What You Need to Know About Real Estate Contracts
Working in the Real Estate field, you are regularly presented with situations where the standard contract doesn’t meet the needs or wants of your client. A Florida real estate contract can be modified, re-printed, re-written, crossed out, added to, and all around changed as many times as necessary during the negotiation process to reach a true agreement between the parties. It is important to know when to use certain clauses in the contract, and to know how you can modify them to benefit yourself or your client. Here are a few examples that you may find helpful.
CLOSING COSTS, FEES, AND CHARGES
In Florida, a buyer and a seller can negotiate the fees of a real estate contract any way they wish. Many new Realtors use the standard FAR-BAR contract under the false assumption that their clients are bound to the fees as laid out in the contract. If your client doesn’t want to pay for the title search or the municipal lien search, strike it out and write it under the fees of the other party. If you are confronted with a seller who does not want to pay any closing costs, do not be alarmed as this is fairly common. Many clients will say something along the lines of, “I had to pay fees when I bought the house, I shouldn’t have to pay them again!” The best way to handle this situation is to explain that while the seller does not have to pay closing costs, it will be very hard to find a buyer that is willing to close on the property. Once the seller understands that the choice to pass on all of the closing fees will severely restrict the buying pool, they are likely to become more flexible.
The key part that the seller is not factoring in is that the buyer is typically purchasing the property at market value. The buyer does not want to pay market value for the property and then pay additional fees on top of the market value because the buyer will feel as though they have paid too much money for the property. A typical way to combat this issue is to try and factor a credit into the deal to cover the sellers closing costs. The seller may ultimately have to accept slightly below market value for the property, but they can walk away from the sale without putting in any of their own cash.
INSPECTION PERIOD
A home inspection is a vital tool to be used during the home buying period. A home inspection will help you determine whether your client’s dream home is actually dream worthy. Without a home inspection, you are relying on data from county records, and bits and pieces of information provided by the seller or the selling agent to ensure that systems such as plumbing and electrical are functioning behind the scenes. Although many times the client will reject your advice on actually obtaining a home inspection, you should nonetheless advise your client to leave the inspection clause in the contract. The typical FAR-BAR contract has the following inspection clause:
“PROPERTY INSPECTION AND RIGHT TO CANCEL: Buyer shall have _________ (if left blank. than 15) days after Effective Date (“Inspection Period”) within which to have such inspections of the Property performed as Buyer shall desire during the Inspection Period. If Buyer determines, in Buyer's sole discretion, that the Property is not acceptable to Buyer, Buyer may terminate this Contract by delivering written notice or such election to Seller prior to expiration of Inspection Period. If Buyer timely terminates this Contract, the Deposit paid shall be returned to Buyer, thereupon, Buyer and Seller shall be released of all further obligations under this Contract;”
The Inspection clause allows a buyer to have an additional period after the signing of the contract in which they can decide whether the property is suitable for their purposes. This clause can be particularly helpful in a situation where the Agent believes their client is jumping into purchasing a house too quickly and is likely going to change their mind after the execution of the contract. Without an inspection contingency (or other applicable contingency), backing out of the contract will be a breach by the buyer, and the seller may be able to keep the escrow deposit as liquidated damages. Liquidated damages are discussed in more detail below. The Inspection clause is particularly useful because it typically states “such inspections of the property performed as Buyer shall desire” and gives the Buyer the option to terminate this contract at the sole discretion of the buyer. This means that the buyer could self-inspect the house without hiring a company, and still use the inspection clause to back out of the contract.
APPRAISAL CONTINGENCY
Wholly separate from the Inspection period, Agents can build an Appraisal contingency into their contract for an extra buffer for their client. Unlike the inspection clause, the Appraisal contingency is a bit more restrictive, often requiring the appraisal to be completed by a licensed Florida Appraiser. The Appraisal Contingency serves two main purposes:
(1) It allows the buyer to back out of the contract if the house is appraised below the contracted for price;
(2) It serves as a bargaining tool for the Buyer to counter offer the seller with a new purchase price based on the appraisal.
An appraisal usually costs a few hundred dollars and the client may state that they do not want one performed. Should the buyer choose not to obtain an appraisal, the most common consequence is that the buyer waives the appraisal period under the contract, and continues with the contract as if it did not have an appraisal contingency. This is typically the most severe consequence. It is smart to build the appraisal contingency into the contract in case the buyer later changes their mind. Since the biggest typical consequence is a waiver of that individual clause, there should be no reason not to have this built into every contract when possible.
DEFAULT / LIQUIDATED DAMAGES
It is well settled that in Florida the parties to a contract may stipulate in advance to an amount to be paid or retained as liquidated damages in the event of a breach. The following test is used to determine whether a liquidated damages provision will be upheld and not stricken as a penalty clause: (1) the damages consequent upon a breach must not be readily ascertainable. (2) the sum stipulated to be forfeited must not be so grossly disproportionate to any damages that might reasonably be expected to follow from a breach as to show that the parties could have intended only to induce full performance, rather than to liquidate their damages. A contract for the sale of land generally suffers from the uncertainty as to possible future damages, and as a result, liquidated damages are allowed.
The typical FAR-BAR contract has the following provision:
BUYER DEFAULT: If Buyer fails, neglects or refuses to perform Buyer’s obligations under this Contract, including payment of the Deposit, within the time(s) specified, Seller may elect to recover and retain the Deposit for the account of Seller as agreed upon liquidated damages, consideration for execution of this Contract, and in full settlement of any claims, whereupon Buyer and Seller shall be relieved from all further obligations under this Contract, or Seller, at Seller’s option, may, pursuant to Paragraph 16, proceed in equity to enforce Seller’s rights under this Contract.
This Liquidated damages provision does not mean that the seller can always retain the entire escrow deposit in the event of a default by the buyer. The key element is whether the deposit amount is a reasonable amount of liquidated damages. If the Court determines that the liquidated damages amount is intended to serve as a penalty, they will find the provision unenforceable. If you are entering into a contract with a buyer and you believe they are going to back out of the contract, do a quick cost analysis review of the purchase price compared to the deposit amount to ensure that the deposit amount is low enough to be considered reasonable damages in the event of a breach, yet still high enough to account for the estimated damages that will be incurred by the seller for taking the property off of the market.
CONCLUSION
Do not be afraid to modify a contract during the negotiation process. Modification of the contract is largely dependent on the situation you are facing with that individual property, although certain clauses like the liquidated damages provisions and the Inspection/Appraisal contingencies arguably should be found in every contract. Give us a call if you or your client want to discuss specific ways to make the contract work for you.