Here's the basic definition of a contingency: it's a
condition or event that must be fulfilled before a real
estate contract is binding on all parties involved.
There can be many contingencies in contracts. A typical
example involves inspection of the property: "This contract
is contingent upon a satisfactory inspection of the home
being completed by January 16 that reveals no significant
defects. If defects are discovered, the Seller will correct
them or provide compensation to correct them."
As you'll see later, buyers often have contingencies for
mortgage financing, the sale of another property,
appraisals and many other items.
Contingencies exist for a very good reason; they provide
protection against potential or hidden legal or structural
problems for both buyers and sellers.
For buyers, it's good way to make sure everything is place
before making an offer—financing, good property
condition, etc.
Sellers, on the other hand, want to qualify buyers so they
know they're serious about the purchase of the property and
can meet all necessary obligations. Before a contract is
signed, both parties must agree on all contingencies.
Generally speaking, there are three results as a result of
contingency negotiations: The contingencies are met. If
all contingencies are agreed upon, the sale proceeds; it's
no longer subject to cancellation or modification of those
items. The contingency is waived or removed. These two
actions can be done by either the buyer or the seller,
depending on who the beneficiary is. Example: a 1031 tax
deferred exchange contingency by a seller. Originally, she
indicated the property would be identified as a replacement
one, but later decided not to do an exchange. So, the
seller notifies the buyer that she's waiving that
particular contingency. The contingency is rejected or
fails. For example, assume an appraisal reveals there's
serious damage to a property's foundation. Receiving this
information, the buyer decides he's no longer interested in
the property because the repair costs are too high. In
this case, the contingency fails, and the buyer receives
his earnest money back.
Contingencies will vary with the type, size, and location
of the property and the needs of the buyers and sellers.
However, the following contingencies should be included in
every agreement (depending on whether it's a residential or
commercial/industrial property):
Property appraisal.
Require that a licensed independent professional conduct
property appraisal. Naturally, the appraisal should show
that the property is at a value equal to or greater than
the proposed purchase price. If you're the buyer, this
keeps you from overpaying for the property.
Books/records inspection.
This contingency is especially important for multi-unit,
commercial and industrial properties. As a buyer, you need
to know the income and expense statements as well as the
nature of the lease. To make sure the seller is giving you
real and accurate numbers, request their IRS Schedule E
statement. He or she isn't legally obligated to provide
those numbers, but you're putting them on notice for future
legal action if the numbers are misleading or false.
Contracts.
If you're the buyer, be sure you get copies of all current
service agreements and contracts associated with a
commercial/industrial property. Unless they're especially
attractive to you, you may request that the seller cancel
or end all non-essential contracts at the end of escrow.
That way you have the option of bringing in your own
vendors.
Financing.
The terms of the loan should be spelled out in
detail—type of loan, maximum interest rate, etc. If
you plan on assuming existing financing, get copies of the
current loan documents and the most recent loan statement.
Marketable title.
If you're the buyer, get a preliminary title report. It
should have copies of each and every exception. Have your
attorney review these documents carefully.
Physical inspection.
As a buyer of a residential or commercial property, you
should always have a physical inspection of the property
done. In the case of commercial/industrial properties, your
team of property inspectors—roofing, plumbing,
electrical specialists, etc.--should have unlimited access
to the interior and exterior. They should conduct a
complete inspection so you can use this information to
negotiate with the buyer to do one of three things: make
the necessary repairs, adjust the purchase price or
terminate the purchase agreement.
Property survey.
Often required by lenders, an ALTA property survey shows
all the boundaries of a commercial/industrial property as
well as the site plan for existing improvements. In
addition, it should include any easements and restrictions.
Additional contingencies:
Testing for lead, radon, mold and other toxic substances.
Inspections for termites and other wood destroying insects.
Testing of private well water to make sure it meets health
standards.
When dealing with contingencies, it's important to make
sure they're written in clear and specific terms.
Otherwise, misunderstandings, misinterpretations, and a lot
of expensive aggravation can occur. Here are two examples
of badly written contingencies:
"Contingent on a water test"—This doesn't specify
what kind of water test; e.g. should it test for bacteria
levels or heavy metals or pesticides? If you don't specify,
it may not get tested and you could end up with clean-up
costs you don't need. "Contingent on a septic
permit"—This doesn't specify the type of septic
system required—a conventional one or one specified
by local laws. From these two examples, you can see that it
pays to know all regulations—local, state and
federal—concerning real estate.
Key Point: As either a buyer or a seller, it pays to know
federal, state and local regulations concerning properties
so you can handle them in contingencies. A lot of knowledge
can keep repair dollars from flying out of your pocket
after purchasing a property!
Jack Sternberg
----------------------------------------------------
Jack Sternberg is a nationally recognized expert on real
estate investment and the creator of the renowned "Buyers
First Program" who's been in the business for more than 30
years. Sternberg's deals have totaled over $750 million and
he's been to the closing table more than 1,500 times. For
more, visit http://www.askjacksternberg.com
