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 types of 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 that were agreed upon when two or more individuals negotiated a real estate transaction. The terms outlined in a contract are put into effect upon signing, and 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.
Is A Real Estate Contract Legally Binding?
A real estate contract becomes legally binding when the document secures the status of a property 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. In order to obtain both signatures, all parties must come to an agreement before a contract is considered valid. If one party submits a counter offer, for example, 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, it is crucial that everyone understands 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).
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 estate agreements and contracts:
- Inspection Details:Every real estate contract should include a contingency that allows buyers to walk away if the property inspection does not go to plan. At the very least, contracts should specify which issues the sellers are responsible for repairing before closing. This will clarify expectations for both parties, and protect buyers from being forced into a transaction they did not sign up for.
- Financing Clause:It is important to 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 in the event their previous home does not sell.
- Closing Costs:Always specify who is responsible for closing costs, and always keep an eye out for this information. In many cases, sellers may be in charge of covering these costs but it could be buried within the contract. Make sure closing cost information is clear in any real estate contract to avoid confusion.
- 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.
- Contract Default:It is very common for real estate contracts to state what happens if one or more parties default. This not only sets clear expectations for buyers and sellers, but also 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.
Types of Real Estate Transactions
There are several types of real estate transactions that 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:
- 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 through the purchase agreement.
- 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.
- 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.
- 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 then re-list the property on the market as soon as they can for an increased value.
- 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.
- Prehabbing a property:A property is prehabbed 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.
- 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 borrower, such as the loan term and interest rate.
Types of Real Estate Contracts
As a real estate investor, it is absolutely necessary to be well-versed in the various real estate agreements and contracts that 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 how these contracts work to protect the other party. Here are four common real estate contracts that you should familiarize yourself with today:
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:
- Identification of both parties
- Property description
- Condition of the property
- Purchase price of the property
- Included and excluded appliances and fixtures
- Type of deed
- Earnest money deposit
- Closing costs
- Party responsible for each cost
- Date of closing
- Terms of possession
- Signatures of both parties
Now, 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:
- State/Association Purchase Agreement:Many states, and the realtor associations that serve local markets, have standardized purchase agreements they use to guide their transactions.
- 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 do 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.
- 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 do have certain clauses which pertain to the type of property being transacted.
Real Estate Assignment Contract
A real estate assignment contract is used, primarily, in a wholesaling investment strategy, in which 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. Often times, an assignment contract simply 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 gives you the opportunity 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 do provide a tremendous amount of flexibility to you as an investor.
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 in the event that something unforeseen happens.
Power of Attorney
Though not used exclusively in a real estate setting, power of attorney documents are a form of real estate contract and can be exceedingly useful 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:
- Hospitalized or has any illness restricting them from being present to sign the real estate contract
- Not physically present in the area
- The owner of several different investment properties
- Mentally disabled
- Elderly and may not be able to sign the contract themselves
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.
How well do you know real estate contracts? Do you have some favorites of your own? Perhaps there are some you would rather avoid? Feel free to share which real estate contracts have influenced your career path the most in the comments below. You may find that great investors think alike.
–JD ESAJIAN FortuneBuilders