANIES 294

Student Learning Outcomes 294

10.1 ESCROW 295

Definition of Escrow • Legal Requirements for a Valid Escrow • Confidentiality

of Escrows • Status of the Escrow Holder • Regulation of Escrow Holders •

Who Decides Which Escrow Company to Use? • Services Provided by Escrow

Holders • Termination of Escrows • Escrows and RESPA

10.2 TITLE INSURANCE COMPANIES 300

Title Search • Title Examination • Title Insurance • Types of Title Insurance

Policies • Extended-Coverage Policy • How Much Does Title Insurance Cost?

• Who Pays for the Title Insurance? • Who Decides Which Title Insurance

Company to Use?

10.3 CLOSING COSTS 306

Buyer’s Closing Costs • Nonrecurring Closing Costs Usually Paid by the Buyer

• Recurring Closing Costs Usually Paid by the Buyer • Seller’s Closing Costs •

Closing Costs Usually Paid by the Seller

CHAPTER SUMMARY 310

IMPORTANT TERMS AND CONCEPTS 311

PRACTICAL APPLICATION 311

REVIEWING YOUR UNDERSTANDING 312

x Contents

11 LANDLORD AND TENANT RELATIONS 316

Student Learning Outcomes 316

11.1 LEASES 317

Types of Leasehold Estates • Requirements for a Valid Lease • Other Provi￾sions • Security Deposits • Assignment Versus Sublease of the Lease • Lease

with Option to Buy • Major Types of Leases • Important Concepts

11.2 DUTIES AND RESPONSIBILITIES OF LANDLORDS AND TENANTS 328

Landlord’s Duties and Rights • Tenant’s Duties and Rights • Rental Offset •

Rental Payments to Neutral Escrow

11.3 EVICTIONS AND OTHER WAYS TO TERMINATE RENTAL

AGREEMENTS 331

Unlawful Detainer Action • Three-Day Notice Versus 30 or 60-Day Notice •

Serving Notice • Superior Court • Sheriff Evicts the Tenant • Delays and

Appeals • Termination of Lease • Mobile (Manufactured) Home Park Tenants

11.4 PROPERTY MANAGEMENT 334

Field of Property Management • Compensation

CHAPTER SUMMARY 336

IMPORTANT TERMS AND CONCEPTS 337

PRACTICAL APPLICATION 337

REVIEWING YOUR UNDERSTANDING 337

12 LAND-USE PLANNING, SUBDIVISIONS, FAIR HOUSING,

AND OTHER PUBLIC CONTROLS 342

Student Learning Outcomes 342

12.1 GOVERNMENT LAND-USE PLANNING 343

Private Deed Restrictions • Public Land-Use Controls • Planning • General

Plan • Zoning • Controversy: Local Versus State and Federal Planning

12.2 SUBDIVISIONS 348

Subdivision Laws • Out-of-State and Foreign Land • Red Tape • Land Project

Right to Rescind Sale • Interstate Land Sales Full-Disclosure Act

12.3 COMMON INTEREST DEVELOPMENTS (CIDs) 353

Condominiums • Planned Unit Development (PUD) • Stock Cooperatives

and Community Apartments • Disclosure Requirements • Recreational

Developments Selling Undivided Interests • Time-Sharing Ownership

12.4 HOUSING AND CONSTRUCTION LAWS 356

State Laws and Regulations

12.5 FAIR HOUSING 357

State Laws and Regulations • Federal Laws • Senior Citizen Housing • Many

Other Laws

Contents xi

CHAPTER SUMMARY 360

IMPORTANT TERMS AND CONCEPTS 361

PRACTICAL APPLICATION 361

REVIEWING YOUR UNDERSTANDING 362

13 INTRODUCTION TO TAXATION 366

Student Learning Outcomes 366

13.1 REAL PROPERTY TAXES 367

Assessment Procedure • No Change in Ownership Since March 1, 1975 •

Change in Ownership Since March 1, 1975 • Supplemental Property Tax Bill •

Is This Discrimination? • Other Adjustments • Transfer Exclusions • Special

Treatment for Senior Citizens • Real Property Tax Dates • Tax Sale • Public

Auction • Real Property Tax Exemptions • Special Assessments • Taxing

Personal Property

13.2 INCOME TAXES 374

Major Income Tax Advantages for Homeowners • Major Income Advantages for

Investment Property Owners • State Income Tax • Special Withholding Rules

for Foreign and Out-of-State Sellers

13.3 OTHER TAXES 380

Documentary Transfer Tax • Estate and Inheritance Tax • Gift Taxes •

Miscellaneous Taxes

CHAPTER SUMMARY 382

IMPORTANT TERMS AND CONCEPTS 383

PRACTICAL APPLICATION 383

REVIEWING YOUR UNDERSTANDING 383

14 SINGLE-FAMILY HOMES AND MOBILE HOMES 388

Student Learning Outcomes 388

14.1 HOME CONSTRUCTION STYLES 389

Roof Styles • Architectural Styles

14.2 MOBILE (MANUFACTURED) HOMES 394

Types of Mobile Homes • Legal Requirements Related to Mobile Homes •

Violations of Business and Professions Code • Financing Mobile Homes •

Termination of Tenancy in a Mobile Home Park • Advantages of Mobile Home

Ownership • Disadvantages of Mobile Home Ownership • Converting a

Mobile Home to Real Property • Modular Homes

xii Contents

14.3 CONDOMINIUMS 398

Advantages of Condominium Ownership • Disadvantages of Condominium

Ownership • Basic Items to Check When Buying a Condominium

14.4 VACATION HOMES 400

Where You Buy Is Important • A Second Home as an Investment

14.5 SHOULD YOU RENT OR BUY? 401

Advantages of Renting and Disadvantages of Buying • Advantages of Buying and

Disadvantages of Renting

CHAPTER SUMMARY 403

IMPORTANT TERMS AND CONCEPTS 403

PRACTICAL APPLICATION 403

REVIEWING YOUR UNDERSTANDING 404

15 PART 1: A CAREER IN REAL ESTATE AND THE

DEPARTMENT OF REAL ESTATE LICENSE EXAMINATION

REQUIREMENTS 408

Student Learning Outcomes, Parts I and II 408

15.1 STRUCTURE OF THE REAL ESTATE INDUSTRY 409

Real Estate Agents • Real Estate Trade Associations • Professional Designa￾tions and Code of Ethics • Other Real Estate Employment

15.2 LICENSE REQUIREMENTS AND COMPETITION 412

Real Estate Salespersons • Real Estate Brokers • State Examination •

Continuing Education Requirements • The California DRE: A Summary • Real

Estate Licensees in California • How About a Part-Time Real Estate Job? •

Working Hours and Fringe Benefits • Realistic Picture

15.3 PERSONAL PREPARATION TO ENTER THE REAL ESTATE INDUSTRY 417

Personal Checklist • Questions to Ask Yourself Before You Enter the Real

Estate Business • Ending Note

15.4 SELLING BUSINESS OPPORTUNITIES 420

CHAPTER SUMMARY, PART I 421

IMPORTANT TERMS AND CONCEPTS 422

PRACTICAL APPLICATION 422

REVIEWING YOUR UNDERSTANDING 423

Contents xiii