Letter to the editor: Does a broker acting as a principal need to disclose they are a DRE licensee?

Question: Does a licensed real estate broker acting as a principal in a transaction need to disclose they are licensed?

Answer: A real estate licensee who acts solely as a principal when buying or selling property need not disclose the existence of their real estate license; they are not acting in the capacity of a licensed broker (or a licensed agent employed by a broker) in expectation of a fee.

By receiving a fee, an agency is created, but not with whom you thought

Consider a broker selling their personal residence. The seller-broker, either representing themselves or retaining a real estate broker to market the property, has no expectation of receiving or sharing in a brokerage fee.

Further, a licensee (broker or agent) acting as a principal who intends to use their license status to share in the broker fees must, upon first inquiry of a prospective buyer or their agent for more property information, immediately disclose to all parties involved in the transaction their intention and may not later demand or much less collect a fee on the sale.

Simply put, a licensee who delays disclosure of their intention to share in the fee misrepresents the nature of their involvement in the transaction. When all parties involved are not immediately made aware of the seller’s role as licensee to claim a brokerage fee, the seller-broker has failed to fulfill the general agency duties they owe to all parties involved. It is, in a word, deception.

The rule:  Negotiating on one’s own behalf does not create an agency relationship. Thus, without an agency relationship the participation as a principal does not require a license — nor a disclosure the principal is licensed by the DRE.

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The deceptive owner-broker selling their property

When a licensee acts as a principal and shares in the fees paid on the transaction, the licensee subjects themselves to real estate agency duties and obligations they otherwise do not owe others in the transaction when acting solely as a principal.

In turn, when a licensed principal in a transaction participates in the brokerage fee, the amount of the fee received must be disclosed to all participants, no matter who pays the fee.

Consider a licensed broker who sells a property they own. The property is in violation of safety requirements for occupancy due to defects in the foundation known to the broker. The owner-broker does not tell the buyer about the defects.

Out of the gross sales proceeds the owner-broker receives on the sale, they instruct escrow to pay the owner-broker a brokerage fee. The owner-broker claims to be exclusively representing themselves —  although negotiating on one’s own behalf never creates an agency and does not require a license unless, of course, they are to receive a brokerage fee.

The buyer later discovers he must reconstruct the improvements due to the defective foundation. The buyer obtains a money judgment against the owner-broker as a licensee for breach of their general agency duty owed to all parties in a real estate transaction to disclose known property defects, defects that caused the buyer to take a loss.

The broker is unable (or unwilling) to pay the money judgment. The buyer seeks payment from the Department of Real Estate (DRE) Recovery Fund.

Recovery is received from the DRE Recovery Fund since the broker held themselves out as acting as a real estate broker in the transaction — they received a fee. The broker’s license is then suspended. Before the broker can reactivate the license, the DRE Recovery Fund must be reimbursed. [Prichard v. Reitz (1986) 178 CA3rd 465]

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Disclosure to lenders

Further, a buyer-broker acting as both principal and agent in a transaction must be sure to disclose their expectation of a fee — essentially a kickback to the buyer — to any lender providing purchase-assist financing to fund the transaction.

When a buyer makes a down payment on the purchase of a property, then receives a fee from the seller or the seller’s broker, they are essentially getting a portion of their down payment back — the kickback. It works the same as giving yourself credit toward the down payment using the brokerage fee.

Thus, the broker is paying a smaller down payment setting up a different loan-to-value (LTV) ratio for mortgage financing, unless disclosed to the lender — a fact that may well affect the terms of the mortgage when disclosed. However, the Federal Housing Administration (FHA) provides for a broker/agent to use the fee as a credit toward the down payment so long as the credit is disclosed, and the fee is a reasonable amount for the price paid.

Taxwise, conditions worsen: property acquired by the licensed broker is a capital asset subject to capital gains treatment when buying or selling. As a personal residence, profit up to $500,000 is exempt from taxation. However, to deliberately convert part of a capital investment on purchase — not taxed — into ordinary income (taxable in the year of the purchase) is an out of pocket cash payment for taking a fee when purchasing or selling property for your own account.

How to properly disclose a license

So, what ought a licensee acting as a buyer or seller to do when they use the existence of their licensing status to cut a better deal financially?

Upfront — the moment negotiations have begun — the licensee-seller must advise the other party’s broker of the amount of the reduced fee the other party’s broker will be paid. Thus, the only broker in the transaction will not be able to double dip on fees, pulling “both ends” of a 6% brokerage fee.

In turn, the licensee seller increases their net proceeds from the sale by using their licensee status to negotiate a reduce transaction fee while taking an additional profit at, well, capital gains rates, or maybe exempt from taxation entirely. Think IRC §1031 and sale of a personal residence exemptions.

When acting as a buyer, a licensee ought to simply reduce the price they offer by the amount of the fee they otherwise will receive as a buyer’s agent, setting the fee due the listing broker at the amount remaining. Thus, in both cases, the fee avoided and the price adjustment are a wash.

A principal engaging an agent on their own behalf to be involved in the negotiations — investigations and escrow — seems to obtain better results (including price) than when going it alone with no buffer between the principal-licensee and the other participant and their broker.

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