When it comes to real estate transactions, there are some red flags you need to look out for. These could be structural red flags such as foundation failures, old or faulty wiring, mold, non-functioning windows, poor drainage, and pests. You should also look out for neighborhood red flags such as too many houses on the market, lack of parking, empty storefronts, heavy police presence, and poor street maintenance.
Related: Guide to the Red Flags of Property Investment
Another less obvious, but critical red flag to take note of before buying an investment property for sale is an encumbrance in real estate.
So, What Is an Encumbrance in Real Estate?
Encumbrance real estate definition – A real estate encumbrance is a claim made regarding the use of real estate by someone besides the owner. This can prevent the buyer from enjoying the full rights of ownership. In addition, a real estate encumbrance can lower your property’s market value and hinder your ability to sell it. This is why due diligence in real estate is important to ensure that investment property for sale is free from such restrictions.
4 Types of Real Estate Encumbrances
1. Encroachment
Encroachment happens when someone intrudes into someone else’s real estate property. For example, a neighbor could put up a wall, fence or shed that crosses into your property. At other times, encroachment happens over time, like when a tree grows big and begins to hang over a neighbor’s property. An encroachment will remain a real estate encumbrance until both parties resolve the issue. Therefore, don’t buy an investment property until this encumbrance in real estate has been dealt with.
2. Lien on a property
A lien is a claim on real estate for the payment of a loan. If the owner does not repay the loan, the lien holder has a right to sell the property in order to recover a portion of their money.
Common types of liens include:
- Tax liens – If the owner doesn’t pay income taxes or property taxes, a lien can be placed against the property. In addition, failure to pay condominium or homeowner association fees could result in the filing of a lien on a property.
- Mortgage liens – These are a result of defaulting on your mortgage payments.
- Judgment liens – In case the owner lost a lawsuit, a lien could be placed on the home. This can happen even when the lawsuit is not connected to the home.
- Mechanical liens – This is a claim on property that the claimant has worked on. For instance, if a contractor does major work on the air conditioning or heating system and the owner fails to pay in full, he/she is likely to have a mechanic’s lien on the property. This is why it is very important for property owners to keep receipts for all the work done in their home.
- IRS liens – If the owner doesn’t pay taxes even after getting reminders, the IRS can place a lien on his/her real estate investments. This is especially likely if the owner is self-employed or unemployed, meaning that his/her wages cannot be attached.
- Child support liens – If the owner owes lots of money in alimony or child support, a claimant can place a lien on his/her investment properties. The lien will remain in effect until the owner pays what is owed or sells the property.
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3. Deed restriction
As the name suggests, these are restrictions written into deeds. Also known as conditions or covenants, deed restrictions place limitations on the type of structures that can be built on a property or even how a property is used. For example, a deed restriction could prohibit homeowners from storing boats or RVs on the property. Or the restriction could require a property owner to leave the building’s original façade intact.
Developers usually place such restrictions in order to maintain standards in their properties. However, covenants or restrictions that are too strict could make it difficult for real estate investors to find tenants for their rental properties.
Related: The Ultimate Real Estate Due Diligence Checklist
4. Property easements
An easement refers to someone’s right to renovate or use portions of someone else’s property. For instance, a utility company might have the right to place power lines on an income property. Or residents might have the right to drive through a road passing through an investment property. Easements are an encumbrance because they affect the rights to the property and prohibit certain actions. For instance, you cannot build a patio over a space reserved for power lines. It is therefore very important for investors to be aware of this real estate encumbrance since it will be transferred to anyone that buys the property.
How to Find Out If a Property Has an Encumbrance
When conducting an investment property search, part of your due diligence should be to conduct a title search. This will reveal issues that could affect the value or use of property, including easements, liens, and other encumbrances. Don’t forget that many rental properties are sold ‘subject to all encumbrances and liens’. It is your responsibility to discover any encumbrances before deciding to buy real estate.
When it comes to encumbrances, your best protection as a buyer is a general warranty deed. This kind of deed comes with a ‘covenant against encumbrances’ warranty that assures you that the property has no encumbrances besides those mentioned in the deed.
Conclusion
An encumbrance in real estate can be a real headache for any property seller or buyer. An encumbrance will lower your property value, limit how you can use it, and make it difficult to sell. This is why you should do your due diligence to uncover any encumbrance in real estate before buying a single family home, condo, apartment or multi family home. Detecting these red flags early enough will save you a lot of time and money.
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