USA: Regional Real Estate 2018 Comparisons

Last Updated June 08, 2018

Contributed By Burch & Cracchiolo

Law and Practice

Authors



Burch & Cracchiolo has a primary real estate team consisting of 11 attorneys. Its key practice areas are land use and zoning, real estate law, real estate litigation, real estate financing, real estate transactions and real estate leasing. The firm has an extensive history representing local, national and international clients in all facets of real estate transactions and related litigation, with experience in acquisition, development and zoning of large commercial, residential and planned development projects, as well as build out and lease up of shopping centres, commercial and industrial facilities, and office buildings. Burch & Cracchiolo is also skilled in representing local and national lending institutions in the negotiation, preparation and enforcement of financial documentation for large commercial transactions.

For transactional attorneys, familiarity with statutory and case law regarding contracts, real estate and leaseholds is important, as well as a facility in translating letter of intent descriptions into understandable contract language. Some tax law and bankruptcy law awareness and negotiation skills also are important. Real estate litigators should have similar familiarity with statutory and case law and should also be skilled at advising their clients about the potential costs and benefits of different approaches to dealing with issues, including the judicial alternatives of mediation and arbitration. 

In the last 12 months an insufficient supply of affordable residential units has resulted in continuing increased interest in new housing starts. Commercial, industrial and multi-family developments also continue to strengthen. There has been an increase in in-fill projects and smaller developments versus developments in prior economic cycles where each housing project often consisted of hundreds of single family homes. Lot sizes have also significantly decreased as projects move closer to urban development.

A federal bill known as the Tax Cuts and Jobs Act retains the current US Internal Revenue Code Section 1031, Like Kind Exchange Rules for real property but repeals them for personal property, such as artwork, auto fleets, heavy equipment, etc. The Act retains the current recovery periods for non-residential real property (39 years), residential rental property (27.5 years), and qualified improvements (15 years).

The Act creates a new tax deduction of 20% for pass-through businesses. For taxpayers with incomes above certain thresholds, the 20% deduction is limited to the greater of: 50% of the W-2 wages paid by the business or 25% of the W-2 wages paid by the business, plus 2.5% of the unadjusted basis, immediately after the acquisition of depreciable property (which includes structures, but not land). Estates and trusts are eligible for the pass-through benefit. The 20% pass-through deduction begins to phase out beginning at USD315,000 for married couples filing jointly.

An individual or entity can own real estate in fee simple. Two or more unmarried people may own property as tenants in common or as joint tenants with the right of survivorship. Entities may own property as tenants in common. Married people can own property together as community property, or community property with the right of survivorship; or in some instances one spouse may own the property independent of the other spouse as a sole and separate property. Arizona does not permit property to be owned in blind trusts (when transferring property into or out of a trust, names and addresses of trust beneficiaries must be disclosed). Arizona does not recognise tenancy by the entireties. Easements, leasehold interests and licences in land are also recognised as real property interests. 

The Statute of Frauds requires that transfers of real estate interests be in writing, ie, a deed. Deeds must contain the names of sellers and buyers and the legal description of the property to be transferred. A seller’s signature must be notarized. Executed deeds should be recorded with the County Recorder of the county where the property is located. Arizona is a “notice” state (a subsequent bona-fide purchaser prevails over an earlier purchaser if the earlier purchaser’s deed was not recorded and the subsequent purchaser did not know of that earlier transfer). There are no special laws for specific types of real estate. A completed and notarized affidavit of value must accompany the deed to be accepted for recording unless a specific statutory exemption applies and is indicated on the deed.

Real estate title is transferred when a properly executed deed is delivered to a grantee. The most common deed types are Warranty Deed (the title is warranted against all acts or omissions during the time the grantor owned the property and all prior periods of time); Special Warranty Deed (the title is warranted only with respect to acts or omissions occurring while the grantor owned the property); and Quitclaim Deed (the grantor is conveying whatever interest the grantor may have without warranting that the grantor has any title at all). Regardless of the type of transferring deed it should be recorded with the County Recorder of the county where the property is located. The deed must contain the full legal description of the property, reference to a tax parcel number or street address is not sufficient. A completed and notarized affidavit of value must accompany the deed to be accepted for recording unless a specific statutory exemption applies and is indicated on the deed.

Lawyers do not typically perform due diligence in Arizona real estate transactions, although a buyer might request lawyer assistance on some aspects, particularly with zoning histories or assistance with title or survey reviews. In a home-purchase transaction, lawyers are rarely used. Arizona law requires that a residential buyer receive a Seller’s Property Disclosure Statement disclosing important facts about the property, and a buyer might typically hire an inspector to perform an inspection as part of the due diligence. Most transactions will also involve title insurance and a buyer will receive a title report allowing the buyer to examine any deed restrictions, covenants, liens, encumbrances or other recorded interests related to the real property. A transaction for undeveloped land, bulk sales of residential property, multi-family property, industrial property, hotels, commercial property and the like typically will have a higher level of due diligence. Such due diligence is often conducted by the client’s in-house team as assisted by the client’s consultants such as engineers, planners, architects, environmental consultants, archeological consultants, legal counsel and so on. In addition to receiving a title report with copies of relevant recorded documents (as with a residential transaction), a buyer will frequently contractually require the seller to provide available historical documents regarding the property, such as any recent surveys; recent real property tax bills; any prior soil or drainage studies; any environmental reports; copies of any leases affecting the property; and any notices of violations of any governmental law or regulations. Such buyers may also contract for a new survey, have a specialist perform an environmental assessment as to exposure to any hazardous materials, and/or have engineering or other testing done. If a new use is contemplated, due diligence may also include investigation of zoning and land entitlement issues.

Buyer representations are typically limited to authority to enter into an agreement without violating any law or other agreement and, if an entity, that the buyer is in good standing and authorised to execute and perform the contract. Seller representations typically include the same categories as buyer representations and additionally (as negotiated) may provide warranties as to the environmental condition of the property; absence of liens or encumbrances not disclosed on the title report; notice of any existing or threatened regulatory violations; any third-party possessory rights as to the property; maintenance of condition before closing; and other matters of importance to the buyer. Representations and warranties of the seller are generally negotiated during drafting of the purchase and sales agreement in commercial sales transactions, with individual dwelling unit residential transactions typically using purchase and sale agreement forms created and/or approved by the Arizona Realtors’ Association. Any negotiated provisions would be addressed in an addendum to such form agreement. In the event a seller misrepresentation is discovered prior to the closing, the buyer may be able to postpone its performance and the closing until the seller cures the misrepresentation or the buyer may be able to rescind the contract. Generally the purchase and sale agreement will set forth the buyer’s rights with respect to a refund of any earnest money deposit, or other damages and/or remedies which may be available to the buyer in the event that a misrepresentation is discovered prior to closing. With respect to a misrepresentation discovered after the closing, depending upon its materiality or significance to the buyer’s ability to use the property, a buyer may be able to rescind the contract and receive back its payment upon conveying the property back to the seller, but it is more likely the buyer will sue for damages, which may be the cost of correcting the problem or the difference between the value of the property received as compared to its value if it had been as represented.

Foreign investors should be aware of applicable tax laws, particularly with respect to their future plans to sell a property. One important tax law is the Foreign Investment in Real Property Tax Act (also see Section 1445 of the Internal Revenue Code). Under this Act foreign sellers may be required to withhold up to 15% of the purchase price for federal income taxes. Foreign investors should also be aware of requirements contained in the rules and regulations of the Office of Foreign Asset Control, Department of the Treasury (including Executive Order No 13224, 66 Fed. Reg. 49079) which restrict transactions with persons or entities associated with nations on a designated terrorist list. 

There are numerous federal and state statutes that may impose liability with respect to environmental contamination. One primary federal act is the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) (the Resource Conservation and Recovery Act (RCRA) is another federal act) and it imposes strict liability on present and prior owners. Between a buyer and seller, however, responsibility may be allocated in their contract, so that if the buyer is held strictly liable for clean-up by a governmental entity, the buyer may have recourse against the seller for reimbursement. Typically, if the seller has owned and operated the property for a significant period of time, a buyer may reasonably expect the seller to give a warranty as to the environmental condition and agree to indemnify for later discovered contamination. That is a negotiation item, though, and where the seller has merely owned the property without operating on it, such as an acquisition by a foreclosure upon a prior owner, a seller may disclaim any such warranty and require the buyer to receive the property “as is,” including any environmental defects not discovered during the due diligence period.

Buyers can ascertain the permitted uses of a parcel of real estate in several ways. Most cities and counties can provide zoning maps that detail the zoning classification(s) of the subject property. Many cities and counties have a planning department where such information including additional restrictions or requirements imposed by zoning “conditions of approval” (aka “zoning stipulations”) may also be obtained. If title insurance is being obtained as part of the transaction, most policies may include, for a fee, a zoning endorsement which will identify the property’s zoning designation and ensure that it has such zoning designation. A title insurer zoning endorsement may be costly. Sufficient time should also be built into the transaction to allow the title insurer to adequately research the property’s history. Buyers should also speak with a qualified zoning attorney about any uncertainties regarding the zoning or permitted uses of the property. Arizona law does allow specific development agreements with relevant public authorities, such as cities, to facilitate development projects. Whether a particular city will enter into such development agreements, and the types of obligations for which a city will execute a development agreement, are matters of policy determined by each city. Contract zoning via development agreements is not lawful in Arizona.

The government has the ability to take land or interests in land (such as easements) through the process of condemnation or eminent domain. Taking is only valid if the government entity takes the land for a legitimate public use; the taking is necessary for that use; and just compensation is paid to the landowner. The process begins when the government entity appraises the property and makes an offer to purchase. The owner then has two options: accept the offer or refuse the offer. If the owner accepts the offer the government entity pays the agreed price and title is transferred. If the owner refuses the offer, the government entity initiates formal eminent domain proceedings and the owner can challenge with its own evidence the value of the property taken and/or raise claims for additional damages caused by the taking.

Changes in the ownership of an entity, which entity owns real property, do not typically involve any deed or other conveyancing instrument with respect to real property and are generally not treated as transfers of the real property interest by taxing authorities. Arizona does not have any specific transfer or stamp taxes with respect to real estate transactions. There are nominal fees charged to record real estate documents with the County Recorder (typically USD15 for a deed, USD2 for its accompanying affidavit of value, and USD25 for a mortgage or deed of trust). The buyer will typically pay these, although allocation could be negotiated. Real property taxes, in contrast to taxes on a real property transaction, are assessed annually and paid in two semi-annual instalments. That liability is typically allocated pro-rata to the date of closing as part of the transaction. Following a sale, because the purchase price is required to be disclosed within the affidavit of value, the assessing authority may take that into account at the time of the next annual assessment. 

Foreign investors must follow all the rules and regulations that apply to any buyer in the US or Arizona. Foreign investors may be required to have access to a US bank account. The Foreign Investment in Real Property Tax Act (also see Section 1445 of the Internal Revenue Code) may require sellers to withhold up to 15% of the purchase price for federal income taxes.

Commercial properties are financed in numerous ways, including from banks, insurers, hedge funds or other private institutions. Lenders typically secure their loans through a mortgage or a deed of trust (the latter instrument permitting, at the lender’s option, either judicial foreclosure as with mortgages or a non-judicial foreclosure pursuant to a specific statutory scheme) encumbering the buyer’s interest in the property. A deed of trust is most commonly used. The mortgagor deed of trust is treated as conveying an interest in real property (so the same law as to notice governs priority) and recorded in the office of the County Recorder in the county where the property is located. The initial mortgage is superior to any mezzanine loans used to fill any gaps not covered by the initial loan. This makes mezzanine loans riskier and as a result they typically have higher interest rates. In transactions for acquisitions of large real estate portfolios, it is not uncommon to have multiple lenders participating with one lender being the lead lender for servicing and monitoring of the loan. The lenders will enter into inter-creditor agreements to govern their relationship within the loan.

Traditional mortgage lenders typically hold senior priority security interests, created through a mortgage or deed of trust, while any mezzanine loans are typically junior or subordinate in priority to the security interest of the first recorded mortgage. 

Foreign investors must follow all the rules and regulations that apply to any buyer in the US or Arizona. Foreign investors may be required to have access to a US bank account. The Foreign Investment in Real Property Tax Act (also see Section 1445 of the Internal Revenue Code) may require sellers to withhold up to 15% of the purchase price for federal income taxes.

There is no federal excise tax applicable to the recordation of real estate transfers. Arizona does not have any specific transfer or stamp taxes with respect to real estate transactions. There are nominal fees charged to record real estate documents with the County Recorder (typically USD15 for a deed, USD2 for its accompanying affidavit of value, and USD25 for a mortgage or deed of trust). 

There are no laws in Arizona that must be complied with before an entity can give valid security over its real estate assets. 

A mortgage may only be foreclosed by a judicial action. A deed of trust permits a lender to elect either judicial or non-judicial foreclosure procedures. If the court orders a foreclosure, the property is sold at public auction to the highest bidder. Non-judicial foreclosures do not involve a lawsuit. Notice of the default and the setting of a foreclosure sale (no less than 91 days later) must be sent to all persons or entities claiming any interest in the property (including taxing authorities). Arizona statutes governing trustee sales must be strictly adhered to as to the notice, publication, and posting of the sale. The sale is conducted by the trustee (whose eligibility is set by statute) designated in the deed of trust. At the time appointed for the sale, the property is sold to the highest bidder. The lender may bid at the sale and apply as a credit part or all of the unpaid indebtedness of the borrower. With respect to some property (generally non-residential property), the lender may still have a claim for deficiency if the amount for which the secured property is sold is insufficient to satisfy the entire indebtedness. There is a separate procedure, requiring strict adherence, for a lawsuit to establish such a deficiency. 

It is possible for existing secured debt to become subordinated to newly created debt by contractual agreement. Typically such an agreement would be recorded with the County Recorder as with deeds, mortgages and deeds of trust. 

A lender that acquires the title to a real property by enforcing its security interest and foreclosing may become liable as any other owner is subject to liability under environmental laws. This is one reason lenders may require environmental assessments prior to lending funds, or prior to enforcing its security interest in any real property. Lenders may also purchase insurance that addresses pollution of the property or require the borrower to acquire insurance.

Typically, a borrower that becomes insolvent begins federal bankruptcy proceedings. Pursuant to federal law, there is then an automatic stay order suspending any enforcement actions, such as a mortgage foreclosure or non-judicial foreclosure. As a result, most foreclosure actions will have to wait until either an order is obtained lifting the restrictions of the automatic stay as to that lender’s enforcement activity or until after the bankruptcy proceedings conclude (assuming the lender’s interest or claim is not resolved within the bankruptcy proceedings). 

Arizona has approximately 91 municipalities and 15 counties plus tribal governments that regulate development on Native American reservations. Each jurisdiction has its own particular set of codes or regulations, often referred to as the “Zoning Ordinance”, that address the design, appearance and method of construction of new and refurbished buildings within the city. Any re-zoning or variance to the Zoning Ordinance requires a developer to seek specific approval from the city, county or tribal government, and such approval may include additional terms and conditions to allow the developer to secure such relief from the established Zoning Ordinance.

Land use is regulated by governmental regulations such as city zoning ordinances, general and specific plans, and property-specific zoning, use permit, variance, site plan, subdivision plan and other entitlements. Land use and zoning decisions are often made by city councils following public hearings where developers, neighbours and others may present evidence regarding the anticipated effects of the proposed changes. 

Entitlements typically start with obtaining feedback from municipal planning staff to gauge what staff require to get an approval recommendation. Ultimately entitlements require notice to surrounding property owners and a city council review. However, the level of review and amount of notice depends upon the particular development and the particular jurisdiction. For example, if a developer’s project is permitted by the city’s Zoning Ordinance and is not restricted beyond a typical Ordinance by site-specific zoning conditions (aka stipulations), the developer need only apply for site plan approval while unpermitted uses require higher levels of review. Third parties, such as citizens of the neighborhood to be affected and owners of competing properties, are allowed to attend the hearings or reach out to city officials. While the citizen’s opinions or objections do not directly affect the fate of the developer’s application, city officials are politically elected and may take them into consideration when making their decisions.

Some types of decisions are particularly set forth in a statute as reviewable by statutory special action (roughly equivalent to a judicial appeal) in the superior court (the trial court). For example, in some cities a Board of Adjustment hears appeals of the zoning administrator’s decisions regarding variances, use permits, interpretations and enforcing the city’s Zoning Ordinance. If dissatisfied with the decision of the Board of Adjustment, a specific statute permits a party to bring a complaint for special action in the superior court. For zoning or entitlement decisions made by city councils, however, there is no specific statutory authority and those are reviewable only by a discretionary special action (called extraordinary writs in some jurisdictions) to the superior court. A statutory special action is an appeal by right; a discretionary special action is an appeal that the courts may accept or decline in its discretion. In either event, the review is based upon the record made in the municipal forum and is not like a new trial with additional evidence. Superior court special action decisions are themselves then eligible for further review by an appeal to the court of appeals. Those who are opposed to a city counsel’s legislative action (such as approving a re-zoning, a general plan amendment or other legislative decisions) may attempt to reverse those approvals by referendum.

It is not necessary to enter into agreements with local or governmental authorities etc to facilitate a development project. However, development agreements, pre-annexation agreements, incentive agreements, and the like, are sometimes executed with a city to memorialise some public improvements being provided or constructed by a developer in exchange for some accommodation or special consideration the developer is to receive in return. As noted previously, contract zoning is unlawful in Arizona.

In Arizona, it is typical for a city’s Zoning Administrator to be charged with enforcing a city’s Zoning Ordinance. The Zoning Administrator has the authority to prevent the construction, repair, alteration, etc of any building or structure that would violate the ordinance and other property-specific entitlements. Furthermore, any building or structure that is not in compliance with the applicable Zoning Ordinance may be ordered to be corrected or abated. 

There are a number of different kinds of entities commonly used to acquire real estate. Some of the more common entities include limited liability companies, general partnerships, limited partnerships, corporations, and trusts. It is common for a particular real estate asset to be owned by a single-asset limited liability company, which itself may be owned by another entity as a holding company for multiple such investments. Sometimes tax considerations or lender requirements will dictate the type of entity for investment ownership.

Provided capitalization and entity legal formalities are properly recognised and documented, corporations and limited liability companies may both shield individual owners from personal liability. Owning individually or as a general partner (or as a member of a joint venture) does not shield from personal liability. In a limited partnership, any general partner remains personally liable, but limited partners should be shielded. A revocable trust is generally treated the same as individual ownership. An irrevocable trust may be able to shield trustees from personal liability.

The expenses of formation and maintenance vary. Individual ownership and ownership as a general partnership may not involve anything additional to a deed. Persons owning via a general partnership would be prudent to have a partnership agreement, but there are no filing requirements for those. Corporations, limited liability companies and limited partnerships are all statutory creations which require particular types of organizational documents to be filed (and published) with specific governmental agencies. A disadvantage of corporations is that there is an annual filing requirement. In addition to the minor expense, the consequence of not filing annually can be administrative dissolution of the corporation, and the annual report contains certain identifying information with respect to owners, officers and directors. An advantage of limited liability companies and limited partnerships is that there are no annual reporting requirements after formation and less information is provided in a public record as to ownership.

There is a USD50 filing fee related to creating a new Arizona corporation or limited liability company. Arizona limited liability companies thereafter are not required to pay an annual fee or prepare an annual report. Limited partnerships may be formed upon filing a certificate of partnership with the Arizona Secretary of State for a fee of USD10 (plus USD3 for each additional page). Foreign entities may file to transact business in the State of Arizona by filing an Authority to Transact Business form for a fee of USD20 (plus USD3 for each additional page). No adverse state-specific tax regarding flow-through entities exists at state level.

All entities must comply with applicable state and federal laws, such as tax laws. Some entities must also comply with regulations set forth by a particular governing body. For example, corporations and limited liability companies are regulated by the Arizona Corporation Commission. Arizona recognises manager-managed and member-managed limited liability companies. Each must file articles of organization with the Arizona Corporation Commission. It is recommended that each type of entity have an executed operating agreement (although this is not statutorily required) which does not have to be filed with the state, but which will often be required by the title insurer in any transaction for the acquisition or sale of a property, and by a lender for any financing. Limited partnerships fall under the Arizona Secretary of State while general partnerships do not fall under any regulatory body. 

There are several arrangements that allow an entity to occupy and use real estate for a limited period of time without buying it. For example, there are leases, occupancy agreements and licence agreements. Under a lease, the owner of the property, or a landlord, retains all ownership interest in the property while a tenant receives a possessory right to the property for an agreed-upon duration, typically a period of years. Occupancy agreements are created between a buyer and seller of a property when the buyer wishes to occupy the property prior to the close of escrow. License agreements are utilised when a person or an entity wants access to a property for a specified purpose, but does not require exclusive possession as lessees entering into a lease. There are also temporary easement rights which may be entered into to allow access over property for the limited purpose of constructing improvements (such as utilities and shared driveways) or maintaining improvements. 

There are several types of commercial leases, including gross leases and net leases. Under a gross lease, a tenant pays a flat rent while the landlord pays for various additional costs including taxes and maintenance. Under a net lease, the tenant pays the rental amount plus at least some of the other costs incurred in the operation and maintenance of the property. Modifications of both types of leases are also common. With respect to unimproved land, sometimes the tenant will rent for a very long period of time via a ground lease, permitting the tenant to construct the improvements and then get the use of those improvements over the period of the lease. 

Because lease agreements are contracts, many of the terms can be negotiated between a landlord and tenant as they see fit. However, Arizona does have statutes regulating claims for default, foreclosure, calculating interest and repossession of the property. Terms as to the amount of rent and changes in rent over time are left to the contractual negotiations of the parties and are not regulated by any state statute or agency. 

Commercial lease terms usually last for a period of years. Five-year leases are common but generally leases can range from less than a year to even 20 years. A ground lease would typically be within a range of 50 to 99 years. Many leases also include options to extend or renew the lease for additional terms. There is no set duration for renewed terms, either in the length of the renewal term or the number of renewal terms. The terms are determined by individual lease agreements.

Responsibility for maintenance and repair may be allocated in accordance with whatever is contractually agreed between a commercial landlord and tenant. Commercial tenants are usually responsible for any maintenance and repairs to the portion of the property occupied by tenants while landlords are usually responsible for the actual structure of the property and any surrounding grounds. Tenants may also be responsible for contributing to the maintenance of any common areas through the form of CAM (common area maintenance) payments additionally included with their basic rental payments.

Rental payments are typically paid each month.

The terms regarding the rent payable vary from lease to lease. The amount of rent payable may remain the same over the term of the lease, but may increase if and when the tenant renews for an additional term, or it may remain the same. It may also be set to increase periodically, such as annually or every five years. While landlords and tenants are free to negotiate the rent payable as a term of the lease agreement, it is common for the rent payable to increase at some point under the lease. Rental increases may be by a fixed or stair-step formula, or by reference to some published measure such as a bank prime rate or federally determined consumer price index. A minority of leases are percentage rent leases where part or all of the rental amount is determined from some measure of the revenue of the tenant, such as a percentage of gross sales.

Changes or increases to the rent are based on the terms provided in a lease agreement. The lease may provide specific dollar amounts or instructions for calculating or determining an appropriate increase. Terms as to the amount of rent and changes in rent over time are left to the contractual negotiations of the parties and are not regulated by any state statute or agency.

There is no statewide rent tax, but almost all cities impose a tax on rent – 2% is common but is not a universal rate.

Other than rent, tenants are typically responsible for paying a security deposit. If tenant improvements are needed for a commercial lease (such as redesigning the appearance of the property to suit the needs of the tenant or completing shell space provided by a landlord), the tenant may be responsible for that at the outset, or the landlord may agree to pay a portion. A part of the negotiation between landlord and tenant is the scope of work to be undertaken within the space, the requirements for insurance during construction, approval of plans and any changes to the plans, approval of the parties completing the work within the space, and whether there would be any landlord reimbursement for any improvements. Some commercial leases require a tenant to pay the first several months of rent at the start, and some include a requirement that the tenant pay, in addition to the security deposit, the first and the last months’ rent at the outset.

Although Arizona law imposes a transaction privilege tax under the commercial lease classification on the gross proceeds from leasing real property for commercial purposes, the state rate applied to this classification has been reduced to 0.00%, effectively repealing the tax. However, counties and cities may tax commercial leasing, which varies according to each municipality.

The Arizona government property lease excise tax (GPLET) is a local excise tax that is based on the square footage of a building rather than its value. GPLET is levied only on entities that lease the property of a city, town, county or county stadium district for commercial or industrial purposes for at least 30 days.

Typically, a landlord will facilitate the maintenance and repair of common areas used by tenants. The tenants may then reimburse the landlord through common area maintenance (CAM) charges added to their normal rent payments.

Landlords typically have the duty to provide access to utility lines to all tenants. The tenants, however, are typically responsible for establishing their own accounts with utility providers and are responsible for paying for the utilities. Such payments may require that the tenant provide applicable deposits with the utilities.

Typically, both a landlord and tenant will have insurance policies protecting a leased property. However, the landlord’s policy may be more inclusive as to the real property improvements, particularly if the policy protects property that includes multiple tenants. And sometimes the landlord will acquire the insurance, but factor the cost of the policy into a tenant’s rent or fees, such as inclusion in CAM charges. The landlord may also have requirements to provide for amounts or types of coverage required by any lender on the property. These coverages would be for the benefit of the landlord and its lender and would not provide any coverage for the tenant or their property. A tenant is typically responsible for any contents insurance coverage, and under the term of any lease agreement may be required to provide insurance for loss of rental income or business interruption insurance. A landlord, and possibly its lender, would be named as additional insureds. 

A landlord may impose restrictions on how a tenant uses a property. Tenants must also comply with any municipal regulations such as zoning regulations or covenants, conditions, and restrictions (CC&Rs, if any), as well as state and federal laws. 

Tenants are typically required to obtain written permission from a landlord for any alterations or improvements to a property. Usually, a landlord will also require that all work complies with any local regulations and laws. The landlord may also require final approval of any work being performed. Some leases (including ground leases) contemplate improvements that may be pre-approved as part of the negotiated terms of a lease. 

Arizona has some specific regulations that apply to leases of particular categories. For example, the Arizona Residential Landlord and Tenant Act provides specific regulations that only apply to residential leases. The Act provides greater protection for residential tenants than exists for commercial tenants.

Typically, a tenant that becomes insolvent begins federal bankruptcy proceedings. Pursuant to federal law, there is then an automatic stay order that suspends any enforcement actions, such as eviction. Depending on a tenant’s plans for remaining in the property, the tenant may reaffirm the lease and resume paying the rent, or the landlord may seek an order lifting the restrictions of the automatic stay to permit an eviction action.

Landlords may require a security deposit prior to the start of a lease to protect against a default. They may also require personal guarantees. In the event of a default, the landlord can demand the missing payments from the guarantor if demands upon the tenant have been unsuccessful. A commercial landlord could also require a security agreement as to the personal property (eg, business equipment and accounts) of the tenant.

Residential tenants are protected by the Arizona Residential Landlord and Tenant Act which does not permit lockouts or distraint of property for rent. A commercial tenant does not have the same protections as a residential tenant. Subject to any different terms that may have been made a part of a lease, upon the landlord giving a commercial tenant the limited notice required by statute and terminating the lease, the landlord may lock the holdover tenant out of the premises and may also assert a landlord lien against the personal property contents (subject to any higher priority of secured creditors of the tenant in such property). If a lockout cannot be accomplished, or is undesirable, a landlord may seek eviction by court process, as with residential tenants. Commercial leases may also contain specific provisions within the lease detailing an increase in the rent during the holdover period (typically from 125% to 200% of prior rent).

A landlord or tenant has the right to terminate a lease following any material breach of the agreement. The most common reason is failing to pay rent. Use of real property for illegal purposes, or purposes contrary to that permitted by the lease, are also examples. A landlord may also include provisions within a commercial lease that the landlord may retake possession of the property without terminating the lease.

A tenant can be evicted in the event of default prior to the expiration date of a lease. After providing the statutorily required notice and opportunity to cure the default, landlords may file a Forcible Entry and Detainer action with respect to residential or commercial tenants. However, non-judicial evictions may be performed on commercial tenants, as well. Non-judicial evictions typically involve a lockout and seizure of any personal property belonging to the tenant left on the property pursuant to the landlord’s statutory lien. A residential eviction is supposed to be tried within six days of service and a commercial eviction action is supposed to be tried within 30 days. Additional time thereafter to accomplish a court-ordered eviction may be needed for the constable or sheriff to carry out the writ of restitution. 

A lease may be terminated by the government or municipal authority through the process of condemnation, which can take several months or up to a year or more. Whether a tenant is entitled to compensable interest depends upon the terms of the lease. If the lease provides that the landlord has the right to terminate the lease of the property, or a substantial portion of the property is taken through condemnation, then the tenant usually is not entitled to compensable interest. When leased real property is taken by eminent domain, it is not unusual for the tenant to have a claim for the taking of its leasehold interest that is separate from the taking of the fee interest from the landlord. 

The most common contractual structures used to price construction projects are fixed price contracts (lump sum), cost-plus contracts (where a contractor’s fee is either a fixed amount or a percentage of the cost of construction intended to cover the contractor’s overhead and profit), and cost-plus contracts with a guaranteed maximum price. 

Traditionally, regardless of the pricing mechanism for construction, most projects utilise the design-bid-build delivery method. In that scenario, the owner hires a design professional to prepare the project design. Once the plans are prepared, the owner puts the plans out to bid and then hires a contractor to construct the project based upon those design plans. Under the design-bid-build method, the owner legally warrants the sufficiency of the plans. 

Another delivery method is design-build. On a design-build project, the design and construction services are provided by a single entity called the design-builder or design-build contractor. Usually the contractor has either the architect or engineer in-house or enters into a joint-venture agreement with the applicable design professional to provide the design-build services.

Construction Manager at Risk (CMAR) is a variation on the design-bid-build model that utilises some of the collaborative aspects of design-build.  Using the CMAR delivery method, the owner still hires the design professional and also hires the CMAR contractor separately. Usually, the CMAR contractor is hired early in the process and provides pre-construction services, constructability expertise, cost estimating, budgeting, schedule development and construction management. Thereafter, the CMAR contractor will typically enter into a guaranteed maximum price (GMP) contract to construct the work, in essence guaranteeing the cost of the work, although a fixed price or cost plus without a GMP may also be utilised.   

Construction risks can be managed contractually in a number of ways, including indemnifications, warranties, limitations of liability and waivers of certain types of damages. Typically, in a top down manner, the owner, general contractor and subcontractors each seek to contractually assign or allocate as much liability as possible to the subordinate contracting party; however, under Arizona law parties cannot be indemnified for their own sole negligence. Waivers of consequential damages are typically utilized in construction contracts. In addition, having adequate insurance and waivers of subrogation are prudent to minimize disputes among the contracting parties and prioritise completion of the work. Limitations of liability are commonly utilized and are enforceable in the context of design contracts. In addition to any express warranties that may be provided contractually, implied warranties of good workmanship and habitability are implied as a matter of law into every construction contract. On commercial projects enforcement of such implied warranties is limited to the contracting parties, but on residential construction projects implied warranties are enforceable by subsequent purchasers. 

Schedule-related risk associated with construction projects is best addressed through carefully drafted contract provisions. Waivers of consequential damages may limit claims for delay damages to the direct costs resulting from project delay. In addition, owners may limit their exposure to contractor delay claims by including no damage for delay provisions that limit the contractor’s remedy for delay to time extensions. In addition, contracts may include liquidated damage provisions in an attempt to estimate in advance the damages that may result from project delay, although the enforceability of such provisions has been narrowed by the courts in recent years. Express penalties for delay are not enforceable under Arizona law.

Although payment and performance bonds are generally required on public works projects, such bonds are less frequently utilised on private construction projects. On large commercial projects, sophisticated owners may assess the financial integrity of a contractor as part of a pre-qualification process.

Contractors, subcontractors, material suppliers and design professionals are permitted to encumber property in the event of non-payment by recording a Notice and Claim of Mechanics or Materialman’s Lien. To have lien rights on a project, claimants must serve a Preliminary Twenty Day Notice. Arizona statutes prescribe strict requirements for filing preliminary notices and for perfecting mechanics liens. Once the lien has been recorded, the lien claimant has six months from recordation of the lien to bring an action to foreclose on the lien. In addition, if an owner wants to remove the encumbrance after recordation it may record a statutory lien discharge bond. The lien will expire if no action to foreclose the lien is brought within that six-month period. After the lien is satisfied, the lienholder has 20 days to release the lien. Failure to do so could result in liability for damages caused by the lien’s attachment to the property. The general rule for lien priority is that all lien claimants performing under the same prime contract have the same priority regardless of when they performed their work, and for priority purposes the liens attach to the property when labor is commenced or materials are first furnished on the project. Due to a statutory ten-day grace period provided for lenders, unless the first labor or materials on the project is performed more than ten days before the construction loan is recorded with the County Recorder, then the loan would have priority over any liens on the project.

Local regulations determine what is required before a project may be occupied for its intended purpose. For example, the Building Construction Code of most cities establishes which projects require certificates of occupancy and what requirements must be met before certificates can be issued. Typically, construction plans are reviewed prior to issuance of a building permit. The municipality thereafter will conduct building and site inspections for compliance with code requirements, such as for foundation, framing, plumbing, electrical and mechanical, etc. Passing the final building inspection is normally the prerequisite for issuance of the certificate of occupancy. 

There is no federal excise tax applicable to the recordation of real estate transfers. Arizona does not have any specific transfer or stamp taxes with respect to real estate transactions. There are nominal fees charged to record real estate documents with the County Recorder (typically USD15 for a deed, USD2 for its accompanying affidavit of value, and USD25 for a mortgage or deed of trust). 

Cost segregation studies are performed to accurately reflect cost basis and accelerate the depreciable life of the tax basis of acquired commercial real estate.

Local municipalities may levy a transaction privilege tax that is similar to the Arizona state transaction privilege tax. However, it should be noted that there are differences between the state and municipally imposed transaction privilege taxes. Often the taxable transactions and exemptions vary between municipalities and do not correspond to the state tax base. For example, the state does not impose a transaction privilege tax on renting or leasing residential real property or the sale of advertising.

In an attempt to promote uniformity among municipalities in the imposition of local transaction privilege taxes, the Arizona Department of Revenue promulgates the Model City Tax Code (MCTC). The MCTC provides uniform definitions and categories of potentially taxable transactions while allowing cities options about which transactions to tax. Cities are authorized to adopt all or portions of the MCTC when enacting a local transaction privilege tax. All city and town privilege taxes are subject to local voter approval. Any changes to the MCTC that are not reflected in the official copy on file with the department are void and have no effect. Further, the failure of a city or town to notify the department of a new or different tax rate renders the new or different tax rate void and without effect.

There is no distinguished difference in taxation for foreign investors. Capital gains are treated and taxed as ordinary income. The Arizona tax rate falls between 2.59% and 4.54%.

Real estate investors enjoy many benefits of owning real estate such as depreciation deductions based on a 39 or 27.5 year schedule depending on the nature of the property. Also, improvements may qualify for additional accelerated depreciation methods such as Section 179 and bonus depreciation under Section 168(k)(2).

Investors also receive the tax benefits of cost segregation studies for accelerating and increasing depreciation. Investors also receive the benefits of any gain on real estate being taxed as capital gains versus ordinary income.

A federal bill known as the Tax Cuts and Jobs Act retains the current Section 1031 Like Kind Exchange rules for real property. However, it repeals the use of Section 1031 for personal property, such as art work, auto fleets, heavy equipment, etc.

The Act also retains the current recovery periods for non-residential real property (39 years), residential rental property (27.5 years) and qualified improvements (15 years). The bill also replaces separate definitions for qualified restaurant, leasehold and retail improvements with one definition of “Qualified Improvement Property.”

The Act creates a new tax deduction of 20% for pass-through businesses. For taxpayers with incomes above certain thresholds, the 20% deduction is limited to the greater of: 50% of the W-2 wages paid by the business or 25% of the W-2 wages paid by the business, plus 2.5% of the unadjusted basis, immediately after acquisition, of depreciable property (which includes structures, but not land). Estates and trusts are eligible for the pass-through benefit. The 20% pass-through deduction begins to phase-out beginning at USD315,000 for married couples filing jointly.

Burch & Cracchiolo

702 E. Osborn Road
Suite 200
Phoenix, AZ 85014

602.274.7611

602.234.0341

info@bcattorneys.com www.bcattorneys.com
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Burch & Cracchiolo has a primary real estate team consisting of 11 attorneys. Its key practice areas are land use and zoning, real estate law, real estate litigation, real estate financing, real estate transactions and real estate leasing. The firm has an extensive history representing local, national and international clients in all facets of real estate transactions and related litigation, with experience in acquisition, development and zoning of large commercial, residential and planned development projects, as well as build out and lease up of shopping centres, commercial and industrial facilities, and office buildings. Burch & Cracchiolo is also skilled in representing local and national lending institutions in the negotiation, preparation and enforcement of financial documentation for large commercial transactions.

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