All is fair in love for business and war for transactions. And in real estate transactions, the goal is to reach a fair market value for all parties involved.
Through this, the seller is able to sell at not too low of a price.
While at the same time, buyers are able to purchase at not too high of a price.
Fairness in these deals is what an arm’s length transaction is all about. And for a fair market value to be achieved between two parties, such a transaction is ideal.
What Is an Arm’s Length Transaction?
An arm’s length transaction is a business deal in which two parties act based on each other’s self-interest. This is also sometimes referred to as an arm’s length principle.
Without fear of pressure from each other, parties are able to arrive at a fair market value upon coming into an agreement.
Arm’s length transactions also guarantee that transactions between parties are not scheming for their own benefit.
As such, no existing relationship between parties under an arm’s length transaction is observed.
To illustrate it better, this transaction can be characterized as follows:
- Independent of each other
- Possessing equal bargaining power
- Having equal access to information
- Fair settlement on a price
- Driven by self-interest
Through this, each party becomes a check of the other party. This enables the market to still freely dictate a deal without interfering in at least some of the transactions of one party.
Non-Arm’s Length Transaction
A non-arm’s length transaction is a business deal in which buyers and sellers have a common interest or are after the same outcome.
In direct contrast to the former, this acknowledges the existing relationship of parties through their business or personal lives.
This is also sometimes called an arm-in-arm transaction.
Transacting With Family Members
Believe it or not, but this transaction is frowned upon in real estate.
For example, having a family member as the seller of a person’s house property purchase could result in a decrease in the sales price.
Therefore, the existing relationship results in a depreciation of market value.
In The Eyes of Investors
Investors usually overlook companies that do not conduct a real estate transaction at arm’s length.
This is because the existing relationship between parties is prone to scheming.
Long-term investing then becomes less favorable because of the possibility of stock price depression.
Tips for Non-Arm’s Length Transactions
Although not advisable, these deals are still highly convenient to partake in.
Should you wish to do this, here is some advice we have for you:
- Ensure that your partner has the means to settle their payments
- Transact with a third-party company for legal matters
- Get the advice of a legal advisor for a possible oversight
But again, be careful of the risks that come with it!
Arm’s Length Transaction in Real Estate
Real estate purchases could refer to those pertaining to a house, a home, a condominium, etc.
Arm’s length transactions are common in real estate transactions because they are affected by other market drivers as well.
As such, the involvement of drivers such as a mortgage lender, real estate agent, or tax authority can influence the market value of a property.
Transaction With A Real Estate Agent
Real estate deals are often made with the help of agents. An agent offers services to reassure all parties that sales are made at arm’s length.
If you’re planning to purchase a house, consider contacting one of them instead of the actual seller.
As a buyer, you may expect to know about the prices and offers for a deal through them.
Doing so ensures the professionalism of the deal and the avoidance of an existing relationship between your party and the other.
Transaction With a Mortgage Lender
Lenders are important because they help buyers afford their target properties within their desired price range. However, it is likely that such a deal results in a short sale.
Short sales happen when a lender accepts the sale price of a property despite it not being enough to pay the mortgage balance.
By helping improve the bargaining power of the buyer, the market shifts less in favor of the lender because of the associated risks.
For example, lenders run the risk of transacting with parties that do not have the means to pay off their debts.
To settle this, companies like Freddie Mac require their parties to sign an arm’s length contract law.
This is done in order to prevent family members from engaging in a deal with each other through an arm-in-arm transaction.
Be extra careful though! Violating such a contract can make you liable for mortgage fraud or scheming.
Transaction With A Tax Authority
Tax authorities ensure that arm’s length transactions adhere to legal and tax laws.
For example, conglomerates are prone to evading their taxes because of their non-adherence to the guidelines of an arm’s length transaction.
As the affiliated companies transact with each other, some of them fail to transact at arm’s length due to their large-scale operations.
This not only lowers the market values but also can be a case for tax evasion for a specific party.
As a regular buyer, you will still come across a tax authority when purchasing property at a certain price.
The only piece of advice here is to always be careful when striking a deal. And in the same way, keep everything under an arm’s length transaction.
Why Partake In Arm’s Length Transactions
There are way more benefits when striking a deal at arm’s length.
As a buyer, you can purchase a home at a price that isn’t at all outside of your budget range.
As a seller, you are able to make a sale without incurring losses.
And even as an agent, you are able to make a sale while appeasing both the buyer and seller in agreeing to a beneficial deal for all parties.
To add, dealing with agents, lenders, and authorities is a protocol for all buyers and sellers. So really, the only danger that comes with the arm’s length transaction is the deviation from the standards!
And if anything, the question is fairly simple: do you want fair transactions or not?