Twice a year, lawyers in Pennsylvania who specialize in family law convene to discuss developments in their field. At this year’s first meeting, just concluded in Lancaster, the Family Law Section of the Pennsylvania Bar Association heard from three experts concerning energy law and its impact on real estate.

Roughly a decade ago, hydraulic fracking came in Pennsylvania and began to radically change the energy industry and real estate values. Within five years it seemed that the Commonwealth was going to become a 21st century Texas.  As deposits of natural gas became to come on line by 2008, energy prices spiked to record highs.  Using crude oil prices as the benchmark oil reached $140 a barrel in 2008 but then dropped just as fast, then climbed from $40 a barrel back into the $80-110 range.  2014 saw another rapid decline in prices, falling first to $50 and then dropping to today’s price of $29 a barrel.

This precipitous decline has caused fits for energy producers prompting some to lose 2/3 or more of their market capitalization in the past two years. It has also slowed production and royalty income as well.  The result has created an impression that the shale gas boom was going into hibernation.

There is truth to this but as the experts presenting in Lancaster noted, the industry remains a fast evolving one. The return of the energy industry to Pennsylvania has not only prompted a revolution in technology.  Falling prices have forced geologists and engineers to think more creatively about what can be extracted and how most efficiently to accomplish that.  Today, the industry is looking beyond Marcellus shale to other forms of energy deposits.  Among those noted by Bud Shufstall, an energy attorney with Northwest Savings Bank is a return to the original oil fields discovered in the 1860s with a process that extracts oil deposits which heretofore could not be recovered.

A couple of points seem clear. Energy producers are evolving in terms of what mineral and gas deposits they want and how they may be extracted.  Pennsylvania law on this subject which evolved from 1870-1920 and then was largely ignored for almost a century is now being revived to address new technologies.  Family lawyers trying to dabble in this field do so at their peril because they may be focusing on both the wrong form of subsurface deposit as well as the wrong form of agreement to address what lies below the surface.

The divorce law itself has not formally addressed these subjects. The consensus of the experts, including Brandon Otis, a valuations expert from BDO Seidman and Taunya Rosenbloom, an energy attorney in Athens, PA was that a subsurface deposit for which there was no technological means of extraction had no value until the technology changed that.  But that conclusion may be subject to challenge in a judicial setting.  Then there is the problem confronting Mr. Otis of trying to put a value on what lies below in a world where natural gas prices have fallen 25% in the past 11 weeks.  Prices may be depressed but one thing is emphatically clear.  Pennsylvania is the second largest producer of natural gas in the United States and it is going to remain a focal point of energy production for many years to come.  Those substances trapped below ground are going to be valued and divided whenever there are marital rumblings of the people who live above ground.  Doing it correctly is no easy task.

We periodically report on macro trends in housing prices because our clients typically have a lot of their wealth invested in their homes.  And each time we have a case, one of the questions that comes about is:  Stay or go?

We recently happened upon some data that gives us insight into home values measured over roughly 20 years.  In the early 1990s Toll Brothers began to build luxury homes in central Chester County, about 30 miles Northwest of central Philadelphia and accessible to the city both by train and turnpike.  These were big homes ranging in size from 3100-6300 square feet on lots that were typically one acre.

What was unusual was that we identified seven homes on one street which had sold in the last nine months.  We confirmed that this was not a fire sale caused by the construction of a nuclear plant or abattoir next door.  Moreover the economy of this area is strong with low unemployment.  Median household income in the township where the homes are located ranges near $100,000 per annum.

The homes we examined were all built between 1995 and 1998.  Only one sold more than once during the last 18 years.  So, we looked at what they sold for when built and what prices they commanded in 2013 and 2014.

DATE   SOLD BEDS/BATHS SQUARE   FEET ACRES PRICE 1995-8 PRICE
A.     7/2014 4/4 6300 1        650,000 1995/410,000
B.     7/2014 5/4 4800 2        570,000 1995/435,000
C.     2/2014 5/3.5 5200 1        590,000 1998/335,000
D.     11/2013 5/4 3100 1.2        555,000 1997/341,000
E.    10/2013 4/2.5 4200 1.2        557,000 1996/345,000
F.    10/2013 4/2.5 4500 1        579,000 1995/435,000
G.    10/2013 5/4 3500 1.3        565,000 1995/354,000

 

Four of the Magnificent Seven were sold in 1995 at an average price of $85.50 per foot.  In 2013-4 these houses sold for $124 per foot.  Over 19 years, the average return comes to 2.4%.  This trails the 2.7% average annual increase in consumer prices over the same period.  It rose from 162 to 245 for the Philadelphia region.

The lesson.  In June 1996 the S&P 500 closed at 670.  Nineteen years later it was just over 1600. So where the Toll Brothers manse increased by 1.45x, an index fund would have increased 2.3x.

Now, we acknowledge, you can’t raise a family inside an index fund.

An index fund does not allow $250-500,000 in gain to pass tax free.

And you can’t margin stock 90% anymore when you can still buy a house with less than 10% down.

But houses are not the investment they were from 1950-2007.  We are in a new age where real estate is not high-yield and risk free.  So, think clearly when choosing to keep a marital residence.

 

This is not a real estate blog but many of our clients have a heavy portion of their net worth invested in residential real estate.  So when the Fels Institute of Government at Penn Published a State of the Philadelphia Housing Market in mid November we thought it worthwhile to secure and read a copy.

According to the survey home prices peaked both in the region and the country in the first quarter of 2007.  The last time we had seen a decline was from 1990 to 1994. We tend to forget that prices climbed as an amazing rate from 1998 to 2007 and that prices are currently in the same range as they were circa 2004-05.  Measured against 10 other metropolitan markets over the past 25 years Philadelphia housing grew 25% less in price than the other cities.  But, in typical Quaker style when we did plunge from the high, Philly houses declined by less than one-half of the decline in the 10 composite cities.  Where we feel like today is 2005 in home pricing our ten city neighbors are feeling more like mid-2003 in terms of value. Resorts fared the worst with losses of 61% in Las Vegas 51% in Phoenix and 45-48% on the Florida coasts when measured against the high.  Only Dallas and Denver fared better than Philadelphia.  Even the darling markets of Washington and New York was 26-27% declines from the peak.  Still, we will need to recover an additional 14% to get back to our 2007 peak.  We may not feel happy about what occurred but our house value declined later and was more modest than in our shoulder cities of New York and Washington, both of which will need to see another 25% price rise to recover that old time 2007 feeling.  Meanwhile if you had been in a Dow Jones index fund this entire time you are less than 2% away from the Dow’s all-time high in early October, 2007 of 14,006.

 

There is another unhappy aspect to consider.  Securities are highly liquid.  And while we are reporting that home prices are recovering, actual home sales remain very sluggish.  From 2002-through the third quarter of 2008 (the Lehman Bros crisis) the Philadelphia market saw pretty steady sales of more than 5,000 houses each quarter, the first quarter of each year excluded.  In 2012 just over 3,000 homes sold and our region has not seen us break 4,000 since second quarter of 2010. The quarterly average since 1995 has been about 4,300 homes per quarter and measured by sales alone in contrast to price, the data look more like 1995 than 2005 when we peaked at 8,000 homes sold each quarter.  Another approach to this is to look at the number of homes on the market.  From 2001 to early 2005 Philadelphia typically had 5,000 6,000 homes for sale each quarter. In 2005 that number began to spike reaching a peak of more than 12,000 homes for sale in late 2006 and again late in 2007. The number has bounced around between 9 and 11,000 homes since late 2007 with the current trend close to 9,000.  But this still means that in times of relatively stagnant growth we have one-third more homes on the market than we did eight to thirteen years ago.  So the lesson is that if you want your price be prepared to wait a long time and if you don’t have time, your price is going to have to be very competitive.

 

In the end, the news is not gratifying but before we start complaining it might be wise to remind ourselves that in comparison with almost all of the rest of the United States, we were not badly hurt.

Lawyers are not financial advisers but we do lots of real estate transactions and for most divorce clients, the largest asset in the portfolio is the family home.  So in just about every matrimonial case, there is the inevitable question.  Should we hold or is it time to fold?

It’s always good to study the data.  And the news for our region for the second quarter of 2009 is relatively good.  Prudential Fox and Roach reported the first region wide increase in housing prices in two years.  The biggest increase was in the city (6.8%) while the suburban increase was less than half that (2.7%).  There had been a sharp decrease in the first quarter of the year.  We have also weathered the storm well compared to other large cities. Philadelphia prices have declined 12% from their peak while average declines in the ten largest cities was closer to 30%.

Inventories (homes listed for sale) are leveling off and there is an increase in the rate of sale of those houses in inventory.  This has meant a reduction in the number of days it takes to sell a house.

So, does that mean the end of the downturn is over.  Even the experts a Fox & Roach hasten to note: “Those expecting a near-term return of 2005’s peak prices will be sadly disappointed.”   Within the region, the worst sales markets were Camden and South Jersey (down 10-11% in the past year) while Trenton area fared best (down 0.5%).  The Philadelphia market fell 5.31%.

While the second quarter offered an uptick in the rate of sales, it still took 20% longer to sell a home in June 2009 than it did June, 2008.  The average house sold was on the market more than three months.  If no new homes were listed, the 2,500 homes on the market would still take almost a year to clear at the current rates of sale.  That number has changed very little from last June.

Homes are not just places to dwell in.  They are an investment.  And since the collapse of the dot-com bubble of 2000 Americans have invested heavily in their homes.  We have been taught and there is data to show that homes can be a good investment.  What most of us tend to ignore is the fact that value is a moving target. And in markets like Phoenix and LasVegas, where prices have declined an average of 33% in the last 12 months the picture is especially clear.

Let’s use LasVegas as an example.  Let us say that in April you owned a house in that market in which you had equity (price $300,000 –debt of $200,000) of $100,000.  A buyer approaches you and offers you $300,000.  But you bought the house for $450,000.  So you decide to wait and turn down the offer.  Between April and the end of July, the data show that you lost another 2.6% on average.  Now suppose you took the offer and took your equity of $100,000 and put it in an S&P index fund, it would have risen to $130,000.  So your decision to hold cost you $40,000 between the loss on what you had and the money you failed to make.

Home equity is an engine of potential wealth.  We are not advocating irresponsible borrowing but home equity is trapped wealth except in times when home prices are rising. And with the inventory of homes still out there, it is going to be a long time before we see prices rise.  Bear in mind also that the increases reported earlier in this piece come at a time when interest rates are at historic lows.  As interest rates rise, price increases in homes will inevitably face the headwinds of increased interest rates.  So, if you bought at the height of the market, realize that in your quest to recover your losses, you may be foregoing the opportunity make real money in other investments.

This short memorandum will send any competent real estate lawyer into fits of hysteria. Lien law is some of the most complex real estate law one can encounter. But ordinary people bang into these kinds of problems every day and especially so when parties are separated from one another.

There are three ways to own property with another individual in Pennsylvania. Be careful at the outset, because you can also own property as a limited liability company (LLC) a partnership (either general or limited) or as a shareholder in a corporation. But where individuals hold property with others they usually do so in three ways:

                                Tenancy in common

                                Joint Tenancy with right of survivorship

                                Tenancy by the entireties

A tenancy in common means that our interests are completely divisible. If you and I own a bank account or a piece of real estate as tenants in common and one of my creditors gets a judgment against me, that creditor can seize my interest in the asset through proceedings to enforce the judgment. If we have a bank account with $1000 in it and we own it as tenants in common 80% me and 20% you, a judgment for taxes, child support, or any other kind of debt allows the creditor to seize my 80% interest to satisfy the judgment against me. He cannot get at your 20% interest but if we have a house together or we own a race car, the creditor can seize the asset, sell it to satisfy his lien and turn over to you 20% of the proceeds. Goodbye race car.

A joint tenancy is an estate planning device. We own the property together but if either one of us dies, the survivor gets the whole of the asset. We own the $100,000 race car we share. I die. You get it even though I put up $80,000 and you $20,000. Most tenants in common and joint tenants hold equal shares but they can make the percentages whatever they want. It is also not a device limited to two owners. A hundred people can own a joint interest in property if they want. Usually, that does not occur.

Now suppose the two of us own a race car and my ex-wife gets a judgment against me for failing to pay child support. She can take her judgment and use it so sever the joint tenancy just as she would with a tenancy in common. It just requires the extra step of breaking apart the joint tenancy. In the end, our race car is sold and she will get her judgment from the 80% of the proceeds that are mine.

Tenancy by the entireties is a joint tenancy between a husband and wife. No one else can qualify for this status. Unlike joint tenancy, the only person or entity that can break apart a tenancy by the entireties and sell the asset it owns is someone who has a judgment again both my wife and me. Let us say my current wife and I own the race car. I don’t pay my child support or my taxes. My ex-wife can’t get a judgment against my current wife. She does not owe child support. I do. So she might have a judgment for a million dollars. The law says she can’t get to our race car (new wife and me).

But suppose my current wife and I don’t pay our taxes. We file jointly but we just don’t send the money in. Now the tax authority has a claim against both of us because it is a joint obligation we both owe. They can get a judgment for what is owed and execute on the race car, because the debt, like the car is held as tenant by the entireties. If we filed our taxes separately, the answer is quite different. We don’t owe the taxes joint then, we owe them separately.

Husband and wife own a house. Usually they will have title as tenant by the entireties. Husband leaves wife and runs off to Las Vegas. He signs $100,000 worth of gambling markers and promptly loses all the money. Can the casino come after the house? No. That’s husband’s debt; Not joint debt even though the parties are not legally separated. Suppose wife get s angry at Mr. Gambler and buys a $25,000 ring on her American Express card. Can Amex get to the house? Again, no, unless the credit card is a joint card. Suppose the Amex card is a privilege card; meaning that Husband is the card holder and Wife is an authorized user. Curiously, no. Wife is not legally obligated to American Express unless she signed the agreement with American Express as well. So husband and wife could be back in the house; he with a gambling hangover and she with a beautiful new ring. But neither the casino nor the card issuer can force the sale of the home to get the debt paid.

A question we commonly are asked is whether one party can put the house in jeopardy by taking out a mortgage. The short answer is that where a home is owned as tenants by the entireties, it takes two to make the tango. No bank will issue a mortgage (which is to say lend money) on an entireties house unless BOTH parties sign the mortgage. So what if one party fraudulently signs the other parties name without his or her permission (known in the industry as a windshield signature). That’s not a valid mortgage and the risk ordinarily is taken by the lender. The lender has the duty to take precautions to insure that the signatures are legitimate.

Having fun yet? Here are a couple other wrinkles we see where clients have made trouble they failed to recognize. Many young couples these days like to buy their homes before tying the knot. If they close on the property before the wedding day, they CANNOT take title as tenants by the entireties. Reason: they are not married. And a subsequent marriage does not change the status of the ownership. So, when wife defaults on her student debt or her car loan, the creditor may be able to get to the house and force it to be sold.

A second extra credit problem we are seeing more of. Husband and wife are married. They want a house at the shore. Husband has bad credit. Wife has good credit. The lender does not want anything to do with husband. What they will do is make the loan to wife only.  She will sign the promissory note for $500,000. But they will make both husband and wife sign the mortgage if they want the property to be tenancy by the entireties.  Husband and wife own the property together.  But only she is on the note and can be sued for it.  Should she default, the lender will have the right to take a judgment against her in accordance with the note, but the mortgage says that it is collateral for the note even though husband is not on the note.  Husband does not owe the $500,000 but he pledges whatever interest he had in the shore home to the mortgage company. What we call mortgages are actually two separate transactions done at the same time.  Lenders who give you money make you sign a promissory note to pay it back.  That is itself an “unsecured transaction” because there is nothing to “secure” your promise to pay.  But if the lender demands collateral (such as a house, boat, car, aircraft) the mortgage is a document by which you pledge the asset in what is now a secured transaction (the object is the security).  You don’t need to be on the debt itself to pledge an asset.  If your no good brother in law borrows $50,000 from a bank, they may tell him he must get a guarantor who will pledge assets to secure the debt.  When your bride comes crying to you that her nieces and nephews will be on the street unless the two of you are willing to help, just remember it could be your house that gets sold when brother in law defaults.

          

Now wasn’t that fascinating.  Even we don’t think so.  But this is important stuff to know.