How to Use an Inspection Contingency

How to Use an Inspection Contingency

Almost every real estate transaction contains an inspection contingency. It is imperative that we understand how to use this type of contingency to our advantage whether we are buying a retail or investment property.

First, we should know the definition of a contingency in a real estate purchase agreement.

“A contingency clause defines a condition or action that must be met in order for a real estate contract to become binding.” (Investopedia, 2013) Therefore, in this case, the home must pass an inspection in order for the purchase to be completed. The details of inspecting the property will be defined in the purchase contract.

Most people hear “inspection” and automatically think of the physical condition of the property. However, inspections can include more than physical condition. Here are a few other things that can be covered under the inspection contingency:

  • Zoning and Ordinance Restrictions
  • HOA Details
  • CC&R’s (Codes, Covenants, and Restrictions)
  • Cost of Repairs
  • Profitability of the Transaction

The real estate purchase contract will define what is required in the inspection contingency. For example, some contracts require a copy of the inspection report be presented to the seller in order to withdraw the offer. This means we would have to hire a home inspector to physically go through the property and create the report. This could cost anywhere from $300-$500 depending on location and size of the property. As investors we need the freedom to withdraw from the contract without having to present an inspection report. As a remedy to this obstacle the investor will insert a new, favorable inspection clause into an addendum that supersedes the requirement in the purchase contract.

These contingencies are always associated with a time frame. The standard time frame is 14 days. However, the length of time is dictated by the market. If the market is moving quickly the length of time could be 7-10 days or less. This time frame could be much longer than 14 days during a slower market. There are two take-a-ways from this:

  • Pay attention to the type of days – are they business days or calendar days? Typically, but not always, the “days” in a contract refer to calendar days. It is preferable to have business days in the contract to have a definitive benchmark for all deadlines.
  • The time frame is always negotiable. Therefore, as an investor, negotiate the longest amount of time possible.

Regardless of the investing technique we are pursuing there should be an inspection contingency included in the contract in order to protect yourself.