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Contracts Objectives Upon completion of this section the student should be able to:
● Demonstrate knowledge of the conditions required for a valid contract including: ○ Elements of a Contract ○ Void and voidable contracts ○ Statute of Frauds, Valid Legal Description and other Requirements
● Show an understanding of the use of contracts in real estate, including issues related to:
○ When a contract is required ○ Assignment ○ Amendments and modifications ○ Completion ○ Rescission ○ Termination and Discharge of a Contract ○ Default ○ When to seek assistance from an attorney
● Knowledge of specific real estate forms/contracts such as: ○ Representation Agreement ○ Purchase and Sale Agreement ○ Residential and Commercial Leases ○ Compensation Agreement
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Elements of a Contracts
For a contract to be valid and enforceable in court, the following elements must exist:
● Mutual agreement: Each and every party involved in the contract must agree to and accept the contract and its components. All parties must recognize and acknowledge that an agreement has been made and accepted.
● Consideration: A contract must be mutually beneficial, and all parties must recognize and accept the benefits from the contract. These benefits can include money, transfer of ownership, transfer of rights, exchange of services, and/or anything of value.
● Legally competent parties: In the United States, a person or entity (such as a business, trust or corporation) must be competent and at least 18 years of age to enter into a contract. If the party is a business, the person representing the business must also be legally competent and have the authority to act for the business.
● Lawful objective: A legal contract cannot require any party to knowingly break the law. If so, the contract is usually void.
● Written contract: The Statute of Frauds is a Washington State law, which requires that all real estate contracts be in writing.
Valid, Void, Voidable and Unenforceable Contracts If a contract has all of the required elements, then it is a valid contract and enforceable in a court of law. An example of this would be a homeowner (who is over the age of 18 and of sound mind) who signs a contract with the appliance store to buy a refrigerator. The homeowner pays for the refrigerator and the appliance store presents the refrigerator to the homeowner to take home. A void contract is not a contract and has no effect in a court of law. Most commonly, a void contract will be missing one or all of the essential elements needed for a valid contract. For instance, a contract between an illegal drug dealer and an illegal drug supplier to purchase a specified amount of drugs for a specified amount. The contract is void because there is no lawful objective, therefore the contract was never formed. A voidable contract is a contract which may appear to be valid but which has some type of flaw, that could cause one or both of the parties to void the contract. A breach of contract by one party would make the contract voidable by the nonbreaching party, since they can terminate the contract or choose to accept the breach and continue with
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the transaction. The nonbreaching party must exercise their right to void the contract within a reasonable amount of time. If a minor, a person under the age of 18, signs a contract, the contract is voidable at the option of the minor. Voidable means the minor can terminate the contract if he/she chooses, though the other party to the contract is bound to follow the terms and conditions as agreed as long as the contract remains in effect. If the minor turns 18 (becomes a majority) then the contract will be fully enforceable if he/she does not void the contract within a reasonable amount of time after becoming a majority. A similar rule exists for those who are deemed mentally ill at the time the contract was signed. It is voidable by the person who was/is mentally ill. It must be voided within a reasonable time after the person was no longer mentally ill. The other party to the transaction is bound by its terms and conditions. The contractual element missing is legally competent parties. A party could also be deemed legally incompetent, for example, if they were drunk at the time the contract was signed. An unenforceable contract is a contract which cannot be enforced in a court of law. This could happen because the terms of the contract are ambiguous, or if one party has a voidable contract, or if the statute of limitations has expired. The statute of limitations requires that lawsuits be filed within a certain period of time following a breach. The time frame in which lawsuits can be filed in Washington State after a breach for written contracts is six years and three years for oral contracts.
Statute of Frauds The Statute of Frauds law requires that certain types of contracts be in writing and that they must be signed (acknowledged) by all of the parties that will be bound to the contract. Contracts involving the sale or transfer of real property in Washington State fall under the Statute of Frauds law, and all contracts must be in writing. Contracts not in writing are not enforceable. The purpose of the statute of frauds is as the name suggests: to prevent parties from fraudulent conduct. Historically, especially when real estate was conducted with a handshake, the opportunities to commit acts of fraud were abundant. There are some basic reasons why all real estate contracts should fall under this statute. The purchase or transfer of
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real property often involves many terms and conditions in addition to price. Because of these situations, having these agreements in writing is essential. Many of the contingencies in a real estate contract have deadlines for completion. If these deadlines are not met, there can be serious consequences for either party. Again, having these agreements in writing provides clarification for all the parties. Should there be any dispute between the parties in a contract, the issue may require arbitration or intervention through the court system. Should this arise, an arbitrator or judge could obtain a clearer understanding of the intentions and promises between the parties by reviewing a written contract stating the specific agreements in the contract. The Importance of a Legal Description A legal description is one of the most important components of a real estate contract. Without the full legal description, contracts are voidable meaning either party can cancel the contract. Please make note that the legal description of the property, is not the same as the street address.
When a Contract is Required
A written contract is required for the sale and lease option of real estate. Leases for a fixed term must be in writing and if the term is greater than one year the landlord’s signature must be notarized. If the lease is for a periodic tenancy (i.e. month to month tenancy for example) the law does not require a written contract. The exception to this would be when the period is greater than a year. Even if a written lease is not required by law, it is a sound practice to always have a written contract so that there is no confusion regarding the terms of the lease and intentions of the parties.
Assignment
Assignment An assignment of a contract is when the interests of the original party (the assignor) are transferred to another party (the assignee). In general, an assignment will generally be permitted unless there is an express prohibition against assignment in the contract. The new party, (the assignee) assumes primary responsibility for the performance of the
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contract and the original party (the assignor) incurs secondary responsibility for the contract. Certain contracts cannot be assigned since an assignment cannot have any effect on the duties of the other party to the contract, nor can it reduce the possibility of the other party receiving full performance of the same quality. An example of this would be a contract between a patient and a doctor who specializes in a certain field of medicine. The doctor could not assign his contract to another doctor, as it could be detrimental to the patient. This is in contrast to Novation. Novation In the first instance, novation is the substitution of a new party into a contract. The original party is relieved of any obligation for the contract. Novation can also be the substitution of original contractual terms for new contractual terms if both parties agree to the new terms.
How a Contract can be Discharged or Terminated Contracts can be discharged or terminated legally without a breach of contract by one or both of the parties. This is accomplished by agreement between the parties to the contract because of:
● Cancellation – When both parties to the contract decide to terminate the agreement.
● Rescission – When a contract is cancelled and both parties are returned to their original position.
● Novation – When the contract has been substituted for a new contract. ● Full performance – When all of the parties have performed their obligations
under a contract, then a contract is discharged. This is known as full performance.
Novation can be tricky, let’s look at it more closely. The substitution can only be valid if all parties agree. The original party is then relieved of any obligation for the contract. Novation can also be the substitution of original contractual terms for new contractual terms if all parties agree to the new terms. When dealing with contracts to purchase, the
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new buyer would become bound by the provisions in the contract, relieving the seller of responsibility.
Example: John (current lessee) and Julie (new lessee) have an agreement under which Julie will take over John’s liability for payment on the existing lease. This novation can only occur at the agreement of the landlord as well. Julie would become liable and John would be released of his obligations.
Assignment and Novation An assignment of a contract is when the interests of the original party (the assignor) are transferred to another party (the assignee). Assignment is very similar to novation, but the key difference is that assignment transfers the interests and benefits but does not release the original party of the obligations if the assignee fails to perform. In general, an assignment will generally be permitted unless there is an express prohibition against assignment in the contract. The new party, (the assignee) assumes primary responsibility for the performance of the contract and the original party (the assignor) incurs secondary responsibility for the contract. Certain contracts cannot be assigned since an assignment cannot have any effect on the duties of the other party to the contract, nor can it reduce the possibility of the other party receiving full performance of the same quality. An example of this would be a contract between a patient and a doctor who specializes in a certain field of medicine. The doctor could not assign his contract to another doctor, as it could be detrimental to the patient.
Breach of Contract If there has been a material breach (meaning that the breach was important to one of the parties), then the other party may be able to take court action. There are four legal remedies for a breach of contract, which include:
1. Specific Performance 2. Liquidated Damages 3. Compensatory Damages 4. Rescission
Let’s take a look at each remedy in more depth:
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Specific Performance Specific Performance is a legal action where the court orders the party who breached the contract to perform according to the contract. In the circumstance of a purchase and sale agreement, the seller would be obligated to sell the property as promised and deliver the deed to the buyer, and the buyer would be obligated to purchase the property as promised. Specific performance, as a remedy, may not always be possible.
Example: John and Saul had a contract with the Cobalt Company, a retailer, to purchase an air conditioner. The manufacturer of this specific model air conditioner went out of business and the Cobalt Company could not deliver the unit, as per the contract. In this case, a remedy of specific performance would not be possible, since this particular model of air conditioner was no longer available.
Liquidated Damages When both parties to a contract agree in advance to a dollar amount that will compensate the other party in the event of a breach, this is considered liquidated damages. This amount must be set forth in writing. There are two important points to remember about liquidated damages. First, it limits the amount that the nonbreaching party can recover. Second, it makes it easier for the nonbreaching party to recover these damages, since they were agreed to in writing in advance. In a purchase and sale agreement contract, it is common that the parties will agree to the amount of earnest money being offered as liquidated damages. Earnest money is a deposit that shows the buyer’s seriousness in purchasing a property. It is applicable towards the purchase price and is usually held in a trust account. In the event of default on the contract by the buyer, the seller is usually entitled to the amount of earnest money the buyer deposited. Compensatory Damages The most common remedy for a breach of contract, given that there was not a liquidated damages clause, is compensatory damages. This compensates the other party for the financial loss that they incurred because of a breach of contract. The amount awarded is usually intended to place the nonbreaching party in a financial position that they would have been placed in if the breaching party had performed as per the terms of contract. Rescission As mentioned earlier, a rescission takes place when a contract has been cancelled and each party is returned to their original position. If a purchase and sale agreement were to be rescinded, then the buyer would forfeit the right to purchase the property, and the
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seller would refund the earnest money to the buyer. A rescission could result from an agreement of the parties or by court order.
Amendments and Modifications
Amendments Amendments are additions to the main Purchase and Sale Agreement which cover specific or unique circumstances. They are commonly referred to as addenda. Many of these addenda become contingencies to the contract. A contingency is a provision in a real estate contract that specifies that the contract would cease to exist upon the occurrence or nonoccurrence of a certain event. A contingency should be clearly written, concise and have a definite time limit. As a real estate professional, it will be your duty toward your client to watch these time lines very carefully and act within their limits. Many of the contingency forms essentially state that silence construes acceptance, meaning that if don’t respond within the time period specified, then you have waived the contingency. A contract could be contingent on many items but some of the most commonly used in residential real estate are:
● Inspection Addendum ● Financing Addendum ● Optional Clauses Addendum ● Homeowner Insurance Addendum ● An addendum which would address what personal property was included in the
sale. ● Possession Addendum (if not at the time of closing)
Inspection Addendum An inspection addendum usually covers an inspection of the property, deals with structural issues, some pest infestations, underground residential heating oil tanks, and onsite sewage disposal systems.
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As a result of this inspection, the buyer can approve of the inspection, terminate the transaction, request additional inspections or ask the seller to perform repairs or modifications. The seller may agree to perform the requests repairs/modifications or refuse. The buyer retains the right to proceed or terminate the contract.
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Financing Addendum When an offer is contingent upon the buyer obtaining financing NWMLS Form 22A can be used for example. This form specifies:
● Type of loan that the buyer will acquire ● Percentage of down payment ● Time frame to make application if they have not already done so ● Time frame for a loan commitment ● Consequence of an appraisal being less than the sale price ● Closing costs that the seller will pay for the buyer ● Homeowner insurance contingency
Note: Consider using this form even if your buyer is paying cash or the offer is not contingent upon financing for the following reasons: In the event that your clients decide to have an independent appraisal performed, the appraisal paragraph will allow the buyer to terminate the deal if the appraisal is less than the sale price.
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Optional Clauses Addendum An optional clause addendum addresses such items as:
● Square footage, lot size and encroachments ● Title insurance ● Grounds maintenance ● Item left by the seller ● Utilities ● Insulation for new construction ● Leased property ● Homeowner’s association review board ● Other
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Feasibility Contingency Addendum A feasibility addendum will often accompany an offer to purchase vacant land or commercial property. The buyer will be given a certain amount of days to perform an independent study of the property which might include:
● Building or development moratoria ● Flood Zones ● Wetlands and shorelands ● Roads ● Water ● Sewer ● Other utilities ● Capacity Charges ● Assessments
Homeowner's (Hazard) Insurance Addendum Homeowner’s (hazard) insurance is important for almost all residential properties. Not only is it good risk management for the homeowner, but most lenders require it as a means of reducing their own risk. There can be times when a buyer may be refused insurance on a particular property. This may be due to an unsatisfactory CLUE report. CLUE is an acronym for Comprehensive Loss Underwriting Exchange. It is a compilation of all insurance claims. The CLUE may be a report on a particular person or on a property. Incorporating an insurance contingency into a PSA can protect your buyer. This can be done through such forms as a financing addendum or on an addendum specifically designed solely for this purpose. An addendum which would address what personal property or fixtures were included in the sale. All personal property and trade fixtures which are included in the sale should be clearly specified in the purchase and sale agreement. There are a number of ways to do this:
● Some appliances are addressed on the purchase and sale agreement. ● Use of a separate addendum which has space to itemize personal property.
Possession Addendum (if Possession is not at the Time of Closing) In many circumstances, the date of possession is not the closing date. Usually this is because the seller will need to close their current home and receive the net proceeds from this home before they can purchase their next home. Even in an ideal situation where both homes close concurrently, the homeowner will need time to move to the
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next home. There are also circumstances where the seller will need extra time to move for various other reasons. An addendum should be drawn up and attach to the PSA which addresses all of the following:
● Length of the possession period by the seller ● Which party will insure the home during the “possession” period (this is usually
the buyer through their homeowner’s insurance) ● What charge, if any will be paid by the seller for this “possession” period
Note: Insurance liability is important. All parties should make sure that the property is insured during this time.
Another situation may arise where a buyer may want to take possession prior to closing, especially on a vacant home. This situation should be avoided if at all possible for the following reasons:
● There’s always a chance that a buyer may move into a property, discover some unknown undesirable fact, and not want to proceed with the transaction.
● The insurance liability is extremely high. Example: should one of the buyer’s movers injure themselves, the seller may have to bear the liability.
Should the transaction fail to close, the buyer already has possession of the property. Should the buyer refuse to leave, the seller may be forced to proceed with an eviction process.
Note: Before writing an addendum for early possession consult with your manager first. There is also risk of liability for you as a licensee and for your brokerage.
Modifications A contract is said to be fully acknowledged once it has been signed by both parties (the purchaser and the seller). This constitutes a legally binding contract and is also known as a mutual acceptance. Changes to the contract after mutual acceptance can only be made if both the buyer and the seller agree to the changes. Both parties must either sign or initial and date the changes. When changes are made, it is important to copy all parties after the agreed upon changes. These parties may include:
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● The buyer ● The seller ● The listing broker’s transaction file and their brokerage’s transaction file ● The buyer's broker’s transaction file and their brokerage’s transaction file ● The closing agent (escrow) ● The lender
Example: Buyer and seller have mutual acceptance on a contract. Buyer realizes that they have plans to be out of town for a wedding during the closing and possession time. Buyer wishes to extend the closing date for one week. Seller, on the other hand, has purchased another home and intends to close the new home concurrently with their existing home. Seller refuses to extend the closing date. The seller has the legal right to do so.
Attaching Additional Pages and Addenda to the Contract There are circumstances that arise where something changes during a transaction. The need for additional paperwork may be desired. Again, it must be remembered, that any additions to the contract after mutual acceptance can only be made if both parties agree. If changes, additions or deletions are made, both parties must initial or sign and date the item or clause that has been changed, added or deleted. It is illegal to make any change to a contract without the agreement and initials of both parties.
When to Seek Assistance From an Attorney
In other sections in this course, we discuss when it is appropriate for your client to seek legal advice. In this section we’ll be discussing when it is appropriate for you, as a licensee, to seek legal advice. It’s important to remember that you should always get the approval of your Designated Broker, Managing Broker or Branch Manager before seeking legal advice on real estate matters as they may want to accompany you when consulting with an attorney. Here are some situations where you may want to consider seeking out some legal advice:
● When any party to the transaction is threatening a lawsuit ● When there are legal situations which are beyond your area of expertise ● When you and your brokerage are legally at risk ● When an important major mistake has been made and needs to be rectified ● When a client breaches a contract ● When major complications arise from the title of a property
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● When the offer requires additional written language which is beyond the framework of the preprinted forms
Specific Real Estate Forms/Contracts
Representation Agreements The law of agency pamphlet is required by the state of Washington and it is legally required to contain the text of the laws regarding agency in real estate. The law even stipulates the size of the paper it is printed on (8.5 x 11), the text size (no smaller than 10 point font) and the title of the cover page must be “The Law of Real Estate Agency” (18 point font minimum). It is very stringent in its requirements and the MLS or association your brokerage works with will likely provide a compliant copy for you to print and distribute to your clients. As a broker you are required to give a copy to any person you provide brokerage services to. What follows is a copy of the pamphlet. You should spend the time to read the entire document and have a clear understanding of your agency responsibilities in various situations.
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A broker must provide this pamphlet to the client just as soon as possible. The broker should have the client initial two copies. They should keep one copy in their transaction file and give the other copy to the client. There are consequences for not adhering to agency disclosure laws. Buyer’s Agreements Commonly used by residential brokers is the Buyer’s Agreement. There are two types: Buyer’s Agency Agreement and Buyer’s Agreement No Agency: Buyer’s Agency Agreement states that the broker represents the buyer and that the buyer has an obligation to that agent for commission during term of the agreement. This agreement is unilaterally cancelable by either party and must be done in writing. If two brokers are ever in a dispute over commission, a buyer agency agreement can be the proof that a broker would be entitled to earn a commission.
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Buyer’s Agreement No Agency This contract states the broker does not represent the buyer, even though they may be performing brokerage services for the buyer.
Listing Agreement
The listing agreement and the attached addenda is the contract between the brokerage and the seller. There are many important terms and conditions stated within this contract such as the commission rate, the length or duration of the listing, the consequences of a breach by the seller, the terms under which dual agency is handled, seller’s disclosures, cancellation of a listing, ownership of a listing, and other terms which are of extreme importance. The listing agreement is the first contract in what can be a long process to the sale and closing of a property. We’ll, explore the many intricacies of this agreement as well as explore some case studies to understand listing agreements as they are used throughout your real estate career. It is important to take note here, that all of the statewide forms in Washington State have recently changed and that you’ll want to make sure that you’re using the latest version of the forms to comply with the new law. Again, the important points to remember are:
● Use the new version of the form and be sure to discard of all of the old hardcopy versions of the form that you or your brokerage may have.
● Familiarize yourself with all new laws, and use the available resources listed to get further information.
Information that you Should Gather Prior to Completing a Listing Agreement It is helpful to gain as much information as you can about a property prior to listing it. Here are some general items:
● Property Profile Details Report ● Information About Comparable Sales Comparative Market Analysis (CMA) ● Photos of the Property ● Information About the Neighborhood
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● Seller’s Property Disclosure Statement ● Information on the Occupants ● Showing of the Property ● Reason(s) Why the Seller(s) is/are Selling the Property ● Timing for Selling the Property
Property Profile Details Report A property profile can be obtained from county tax records or from a title company. They can supply the following information:
● Names and addresses of the owners ● Location information ● Tax Information ● Characteristics of the property and the dwelling ● Sales History ● Mortgage History
Information about Comparable Sales Comparative Market Analysis (CMA) Performing a Comparative Market Analysis allows a licensee to obtain a price range for the property. Photos of the Property Photos of the property can be used for flyers and promotional literature of the property and can also be submitted to the MLS to be included with a listing to be posted to their site. It is advisable to plan ahead when considering when to take photos. The following should be considerations:
● Walk through the house prior to shooting the photographs and get a visual plan as to what you would like to capture.
● Daylight the exterior of a home will look better on a sunny day rather than a gloomy day, but be careful of shadows on sunny days (such as a shadow from a big tree)
● For Interior lighting make sure that there is sufficient light and the flash is set on the camera.
● Back up as far as you can into a room to make it appear as large as possible. ● Stage the rooms being photographed (remove clutter and perhaps add a vase of
fresh flowers. ● Photograph special features that would enhance the perception of the house. ● Avoid photographic negative areas such as torn vinyl flooring in a kitchen.
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Information about the Neighborhood It is helpful to potential buyers and brokers who view the home to have information on the neighborhood. You may want to gather this information ahead of time and ask the seller(s) for assistance in compiling this data. Consider leaving a booklet of information in the home near where the flyers of the property are located. Helpful information might consist of:
● Schools ● Parks and recreational facilities ● Distance to shopping and health care ● Proximity to bus lines or other public transportation ● Area attractions
Seller’s Property Disclosure Statement Have the seller(s) fill out a seller property disclosure statement before you take a listing or market the property. If there are any negative issues disclosed on this statement, you’ll be able to discuss these items with the seller(s) prior to taking the listing. Information on the Occupants You’ll want to have information on who is occupying the property for a variety of reasons. Let’s look at some case studies as examples:
Example: The Anderson’s property was listing on July 1st. It is being occupied by tenants who have a lease until September 1st. This information is very important, especially if the property was to be purchased by an owner who desired to occupy the property upon closing. The tenants will also need to be notified about the sale and permission needs to be obtained from the tenants for showing the property.
Example: The Barker’s have listed their property with Lola of XYZ Realty. Mr. Barker works a night shift and sleeps until 10:30am. Lola can put restrictions on her listing for showing times to accommodate Mr. Barker’s schedule.
Example: The Taylor’s have a dog who does not like it when strangers enter the home. This could possibly be a safety issue for brokers and potential buyers touring the home using a standard lock box. The Taylor’s broker will want to know when one of the occupants is home so that they can contain the dog. The broker will want to put these special showing instructions in the listing.
Showing of the Property As our three prior case studies showed, there are certain considerations about showing property which might include:
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● Permission for a lock box ● Schedule of the occupants ● Permission and notice to tenants of the listing and to show the property ● Hazards such as a slippery deck or loose handrail ● Pets in the home (such as instructions not to let the cat outdoors) ● Notice to occupants of showings ● Driving directions ● Instructions on how to use the security system
Reason(s) why the Seller(s) is/are Selling the Property To fully understand the motivation of the seller(s) and to best represent them you’ll want to know their reasons for selling. As their representative, ask many questions about their reason for selling so that you can fully understand their unique situation. Timing for Selling the Property The timing for selling can be extremely important and you may want to make sure that the coordination of the closing of a property is tailored to your seller(s) circumstances. Consider some of the following situations in relationship to timing:
● Their next home closing ● The end of the school year for their children ● Scheduled job transfer ● Financial situation ● Health situation
Exclusive Right to Sell Listing Agreement This agreement provides a real estate brokerage the exclusive right to sell the property, meaning no other brokerage represents the seller in the transaction and the brokerage will be paid if a buyer is found for the property. It is definitely the most popular of listing agreement types because of the protection it provides the brokerage and broker regarding their compensation. Marketing a property can be costly and time consuming and this agreement provides the greatest protection to the brokerage to recoup the cost of doing the work. A brokerage signing an open listing for example is not provided the guarantee of payment unless they are the party who brings the buyer to the transaction.
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Legal Description and it’s Importance A legal description is one of the most important components of the listing. Without the full legal description, the listing agreement is voidable. This means that either party can cancel the contract. Please make note that the legal description of the property, which can be obtained from the last deed and supplied by the title company, is not the same as the street address.
Residential Purchase and Sale Agreement
The Residential Purchase and Sale Agreement is the most commonly used form for purchasing property.
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Note: Do not leave any spaces blank on any preprinted forms. If the space does not apply, put a hyphen through it.
Key Provisions Let’s briefly review a few of the often asked about sections and those that are cause confusion. Often these questions and confusion relate to timelines in the contract, closing and when the purchaser can take possession of the property. Closing Date Closing date is when the property is scheduled to be transferred from the seller to the buyer. Money will be transferred to the seller after paying off all creditors. The payments to all parties will be calculated as of the day of closing. The buyer will pay their portion and the seller theirs in relation to items such as property taxes and homeowner's dues. Any funds need to be wired and ready for disbursement on the day of closing. The lender will need to have all of the documentation they require from the borrower and adequate time to approve the loan before they will release money. Loan processing takes time and the real estate broker should be sure to communicate with the lender to find out what their timelines are to close a loan. If the buyer is particularly challenging the lender may need more time. Everything in the contract must be completed prior to the transfer date so any delay would require an extension of the closing date. Without an extension the failure to close would result in a breach of contract. Most of the time it is useful for both parties to extend the closing date if the adjustment is only a few days late. Putting the property back on the market would result in additional costs and time versus extending closing a few days. The buyer meanwhile, wouldn’t want to lose their earnest money deposit. Closing on time is always easier, make sure you provide enough time. If the closing date occurs on a Saturday, Sunday, legal holiday or a day when the recording office is closed, the transaction will close the next business day. Recording is the filing of the change of ownership with the county. This provides notice to the public of the transfer (constructive notice) since recording with the county adds any documents to the public record. This allows other title companies or the public in general to view the ownership transfer.
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Possession The date physical possession of the property will take place. This doesn’t necessarily occur on the closing date, although it most often does. Even on the day of closing, possession in most contracts will have a specified time of day which is unlikely to happen in conjunction with the time of recording (change of ownership). Possession time in the contractual example we have is 9:00 pm. It is important that all parties are keenly aware of the possession times to avoid confusion and confrontation. If possession is going to occur after closing, the buyer and seller will want to execute an agreement for a rental of the premises for any additional time. Conversely, the buyer and seller will also want to execute an agreement in the event the buyer is to take possession prior to closing. If possible, aim to have closing and possession happen on the same day to avoid potential issues. Moving a buyer in before closing is usually not the recommended. Timelines Computation of time in a transaction is critical. Everything in the agreement is time bound and often contingent on other dates. Mutual agreement is the typical starting date for any timeline related provisions. Mutual agreement is when all parties consent to all terms in a contract. Most purchase and sale agreements don’t get signed on the date they are written, so the date at the start of the agreement isn’t the start date for many provisions of the contract. For example, inspection agreements are most often signed with a required response time from each party that is dependent on the date of mutual agreement. The buyer will most often agree to respond in a specific number of days after mutual agreement. After establishing the mutual agreement date, there are two ways to count the number of days until the inspection or any other time dependent provision must occur. The first is calendar days. Calendar days is what it sounds like, every day on the calendar is counted. The second is business days. Business days represent any days of the week Monday through Friday that are not holidays. Saturdays and Sundays are not included in business days. Both ways of calculating time cannot terminate on a Saturday, Sunday or legal holiday except the possession date. Check the contract to be clear with clients when calendar days apply and when business days apply. The contract should state when each is used. In the purchase agreement we are using as an example, if the number of days is 5 or less, they are counted as business days. If the number of days listed in the contract is 6 or more they are counted as calendar days. Pay close attention to timelines in contacts because
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missing a date can have major consequences for your client. Many times, clauses in the contract will state nonresponse is to be construed as agreement with any proposal or potentially a waiver of the options in the clause. Time is of the essence is a common contractual concept and included in most contracts. If it is expressly included in the contract it means the parties agree to abide by all timelines listed and missing a timeline will constitute a breach. Signing Authority Whenever a person is signing real estate documents on behalf of an entity, the real estate broker must request legal proof of authorization to sign. It is important the person signing a real estate document has the legal authority to sign. Common situations might include:
● Guardians ● Power of Attorney ● Personal Representatives of an estate ● Trustees ● Corporations and LLC’s
The proof of signatory authority should be available from the court of jurisdiction or from a notarized document such as a Power of Attorney. Brokers should copy the files and include them in the real estate transaction file.
Vacant Land Purchase and Sale Agreement
A vacant land purchase and sale agreement is filled out and contains much the same information that is included in a residential purchase and sale agreement with a few notable exceptions:
● Feasibility ● Closing time ● Subdivision requirements ● Charges/Assessments levied before but due after closing
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Feasibility A feasibility in a vacant land purchase is most similar to an inspection in a residential purchase and sale agreement. The purchaser is given the opportunity to evaluate the property in order to determine if given it’s current condition is satisfactory for what they plan for it. As a developer or builder purchasing a vacant piece of property the feasibility period allows for the buyer to investigate and complete things like evaluation of wetlands, survey the property, check zoning laws, view current permits and plans, check with the county or city to verify the use they plan matches the current laws. Even though this list seems extensive, it is by no means exhaustive because individual properties all have unique challenges such as drainage, sewer availability, access to the property for cars and trucks and on an on. Closing Time Closing time is listed here, not because the day of closing is very different from a residential or commercial purchase, but more because the time that it may take for the transaction to close. Because of the many legal hoops that must be jumped through in either the development or building of a vacant piece of property, the timeframe for closing is often much longer. A purchase of a vacant piece of property may take very little time, however it is much more common to see closing times that extend past 90 days and up to over a year in advance of the document being signed. The risk to the seller and buyer in regards to the market changing from the time they sign the agreement to time the property closes is high. Subdivision Requirements Subdivision requirements is a provision added to the vacant land purchase and sale agreement that isn’t present in the residential purchase and sale. What it does is allows the buyer to indicate if the seller must have the property subdivided prior to the closing of the sale. A property is considered subdivided only after final plat approval from the presiding jurisdiction (e.g. county or city). Final plat approval is the last step in the process of dividing a property into more lots than there were previously. In order to get the property legally divided so each lot is it’s own legal piece of property (able to be transferred separately from others) it is often required each lot have sewer, water, electrical, and roads installed. Charges/Assessments Levied Before but Due After Closing During the development process, there can be many charges incurred. They include fees from the electrical company, sewer provider, state department of transportation and others. Fees, charges and assessments are not always due immediately and
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therefore there can be considerable costs borne by the seller or buyer. There isn’t necessarily a standard response to this question and will need to be negotiated between the parties prior to signing the agreement.
Residential Landlord‐Tenant Act
The Residential LandlordTenant Act in Washington is composed of many statues and codes, which deal with the relationship of a landlord and tenant. These laws or provisions, along with the terms of a lease, govern the relationship and agreement between the landlord and the tenant. In most cases the provisions of the act cannot be waived by the tenant or the landlord. These laws also impose certain restrictions and provide remedies if one party fails to carry out a duty. The remedies include eviction, a reduction of rent, selfhelp repairs, the right to sue for money damages, and an award of attorney's fees to the prevailing party. Other local codes and ordinances may also be imposed which further regulate this act. Further information on local ordinances are usually available from the city council. The major provisions of the act are: Rental Agreements While not always required to be in writing, it is a safe habit to always have this contract in writing to avoid misunderstandings, and should contain all of the terms agreed to by the landlord (lessor) and the tenant (lessee). Rental agreements for furnished dwellings should contain a detailed inventory of furniture or other personal property, along with a description and condition of each individual item. Just because something is agreed to in a lease does not necessarily mean it is enforceable by the landlord. Some clauses may be illegal, such as a waiver of rights under the Residential LandlordTenant Act. Rental Precaution Before renting property, a tenant should inspect the dwelling to be sure it is in acceptable condition. Before moving in, a list should be compiled of all existing defects or damages, with both the landlord and tenant signing and keeping a copy of this list.
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Any commitments made by the landlord (such as a promise to perform repairs) should be written directly into the lease. Rent Increase If there is a lease for a specified period of time, rent may not be changed during that period. In the case of a periodic tenancy (such as monthtomonth rental agreement), the rules, including the rent, may be changed upon 30 days' notice. This notice must be in writing. Rent increases cannot be in retaliation for a tenant's assertion of their legal rights. The landlord may charge a late payment fee if the rental agreement provides for the charging of a late fee. Termination of Tenancy If a landlord seriously violates his or her obligations under the rental agreement, a tenant may be able to terminate the tenancy without liability. A landlord must follow very specific procedures to terminate a tenancy. To terminate a periodic tenancy, a landlord must give at least 20 days written notice prior to the end of the month. However, if the tenant violates his or her obligations, for example, by failing to pay the rent, the landlord may terminate the lease through eviction proceedings. When a tenant is being evicted because of a rule excluding children or because of conversion to condominiums, 90 days notice is required. Requirements for Deposits A landlord may require a deposit to ensure that the tenant treats the dwelling properly and complies with the terms of the rental agreement. Deposit requirements cannot be discriminatory, nor may a deposit be increased to retaliate against a tenant who asserts their legal rights. A nonrefundable fee cannot be called a “deposit.” A refundable damage or security deposit must be distinguished from nonrefundable fees for cleaning or pets. Maintenance and Repairs The landlord must provide and maintain the rental property, and must comply with the rules of the rental agreement. The landlord (or his/her representative) must be accessible to the tenant and must:
● Keep the premises up to code. ● Maintain the structural components. ● Provide a reasonable program for control of pests.
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● Provide necessary facilities to supply heat, electricity, and hot and cold water. ● Provide reasonably adequate locks. ● Maintain appliances furnished with the rental unit. ● Comply with any duties imposed by local laws.
Tenant Obligations The tenant must:
● Pay rent. ● Keep the premises clean. ● Not damage or permit damage to the unit. ● Properly dispose of garbage. ● Properly use appliances. ● Restore the property to its initial condition, except for normal wear and tear, at
the end of the rental term. ● Comply with the rental agreement.
If the tenant fails to perform their duties, the landlord may seek to evict the tenant. If a tenant fails to maintain the premises, the landlord may:
● Evict the tenant. ● Make repairs and bill the tenant. ● Sue the tenant for damages or force compliance with the rental agreement.
Insurance Unless the rental agreement provides otherwise, the tenant has no obligation to insure the dwelling. However, tenants should consider purchasing renter's insurance on personal property and liability insurance for claims by third parties (such as guests) for personal injuries occurring on the premises, since the landlord's insurance covers only the property itself. Right of Entry With tenant consent and notice from the landlord, a landlord has a right of entry to inspect the property, perform repairs, supply necessary or agreed services, or show the property to potential tenants or purchasers. Entry is limited to reasonable times, and two days notice of intent to enter is required. A landlord may enter the premises without the tenant's consent if an emergency or abandonment occurs, or if the landlord obtains a court order. A landlord may not abuse his or her right of access to the property to harass a tenant.
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Eviction The action by a landlord to remove a tenant from a rental unit is known as an eviction or an “unlawful detainer.” Some local housing codes define “just cause” for an eviction and outline procedures that must be followed. Legally an eviction can be referred to as a Writ of Restitution. In an eviction based on nonpayment of rent, a tenant may assert any claim for money owed the tenant by the landlord. The tenant's claim (sometimes known as an equitable defense or setoff) must be related to the tenancy, such as the tenant's payment of a gas bill that was the landlord's responsibility under the rental agreement. In eviction actions strict rules and procedures must be observed. Generally, a legal eviction process involves:
● Proper notice. Before evicting a tenant, the landlord must serve the required eviction notices using proper procedures.
● Filing of a lawsuit. If the tenant fails to move out, a lawsuit must be filed to evict the tenant.
● Entitlement to a court hearing. If the tenant disputes the reasons for the eviction, the tenant is entitled to a court hearing.
● Sheriff's involvement. If the tenant loses the court hearing, the sheriff would then be ordered to physically evict a tenant and remove the property in the unit. Only the sheriff, not the landlord, can physically remove a tenant who does not comply with an eviction notice and only after an unlawful detainer lawsuit has been filed.
● Liability for attorney's fees. In an eviction dispute, the successful party is entitled to recoup costs and attorney fees.
Prohibited Eviction Landlords are generally prohibited from locking a tenant out of the premises, from taking a tenant's property for nonpayment of rent (except for abandoned property under certain conditions), or from intentionally terminating a tenant's utility service. Various penalties exist for violating these protections. Retaliatory evictions are also illegal. A landlord may not terminate a tenancy or increase rent or change other terms of the rental agreement to retaliate against a tenant who asserts his or her rights under the LandlordTenant Act or reports violations of housing codes or ordinances.
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Default and Eviction in Residential Leases There are two types of evictions, actual and constructive eviction. Actual eviction occurs when the landlord removes the tenant from the property. Constructive eviction occurs when the landlord causes a major interference with the tenant’s possession of the property. An example would be failure to fix a broken toilet and sink. Default in a residential lease could be caused by a tenant or a landlord. An example of a tenant default would be the failure to pay rent or moving out of the property prior to the lease expiring. An example of a landlord default would be a constructive eviction. In general, any failure to comply with the Residential LandlordTenant Act (if applicable) or the lease agreement by either party could constitute a default. Settlement of Disputes The landlord and tenant may agree to arbitration, asking a neutral party to settle the dispute. The process is usually quick and inexpensive, with the administrative fee shared equally unless otherwise allocated by the arbitrator. Landlordtenant problems can also be resolved through informal mediation. In mediation, a third person intervenes between two disputing parties in an effort to reach an agreement, compromise or reconciliation. Intended to settle a dispute quickly and inexpensively, mediation can be requested by either a landlord or tenant and may be available without charge from the city or county.
Commercial Property and Leases
Industrial Property Managers of industrial properties may have special concerns such as:
● Access to transportation ● Location ● Environmental concerns ● Building features such as ceiling heights, floor load capacities, power and water.
Categories of Office Buildings:
● Garden office buildings which are usually one story structures ● LowRise office buildings which are usually two or three structures ● MidRise office buildings which are usually four to eight story structures ● HighRise office buildings which are usually more than nine story structures
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Classification of Office Buildings
● Class A Newer, more desirable and prestigious buildings with prime locations that command higher rents
● Class B Older yet well maintained buildings that are very desirable yet do not command the rent of a Class A Building
● Class C Older buildings, not in a prime location. ● Class D These are the least desirable buildings with poor maintenance and
poor location
Note: When leasing costs are on the decline due to oversupply or an ailing economy, businesses can often move up a class for the same leasing amount at the end of their lease. For instance move from a Class B building to a Class A building. Conversely, when office leasing space is in short supply, a business may be forced to move down a class at the end of their lease given that they want to keep their lease costs constant.
Retail Property Such as a strip mall, neighborhood shopping center or regional shopping center. The concerns with managing this type of property might include:
● Parking ● Tenant mix ● Tenant income ● Traffic patterns and accessibility ● Tenant retention ● Maintenance for common areas
Agricultural Property An agricultural management company is concerned with assuring the owner that he/she will get the maximum return for the land. Those concerns might consist of:
● Use of water ● Resources ● Soil ● Environmental issues and wetlands ● Erosion ● Flooding
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Types of Leases Graduated Lease A graduated lease is a long term lease which provides for regular adjustments to the payments. It is typically found in commercial leases. The regular adjustments are scheduled at set intervals (e.g. 2 years) and the increases are based on a benchmark of some kind, such as the Consumer Price Index (CPI) or regional property price index. A graduated lease can also have set increases such as a fixed percentage increase of 6% at regular intervals. The part of the graduated lease that covers the increases in rent and the intervals at which it will occur is called an escalation clause. A graduated lease is meant to provide long term use of a property to a tenant while protecting the owner from payments becoming too low over time. Net Lease A net lease charges the tenant additional money above the rent which may include some or all of the common expenses normally paid by the property owner. When the term Triple Net Lease (NNN) is used it usually requires the lessee pay the real estate taxes, building insurance, and net common area expenses. Gross Lease Gross lease is also called a fixed lease, it is really the opposite of the net lease since the building owner is usually paying for the real estate taxes, building insurance and maintenance of the common areas. The gross lease like the net lease can be modified to include or not include items for the property owner and lessee to pay, such as all the previously mentioned expenses and maybe negotiating the payment of utilities.
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Percentage Lease A percentage lease is often used in shopping malls where the lessee pays a base rent and plus a percentage of money earned (revenue) from the shops income. The base rent is sometimes decreased with the upswing in additional income or profits. Ground Lease The ground lease is just that, only the ground is being leased for a specified amount of time typically 10 or many more years. The tenant pays for the improvements, pays taxes, and typically leaves the improvements to the lessor at the end of the lease period. The benefit to the lessee is not needing to purchase the ground but instead investing in the improvements needed to run their business.
Example: The Edmonds School District owns a large piece of property next to the Alderwood Mall. The developer secured a ground lease with the school district for 99 years. The developer saved on the up front costs of a purchase but in this situation also gave the school district a stake in the future should they need the property down the line.
Sublease Subleases are substituting an old tenant for a new tenant. Tenants need to be aware of the original lease language with regards to subleasing. Not all leases can be subleased. The owner may need to approve the new lessee in order to substitute or sublease to a new lessee. Sale of Leased Property Many times commercial property and residential property used as a rental have existing leases in place when a property is transferred to a new owner. The new owner may want to use the property themselves, or often make improvements to the property and raise the rental rates. While a new owner will be anxious to either make use of the property or to change the rental rates, any property that is currently leased is subject to existing contracts. These contracts have to be honored and can’t be violated even though the property is not owned by the party who signed the agreements. Sometimes properties are sold by the occupants, who want to remain in the building as tenants, but they don’t want to be the owner. The situation where a seller sells the property and then leases the property from the new owner is known as a sale and
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leaseback or leaseback. Doing this allows the owner to potentially get a cash infusion due to the proceeds from the sale, and for the new owner to get regular payments from a real estate property with a lease already in place. The business can then use the money from the sale to invest in their business and focus on making money and not on the concerns of property ownership. Lease Purchase Instead of a straight lease or purchase, a lessee can negotiate a lease with the property owner and at a specified time agree to purchase the property. This arrangement is know as a lease purchase. Sometimes the lessee makes an agreement to have the option to purchase at end of the lease or will have the option to purchase by a specified date. This type of agreement is known as a lease option.
Compensation Agreements
Compensation agreements can be in various forms. In this section we’ll explore some compensation agreements that affect real estate licensees. The major agreements for compensation are:
1. Independent Contractor Agreement with Your Brokerage 2. Listing Agreement with Your Client 3. Buyer Agency Agreement 4. Selling Office Commission (SOC) Posted on a Listing
Independent Contractor Agreement With Your Brokerage This agreement is between the licensee and their brokerage which is also known as a Brokerage/Associate Agreement. It specifies the duties and responsibilities of the licensee and the brokerage and the commission split or desk fee involved. Listing Agreement With Your Client The listing agreement specifies the commission that the listing broker and the selling broker will earn from the seller. Buyer Agency Agreement The buyer agency agreement states the amount of commission, if any, that the buyer’s broker will earn from the buyer.
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Selling Office Commission (SOC) Posted on a Listing A listing posted on your local MLS will state the amount that the selling broker will earn as a commission.
Note: While a posted MLS listing is not a valid contract, the Selling Office Commission must be honored and cannot be changed randomly by the listing agent
How Real Estate Commissions are Determined Real estate commissions are negotiated between the seller and their broker. It is perfectly acceptable for an broker to refuse to take a listing if they are not willing to work for a given dollar amount or certain percentage of the list price. What is not acceptable is to conspire with others to fix prices, offer imbalanced commission splits and conspire to boycott another brokerage (especially in reference to the prices) as we learned in the Antitrust section of this chapter. Some brokerages will individually, not collectively suggest that their licensees charge a specific minimum amount of commission for the listings that they take. Let’s look at some examples of how commissions are calculated: Commissions are usually based on the selling price of a property. They are paid to the brokerage and not the broker directly. Let’s look at a scenario to calculate commission. Gilbert’s home was listed for $210,000. The selling price was $200,000. The total commission was 6%. John from ABC Realty was the listing broker and Jane from XYZ Real Estate was the buyer’s broker. The term used for John and Jane’s business relationship is cooperating brokers. The total commission from the sale is $ 12,000. As coop brokers, John and Jane are going to split the commission as specified in the listing (which in this case was 3% to the listing office and 3% to the office that brought the buyer), so it is split 50% / 50%.
$ 6,000 goes to ABC Realty (John’s brokerage) $ 6,000 goes to XYZ Real Estate (Jane’s brokerage)
John and his broker have an independent contractor agreement which states that all of John’s commissions are to be split 70% / 30% with the brokerage which means that John keeps 70% of his commissions and his brokerage keeps 30%. To calculate John’s commission:
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$6,000 x .70 = $ 4,200 commission due to John
To calculate John’s brokerage’s commission:
$6,000 x .30 = $ 1,800 commission due to John’s brokerage To double check the calculation is correct:
Add $ 4,200 + $ 1,800 = $ 6,000
The sum of the two numbers should always equal the total commission Now let’s calculate Jane’s commission. Jane and her broker have an independent contractor agreement which states that all of Jane’s commissions are split 80% / 20% which means that Jane keeps 80% of her commissions and her brokerage keeps 20% To calculate Jane’s commission:
$ 6,000 x .80 = $ 4,800 commission due to Jane To calculate Jane’s brokerage’s commission:
$6,000 x .20 = $ 1,200 To double check the calculations:
$4,800 + $ 1,200 = $ 6,000 (which is the total commission) Compensation Law In any real estate transaction, the broker's compensation may be paid by the seller, the buyer, a third party, or by sharing the compensation between brokers. Any compensation agreement must be in writing. The state put into law the following provisions:
● An agreement to pay or payment of compensation does not establish an agency relationship between the party who paid the compensation and the licensee.
● A seller may agree that a seller's agent may share with another broker the compensation paid by the seller.
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● A buyer may agree that a buyer's agent may share with another broker the compensation paid by the buyer. (e.g. a referral agreement).
● A broker may be compensated by more than one party for real estate brokerage services in a real estate transaction, if those parties consent in writing at or before the time of signing an offer in the transaction (e.g. dual agency).
● A buyer's agent or dual agent may receive compensation based on the purchase price without breaching any duty to the buyer.
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