Having bought and sold houses, commercial real estate, and restaurants, I've made lots of mistakes during the contract negotiation of the transactions. These mistakes can easily be avoided by addressing them properly and up-front in your contract agreements.
Standard MRIS contracts for buying and selling single family houses are typically adequate for handling the vast majority of these kinds of transactions. The 4 tips I'm about to give you apply mostly to commercial real estate deals that require some amount of due diligence and may be more complex to close.
The problem is that none of these tips I'm about to give you are in any standard contracts, and most attorneys don't put them into their contracts either. It's your job to make sure you incorporate them into whatever contracts you execute.
Here they are, the 4 priceless contract negotiation tips that keep you in control of the transaction.
Tip #1: Use Days, Not Dates
Most investors use dates to define important milestones, such as the day due diligence expires or when the closing is scheduled. The problem is, what if something happens that causes you or the other party to miss a particular date?
For example, let's say your lender takes longer than the 45 days you expect to approve the financing. Or you require a permit from the city that is out of date, and the city is taking longer to issue it than you thought and it pushes the closing date.
If you don't accommodate these kinds of unforeseen events, you are suddenly in default of the contract. Unless this is something you desire, not being under contract means you've lost control of the transaction and are now dependent on the other side to get you back into contract.
Instead of using absolute dates, use number of days AFTER a well-defined event occurs.
For example, to define the closing date, say that closing will be 5 days after the removal of all contingencies. Adding "or earlier by mutual consent" normally makes the seller feel better.
Tip #2: Properly Define the Length of Your Due Diligence Period
When buying a property, many investors make the mistake of defining their due diligence period in terms of just the number of days from the signing of the contract.
Let's say the contract gives you 14 days for due diligence. But what if the seller drags their feet without giving you the documentation you requested or gives you incomplete information?
Some sellers truly need that much time to collect all of their documents, but others exploit this weakness in the contract to make you try to short-cut the process.
So what if you don't get everything until the 8th day into due diligence? Can you complete your due diligence in the next 6 days? Probably not. And you shouldn't have to.
Instead of defining due diligence as 14 days after contract ratification, define it as 14 days after receipt of all documentation. Then, if the seller takes a week to deliver everything to you, you still have the full 14 days to complete due diligence.
Tip #3: Build in a Contract Extension
Remember that you want to stay in control of the transaction even if things happen that are out of your control.
Let's say you agreed to a 45 day closing, but your bank needs more time to complete the underwriting process. Now, two things can happen:
- You need the seller to give you an extension (which they may or may not grant you) or
- You're in default of the contract and you lose the deal.
Either option is undesirable.
Instead, build in a 30-day contract extension option that you can exercise at your discretion by paying an additional 0.25% of the purchase price deposit into escrow. Most sellers won't mind this in your contract, but it can save you big time later on.
Then, if your bank needs an extra 14 days to approve the financing, you can exercise this option and stay under contract and still in control.
Tip #4: Require the Buyer to Achieve Multiple Milestones
If you're selling property and you're dealing with a more complex transaction, then build in multiple but shorter milestones that the buyer has to complete to stay under contract.
Here's the situation: You are selling an apartment building to someone who is syndicating the deal, i.e. they don't have the money in the bank yet. You want to sell your building, but you also don't want this buyer to waste your time for the next 30-45 days while he tries to raise the money. You want to be able to terminate the contract before then if the buyer is not making adequate progress.
Instead, get the buyer to agree on shorter milestones that they need to meet to ensure that they are moving forward toward closing.
For example, you might give the buyer the standard 14 days of due diligence, but also require a soft proof of funds by the end of that time as well. A "soft proof of funds" could be a letter intent from each of his investors that documents the investors' intent to invest a certain amount of money for this deal. 14 days should be plenty of time to get something like this from an investor.
And if the buyer can't produce that then this is a strong signal that they won't be able to the money to escrow in time for closing.
The next milestone you can insist on for this kind of buyer he orders the appraisal within 7 days after the due diligence period expires. Why is this important? Because it makes the buyer spend money. And if they're not confident they can raise the money, they won't order the appraisal, which is a strong signal to you that they may not perform.
This tactic requires the buyer to performer milestones in a shorter time frame, and if they don't, it gives you an opportunity to terminate the contract and move on to another buyer.
The goal of your contract is to keep you in control of the transaction at all times, even if something unforeseen happens. This is not impossible to do if you use days and not dates, properly define the due diligence period, give yourself an option to extend the contract, and require your buyer to perform more frequent but shorter milestones to stay under contract.
What are some of your lessons learned from properly (and improperly) constructed contracts?
This article originally appeared on BiggerPockets.com.
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