While my blogging partner, Mike Widener, is an attorney, I am not; I am but a lowly associate broker, and so my legal opinion is worth even less than his! So take this article with a grain of salt. Definitely do NOT depend on it for legal advice – this is just my take. And of course, this article is specific to Arizona.
Many Real Estate investors I talk with make use of bird dogs. Recently, I ran across several agents who claim to be using them. Bird dogs are usually unlicensed individuals who find deals for the principal in a transaction. Further, investors usually pay bird dogs a finder’s fee.
So what does the law say about that? Specifically, ARS 32-2101 defines what a “Real Estate Broker” does (excerpted):
In this chapter, unless the context otherwise requires:
47. “Real estate broker” means a person, other than a salesperson, who, for another and for compensation:
(a) Sells, exchanges, purchases, rents or leases real estate or timeshare interests.
(b) Offers to sell, exchange, purchase, rent or lease real estate or timeshare interests.
(c) Negotiates or offers, attempts or agrees to negotiate the sale, exchange, purchase, rental or leasing of real estate or timeshare interests.
(h) Advertises or holds himself out as being engaged in the business of buying, selling, exchanging, renting or leasing real estate or timeshare interests or counseling or advising regarding real estate or timeshare interests.
(i) Assists or directs in the procuring of prospects, calculated to result in the sale, exchange, leasing or rental of real estate or timeshare interests.
(j) Assists or directs in the negotiation of any transaction calculated or intended to result in the sale, exchange, leasing or rental of real estate or timeshare interests.
(n) Engages in any of the acts listed in subdivisions (a) through (m) of this paragraph for the sale or lease of other than real property if a real property sale or lease is a part of, contingent on or ancillary to the transaction.
A close reading of this indicates that a broker does pretty much what you expect – buys and sells or negotiates Real Estate transactions for others. Of particular interest is item (i), which indicates that a broker is also the person who gets leads.
This is important because of the next section (excerpted):
32-2122. License required of brokers and salespersons
A. This article applies to any person acting in the capacity of a:
1. Real estate broker.
B. It shall be unlawful for any person, corporation, partnership or limited liability company to engage in any business, occupation or activity listed in subsection A without first obtaining a license as prescribed in this chapter and otherwise complying with the provisions of this chapter.
D. Any act, in consideration or expectation of compensation, which is included in the definition of a real estate, cemetery or membership camping broker, whether the act is an incidental part of a transaction or the entire transaction, constitutes the person offering or attempting to perform the act of a real estate broker or real estate salesperson, a cemetery broker or cemetery salesperson or a membership camping broker or a membership camping salesperson within the meaning of this chapter.
So this section seems to say that we have to have a license to do anything falling under the definition of “Broker”; in particular, we cannot find leads for a principal and be paid for it, unless we are licensed. The law seems pretty black and white on this. So how do investors legally pay bird dogs? My feeling is that in most instances, they just pay them and hope not to get caught.
There are a few ways that a bird dog can be legally paid, however. One way, perhaps the “cleanest” way, is for the bird dog to be the initial purchaser of the property; they would write a purchase contract as “Bird M. Dog and/or assignee”, and get the contract signed by the seller. Then, the principal would pay the bird dog an assignment fee, purchasing the contract from the bird dog. Nothing wrong with that! However you might want to ask your tax accountant about the implications here – Is there a step up in the buyer’s basis as a result of the assignment cost? And what happens with any representations and warranties – do they flow from the assignor (Bird Dog) to the assignee (Principal) ? Good questions, I do not have the answers.
A second possible way is for the bird dog to again write the contract, but be a direct party to the transaction throughout: “Bird M. Dog and Joe Principal” are the purchasers, and a separate compensation agreement between the two can be arranged. The question here is, can a separate compensation agreement be made between the two parties without it being considered a commission? And, is a side agreement really needed — to make sure that there is no misunderstanding later that Mr. Dog and Mr. Principal are co-tenants?
A third way is for the bird dog and the principal to form a partnership (or LLC or other entity) which is then the purchaser of the property, and the partners share in sales. Perhaps Mr. Dog has to put in $100 as his contribution, and for his work in finding the property, his compensation is the return of his capital plus $1000. Does this work? Maybe, ask a lawyer!
What must happen is that the bird dog needs to be a party to the contract; then they are not “practicing Real Estate without a license”, instead they are one of the principals in the deal. But let’s suppose for a moment that they are not a party, and just get paid. What’s so bad about this? Is the public really harmed, and, does the State really care? Apparently they do. There was a case where a Real Estate brokerage was paying a monthly fee to a mortgage lender so that the lender would forward all their mortgage leads to the Broker. The fee was not based on whether or not a transaction would close, it was a flat monthly fee. The broker was substantially fined, but not by the State; this was found to be a RESPA violation. RESPA is the Real Estate Settlement Procedures Act, and disallows Real Estate licensees from making payments to unlicensed individuals; the fine is $10,000 per occurrence. So not only can the State go after the recipient of the finder’s fee for unlicensed activity, but HUD can go after the Principal (if they are licensed).
My advice? Make sure your bird dog is on the contract as a principal. Even then, talk to a good attorney and make sure what you are planning is in compliance. And, don’t forget about the potential tax implications.