Real Estate Sales Contracts
A real estate sales contract (aka purchase and sales agreement, purchase agreement) is a contract for the sale of real estate, establishing the legal rights and obligations of both buyer and seller, both in regard to the property itself and to the real estate transaction. The detail of the purchase agreement will generally depend on the state and locale. Most of the details in a contract that are not stipulated by law are negotiable. For some of the provisions, such as the length of escrow, contingencies, assignment clauses, the payment of costs, the amount of the earnest money deposit, and certainly the purchase price itself, the buyer and seller will have opposite desires as to the details of those provisions. The seller will want a short escrow, few contingencies, no assignment clauses, low or no payments for additional costs, and a large amount of earnest money. Naturally, the buyer will want a longer escrow, with more contingencies, where the buyer can back out of the transaction at little or no cost, assignment clauses to possibly resell the property at a profit to another buyer even before closing, little or no additional cost over the purchase price, and low or no earnest money. These are the provisions that are most commonly negotiated.
Many states have mandatory disclosure laws, where known problems with the property must be disclosed either in the sales contract or in a separate document. There may also be a required disclosure of any brokers agency relationship.
As with any other contract, a valid purchase and sales agreement requires:
- acceptance as to the terms and conditions of the deal
- competent parties
- consideration in the form of money, a promissory note, or other value offered by the buyer to the seller
- legal purpose
Additionally, a valid real estate sales contract requires:
- an adequate description of the property
- signatures by the principals or their attorneys-in-fact
Moreover, the Statute of Frauds requires that any contract for the sale of real estate be in writing; oral contracts are not enforceable. If brokers or escrow agents are involved in the real estate transaction, then they must also sign the sales contract.
In most cases, the buyer prepares a signed offer to purchase and presents it to the real estate agent or to the seller, if the seller is unrepresented. But either the seller or the buyer can make the offer; the other party can either accept the offer or reject it, either outright or by a counteroffer, changing some of the terms and conditions that are acceptable to the other party. Likewise, the counteroffer itself can either be accepted or rejected by another counteroffer. This can continue until an agreement is reached or the parties disengage. If the counteroffer is accepted, then the terms of the counteroffer forms the new contract and the previous ones ceases to exist.
Like any contract, an offer or counteroffer can be revoked at any time before it has been accepted, regardless of any agreement to keep the offer open for a specified time. Because an offer only becomes a contract when accepted, the party making the offer or counteroffer must be notified of the acceptance before it becomes a binding contract. Otherwise, it may have been revoked in the meantime. All concerned parties, including their attorneys, will be notified and a copy will be provided to each party.
Sometimes a broker may prepare a binder, which is shorter than the sales contract, to expedite the formation of the contract. It has the essential terms of the contract and stipulates that the broker has received an earnest money deposit for the contract. A traditional sales contract is later prepared for signature by both parties. In some cases, a binder is used so that a more formal, complex contract can be prepared. In some cases, the terms of the agreement are different enough from standard sales contracts that a binder is prepared for the initial acceptance, which will be followed by a custom sales contract covering the terms of the agreement.
There may also be an escrow contract, an agreement between the buyer, seller, and an escrow agent or company stipulating the rights and responsibilities of each party to the real estate transaction. The escrow agent acts as a disinterested third-party to ensure that the terms of the sales contract and escrow contract are being followed in due time.
Common Contract Provisions
One of the most important terms in the contract is the purchase price, which will be stated in the sales contract. No adjustments are made for financing, seller-paid closing costs, or concessions.
The contract will generally include the following:
- buyers name
- adequate description of the property, such as a street address
- seller's name
- type of deed that the seller intends to convey
- kind and condition of the title
- the form of title to be delivered
- the form of the title evidence and who will provide it: abstracted legal opinion, certificate of title, title insurance policy, or torrent certificate
- list of any covenants, conditions, and restrictions
- the list of title defects that will be eliminated, either by the seller or buyer
- purchase price and how it will be paid, including earnest money deposit,
- conditions of mortgage financing, and any additional cash from the purchaser
- dates by which specific steps of the purchase are completed, including the completion of the property inspection, when the inspection is reported to the seller for repairs, loan commitments, and the projected date of closing
- proration of expenses, such as real estate taxes, rents, and other expenses
- provisions for the damage or destruction of property between the signing date and the closing date
- a liquidation damages clause, specifying the remedies available in case of default
- contingency clauses, most of which depend on the property inspection, financing, and title defects
- the dated signatures of all parties, including all co-owners, and in some states, nonearning spouses who may have a marital or homestead right in the property
- if applicable, an agency disclosure statement.
Additional provisions that may appear in sales contracts include:
- what documents each party will provide and when and how they will be delivered
- personal property that will be left for the buyer, such as lawn and garden equipment
- real property that will be removed by the seller, such as a storage shed
- the transference of any applicable warranties on the house, it subsystems or built-in appliances
- the identification of leased equipment that must either be transferred to the buyer or returned to the lessor, such as cable boxes or security systems
- who pays for any outstanding special assessments
- the name of the closing or settlement agent
- closing instructions
- any transfers of escrow account funds
The contract should also specify anything that will affect the property's value, so if the seller claims that the building was built by a certain architect, or that it is of a certain age, then those details should be in the contract.
The contract provision that time is of the essence means that dates cannot be changed unless both buyer and seller agree. Otherwise, the law may allow greater flexibility on dates, depending on the locale. In some locales, if deadlines are missed within a reasonable length of time such as 30 days, then the contract may still be in force.
The contract should stipulate which fixtures will remain. Fixtures are attached to the structural components of the property. For residential properties, fixtures generally include built-in appliances, light fixtures and ceiling fans, furnaces, and central air conditioning. The contract should also state that all major systems are in working order on the day of closing.
The contract may also stipulate liquidated damages, money to compensate for breaching the contract. In many cases, the earnest money deposit serves as liquidated damages if the buyer defaults. If it is further stipulated that the earnest money deposit is the sole remedy, then the seller cannot pursue any further damages in court.
Earnest Money Deposit
Earnest money, usually in the form of a check, is either given to the broker who keeps it in a special account, or to an escrow agent. The amount of the deposit should be enough to compensate the seller for taking the property off the market, to cover any potential expenses resulting from the default of the buyer, and to encourage the closing of the transaction. The contract may specify that the earnest money deposit serve as liquidated damages to the seller, compensation to the seller if the buyer decides not to follow through. In some cases, a seller may proceed to try to collect additional damages unless the contract limits any damages to the amount of the earnest money deposit.
A broker must deposit the money in a separate escrow account that is not commingled with the broker's own finances. The broker may not use that money in any way. However, it is permissible to put the earnest money deposits from several potential buyers into one account. Whether funds in the escrow account earns interest depends on state law, but if it does, then the contract may specify how the interest is distributed, usually either going to the buyer at closing or to the seller as part of the purchase price.
Most buyers of property require a loan to purchase the property, but most lenders will not lend the money until the property is under contract so that a real estate appraisal can be conducted, to ensure that the property is worth more than the loan by a certain percentage. If the borrower defaults, then the lender will repossess the property to sell to another buyer, but the lender will lose out if the property is not worth at least a certain percentage more than the value of the loan. Consequently, lenders will give buyers a preapproval for a loan, to give the buyer an idea of how much she can borrow. However, preapproval for a loan is not a loan commitment, which generally takes place after the property inspection and appraisal.
If the buyer must sell his current property before closing on the new property, then the property should be on the market or the buyer should inform the seller about plans to market the property. Generally, sellers do not want to wait too long.
Consequently, most real estate contracts have a kick-out clause. If the seller gets another offer, then the kick-out clause stipulates how much time the buyer has to finalize the sale or to abandon it, typically ranging from 1 to 3 days, depending on how quickly real estate is selling in the area. The contingency will generally state how quickly the buyer can close on the property if the seller does receive another offer.
Because of the many requirements for a real estate transaction and the need for information by the buyer to ensure that the purchase price is equal to the value being received, a purchase of property is completed after the buyer has a chance to inspect the property, inspect the books and records if it is income-producing property, arrange financing, and to verify any encumbrances on the property, such as easements. Ordinarily, a seller will not allow such a detailed investigation unless the buyer is serious about buying the property. Therefore, the buyer signs a contract and deposits earnest money with the escrow agent to demonstrate to the seller that the buyer is seriously considering buying the property. However, virtually all real estate contracts have contingencies that will allow the buyer, and sometimes even the seller, to terminate the agreement without cost if the investigation reveals that the property is not worth the price. In many cases, the price can be renegotiated if problems turn up.
Contingencies create a voidable contract — if a contingency is not satisfied, then the contract can be voided by the party benefiting from the contingency. A contingency has 3 elements:
- the requirements to satisfy the contingency
- when the contingency must be performed
- who is liable for the costs of the contingency
Both the buyer and seller have contingencies, which are conditions that must be met to the satisfaction of the beneficiary of the contingency, to close the real estate deal. A contingency can either be approved or rejected, or the beneficiary of the contingency can waive the contingency.
Contingencies have a specific duration. For instance, the contingency for a property inspection may last only 10 days, after which, the buyer either accepts the property after the inspection or rejects it. But if the contingency is not rejected before it expires, then the contingency ceases to exist. If the buyer or seller do not agree with the contingency or wants the deadline increased, then the beneficiary of the contingency must negotiate with the other party for the change. The escrow agent has no role in changing or extending the contingency.
The most common contingencies include a:
- property sale contingency, where the purchaser must sell her current home before closing the transaction
- mortgage contingency, allowing the buyer to a refund of the earnest money deposit if the lender does not commit to the mortgage
- inspection contingency, allowing the buyer to inspect the property to ensure that there are no major defects that would devalue the property.
One primary contract contingency that the buyer should insist on is that the seller delivers a clear deed and a legal right-of-way if the property cannot be accessed by public roads.
Other common contingencies for the buyer include:
- approval of property lines and tract size according to a survey
- property appraisal for at least the contract price
- if the land has no access to public sewers, then it must be approved for a septic system
- adequate time to review restrictive covenants or deed restrictions
- time to review leases between the current owner and tenants
- the buyer must sell another property to complete the purchase
- verification that radon gas levels are below minimum standards
Other contingencies may be advisable, depending on the property and location. For instance, commercial properties will generally have other contingencies.
However, too many contingencies is not advisable since the seller may believe that the buyer is looking for loopholes to back out of the contract if necessary or to keep the property off the market longer. In such a case, the seller may demand an escape clause, allowing the seller to continue marketing the property until all contingencies have been eliminated.
The financing contingency usually specifies the type of loan the buyer is seeking and will accept. If the buyer cannot obtain a loan with the required terms, then the buyer can back out of the contract with no penalties. However, financing terms must be realistic; otherwise, buyers can set unrealistic conditions as a means of backing out of the property at will.
The transfer of the real estate title does not occur until a deed is delivered and accepted. When a sales contract is signed, the buyer receives equitable title in the property. The legal rights of equitable title vary by state. However, if the sale fails to close, then the buyer may be required to issue a quitclaim deed to the seller, releasing any rights that the buyer may have had as the holder of equitable title back to the seller.
A buyer who has equitable title may benefit or suffer a loss. If oil or minerals are found in the property, then the buyer will usually be entitled to the profits. In years past, the destruction of property would be borne by the buyer with equitable title. However, both the states and the courts are imputing the loss to the seller if it occurs before closing. Specifically, many states have adopted the Uniform Vendor and Purchase Risk Act, stipulating that the seller bears any losses before the title passes to the buyer. However, the contract may also stipulate who suffers a loss if the property is destroyed or damaged before closing.
Amendments and Addendums
Contracts are often changed either by amendments or addendums. An amendment is a change to one or more the provisions of the contract, while an addendum is an additional provision to the contract. Both amendments and addendums must be signed by both buyer and seller. For instance, an amendment may change the date of closing, which often occurs when unforeseen problems arise. A common addendum is to decide how to split the cost when a major defect is found in the property.