If you’re new to the real estate investing trade, you may be wondering what a real estate contract is and what the different types might be. What role do these real estate investment contracts play? And, perhaps even more importantly, what benefits do they provide investors?
There are essentially four types of real estate contracts: purchase agreement contracts, contracts for deed, lease agreements, and power of attorney contracts. They each have different uses and stipulations. This article will cover the different real estate contracts and give you the foundational knowledge to make informed investing decisions.
What Is A Real Estate Contract?
A real estate contract is a legally binding document that outlines terms agreed upon when two or more individuals negotiated a real estate transaction. The terms outlined in a contract are put into effect upon signing. They typically include details such as real estate contingencies, what appliances are included, the deposit amount, who is responsible for paying closing costs, and the date of closing. As a real estate investor, you will find yourself negotiating and signing real estate contracts any time you strike a deal.
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Building A Real Estate Contract
Simply put, a real estate contract aims to clarify the home buying process while offering protection to both the buyer and seller. It can be helpful to keep this in mind as you start to build a real estate contract. To start, a prospective buyer will submit their official offer letter. The seller can either reject or counter the offer, changing items like the purchase price, closing costs, or contingencies. Thus beginning the negotiation portion of building a real estate contract. From there, the buyer can choose to modify or accept the new terms — adjusting the same items listed above. Often this process occurs between the buyer and seller’s real estate agents. What they eventually decide on will then become their real estate contract.
Is A Real Estate Contract Legally Binding?
A real estate contract is legally binding, which is why Adam Garcia, Founder of The Stock Dork, recommends working with a qualified professional. “As a given, every contract must be done by people with the legal capacity to commit to a contract,” says Garcia.
A real estate contract becomes legally binding when the document secures a property’s status and is signed by both parties. In simpler terms: a contract only becomes legally binding when it is signed and sealed. Real estate contracts are sealed by properties and then signed by those on either end of the deal. To obtain both signatures, all parties must agree before a contract is considered valid. If one party submits a counteroffer, the original contract will not be legally binding because both individuals did not agree to the terms.
There are a few steps investors can take to ensure the success of a real estate contract. First, everyone must understand what is said within the agreement. This will require using everyday language, avoiding abbreviations, and reviewing any potentially confusing areas. Investors should also be sure to include an expiration date, as real estate contracts are often time-sensitive. Include deadlines within the contract, and specify what happens if they are not met (typically, this would result in breaking the contract).
Who Needs To Sign A Real Estate Contract?
Both the buyer and seller need to sign a real estate contract. Both signatures are required to make the paper legally binding. In some cases, the real estate agents may sign the document on behalf of their client (with consent). However, in almost all cases buyers and sellers are responsible for signing the real estate contract to complete the transaction.
Requirements Of A Real Estate Contract
As with most contracts, requirements must be met before a real estate contract can be enforceable. Here are all the requirements needed in real estate contracts:
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Offer: The first party will present an offer to the second party in the form of a real estate contract. They must write it, sign it, then give it to the second party. The second party may then accept, reject, or make a counteroffer.
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Acceptance: The second party accepts the offer by signing the real estate contract. The contact is required to have original signatures from both parties. Any changes either party makes should be initiated. In the case of a counteroffer, the original offer will be voided and not legally binding for either party. If the offer is rejected, the contract is terminated. If you receive no response, the contract will expire on the date indicated.
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Consideration: Consideration indicates something of value that will be exchanged between both parties (most commonly in the form of money). Consideration could also be another property or a promise of performance.
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Legal Capacity: Both parties should be eligible to enter into a real estate contract. Those who are not legally able include minors, someone who is mentally impaired, etc.
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Legality of Purpose: The real estate contract cannot include any illegal actions.
What To Include In A Real Estate Contract
Contracts are used to close different types of real estate transactions, and each agreement will vary accordingly. There are, however, a few essential elements to any real estate contract that you should become familiar with. By understanding the materials needed, you can help ensure each agreement you enter is comprehensive and precise. The following list outlines items to include in various real estate agreements and contracts:
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Price and Timing: The two most basic elements necessary to every real estate contract are the final purchase price of the property and the transaction timeline. This portion of the contract should specify when contingencies will be completed and when the title will be transferred. Both parties need to clearly understand this information for the purchase to be successful, and it is commonly what the real estate contract will open with.
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Contingencies: Contingencies refer to any items that must be completed for the transaction to go through. Each type of contingency will specify how and when it is to be done. For example, the seller may need to make certain repairs to the property before the closing period. If contingencies are not met, both parties have the right to walk away from the deal.
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Inspection Details: The most common type of contingencies are those associated with the home inspection. Every real estate contract should include a contingency that allows buyers to walk away if the property inspection does not go to plan. They should specify which, if any, repairs the sellers are required to make before closing. Inspection details (and contingencies) will clarify expectations for both parties and protect buyers from being forced into a transaction they did not sign up for.
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Financing Clause: It is important to also include a contingency that allows buyers to back out of the transaction should their financing fall through. In some cases, it is also a good idea to add a clause protecting the buyer if their previous home does not sell.
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Closing Costs: Always specify who is responsible for closing costs, and always keep an eye out for this information. In many cases, sellers may cover these costs, but they could be buried within the contract. Make sure closing cost information is clear in any real estate contract to avoid confusion.
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Warranty: Some sellers will include a home warranty when advertising a property. This is meant to cover certain repair costs, though it all depends on the sellers. If there is a warranty for the property, it needs to be listed out in the contract, so both parties understand who is responsible for what.
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Contract Default: It is very common for real estate contracts to state what happens if one or more parties default. This sets clear expectations for buyers and sellers and helps avoid court proceedings if someone fails to live up to their end of the bargain. By including the ramifications of default, there will be no “what if” questions at the time of the agreement.
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Riders and Addendums: This portion of the contract will specify any additional information necessary to the transaction. The most common example of a rider or addendum is information about an HOA, if applicable. The real estate contract should clearly state the rules and requirements, making the potential buyer fully aware.
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Appliances: If you would like any of the existing appliances to remain in the house upon closing, be sure to specify this in the contract. If you do not detail what appliances the house should be left with, it is not ever guaranteed that a verbal agreement would sufice.
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Types Of Real Estate Transactions
Several types of real estate transactions will demand the use of a contract agreement. Before getting into the dissection of different real estate contracts, it will be helpful to review the following types of real estate transactions:
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Buying a home: As an investor, you will come across many properties that you’ll want to purchase throughout your career. You can work with a buying agent to help find potential deals through the MLS, submit offers on your behalf, and help you navigate the purchase agreement.
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Selling a home: You will also find yourself selling some of the properties you had purchased, and hopefully at an increased value through improvements and appreciation. Your selling agent can help market your investment property to prospective buyers.
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Buying a property to rent: If you are interested in becoming a landlord and earning rental income, then you will, of course, purchase rental properties. This can range from single-family homes to multi-unit apartment buildings.
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Fix and flip: A fix and flip property is the type of investment in which you will typically acquire a property that is being sold under market value, such as a foreclosure or distressed home, and put in an investment to renovate it. Investors will typically re-list the property on the market as soon as possible for an increased value.
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Wholesaling a property: A wholesaler plays an integral role of finding off-market properties and assigning the purchase contract to an end buyer, such as a rehabber.
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Prehabbing a property: Prehabbing is a type of exit strategy through which an investor makes minimal improvements to a property, just enough to make it appealing to another end buyer such as a rehabber. Some might argue that prehabbing is a step between wholesaling and rehabbing.
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Serving as a lender: At some point in your investing career, you may build enough cash flow to the point at which you can serve as a private money lender to other investors. In this case, you will need to strike up an agreement with your borrowers, such as the loan term and interest rate.
Types Of Real Estate Contracts
As a real estate investor, it is necessary to be well-versed in the various real estate agreements and contracts you will use throughout your career. These contracts are designed to serve your best interests, such as protecting your investments and minimizing your liability and risk. It is also helpful to have an understanding of how these contracts work to protect the other party. Here are four common real estate contracts that you should familiarize yourself with today:
Purchase Agreement
A purchase agreement, or sales contract, is the most common type of real estate contract. As the name suggests, this is a real estate contract that lays out an agreement between the buyer and seller of a specific property. This type of real estate contract includes all the typical elements of a contract:
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Identification of both parties
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Property description
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Condition of the property
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Purchase price of the property
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Contingencies
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Included and excluded appliances and fixtures
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Type of deed
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Earnest money deposit
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Closing costs
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Party responsible for each cost
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Date of closing
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Terms of possession
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Signatures of both parties
As one might expect, there are different types of purchase agreements that you can utilize as a real estate investor. Which type you end up using, however, will depend on a variety of factors. Here’s a quick look at the different types of purchase agreements at your disposal:
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State/Association Purchase Agreement: Many states, and the realtor associations that serve local markets, have standardized purchase agreements they use to guide their transactions.
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General Purchase Agreement: This is a stripped-down, usually much shorter, version of the state/association purchase agreement. This real estate contract is a great option when working directly with sellers and not buying a property through a real estate agent. If you prefer to use a general purchase agreement with an attorney or real estate agent, be sure to point why you want to use the agreement, and emphasize how it can save time for all parties.
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Property-Specific Purchase Agreement: If you’re buying a property outside the traditional single-family paradigm, such as a mobile home or piece of vacant land, you may need to use property-specific purchase agreements (this will depend on the market). Though there is quite a bit of similarity with these types of purchase agreements, these types of real estate contracts have certain clauses about the type of property being transacted.
Real Estate Assignment Contract
A real estate assignment contract is primarily used in a wholesaling investment strategy. You find a distressed property, secure it under contract, and “assign” that contract over to a second buyer (usually at a small profit to you).
The “meat” of real estate assignment contracts is very similar to a regular purchase agreement. Frequently, an assignment contract has the addition of a few extra words. As an example, you might add the following phrase to a purchase agreement: “John Smith, and/or assigns.” (When people refer to “wholesale real estate contracts,” this is the document they mean.)
The “assigns” part allows you to lock up a property with a purchase contract and pass along that property to someone else if you so desire. Though the extra words may not take up much ink, they provide a tremendous amount of flexibility to you as an investor.
Lease Agreements
Even if you’ve never purchased property before, chances are you’re familiar with lease agreements or have signed one in the past. As one might surmise, these real estate contracts outline an agreement between the lessor (the property owner or landlord) and a lessee (the tenant).
In this real estate contract, the landlord agrees to offer the property to the tenant at a specific monthly rate. Agreements of this kind specify important considerations such as the rent amount, security deposit, how utilities are handled. It should go without saying lease agreements that are intended to avoid future issues between lessor and lessee and protect both parties if something unforeseen happens.
Power of Attorney
Though not used exclusively in a real estate setting, power of attorney documents are a real estate contract and can be exceedingly helpful in certain situations. This is because if you’re not able to sign a real estate contract, whether because you’re out of the country or because of some mental incapacity, this document gives another party the power to sign on your behalf.
This type of real estate contract can be quite helpful if you’re the owner of rental properties or you are caring for an elderly parent, or relative, who may encounter a situation when they can’t sign their own real estate contract. The principal or party who has given permission to act on their behalf can have someone sign in their stead. The principal maybe someone who is:
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Hospitalized or has any illness restricting them from being present to sign the real estate contract
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Not physically present in the area
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The owner of several different investment properties
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Mentally disabled
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Elderly and may not be able to sign the contract themselves
Real Estate Contract Terminology
The “legalese” used in real estate contracts can be intimidating when you first take a look. However, these terms are not too hard to figure out and remember. Get familiar with some of the terminology below, it will help the next time you negotiate a contact (and when you review one for yourself).
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Title Search: We’ll start off with an easy one. A title search is simply the process of looking for the rightful owner of the property. This responsibility is typically straightforward and can be handled by a title company.
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Contingencies: A contingency is essentially a condition added to a contract that requires something be completed before the contract can go into full effect. These can include buyers stating they will not buy the home unless their previous house sells, or requesting that sellers make a specific repair before the transaction.
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Riders: Riders are added to contracts to specify additional rules as part of the contract. These are most frequently used when the property belongs to an HOA.
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Earnest Money: An earnest money deposit is often made by the buyer to show a commitment to the property. The funds are usually held in an escrow account until the closing process is complete, and are a percentage of the home price.
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Deed Of Trust: Deeds of trust are typically used between a lender and borrower. It allows the lender to move the loan to a neutral third party during the repayment period.
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Recording Fee: Recording fees are often charged by the county for documenting the final real estate transaction.
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Closing Costs: These costs are incurred at the time of the final contract signing. Closing costs include recording fees, title costs, notary costs, taxes, and any other charges associated with the sale of the property. Closing costs also include agent commissions and can be split between the buyer and seller.
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Seller Assist: As a buyer, if you do want the seller to pay for a portion of closing costs you may need to utilize a seller assist. This essentially documents what costs the seller will absorb at closing.
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Mortgage Note: In addition to the contract, a mortgage note will be signed at the closing table. This essentially documents the terms of the new home loan and is shared between the lender and borrower.
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Considerations: During the contract negotiation and closing process, considerations refer to anything of value exchanged during the transaction. As you can guess, this often simply refers to the funds changing hands.
Summary
A real estate contract doesn’t have to be overwhelming or confusing. A good first step is to understand the types of real estate contracts available, how they benefit you as an investor, and the best situations for using them. Knowing this will put you one step closer to investing mastery.
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