When it comes to real estate investing, there are few things that are as intimidating as preparing the first contract. When you are writing up your first offer to purchase a property, it can be absolutely overwhelming. In fact, many people freeze up at the mere mention of the word “contract.” For psychological reasons, most people prefer to use the word “paperwork” just to take some of the fear out of it.
Since so many new investors freeze up when it comes to contracts, this article will be devoted to the key fundamentals you need to have when it comes to preparing a contract.
Fundamental #1 – Give Yourself an Out
There is no worse feeling than feeling locked into something that you do not want…so do not get yourself in that position with your investments.
At the very least, you should have a minimum of one opportunity to get out of the contract if the need arises. Ideally, everything with the transaction will turn out the way you thought it would; however, in the real world problems can arise. The problem could be any number of things, such as the property not passing an inspection, you are unable to secure the financing, the property does not appraise for high enough of a value, or any other myriad of problems. You want to write the contract in a way that provides exit opportunities for these situations.
The opportunity to get out of the contract is frequently referred to as an escape clause. You want to have escape clauses in your contract that allow you to handle unseen events in a way that favors you. You do need to exercise good judgment though. There is danger in putting too many escape clauses in a contract. What is that danger? Think about it from the seller’s point of view.
If you were the seller and you received a contract that had as many escape clauses as there are lines in the contract, would you think that buyer was serious about buying the home? Of course you wouldn’t. You would probably not even consider the offer unless you were in a desperate situation.
In order to have the best possible chance of getting your offer accepted, use as few escape clauses as possible, but you do need at least one clause to get out of the deal. What are the suggested escape clauses?
We recommend using clauses dealing with the inspection, financing, and appraisal of the property. These are the ones that are most commonly used in most standard real estate purchase contracts. Since these clauses are commonly used, they are also commonly accepted by most sellers. These clauses provide you ample opportunity to walk away from the deal if you need to do so.
Some people like to use the clause “purchase of property is subject to approval of buyer’s partner.” While this one does work as a way to get out of the deal, some sellers will have an issue with it because it does not state who the partner is and what time frame the partner has to approve it. If you are making an offer on a property from a savvy seller, you may not get your offer approved.
The whole point is that you want to write the contract in a way that balances providing you with an opportunity to back out if something is wrong and making a strong enough offer to make the seller feel comfortable.
Fundamental #2 – Time Is of The Essence
Most standard contracts have a clause that says, “time is of the essence,” which means that all parties involved must do what they said they were going to do within the time frames specified in the contract. We mean something a little different…
We want you to provide yourself with enough time to perform according to the terms of the contract. Most real estate contracts will allow you to specify the necessary time to get financing, to do an inspection, or for the appraisal to be completed. Give yourself enough time for these tasks. You need to have enough time to do your due diligence on the property without missing a deadline.
For the inspection period, usually 7-14 days is plenty of time to hire an inspector, review their findings, and be satisfied with the condition of the property. If you find something you object to, you have the ability to renegotiate with the seller. Of course the seller can decline, but that option is available to you if you made your offer subject to approval of an inspection.
For the appraisal period, 7-14 days is also enough time. If interest rates are low and there are a lot of refinance loans going on, the appraisers may be extra busy and have a backlog of work to complete. To be sure, ask your lender how long it is taking appraisers to complete an appraisal in your market. With that information, you will know what to put in your contract.
For the financing approval period, typically 45-60 days is more than adequate. If you have already supplied your lender with the necessary documentation (pay stubs, bank statements, tax returns, etc.), then you can cut down on this time frame even more.
The major point here is that it is better to have too much time than not enough time.
Fundamental #3 – Be Familiar With It
As a real estate investor, preparing contracts is part of what you will be doing on a regular basis. This may be a crazy idea (note the sarcasm) but you might actually want to read the contract to know what is “standard” and what is not.
The contract is a tool of the trade and you need to know it. You need to read it to know what your rights are as well as the rights of the seller. When it comes to cancelling a contract, all contracts state what needs to happen and what the effects are. It is different from one state to the next and you need to know.
Sure, it is not the most exciting reading in the world. We could certainly recommend reading that would be more stimulating. However, reading the contract provides you with knowledge that will help you make a profit.
If there are specific terms or phrases you are unsure of, ask for professional advice. Any real estate agent that is worthwhile can explain to you the meaning of parts of the contract. If you have specific questions regarding the legality of something, we highly suggest speaking to a qualified attorney.
We frequently come across investors that are afraid to make an offer because they do not understand the paperwork. Do not let something as simple as some paperwork prevent you from your goals and your dreams.
Use these fundamental tips to ensure that you are properly protecting yourself in the contract and that you are giving yourself the greatest opportunity to succeed.