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Great Expectations: Lawyers, Legal Fees and the Due Diligence Dilemma

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A Real Estate Zen Koan

About a week ago, an article in the Times found a positive consensus of opinion on the following question: "whether to hire a real estate lawyer." The query struck me with equal parts amazement and amusement. At a time when the complexity of a basic residential real estate transaction has increased geometrically, could the presence of an attorney in the process actually be optional? So I asked myself, how did we get here?

Deconstructing the Process

Think of the buyer's broker as the industry infantry. On the ground every day, showing apartments until the right set of metrics kicks in and the buyer finally says, "yes, I'll take it." It can be a long and arduous process. Once that decision is made, whether the apartment is $500,000.00 or $5,000,000.00, the drill is basically the same: the lawyers are selected, the deal sheet goes out with the transaction details, the seller's attorney drafts the contract and the buyer's attorney conducts "due diligence" prior to the execution of the contract and the delivery of the deposit. In that window that due diligence is conducted, the buyer's attorney has two significant roles: first, to make sure that the co-op or condo does not have any serious physical or financial problems, and more importantly, to educate the consumer on what he or she is getting into. The latter obligation being the tricky part.

Is it a Service or a Commodity?

As I discussed in "A Lawyer Is Not a Toaster," there is often a Costco mentality about selecting an attorney that makes no distinction between cost and quality. In great part, this is due to the Internet, the consumer's main source of information, which reduces all things to the lowest common denominator and the lowest price point. Further underlying that commoditization of legal services, is the unspoken message from the buyer's broker to the buyer's attorney: "Do all the due diligence you want, just don't kill the deal." That go-along-to-get-along philosophy focuses the brokerage community on attorneys who are "easy to work with" and who don't charge a lot for their services. As a result, the downward pressure on legal fees encourages many lawyers to do the minimum investigation that will allow the transaction to go forward. In other words, lawyers are urged to adopt a Hippocratic Oath of sorts: first, do no harm... to the deal. Here's an interesting equation on legal fees. If a lawyer charges a fee of $1,500.00 to handle a co-op or condo closing, that attorney will be required to close more than six transactions for the same four transactions that an attorney who charges $2,500.00 will be obligated to close. Question: Which attorney will allocate more time to each transaction? Which attorney is more likely to perform the due diligence that should be done and must be done to protect the buyer?

Lie of the Mind

So in order to carry out the due diligence obligations, the buyer's attorney, reviews the minutes, financials and governing documents, suggests an inspection, interviews the managing agent, negotiates the contract and dialogues with the buyer on any number of issues. Of course, all these components are to be completed in the shortest period of time possible to keep things moving and to get the deal done. The exhausted buyer, who has no doubt looked at a mind-numbing number of apartments, cowed by the possibility of more open houses and other offers, often uses this due diligence period to rationalize the purchase, no matter how bad the intelligence is about the building or the apartment. It's what I like to call the "real estate leap of faith. "

Measure Twice, Cut Once

In truth, there has never been a time when due diligence has been more important than right now. With an aging housing stock often requiring major capital improvements, escalating carrying costs, shoddy new construction, increased lender underwriting scrutiny, difficult Boards and a variety of other critical issues that must be explained and understood, a buyer must carefully consider whether all of the factors, when taken together, coalesce into a decision to go forward. Most of the time, the answer is "yes," but sometimes, it should be a very resounding "no."

A Decision That Can Cost...

At the end of the day, the best protection against buying into a troublesome transaction is your attorney. Considering the complexities, buyers should be less price sensitive and more concerned about quality when they decide on counsel. Remember, getting into a deal is a lot easier that getting out of one.