Real estate has long been the go-to investment for those looking to build long-term wealth for generations. Let us help you navigate this asset class by signing up for our comprehensive real estate investing guide.
Because a home is possibly the biggest purchase that a person will make in their life, there's a lot of anxiety around it -- but also a number of safety measures that the government has set up to keep people honest. The real estate disclosure statement is one of those. In one sense, it's just a piece of paper and the veracity of it depends on the seller's honesty. But it's also legally binding and thus a powerful document in court if major undisclosed issues are discovered post-sale. In any state where disclosure statements are required for residential real estate transactions (that's most of them), disclosure statements are a vital part of putting the buyer at ease.
What is a real estate disclosure statement?
Also called a property disclosure statement, this is a legally binding document that involves the buyers and sellers. The seller lists anything they know about the property that might impact the buyer's use and/or enjoyment of the property later on -- especially anything that might cost them significant amounts of money. This might include flaws or age-related issues to household systems, like water damage, paint hazards, or construction. It should include information on liens and judgments. The real estate agent is typically required to disclose relevant fiduciary information, such as conflicts of interest and any "urgent need" to sell.
It might include notes on neighborly disputes, as well as events that would stigmatize the property or neighboring property. Pest problems also should be listed on a disclosure statement. Even notes on pets that lived on the property could be disclosed, especially if there were incidents with neighbors or Animal Control.
Who is responsible for drafting the disclosure statement?
The seller is responsible for drafting the statement, but they don't have to write it from scratch. There are boilerplate disclosure forms available from many state regulatory agencies that legally require them, as well as multiple online sources. Your Realtor should have copies on hand as well.
At what point in a real estate transaction does the disclosure statement come up?
A seller should provide the disclosure statement to the prospective buyer after the offer is accepted and the earnest money deposit (EMD) is in escrow, but definitely long before closing. It makes sense to provide it around the same time that the inspection takes place since both documents provide information on the home's condition. This means it will happen before the bank's appraiser comes out to look for flaws in the property and reasons to question a home's value.
What are you required to include in a real estate disclosure statement?
The requirements vary by state, but in general, it is mandatory to disclose all-important "material defects" related to the home's structure and systems. This means physical flaws that may negatively impact the livability of the home for future buyers.
Additionally, any past or present legal issues, including property liens, property line disputes, and criminal stigma, should be disclosed.
While each state has its own rules, in general, disclosure statements should include information on all renovations and improvements -- both finished and unfinished, permitted and unpermitted. While unpermitted work is most likely to pose a problem for potential buyers, it's important to disclose. Unpermitted work could lead to issues with code enforcement and could cause major problems for future owners if they don't know about it. Such issues, if expensive or disruptive enough, can provide grounds for a lawsuit.
State-by-state variances: A few examples
Each state has its own legal requirements around disclosure statements. A few, like Arkansas and North Dakota, don't require them at all. Others require specific information in addition to the general standard disclosures; for example, buyers in Virginia must disclose any nearby mining operations, while Washington requires buyers to disclose if they're near a farm.
A few states don't have boilerplate forms and leave it up to the real estate agent. California is the opposite -- it requires a "transfer disclosure" and several other supplemental natural hazard disclosures (dependent on the region), and the seller's agent is absolutely not allowed to help with the forms. If the seller needs assistance, they will need to hire an attorney.
Caveat emptor -- buyer beware!
States that don't require a disclosure statement go by the "Caveat Emptor" rule – also known as "Buyer Beware!" Basically, this places all the responsibility on the buyer to inspect every single thing in the home and on the property, as well as research invisible issues such as disputes with neighbors or hidden unpermitted work.
Interestingly, whatever a state's laws might be, there are always opportunities for things to slip through the cracks -- and the required elements of disclosures don't always align with a state's known problems. For example, in Florida, pest infestation history disclosures are required, but past flooding to the property does not need to be disclosed. (This is particularly ironic because so much of Florida is designated as a flood hazard area and special flood insurance is required.) Florida isn't alone in this either -- according to the National Resources Defense Council, 21 states do not require adequate flood risk disclosure.
What's the difference between a disclosure statement and an inspection?
A home inspection is conducted by a professional inspector hired by the buyer. The information that the inspector finds is given directly to the buyer. Like a disclosure form, the inspection form encompasses an exhaustive list of features to be checked, but unlike a disclosure, it does not cover invisible issues such as municipal assessments, existing liens, deed restrictions, moneys owed to the HOA.
How to check the facts behind a real estate disclosure statement
Between inspections, optional specialized inspections, appraisals, and title searches, there are ample opportunities to cross-check almost everything on a disclosure statement. For example, if there's faulty electrical wiring that causes some receptacles or switches to not work, an inspector will find the flaws first. If the disclosure statement doesn't fully explain the issue and the seller doesn't make necessary repairs, an appraiser will likely find the same flaws a couple of weeks later and investigate them in even more detail.
As another example, if a buyer notices possible concealed unpermitted work and does not receive any information on it in the disclosure, they can go to the city's building department and request to pull past permits. If they don't find anything about the work in those records, they might mention it to their lender who can ask the appraiser to take an extra-close look at that part of the structure.
Most information related to liens, judgments, and other legal actions will come up during the title search and need to be cleaned before the transaction can go through.
What if something is forgotten on a disclosure?
If you're a seller trying to figure out how exhaustive your disclosure statement needs to be, the prevailing wisdom is, "When in doubt, disclose! Full disclosure is better than partial." Since a disclosure statement is a legally binding document, lies -- even by omission -- have the potential to be extremely damaging and expensive if something you left off causes problems further down the line.
If you're a buyer and you're worried, you can always be extra vigilant by getting specialized inspections (septic tank, roof, mold, and plumbing inspections are just a few of the common ones).
You can also ask your real estate attorney to add clauses in the contract, such as requiring sellers to resolve any code violations prior to closing. This one is specifically designed to protect against undisclosed unpermitted work. If it is discovered (even a few years after the sale closes) and causes problems for the new owner, the former owner will be legally liable whether the omission was accidental or intentional.
The disclosure statement is important to buyer and seller alike
While nobody expects real estate transactions to always sail along under best-faith terms, nobody wants the worst-case scenario, either. No one wants a sale to fall apart ... and even more than that, no one wants a lawsuit three years down the road. With that being the case, and especially given the level of due diligence a buyer can undertake through third-party professionals, it behooves the seller to be proactive and forthcoming with their real estate disclosure statement. Some sellers even create them together with a building inspector to be extra thorough. This isn't just being over-cautious; it allows the seller to get ahead of any issues and correct problems before the buyer ever encounters them.
Got $1,000? The 10 Top Investments We’d Make Right Now
Our team of analysts agrees. These 10 real estate plays are the best ways to invest in real estate right now. By signing up to be a member of Real Estate Winners, you’ll get access to our 10 best ideas and new investment ideas every month.
Find out how you can get started with Real Estate Winners by clicking here.