Defining a Real Estate Investment Contract
Because a real estate investment contract is really a contract, it is an agreement to do something or refrain from doing something; however, the "something" in this case is usually related to providing a financial return of some sort (usually interest), and the "refrain" is typically about not doing something with the property. In other words, in these contracts, the investor is the financier (or person or entity providing the money), and the landowner (or person or entity providing the property) is the seller. Imagine what this would look like in practice:
In this example, Investor A owes $300.00 to Landowner C because he sold him the property that his restaurant is located on, and then Investor A promises to lease the property back from Landowner C for ten years at $50 a month. Assuming that neither investor defaults, our contract for this arrangement might look like this:
Contract Between Landowner C and Investor A
I, Landowner C , have sold a piece of land that I own to Investor A for $300. This property is located at 1234 Main St. My restaurant, Steve’s Wings and Things, is currently located on this land. Half of the money is due today, the remaining $150.00 is due in six months, at which point Investor A will take ownership of the property.
I, Investor A, have bought a piece of land that Landowner C owns for $300. This property is located at 1234 Main St. My restaurant, Steve’s Wings and Things, is currently located on this land. Half of the money is due today, the remaining $150.00 is due in six months, at which point Landowner C will take ownership of his property. As part of this agreement, I agree to pay Landowner C $50 a month for lease of the property for a period of 10 years.
As indicated by this example, a real estate investment contract is a contract for the benefit of a third party within a transaction involving a piece of real estate. The purpose of the contract is to secure investors and as collateral for any loans that may be necessary in the future.
The Essentials of a Real Estate Investment Contract
A real estate investment contract is a legal agreement that outlines and governs the relationship between a buyer and seller of a given investment property. Like any other legally binding contract, an investment contract typically includes terms and conditions that the parties must adhere to once the deal has been made.
Being that there are several types of real estate investment contracts—among them, purchase and sale agreements, an offer to purchase and sales contracts—being armed with knowledge on the components that make up an investment property contract can lessen your chances of falling victim to real estate fraud.
The most basic elements are:
• Address of the property and the names of the parties involved
• Amount of consideration (payment)
• Closing date and method of payment
• Deed and title: The stricture details how the seller intends to honor the deed and provide a good title to the buyer
• Title insurance: The general default is that the buyer is responsible for securing a title insurance policy
• Inspections: Outlines the timeline for inspections as well as the deadlines for agreeing to repair costs
• Representations: It is a fairly standard clause that provides a specific timeframe in which the seller and buyer must agree to a solution if nonconformity exists
• Fixtures and personal property: What stays and what goes
It is always recommended to have a qualified real estate attorney review your contract before signing, as doing so can save you from making a legal commitment that may be unfavorable to you. A qualified attorney also can ensure that the terms of the contract correspond with any other contractual obligations you may have previously entered into.
Types of Real Estate Investment Contracts
There are a handful of different types of real estate investment contracts. Each is structured to fit a specific project and situation.
Purchase Agreements
If you’re looking to buy or sell investment property, you need a quality purchase agreement. It’s a formal option contract that defines the terms of a future sale. It imposes certain duties on both parties, and failing to meet those requirements can result in the imposition of damages. For example, if the seller doesn’t pull the trigger on the deal without good cause, they could be sued for breach of contract and expect to pay the price—perhaps even the amount of a deposit. Also, the buyer is expected to satisfy the terms of the contract, which could include securing financing by a certain date.
Leases
Most rental property investors use a lease. Lease contracts are somewhat similar to an option agreement in that they’re formal contracts that allow someone to use or occupy the property for a specified period. Unlike the option contracts, leases generally don’t require a purchase payment.
It’s important to consider the terms of the lease. For one, you need to make sure the lease gives you the right to terminate the agreement in the event of non-payment or some other breach. Additionally, if your rent prices need to increase, you’ll want to make sure your lease agreement accommodates for that change. Also, make it clear what happens when the lease expires if the renter chooses not to extend the agreement. Will the tenant become a month-to-month renter by default, for example? All of these terms need to be clearly defined in the lease agreement.
Joint Venture Agreements
A joint venture is a partnership in which a third party invests in a specific project, such as a major renovation, property acquisition or development. Oftentimes, the third party brings some commercial real estate experience into the fold, and the rules of the partnership are set out in the joint venture agreement. Investors, landlords, lenders and other interested parties can all form joint venture partnerships with this type of agreement. It’s up to you whether you’d like to draft a new agreement for every project you undertake or if you’d like to use a general agreement for all your projects (or maybe use both).
It may appeal to you to use a different joint venture agreement for each project to help you manage risk. That is, some of your projects might be more risky than others, and it may be in everyone’s interest to avoid tying them together under the same terms and conditions.
Investment Property Agreements
This is a general agreement between the investor and the property owner (i.e. the landlord). It provides the terms for share distributions and the distribution of monthly profits and losses from owning the property. If you don’t have a partnership with an outside investor, you might not use this type of agreement. But the terms of the agreement are particularly helpful if needed. The investment property agreement is a way for the parties involved to protect themselves from a financial loss, and it helps ensure each party receives their fair share of the profits.
How to Create a Real Estate Investment Contract
In order to successfully draft a real estate investment contract, there are several steps investors should follow to ensure the document is complete, legally binding, and up to date. First, working with a real estate attorney can make the process easier for investors and can help create a clear contract that outlines the terms of the investment. Investors should avoid using older, outdated templates that could result in an incomplete contract or one that does not meet all necessary obligations. Ensuring the right details are included in the contract from the very beginning can prevent complications or misunderstandings from occurring later. The components of a real estate investment contract generally include: 1. Parties involved — The individuals involved in the property sale and purchase must be clearly defined. Signatures should be obtained from all parties named in the contract. 2. Location of the property — The address, physical description, legal description, and any alterations to the property’s exterior and interior should be detailed in the contract. 3. Purchase price — The exact price of sale of the property must be stated, including how funds will be provided. 4. Financing terms — If the buyer is using financing for the property, details of the financing agreement should be included in the contract. 5. Deed transfer — Whether the sale will involve a warranty deed, special warranty deed, quitclaim deed or any other type of deed must be stated in the contract. 6. Earnest money — The amount of earnest money the buyer will put down and how this money will be held until closing should be specified. 7. Closing — Closing procedures and requirements should be provided in the agreement. If the process involves an escrow account or third-party broker, those requirements should be explained. 8. Disclosures — Any disclosures regarding the property, such as hazardous materials or past health or safety code violations involving the building, should be included in the contract. 9. Home inspections — A specific home inspection period in which buyer and seller can mutually agree on terms for the property should be included. 10. Contingencies — If certain conditions must be met for the sale to go through, those conditions should be added to the contract. It’s important for buyers to work with a qualified real estate agent and an experienced attorney when creating a real estate investment contract.
Negotiation in Real Estate Investment Contracts
When it comes to real estate, the art of negotiation is essential to ensure the best possible investment outcome. This is especially true when the terms of a real estate investment contract are being negotiated. By carefully reviewing, proposing, and countering terms, you can protect your interests, secure favorable deal terms, and pave the way for successful and profitable real estate ventures.
There are a number of different terms that are likely to be included in a real estate investment contract. The price of the property is obviously the most important term, but it is not the only one. Negotiating liability and indemnification clauses is also important, as is negotiating contingencies and conditions. You should also be prepared to negotiate your rights to assignments, brokerage representation, and warranties and representations. Your lawyer can help you to understand the implications of each of these terms and how to secure favorable terms that will protect you.
The best strategy for negotiating the terms of a real estate investment contract is to ensure that you take your time, consider or even counter any terms that you dislike, and to remember that there is always room for negotiation. Use your litigation attorney to get advice and guidance for this process.
The Legal Aspects of Real Estate Investment Contracts
Real estate investment contracts must comply with several legal requirements. These include federal and state laws, as well as local ordinances. These laws vary from jurisdiction to jurisdiction, which means that it is important to be aware of the regulations in the areas in which the property is located.
Contract enforceability and legality depend on following the laws of the applicable jurisdiction. That means that even if a real estate investment contract is completely legal in one area, the same exact contract may be entirely illegal in another.
Reviewing websites such as Justia or PLB provides some basic information about real estate investment contracts for individuals interested in learning more about the issue of legality when it pertains to real estate investments. Disputes about such contracts can even end up being presented in court in some cases , which is another reason it is so important for those drafting the contracts to have an understanding of the law as it pertains in the relevant region.
Having a legal professional review the contract before signing it can also be beneficial in avoiding future trouble. This is because it is very difficult to prove that a contract is unenforceable due to its illegality once the contract has already been signed, so this is likely not something that can be undone later on. Instead, the best course of action is to seek out help from a legal professional before executing any contracts regarding a real estate investment.
Common Errors in Real Estate Investment Contracts
One of the most common mistakes we have found in assisting investors in this area is using a standard lease or other form not tailored to the specific real estate being looked at. This could easily lead to problems such as limits on security deposits, or requiring Realtor involvement when not desired. Another major issue is requiring a non-refundable deposit even with a closing. Such an arrangement leads to discrimination claims by the tenant, as there is no occasion where the tenant is treated differently than everyone else (as may occur where they have a different credit score and thus don’t get a loan from the same source) and forces them to break a contract that may have been otherwise acceptable. Similarly, investors often have a "sample" lease that they use without making sure their proposed lease complies with the law of the state where the property is located so they do not build in provisions possibly not enforceable or even in violation of the law. This occurs with both poorly drafted leases and those prepared by companies that charge a fee for the form or offer it online. It is understandable that the investor moving quickly to obtain a deal signs what they have at hand without fully reading it because they are anxious to cash a check from the lender or buyer and move to another deal for which they have committed the "advance" payment if accepted. But one needs to take the time to go through the entire form, even though it will take time, and make sure it does not contain any term(s) inconsistent with your understanding of the transaction. I once saw a lease for a house with a term ending five days before the loan from the bank closed, and the attorney that prepared the lease had advised that he wanted the long term because a closing was not so certain. The investor was nearly out of business because the landlord of the apartment he had rented through the leased you signed in reliance upon the lease covering very short term refused to allow him to break his lease. Another example would be a release by tenants of all of their rights under state law, which would violate numerous laws like the Fair Housing Act, the Clean Air Act, the Age Discrimination Act and others. Similar mistakes are made when forgetting to include city requirements. We have seen investors offered a "new construction" property claiming that there were no building codes or inspection requirements, and it was only after a utility shut off due to lack of inspection and non-payment of past due bills did the owner realize the requirement imposed by the city of building code inspections, an inspection permit, etc. Another problem arises where the investor believes that the owner is "motivated" and therefore he has the "power" to negotiate for the best terms. For example, if tenants in a distressed building are given money to move immediately, often a surprise to them, they can come back and claim later that it was pressured and possibly obtain a rescission of the sale. The Multi-Family Tax-Exempt Bond Program often has high vacancy rates in its properties, but those same units never go away. A good realtor must obtain fair market value prior to abandoning the property by calling the city to remove any illegal activities, doing inspections, etc. Expect misstatements from the seller about the condition of the building (the new building is "as good as new"), the value of furniture (newer models must be discarded without compensation), the number of units involved or even the entire building is nearly vacant, and the whole thing is listed or even occupied at the first showing. Think about the value of the property, that value in a few years, and what else would be involved in getting the property back to square one, not just the expense of closing. Investigate and document every problem you can find, and understand what the problems may cost to fix as well as how to acquire the funding to remedy them. We see many with grossly inflated rents for comparable apartment buildings. Consider the long-term effects of never meeting those pro formas. New building disclaimers make the owner take all the risk, not the occupants. The City of Flint, Michigan was notorious for subsidizing housing in this fashion, forcing the owners to sell on the cheap without adequate notice and without rights to take any assurance of the future condition of the property. Make sure you understand all of the terms of the deal, and that you can afford to hold it exactly as it stands today. The market may not support it in a few years, or the deal may go south after a year when the current owner "forced" it upon you.
The Influence of Technology in Real Estate Investment Contracts
Technology has introduced significant efficiency within the real estate investment contract process. The typical steps of preparing a purchase and sale agreement, and circulating the agreement among relevant parties for signature are often complicated by complex negotiations and document revisions. Technology has supplanted some of the traditionally cumbersome processes that long delayed more fluidly closing transaction, including email communication and faxed signatures rather than in-person ones. While these developments have been helpful, they are the tip of the iceberg. Businesses have begun to leverage new technologies to both facilitate the process by which real estate purchase and sale contracts are formed and to manage the process of fulfilling the requirements of those agreements. For example, there are now a number of providers of secure portals where entities can post and track all relevant information and documentation required to approve the financing of a project (title, environmental review, insurance, etc.), streamlining the process and avoiding lost time from lost documentation. More significantly, technology platforms are being used to automate the documentation process, allowing comprehensive and custom contracts to be drafted in seconds by simply filling out a questionnaire. Some platforms provide for an automated invoicing and payment systems to facilitate timely payments pursuant to the agreement. Still others allow for the monitoring of the performance of specific provisions of the contract. For example, if the seller has warranted that the premises are free and clear of third party power lines, the parties may contract with a provider that will provide constant surveillance of the property in Uber-like fashion. If a wire becomes detected on the property, the provider will rubber-band its resources to determine the cause of the intrusion, eliminate the threat and advise the relevant parties of the situation, all without the need for an activist response.
Case Studies of Successful Real Estate Investment Contracts
In this section, we share real-life case studies that exemplify successful real estate investment contracts. We highlight the contract strategy employed and the key lessons and success factors in each case.
John and Ellyni, contract for purchase, new development – San Diego
John and Ellyn’s family had outgrown their small home in an area of San Diego that was declining in value. As a result, they were looking to move. They searched for a while but ultimately landed not on a new home, but on a vacant lot ready for development. To them, it was pretty much perfect. It was a great location, and their imagery of the home, once it was built, was exactly what they would want. But there was one big hurdle – they didn’t have enough money to develop it, and they didn’t have enough money to buy it. So, they decided to reach out to a well-known construction company to contract for a new development. The contract details were as follows: Development costs: $425,000 Interested Equity by contractor: $225,000 Outside Financing Needed: $200,000 In this case, the financing was rather easy. The couple went to their local bank, and their credit score was in the 700s, which meant their interest rates would be rather low. The bank agreed to finance the $200,000, which shorted the contractor’s equity, but overall, it would have no negative impact. In fact, it increase the contractor’s margin of return on investment. So, John and Ellyn were looking at a home worth $800,000, with a mortgage of $200,000 and payments of under $1,500/month.
Client A, purchase of a new development: 1,000 units
Client A is a real estate investor in Phoenix, AZ. He buys new developments, with an interest to potentially keeping them for his own company. However, he doesn’t have the ability to develop them himself , so he looks for existing developments and contracts with the developer to facilitate the purchase of his new developments. The contract he negotiates typically looks as follows: Development costs: Vary, but averaging $250-$350. Outside Financing Needed: Vary For the developer, the purchase is a win-win. They realize the profits of the home, and they receive a "sure bet" on their investment because Client A is going to purchase a minimum of 1,000 homes and it typically averages 1,500. Normally, Client A will buy approximately 2,000 at a time, making him a quick "up-and-coming" investor.
Debbie, commercial real estate investment: San Francisco
The last case study is a little different than the rest. This case study examines the commercial side of real estate investment, and how sometimes, investments can be short-sighted. Kudos to Debbie for spotting her investment as a "win-win" scenario. Debbie purchased a piece of commercial land on the pathway to countless businesses, with the view of developing several businesses, operating and selling them. However, when she filled out the appropriate paperwork with the city, they told her she wouldn’t be able to open up her franchise. Why? Because San Francisco has placed a restriction on fast food franchises. Too many McDonald’s and KFC’s have changed the face of San Francisco, San Francisco doesn’t want to deal with their need to! So, Debbie negotiated a small contractual change with her city – she will develop and run all the businesses on the lot, with a clause in the contract that will allow her to subcontract all the businesses to already established franchises, who will operate the business and pay her a monthly franchise fee. The city agreed, and she’s moved on to the next step. This is a creative way to think around a problem while providing a win-win situation.
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