What You Should Know About Real Estate Contracts

Some basic information about real estate contracts that might help you with your next deal

As a professional investor you already know that it’s almost impossible to buy or sell a house, an office building, land, or just about any other kind of property without real estate contracts. But what exactly is a contract, and what makes it a legal, binding document? Following is some basic information about real estate contracts that should be part of your real estate knowledge base.

What is a Contract?

A contract is a written or oral agreement between two or more parties. However, in the world of real estate transactions a contract must be a WRITTEN agreement. In most, if not all states an offer to purchase real estate is not contractually binding unless it is in writing and signed by the parties involved. In short, the agreement must be in writing and it must be signed by all parties in order to be considered a binding contract.

The Four Elements of a Contract:

  1. The Offer - The first part of the contract is the offer. The offer spells out the terms and conditions of the purchase. If you’re a buyer, or an investor, a young couple looking to buy your first home, and you see a house that you like, in order to get the ball rolling, you first need to present a written offer to the seller. The offer will contain all the terms and conditions that you want to incorporate into your purchase like the purchase price, closing date, financing contingencies, and things of that nature. This is where you’re saying, okay, you want to sell your house for $100k but I want to pay $80k, and I’ll pay it on a certain day and I’ll put down so much money, and it’s all subject to the following things that if they work out the way I want, I’ll close on or before this date.
  1. Acceptance – Once the offer has been accepted, it means both parties have agreed to the terms of the sale. The offer doesn’t become a binding contract by virtue of just presenting it. The acceptance is when the seller in this case actually signs the buyer’s offer, and accepts the terms as the buyer has presented them.
  1. Intention – Intention means that there is a meeting of the minds. The seller intends to sell, and the buyer intends to buy. The Purchase Agreement will state this, but the intention should clearly be there. The Purchase Agreement must clearly state all of the intentions of the seller and buyer.
  1. Consideration – Consideration is an old legal term that basically means the buyer has given something of value to the seller for the purchase. It doesn’t matter what the “fair market value” is of the property. You can agree to sell someone a property for far less than the market value. From a practical standpoint, consideration should consist of actual currency. If you go to the point where you’re going to have a purchase agreement indicating a consideration (sum of money), you want to be clear in defining what that consideration is. In short, the consideration is the payment you provide to the seller for the property.

Can people dramatically reduce the consideration noted in the Purchase and Sale Agreement in order to avoid taxes or for some other reason? The answer is yes, they can, although it is a short-term fix. Usually the county auditor’s office does an appraisal of the property every 3 years. In order to justify the reduction in price, the county auditor’s office, or whoever the taxing authority is, would want to see proof of justification for the deflated price. You would have to prove to them beyond a reasonable doubt that the consideration noted in the agreement is the true market value of the property, and you’re just not doing this as a sham to try to reduce taxes. They will fight you on it.

On the other hand, many times a distressed property may have a tax value of, say, $100k, but because of a loss like a fire or a destructive tenant, and the condition of the house has deteriorated, then the fair market value for that distressed property may in fact be half of the tax value. Of course you might have to present proof in the form of an appraisal, pictures, and things of that nature.

Verbal Agreement Contracts

A lot of times people say, and especially those just getting into the real estate business, that there was a verbal agreement to sell, so that constitutes a contract. This is absolutely not true because real estate contracts must be in writing. So unless it’s in writing, presented by the buyer and acknowledged by the seller with the seller’s signature, it is not a legal document and is not binding.  

Notarizing the Contract

In many cases there are purchase agreements where there is no notarization on the signature. In other words, people signed the contract, but who is to know that it really was the buyer’s and seller’s signatures? What if the seller says he’s changed his mind and doesn’t want to sell the house, but his signature seems to be on the contract? What happens then?

In this case there is the presumption under the law that the signature is good. In many states there is no requirement that a purchase and sales contract be notarized. It’s always a good idea to have it, and there’s nothing that says that you can’t have it, but a lot of times deals are made on the spot, when people are going through the house they may have a standard fill-in-the-blanks type of form, and they want to get that agreement in writing so they fill it out on the spot and they don’t have a notary available. It is not a requirement to have that document notarized.

Burden of Proof in Signature Dispute

If you present an offer to buy a house, and the seller signs it, and somewhere down the road they claim they did not sign it, then the burden is on that seller, who is trying to back out, to present the evidence that he did not sign it. The burden of proof always shifts to the person claiming that they did not sign the document.

This discussion is just the tip of the iceberg when it comes to understanding the ins and outs of a strong real estate contract. However, these basics should help to guide you as you develop your own contracts. Remember, the idea is to create a legal document designed to protect you in any given transaction, and that no two transactions are alike.

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