Working with Purchase Contracts
When making an offer on a property, either through an agent or FSBO, a purchase contract will always be used. All the details of a purchase contract will not be discussed so if you have specific questions talk to your agent or attorney.
Eighty-five to 90 percent of properties that are for sale are listed with an agent. If you are making an offer on a property where this is the case, the agent over the property will be required to use a purchase contract (unique to each state) and will fill out for you. When the agent fills out the contract, there are certain things you will want to have them change or put in the contract to protect you.
The first thing you’ll want to have in the contract is a 14-day inspection period. Every state will have a different standard for their inspection period but make sure it’s changed to at least 14 days. In states where the inspection period is longer than 14 days, feel free to keep the standard inspection period. Sometimes the inspection period will be called the due diligence period. The due diligence or inspection period gives you 14 days to cancel the contract without losing any of your earnest money in the chance that you find out something you don’t like about the property.
A second change you can make in the contract is the amount of earnest money you will put down. In general, it’s a good idea to keep earnest money between $500-$1000. Some government foreclosures like Fannie Mae or HUD may require up to 10% earnest money, so you might have to go over $1000 on those specific foreclosures. Push your agent to put in the lowest amount of earnest money possible.
The last part of the contract you need to pay attention to is the addendums or additions. This is where you can give yourself the right to assign the contract, the right to show the property, or include a partner’s inspection and approval. Additionally, anything that is not in the contract that you would like included or anything in the contract you want to change will go in here.
When making an offer, you’ll need to tell the agent the specifics you want in the contract and then double check to make sure they were put in before you sign. You do not have to be an expert on contracts, you just need to know how to protect yourself, and by checking these three elements, you can.
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.