Real Estate Contract Basics

Dec 8

Dec 8 Real Estate Contract Basics

Background

As a subdivider of land and principal representative of the legal landowner, I have sole responsibility to make sure that the contracts I sign are as bulletproof as possible. I would estimate that about 90% of the time I am the seller, which means that the offer is typically drafted for the buyers by their representative(s), typically their real estate agent, or attorney. As the seller I must react and respond to whatever contractual document I am presented with.

I am not a lawyer, but I was schooled by some of the best and one attorney in particular. Here’s what I learned up front:

Real estate contracts must be entered in to voluntarily by legally competent parties. There must be mutual consent, meaning an offer and acceptance of the offer. The contract will state the responsibilities of the parties to do and not do certain specific things. Valid contracts must have a legal purpose to be binding and enforceable. There will be consideration of some type, frequently money. Finally, mutual acceptance by the contracting parties. For real property agreements, a current legal description must be included. There will be performance requirements in the contract and failure to fully perform them can result in a breach of contract. These are the basics.

The Role of Real Estate Agents in Contracts

Real estate agents are often the architects and presenters of a deal on behalf of their client(s). They typically use their Multiple Listing Service (MLS) Forms. The forms are fill-in and the task of the agent is to fully understand the buyers offer, then fill in the appropriate blank spaces to create the finished contract that cements the intent of the agreement.

In addition, specific terms and conditions are described on other forms that are attached as addenda and become part of the contract. Real estate agents know they cannot provide legal advice since they are not lawyers, they simply construct the contract on legal forms that were written by lawyers and approved by the MLS, while following applicable laws.

Attorneys as Contract Architects

Lawyers write the best contracts, as would be expected, but if it’s the lawyer for the other party they will always skew it to favor their client in my experience. A typical example would be drafting the contract so that more representations and warranties are placed on me than on their client, thus increasing my contractual risk. That’s fine, because their job is to protect their client and put as many contractual responsibilities on me as possible. Some people think lawyers are a pain. Get over it! They are highly educated professionals that anyone is wise to employ when the need arises. I am not a lawyer and I am not promoting the legal profession, just saying I respect the qualifications of my attorneys, even my attorney adversaries.

After decades in the business I don’t get too worked-up anymore when I get an offer drafted by an opposing attorney, but I used to. This is because I now fully understand the subtleties in contract language and I know what I will and won’t do in the first place. Having said this, I always bring my attorney into the loop if I have any questions at all before signing a contract, no matter who drafted it.

Subtleties in Contract Language

Language is an art. It is an art with teeth in a contract. See the difference in this simple example of contract language regarding the availability of electrical power to a property:

1. Seller represents to buyer, that to the best of seller’s actual and current knowledge, electrical power is available to the subject property through XYZ Public Utility District.

2. Seller warrants to buyer that electrical power is located on the property, and is capable of servicing a single-family dwelling, and can be connected to the “XYZ” Public Utility District.

Both sentences are roughly the same length, but obviously #2 has more teeth. I take great care to understand the subtleties of words in a contract. In the above example, there is a world of legal difference in representing something based on current, actual knowledge vs contractually warranting something. Ask your attorney for details.

Two war stories:

How I succeeded

A builder, through his agent, presented a contract for a full price offer on 3 finished residential building lots in my project. The inspection contingency was 15 days, shorter than the typical 30 days and the closing date was to be the very beginning of the next month. It looked good at first, but I always read every line in a contract every time. In doing so, I just happened to notice that even though the closing date was the next month, it was the next month of the following year. If I had signed the contract I would have been contractually obligated to hold those three lots as a pending sale for 13 months! I was so exasperated by the sneaky deception that I rejected the offer entirely and never accepted offers from that buyer or his agent again.

How I failed

I made a mistake with a different builder that cost me $25,000 and a few sleepless nights. This builder was really smart and I was really stupid. He had already been to the lots and visually inspected them. In the contract he wrote an addendum for the multiple lot purchase that modified the standard language in the MLS Purchase and Sale Agreement. The standard language stated, in part: electrical power ”is available” to the subject lots and in fact, it was.

However, his addendum modifying the standard language, stated that the seller: “warrants” to buyer “that electrical power is “located on, and available to, each lot”. Well…. the electrical power was at the street and installed in junction boxes that served two lots per box, so it was available in good faith. However, the junction boxes were only physically located on every other lot, so even though the needed power tie-in was literally feet away from its partner lot, I was contractually wrong. Not considering this subtlety, I signed the contract and was contractually bound to it. Result: Poof - $25,000 to avoid a breach of contract suit.

Reading a Contract

As a seller, which I almost always am, I let the buyer’s agent present the deal their way but I ask for a separate printed copy to make notes on during the review. Invariably, the agent verbally summarizes the deal while pointing to the appropriate lines on the contract. After she/he is finished I might ask a few clarifying questions, but I don’t rely on the verbal answers. I ask them to point me to somewhere that I can sit and read the contract at my own pace. Then I do just that, every single line and every single word, even if I have read the boiler plate small print 100 times before. It’s amazing what I can catch. If I am unclear on something I involve my real estate attorney to get clarification.

Common Ways to Get in Trouble with Contracts

1. Real estate contracts must be in writing and properly executed.
2. Relying on verbal agreements that are supplemental to the signed contract - promises made verbally before, during or after signing are never remembered when something goes wrong, or they are partially remembered and interpreted differently by the parties. It’s called amnesia, the partial or total loss of memory.
3. Being a party to a contract and not fully understanding the contract.
4. Speed reading the fine print and focusing on the “important stuff”.
5. Agreeing to sign what’s in writing “right now “so we can get it done today and then we’ll update the rest later”. Really bad if you are the disadvantaged one “right now”.
6. The legal description of the property is not a part of the real estate contract at signing and/or the legal description is incorrect.
7. Failure to seek the counsel of a qualified attorney when needed, before the contract is signed.
8. A mind-set of using an attorney to fix problems, not to prevent them.

Psychology of Contracts

Everyone gets excited and worked up when reviewing contracts. I do every time. This is because real estate contracts involve a lot of money. What constitutes a lot of money for one person is peanuts to another, but we buy and sell at the economic level we are at. So that means every deal is significant to us whether it’s a forty thousand dollar or a forty million dollar deal.

When we get worked up our ability to concentrate and focus is affected. Retention can also suffer. On top of this there is a sense of urgency, since almost every offer has an expiration date for acceptance or counter offer. Even transactions that seem simple on the surface can be complex when examined closely. If there is more than one person on the same side of the deal this can also be a problem. One person thinks they should move forward, the other doesn’t.

I strive for organization, focus and a competitive edge when contracting. Clarity of purpose and an absolute commitment to full understanding of the agreement is essential to me. If I lack these essentials I don’t sign.