It can get even scarier when it’s super-long. In fact, property purchase and sale agreements can sometimes run 30+ pages! Talk about intimidating.
The good news: As a real estate investor, you probably already have a somewhat decent understanding of all of the components of a purchase and sale agreement. These are ideas and aspects of a property sale that you already know – they’re just in a written format.
Still, it’s important to have a firm grasp on each section of a purchase and sale agreement – so you are easily able to determine which ones are relevant to a specific property deal. With time, this will become second nature to you.
So, let’s look at just a few basic facts about a purchase and sale agreement, before we get into the details of the unique sections:
- Depending on your state and local laws, your contract may be called a “Purchase and Sale Agreement,” an “Earnest Money Agreement” or a “Contract To Sell”
- These contracts are known as “living documents” because they are usually modified several times before the buyer and seller eventually sign them
- Again, depending on your local laws, the purchase and sale agreement may be a very brief document that’s main purpose is to open negotiations; or it may be a highly detailed, multi-page and 100% legally binding contract
- Both the buyer(s) and seller(s) are able to make changes to the purchase and sale agreement, but all parties must agree to (and sign or initial for) any revisions
With that said, let’s take a closer look at each section of a standard purchase and sale agreement.
Basic Identifying Info (Property & People)
Every purchase and sale agreement should list the exact property details—including the address and detailed description. And, of course, you need to include the identities of each buyer and seller involved in the transaction.
If there are multiple buyers, it’s important to identify whether they are joint tenants or have what’s known as tenancy in common. In a nutshell, here’s the difference:
- Joint tenants have the right of survivorship. If one passes away, full ownership of the property is automatically given to the other (this is the more common arrangement of these two options).
- If the buyers choose to have tenancy in common, this means that each person owns a share of the property (with may or may not be equal, and which could be transferred to someone besides the other buyer).
Obviously, this is one of the key components of any purchase and sale agreement. It’s really the whole point, right?
Make sure your contract includes:
- The accepted offer price
- The financing method (cash, mortgage type, creative financing, etc.)
- Earnest money – This is used to validate or confirm the contract; the amount may vary, but it’s generally $1,000+. In most cases, the earnest money is applied to the down payment (once the time comes). Usually, earnest money is non-refundable if the deal falls through – but again, this may vary.
- Agents’ commissions – If agents are involved, make sure to specify in the contract who is paying the commission (buyer or seller) and the amount
- Property taxes and fees – Taxes and fees (such as homeowners’ association fees or maintenance fees) should be prorated, based on the closing date
That should cover most of the financial aspects of the transaction. If you have any unique financial circumstances, be sure to include these within the contract.
If the property includes outbuildings, garages or other structures on the land, make sure the purchase and sale agreement outlines which of those are included or excluded from the sale.
Also specify any miscellaneous items that are included or excluded, such as:
- Kitchen appliances
- Light fixtures
- Window treatments
- Large items that are not easily moved, such as pool tables or chest freezers
Settlement & Closing Info
Now we’re starting to get into the “meaty” stuff…
The settlement (or closing) date is very important. Make sure you specify this in your purchase and sale agreement. If any changes to the date are made, all involved buyers and sellers must agree to this change (in writing) before it becomes effective.
Usually, your closing date will be about 30-60 days from the initial contact (although, in the world of investing, things can often move much more quickly, especially when all-cash offers are made). If a property is vacant, you can expect less than 30 days between the contract execution date and the closing date.
Also, every purchase agreement should include:
- Closing cost amount and who will pay -Usually, the buyer covers all of the closing costs; but, the seller could also cover them, or the buyer and seller could split them
- Who will execute the closing -Depending on the situation – and your area of the country – a lender, title insurance agent, Realtor, or the buyer and/or seller’s attorney could be present at the closing. In other situations, an escrow agent will coordinate the settlement and give the involved parties instructions on how to prepare for the closing date
Once you have the main “skeleton” of the contract constructed, it’s time to add in some of the details that are often unique to the specific property deal. The required disclosures are one such component.
What are disclosures?
Well, they’re exactly what they sound like… in many states, there is certain information that sellers must disclose to a buyer, if that information may ultimately impact the property’s value and/or safety.
Willfully concealing such information can be illegal, especially if the buyer’s health or wellbeing could be jeopardized.
A few important disclosures are:
- Wells – location and condition of any wells located on the property
- Lead paint – any structures built around 1978 or earlier may contain lead paint; if lead paint is an issue, this must be included within the contract
- Methamphetamine – this is an odd one, but many states require sellers to disclose, in writing, if the property was previously used for meth production purposes; you’re probably not likely to come across this situation often, but – if you do – make sure the purchase and sale agreement includes any details on remediation measures that will be required prior to the settlement
- Termite damage
- Subsurface sewage disposal system
- Radon gas
- Potential annexation
This is another topic that can add quite a bit of length to a purchase and sale agreement. Long story short: these are all the “if this, then that” parts of an agreement. In other words, all contingencies must be met or fulfilled before a deal can go through.
Let’s take a look at some of the most common contingencies…
Inspection: Typically, a third-party inspection of the property is required. The seller chooses the inspector and the buyer pays for the services rendered. Most contracts specify that the inspection must be completed within 10 days of the agreement being signed. An inspection contingency is enormously important for the buyer, as it will allow them to freely walk away from the deal if the inspector uncovers any major issues with the home (such as the need for a $20K foundation repair).
Appraisal: If a lender is involved in the deal, they will arrange an appraisal to determine the property’s value. If they determine that the property is worth less than the listed value, the buyer will need to cover that difference or negotiate a lower price for the home.
Financing: A financing contingency allows a buyer to walk away from a deal if their financing (loan) falls through. Usually, this type of contingency will also specify that the buyer will be refunded their earnest money as well, should they be unable to finance the deal.
Title: This contingency simply says that the seller must have a valid title for the home, which will be transferred to the buyer at closing.
Sale of Current Home: In some situations, a buyer will specify that their current home must be sold before they are able to close on their next property. Obviously, this is not an exciting prospect for the seller, because it allows the buyer to back out of the sale easily if their current property isn’t sold. If you’re typically selling your properties to other investors, this shouldn’t be a scenario that you encounter often – but, again – it’s something that you should be aware of.
Escalation Clause: If you find yourself bidding on a “hot” property that’s generating a lot of interest from potential buyers, you may want to include an escalation clause in your purchase agreement (if, of course, the seller agrees to it). This states that the seller must accept your offer over any equivalent or higher offer from another interested buyer that may come in later.
Taking the time to research contingencies can be extremely helpful. As an investor, you will likely come across each one of these at some point in your career.
Expiration & Default Info
Some – but not all – purchase and sale agreements will include a deadline by which the offer will expire if both parties haven’t signed the contract. In other cases, this deadline is verbally agreed upon by the buyer and seller.
But, more importantly, the contract should also include default information – in the situation that either the buyer or seller fails to fulfill their end of the agreement within the specified timeframe.
Usually, default happens in one of these cases:
- The buyer does not pay the earnest money by the specified date
- Either party does not return the signed disclosures on time
- The seller fails to complete any required repairs or upgrades to the property
- The seller does not allow an inspector to come onsite
- The seller does not move out by the specified date
This is a business decision… and regardless of whether you are the buyer or seller, you need to protect yourself (before you wreck yourself).
Make sure your purchase agreement contains language that describes the consequences if either party defaults on the contract. If you are the seller, you may require the potential buyer to forfeit their earnest money. On either side of the transaction, pursuing legal action should also be an option.
Purchase agreements are just like people – no two agreements are the same.
While I hope that the info I provided you will prove to be valuable and helpful, it is not all-encompassing. The only way you can understand these contracts is to gain experience writing and executing them. With time, this will become second nature for you.
So while it’s important to appreciate the significance of a purchase contract, it’s also imperative to approach them in a calm and confident manner. You’re an investor, after all – you got this!
If you’re still in the beginning of your investing career, here’s one bit of advice that you may find helpful: handle one contract at a time. Don’t overload yourself by juggling multiple properties (buying or selling) all at once. Take the time to really focus on one property at a time, until you begin to feel more comfortable handling multiple purchase and sale agreements simultaneously.
And – again – I’m not an attorney. Everything I’ve shared is based on my experience. Make sure you consult an experienced attorney for all agreements, contracts and legal matters.
Now It’s Your Turn
I hope this demystified purchase and sale agreements for you. Regardless of whether you’ve handled 1 property contract or 1,000, what’s a piece of advice you would offer for investors who are still figuring out the details of these agreements?