How do you rate the ethical standards of most residential real estate agents?
- Average (52%, 11 Votes)
- Low (33%, 7 Votes)
- High (14%, 3 Votes)
Total Voters: 21
The broker’s duties owed the client
The seller’s broker owes their client — the owner solicited by or employing the broker— a special fiduciary duty imposed by rules of conduct. These special fiduciary rules require the seller’s broker and their agents to diligently market the property listed for sale and locate a buyer.
As part of this fiduciary duty, the seller’s broker uses the knowledge and tools at their disposal — readily available — to arrive at their broker price opinion (BPO) for the listed property. Here, the purpose is to inform the owner about the property’s present market value a prudent, knowledgeable buyer would pay to own it.
On the other hand, the seller’s broker owes a customer — the prospective buyers — a general duty to deal fairly and honestly in negotiations such as property disclosures, evaluation and transactional agreements.
As an exception to the statutory general duty a seller’s agent owes to prospective buyers to disclose all material facts concerning the physical condition of a one-to-four unit residential property, is limited to the agent’s:
- prior knowledge about the property; and
- observations made while competently conducting their mandatory visual inspection of the unit(s).
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Types of conflicts — actual and perceived
An actual conflict may be readily recognized by all parties; for example, when a real estate broker negotiating a transaction represents two or more participants with competing interests in the transaction.
On the other hand, a perceived conflict may occur when a conflict does not exist, but a reasonable person might think it does.
Too often, the lack of comprehensive training on what conditions constitute a conflict of interest and when to disclose it results in brokers, and especially newer agents, erring on the side of nondisclosure, putting their broker fee, if not their license itself, at risk. [Calif. Business and Professions Code §10177(o)]
Generally, when a broker or their agent questions whether it is appropriate to disclose a potential conflict of interest to a client, they ought to disclose it. The existence of any concern is reason enough for a prudent broker to be prompt in seeking their client’s consent to the potential conflict. By timely disclosing a conflict of interest and obtaining consent, the broker immediately creates an honest, and honored working relationship with their client.
When representing a client, a conflict of interest arises and is disclosed to the client when the broker:
- has a pre-existing relationship with another person due to kinship, employment, partnership, common membership, religious affiliation, civic ties, or any other deep-rooted socio-economic context; and
- that relationship might hinder their ability to fully represent the needs of their client.
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Disclosure needed
A conflict of interest, whether patent or potential, is disclosed by the broker at the time it occurs or as soon as possible (ASAP) when the conflict arises. Typically, the conflict is pre-existing, arising prior to taking a listing from a seller or providing a buyer with property information, or referring the client to transactional services such as MLOs, inspectors, or escrow officers.
The disclosure creates transparency in the transaction and eliminates asymmetric awareness of information and conditions which might adversely affect negotiations or property values. It reveals to the client the bias or information held by the broker which, when disclosed, allows the client to take the bias or information into consideration in negotiations about contractual conditions and pricing.
The disclosure and consent do not neutralize the inherent bias. However, the disclosure does neutralize the element of deceit for lack of a participant’s awareness and opportunity to weigh the consequences of the conflict which, when left undisclosed, breaches the broker’s fiduciary duty.
Potential overlaps of allegiance or prejudice which cause a conflict a broker or their agent must disclose include when:
- the broker or their agent holds a direct or indirect ownership interest in the real estate, including any ownership interest in a limited liability company (LLC) or other entity which owns or is buying, leasing, or lending on the property;
- an individual related to the broker or one of their agents by blood or marriage holds a direct or indirect ownership interest in the property or is the buyer;
- an individual with whom the broker or a family member has a special pre-existing relationship, such as prior employment, significant past or present business dealings, or deep-rooted social ties, holds a direct or indirect ownership, leasehold, or security interest in the property or is the buyer;
- the broker or their agents concurrently represent the opposing party, a dual agency situation; or
- the broker or their agent possess an unwillingness to work with the opposing party, or others, or their brokers or agents in a transaction.
Similarly, the referral of a client to a financially controlled business owned or co-owned by the broker needs to be disclosed by use of an affiliated business arrangement (ABA) disclosure. [See RPI Form 519]
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Disclose ownership interests
A buyer’s broker is to disclose to their buyer the nature and extent of any direct or indirect interest the broker, an agent of the broker, or a family member has in any property presented to the buyer.
For example, consider a buyer’s broker who shows the buyer several properties, one of which is owned by the broker and others, vested in the name of an LLC. The broker does not inform the buyer of their indirect ownership interest in the property.
The buyer later decides to purchase the property owned by the LLC. The broker does not prepare a comparative market analysis (CMA) or a BPO on the property for a presentation and review with their buyer. An offer is prepared on a purchase agreement with a dual agency disclosure stating the broker is the agent for both the buyer and seller. The offer is submitted to the LLC. [See RPI Form 159]
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Brokerage Reminder: Disclosing a conflict of interest – the counterpoint mitigating a bias
The broker, aware the buyer will pay a higher price for the property than the initial price offered by the buyer, presents the buyer with a counteroffer from the LLC at a higher selling price. The buyer accepts the counteroffer.
Here, the broker has a duty to promptly disclose their ownership interest in the property to the buyer the moment the conflict arises – at the moment the buyer expresses an interest in buying the property. The conflict of interest in the broker’s ownership is a material fact requiring disclosure since the buyer might alter their decisions concerning acquisition of the property or representation based on the disclosure.
As a result of the nondisclosure of the broker’s conflicting involvement in the property’s ownership, the buyer can recover any fees received by the broker on the transaction. Further, the buyer’s recovery includes any increase in the price paid under the counteroffer or above the property’s fair market value (FMV).
Had the buyer known the broker held an ownership interest in the property when it was first presented, the buyer might have negotiated differently when setting the price and terms for payment, or retaining the broker’s services. Further, the broker would have prepared and reviewed a CMA and BPO with the buyer as a client interested in the property.
Disclose a relationship personal to the transaction
A seller’s broker must disclose their direct or indirect interest to own, lease or lend on the seller’s property. Thus, the broker discloses when a family member, a business owned by the broker or by their agents or relatives, or any other person holding a special relationship with the broker is considering acquiring an interest in the seller’s property. [See RPI Form 527 §3.6]
For example, a broker enters into a listing agreement for the sale of property with the seller. The listing is solicited by preparing a CMA and BPO for the property and reviewing them with the seller.
As previously known to the broker but not the owner, the broker and others affiliated with the broker have determined they want to acquire the property. The broker, having taken the employment under the listing, prepares and submits an offer to purchase the property. The buyer under the purchase agreement is the broker’s brother-in-law.
The purchase agreement calls for the broker to receive a fee on closing. Neither the dual agency nor the conflict that existed when the CMA, BPO and listing agreement were submitted and reviewed with the seller are declared in writing, much less orally.
No disclosure is made to the seller who is unaware the buyer is the broker’s brother-in-law.
The broker then opens two escrows to handle the transaction. The first escrow facilitates the sale and transfers the property from the seller to the broker’s brother-in-law.
The second escrow is not disclosed to the seller. Its sole purpose is to transfer title to the property from the brother-in-law to an LLC funding the purchase price. The broker holds an ownership interest in the LLC.
Both escrows close and the broker receives their fee.
The seller discovers the buyer was their broker’s brother-in-law and that the true buyer was an entity partially owned by the broker. The seller demands a return of the broker fee, claiming the broker had a conflict of interest which breached the fiduciary duty they owed to the seller since it was not disclosed; the seller was unaware and did not consent.
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DRE Hot Seat: Broker fails to supervise or disclose an overt conflict of interest
In this instance, the broker is not entitled to retain the broker fee they received from the seller. Further, the seller is entitled to recover any property value at the time of the sale in excess of the price they received.
Alternatively, the seller may set the sale aside due to the failure of the broker’s agency with the seller and the conflict of interest known to the buyer.
A broker cannot act for more than one party in a transaction, including themselves, without disclosing their dual agency or conflict of interest and obtaining the client’s consent at the time the conflict arises. [Business & Professions Code §10176(d); See RPI Form 527]
The moment the conflict was known by the broker to exist was before the preparation of the CMA and BPO on the seller’s property. Thus, that bias entered the analysis of comparable properties weighing the value of amenities enjoyed by the various properties, including the subject property of the seller.
Further, the BPO valuation was set knowing an offer to purchase designed for the broker to acquire an interest in the property would be submitted. Thus, the timing for the prompt disclosure to the seller was at commencement of the solicitation for the listing hiring the broker to locate a buyer.
Also, a seller’s broker has an affirmative duty to disclose to the seller their agency or other conflicting relationship they might have with the prospective buyer. The affirmative duty requires a voluntary disclosure of conflicts of interest since the seller is not required to ask whether the broker has a conflicting relationship with the buyer (or is the true buyer themselves).
Proper handling of this conflict to acquire an interest in the property is best achieved by submitting an offer to purchase the property, together with the CMA and BPO. Also, no fees paid by anyone involved, no broker acting as an agent in the transaction, and thus no agency duties arise as owed to the seller — a principal to principal situation requiring only honesty in relaying information. [RPI form 159]
Further, failure to disclose a broker’s personal interest as a buyer of their client’s property when they are also acting as an agent representing the seller constitutes grounds for discipline by the Real Estate Commissioner. [Whitehead v. Gordon (1970) 2 CA3d 659]
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The appraiser’s conflict of interest
Consider a lender ordering an appraisal from an appraisal management company (AMC) to determine the value of an SFR property that will be security for a mortgage a homebuyer or homeowner has applied for. Thus, a federally controlled consumer mortgage is involved, which calls for a licensed appraiser when a property evaluation is required.
Most often, the lender owns the AMC which as a mandated intermediary appoints an appraiser to prepare an evaluation of the property. This makes the lender the employer via their control over the entity that actually employs the appraiser at the request of the lender, a dance team which gives the lender near total oversight of the evaluation process as the “money man.”
Here, the appraiser must be licensed as an appraiser by a state agency (in California, the Bureau of Real Estate Appraisers or BREA). Conversely, a real estate licensee, by legislation, is not an appraiser, though they prepare BPOs in the same manner as does an appraiser. Thus, the employment of a DRE licensee to prepare a BPO does not arise in the context of consumer mortgage origination.
Rather, the broker preparing a BPO for a lender arises when employed by a mortgage lender or servicer to evaluate property during a foreclosure or as real estate owned (REO) property the lender needs to sell, but not for consumer mortgage originations.
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The conflict a licensed appraiser faces when preparing a mortgage origination evaluation is that the lender will not likely employ this AMC (or the AMC employ the appraiser) again when the appraiser does not subjectively figure out how to regularly set their evaluation of properties to match the price the buyer has agreed to pay. Sufficient property value is a prerequisite for loan-to-value (LTV) analysis required for the lender to accept the property as security and permit the lender to make the requested mortgage.
Of course, no appraiser or appraisal company may have an interest, financial or otherwise, in the property being appraised.
Further, a lender who is aware of a violation of appraiser independence is prohibited from using that appraisal report. An appraisal is used to determine whether or not the lender is allowed and on what terms the lender may approve an application for a mortgage.
The operative word here for the tainted appraisal is “aware.” With the AMC as the intermediary between the lender and the appraiser, the lender is not actually aware the appraiser’s evaluation is influenced by the appraiser’s livelihood being dependent on pleasing the lender.
Still, while appraisal independence may be avoided on the surface, here there is always a direct conflict of interest for the appraiser. As evidence, nearly half of appraisal valuations in markets of fast rising or fast falling prices come in at exactly the purchase price agreed to by the buyer in their purchase agreement (no coincidence, certainly), according to the Federal Housing Finance Agency (FHFA).
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The Appraisal Foundation urged to revise their Ethics Rule for appraisers
Managing conflicts of interest
The preferred way for brokers preparing a BPO to manage conflicts of interest is to avoid them in the first place. Brokers can take reasonable steps to avoid bias or prejudice by steering clear of property transactions involving family members, LLCs or properties with which they have business or ownership interests.
However, when a conflict of interest arises, the broker needs to promptly and fully disclose the conflict to the client requesting the BPO. To address the conflict, the broker will offer the client potential solutions upon delivering the disclosure, including retaining a different broker. [See RPI Form 527]
However, even when no actual conflict of interest may exist for an agent preparing a BPO, they may find themselves influenced by outside factors.
For example, an agent may be influenced by media reports that tell a story of rising prices, prompting the BPO to produce a dollar figure higher than the data actually suggests.
Conversely, the broker may be improperly influenced by neighborhood characteristics or demographics for which they have a negative attitude and thus produce a below-value BPO.
To avoid bias, a broker’s BPO sticks to the objectivity of data found in the broker’s comparative market analysis (CMA).
The CMA is a worksheet used when establishing a property’s value based on prices recently paid to acquire ownership of properties comparable to the subject property. The CMA is used to note the brokers observations on a visual inspection of the comparable properties about features distinguishable from the subject property, and the dollar adjustments needed to correct for its greater or lesser value than the subject properties. [See Chapter 5; RPI Form 318]
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