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Eight Key Contract Clauses when buying an investment property
In real estate you need a set of "standard" contracts to use when you are buying and a second set to use when you are selling. Your contracts should be carefully prepared by your attorney to cover you as the purchaser when you are buying and to cover you as the vendor when you are selling. Here are eight key points you need in your purchase agreement when you are buying a property. Make sure you go over this list before you sit down and meet with a vendor so that you understand what you are asking for. You can also use this list as a checklist when you are having your attorney draft your contracts, so that you save lots of money and protect yourself when you are buying.
Clause One: Liquidated Damages Clause
A liquidated damages point is critical to minimizing your risk because it lets you contain the cost of walking away from a business. When you enter into a contract with another party, you both have the right to expect the other party to perform everything that was mutually agreed to in the contract. If one party doesn't do what they agreed to do, the other party may sue for "specific performance." This means that they ask a court to make the defaulting party live up to the terms in the contract. When you are buying real estate and you sign an agreement to buy a property, you want to be able to walk away from the business if, after doing your due diligence, you discover something wrong with the business. Now the way many investors give themselves this freedom is by using all sorts of "subject to" points in their agreements with the vendor. For example, "This agreement is subject to Buyer's inspection and approval of the property." Or, "This agreement is subject to Buyer obtaining satisfactory financing." You get the picture. If you were a vendor and your purchaser showed you paper work with all kinds of these over t escape points, would you feel confident that you had a real purchaser? That's where a liquidated damages point comes into play. It accomplishes the same thing as an escape point, provided it's used correctly, without arousing vendor concerns about your commitment as a purchaser. A liquidated damages point merely spells out the exact payment one party must make to the other party in a contract should a default occur. When you're buying a property, you use a liquidated damages point that spells out that if you as the purchaser default (i.e., don't buy the property) then the seller gets to keep all the money you've paid to the vendor so far as "full and complete liquidated damages." This sounds pretty strong and vendors like that, but remember, you are only giving the vendor a token up-front payment. Normally I use a single dollar. Some investors use up to USD500. The key is to delay the payment of any serious up-front funds until the point that you have done your due diligence and are sure you want the business.
Clause Two: ". . . Or Assigns, Buyer"
Anytime you sign an agreement to buy a property, you want to maintain maximum flexibility. You may want to buy and hold the property or you may decide to quickly resell the property for a fast cash profit. One important component to this flexibility to sell fast is the ability to assign your interests in the deal over to another party for a quick cash payment. While any contract is always assignable unless there is a point in the contract limiting or forbidding the assignment of the contract, it still makes sense to clearly put in your agreement the fact that you can may assign the contract. The best way to do this is to preprint into the contract the words "or assigns" right after the blank where you fill in who is the purchaser. The reason you preprint it into the contract is because if you write it in by hand into the line of who the purchaser is (e.g., "John Smith or assigns, Buyer") it calls it to the attention of the vendor. Anything that is printed directly into the agreement flows smoothly past the vendor and is usually accepted without comment. If the contract that your vendor wants you to use has a nonassignment clause, make sure you cross out this point and both you and the vendor initial the change.
Clause Three: The Closing Date and Closing Agent
Controlling the closing is critical for your success when buying (or selling for that matter). You always want to be the one who gets to control who will be doing the closing so that you can make sure they do it in a way you are comfortable with. That's why I recommend you always reserve the right to be able to choose who the closing agent will be. Also, when you are buying, you want to be able to have a degree of flexibility in case you need a little extra time to finish getting your financing together, find your renter for the property, or just to do other preparation for the closing.
Clause Four: Get Access to the Property and Permission to Start Your Marketing Before You Close
Why wait to get started on marketing the property to your end user? Maybe you'll want to rent out the place, or even sell it on a rent-to-own basis. Either way, one of the best ways to reduce your risk in any business is to have a nonrefundable earnest funds or rental deposit from your end user before you ever close on the property. But to do this you need access to show the property and ideally permission to put your marketing sign in the front yard while you are waiting to close. Now I can hear some of you saying that the vendor will get upset that you are selling it for more than they sold it to you for. Of course you are selling it for more! I sit down and make sure every seller understands that the reason I am willing to buy their property is because I want to make a profit. I also tell them that if they don't feel the deal we've agreed to is a real win-win for them, then we shouldn't do it. If you are up front with the vendor, they will be happy when you win too. Remember, you aren't buying from just any vendor. You are buying from a motivated vendor who has a specific need or problem you are helping to solve.
Clause Five: Execution in Counterparts-How to Sign Together Even When You're Miles Apart
Let's say you are working with an out-of-town owner who really wants to dump their property. Do they have to fly out to sign the purchase contract with you? Not if you are smart enough to use a point like this one that lets you lock up the property with a signature signed on a separate copy of the agreement that you can fax, e-mail, or overnight to the vendor and that they fax or overnight (preferably both) back to you.
Clause Six: The World's Best Inspection Clause
Check out this inspection point. It not only clarifies that everything should be working in the property and that the vendor will pay for any needed repairs prior to closing, but it also says that unless otherwise noted you get all the personal property-read curtains and appliances and such things, too. It also comes with a guarantee from the vendor that survives the closing that everything is in working order when you buy. Now I know I'm getting pretty excited over this point, but after using it for close to a decade now I am very partial to it.
Clause Seven: Automatic Renewal or Extension of Note
Many times when you are structuring owner-carry deals, the vendor won't want to have to wait for 30 years to get all of his money. In these cases using a balloon note works wonders. A balloon note is a loan that has a point saying that the unpaid balance all becomes due at some future date. For example, I recently bought a four-bedroom residence where the seller carried back the financing with a five-year balloon due for the balance of the note. This meant that I paid the vendor monthly interest payments and at some point within five years of closing I must pay off the balance of the loan. This is called a balloon payment. Typically it's paid by either reselling or refinancing the property.
Clause Eight: Substitution of Collateral
Another point you should consider asking for in your seller-carry deals is called "substitution of collateral." Imagine you are buying a USD200,000 residence and the vendor carries a second mortgage of USD50,000 at 7.5 % interest. You want to sell that house but don't want to want to lose out on the lowinterest use of the USD50,000. If you have a substitution of collateral point in your loan agreement with the vendor, you can move that low-interest second mortgage of USD50,000 over and secure it against another property you have that has enough equity in it to be fair to the vendor. Again, you don't have to use this point, but it does give you maximum flexibility.